A Currency Board Linked to Gold
March 11, 2011
(This item orginally appeared in Forbes.com on March 11, 2011.)
I like to refer to a gold standard as a “currency board linked to gold.” This accomplishes quite a few things. It helps people throw out their old misconceptions and look at things from a new perspective. It describes, in five words, how a gold standard actually operates. It also serves as a sort of litmus test.
The fact of the matter is, all gold standard systems that have not used bullion coins exclusively–in other words, most gold standard systems of the last 300 years–have operated in a way that resembles a modern currency board. Of course it was not exactly the same, but it was functionally similar. A new Toyota Camry isn’t the same as a Ford Model T–there is not one element that is exactly the same–and yet, they operate on identical principles.
A currency board links a paper currency to another paper currency, through an automatic adjustment mechanism. There is no “discretionary monetary policy,” a committee of supposed wise men to make weighty decisions. The currency board’s target is currency value. It is not the “money supply” or CPI or interest rates or some such thing. In other words, the currency board causes a currency to have a stable exchange rate with another currency.
The currency board’s target can be another currency, but it can also be a currency basket. Singapore uses a currency-basket targeting system. Some people today think that the IMF’s “Special Drawing Rights,” another currency basket, should be adopted as a currency target.
In the same fashion, a currency board could target gold. The currency would have a stable exchange rate with gold, by way of an automatic adjustment mechanism. This is of course a gold standard. The meaning of “gold standard” is that gold is used as the “standard,” or, in other words, as the target of a currency board-like mechanism. Maybe we should call it a “gold target system.”
Although the term “currency board” is somewhat contemporary, the Bank of England used this mechanism to manage its gold standard system in the 18th century. In the U.S., it was used by private banks to manage their gold-linked banknotes during the 19th century.
It was supposed to be used by the U.S. to manage the dollar gold standard in the 20th century, but instead the principle of an automatic, non-discretionary system was abandoned in favor of Keynesian interest-rate twiddling. This inherent conflict led to the abandonment of the gold standard system in 1971.
Currency boards are very reliable. Steve Hanke, a professor at Johns Hopkins University and a currency board expert, says that a properly managed currency board has never failed in practice. In late 2008, for example, numerous Eastern European currencies with loose, informal “pegs” to the euro suffered terrible turmoil, as their exchange rates varied wildly. However, there were six currency boards that used the euro as a target. None of them failed.
That’s all there is to it. Once the merits of a gold standard system are understood, and the decision is made to adopt one, then you set up what amounts to a “currency board linked to gold,” although you might not actually call it that. Gold bullion stored in a vault is not actually necessary. Gold bullion is just inert metal. It is the currency board mechanism–increasing and reducing base money on a daily basis–that creates the link to gold.
In the 19th century, people said that gold is like Polaris, the North Star. You can use Polaris as a “standard” or “target” to help guide your ship. However, it is not Polaris itself that guides the ship, but rather the person with the hand on the tiller, making constant adjustments, that steers the ship using Polaris as a guide. It makes no difference whether or not you “own Polaris.”
Some people–Fed Chief Ben Bernanke among them–like to claim that a gold standard is impossible today for one reason or another. People believe this because they don’t know any better. But a currency board is obviously possible, and in successful use by many governments worldwide. All you have to do is change the target. There is no cost or effort involved. It takes no time. It is just that: a decision.
The phrase “currency board linked to gold” drives some hard-money advocates batty. They also advocate a “gold standard,” or what they call a “gold standard,” but are violently opposed to a “currency board linked to gold.” Of course this is silly because they are two terms for the same thing. We thus find out, rather quickly, who understands that these are two terms for the same thing, and who does not.
So I would encourage you to understand what “a currency board linked to gold” means. After you understand what it means, then you can decide if you agree or disagree with it. But not before then.