Saturday, August 2, 2014

Is There a Role for Gold as Money?: Moving Emphasis Away from Deposit-Based Free Banking

Much of my research focuses on the shortcomings of the international gold standard. This is so much the case that I may come off to readers as opposing any attempts to use gold as money. There is, I believe, an opportunity for individuals to use gold, or really any asset, as money even in the modern environment. I think this would be beneficial for the financial system.

Money is itself a medium of exchange, a store of value, a unit of account, and a standard of deferred payment. As it stands, the unit of account is defined by one’s local legal tender regime. I doubt that this will change any time soon. As long as central banks don’t go off the rails and destabilize prices by their actions, this is not a problem. This might seem like a tall order, but for all their shortcomings, the world’s major central banks have not destabilized prices over the last few decades. (One might argue that they destabilized prices during the housing debacle, but government-provided incentives for investing in the housing market seem to me the appropriate villain in that story.) It follows that the unit of account is also the standard of deferred payment.

That leaves a medium of exchange and a store of value. While investors can write contracts that utilize gold, I don’t expect that to become the norm. More likely, gold, or any other asset, can be used as a store of value quite easily. In order for this to be useful, the asset must be quickly convertible into a common medium of exchange. It must be easily saleable, or in other words, have high liquidity.

Technological advances have greatly increased the degree of liquidity of many assets. If I so desire, the instant that I receive any money, I can invest as much of it as I wish in a gold ETF or mining company, at least while the market is open. Investment firms often provide debit and credit cards for accounts linked to money market mutual funds (MMMFs) if the holder so wishes. It is not a great jump to propose that one be allowed to link a credit or debit card directly to an investment account that includes investments in gold ETFs, or any stock or bond. As long as the account owner sets up a rule for sales and purchases – buy or sell such-and-such investment upon a deposit or purchase made using the account – and therefore cease to use local currency as a store of value if he so wishes, except to the extent that he chooses to hold cash on hand or deposit.

As David Glasner has pointed out with respect to MMMFs, investments that do not guarantee a fixed nominal value do not leave account holders in danger of a run. Investors face any losses immediately and equitably (See Chapter 9 of Free Banking and Monetary Reform). He refers specifically to MMMFs as an alternative to the traditional banking structure because the high level of liquidity of the MMMFs’ assets, typically a diverse portfolio of public bonds and commercial paper, promotes price stability. Following this line of thought, the expansion of the classes of assets that can be linked to an account, beyond MMMFs, would allow for something not too different than free banking.  Typically, free banking is described under a deposit system, but this is not necessary. My proposition might be even safer.

As it currently stands, I see two hurdles that must be overcome in order for this to occur. 1) Credit cards, debit cards, and checks must be allowed to be directly linked to investment accounts. 2) The capital gains tax must be eliminated. #2 is important because it will greatly increase the robustness of the monetary system by allowing investors to diversify wealth holdings as much as possible. Thus, an account will tend to maintain its real value over time, making inflation only a worry inasmuch as it distorts relative prices of dollar denominated assets. Beyond this, investment firms might need to restructure the way they charge their customers, maybe replacing per use fees with a flat fee or a fee based on a small percentage of one’s account. 

By these changes, gold, silver, titanium, shares of Apple stock, and basically any asset with high enough liquidity, can be used as money. One's choice of assets is simply a function of one's appetite for risk. Legal tender will function as a unit of account and as the final medium of exchange when a transaction occurs. I expect that portfolio demand for money - demand to hold cash balances - will diminish as the need to employ legal tender money as a store of value will be unnecessary.

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