On June 12, 2015, the Texas legislature signed into law Bill Number 483, bringing to life the Texas Bullion Depository. The state of Texas owns about $660 Million in gold bullion that is currently housed in a vault in HSBC Bank in New York City. This recently passed bill will allow Texas to bring its gold back within the state and store it at the new depository, saving Texas taxpayers millions of dollars worth of storage fees. Additionally, this will allow for private individuals and institutions to create accounts with the Depository, providing the account holders with the ability to buy and hold gold bullion and complete transactions with the precious metal. Beyond just saving taxpayers money, this bill will help start the restoration of the gold standard to the economy.
The gold standard is the idea that currency, such as the dollar or pound, is related to gold through a fixed price. Thus, every unit of currency is worth a certain amount of gold (or other precious metals, depending on the country). For a deeper introduction to the gold standard, follow this link.
In the United States, the gold standard was officially introduced in 1900, and the government introduced the dollar as a representative currency of gold. This put the U.S. onto a level with the other major powers in the world at the time.
33 years later, the gold standard was abandoned in place of a fiat currency, a currency that is not backed by any material value. This is a controversial topic because the Federal Reserve now has a monopoly on the value of the currency. Opponents of a fiat currency, such as Alan Greenspan, lament that the Federal Reserve can inflate or deflate the value of the dollar through the manipulation of the money supply. They also note that the Federal Reserve can increase the amount of credit with unrestrained power. In his essay, Gold and Economic Freedom, Greenspan states;
“Under a gold standard, the amount of credit that an economy can support is determined by the economy’s tangible assets, since every credit instrument is ultimately a claim on some tangible asset. But government bonds are not backed by tangible wealth, only by the government’s promise to pay out of future tax revenues, and cannot easily be absorbed by the financial markets. A large volume of new government bonds can be sold to the public only at progressively higher interest rates. Thus, government deficit spending under a gold standard is severely limited.”
The problem is that this has happened numerous times in recent history. The 2008 recession provides a stellar example. Private debt in the housing market exploded due to lax credit standards implemented by policies such as the Housing and Community Development Act of 1992 and the National Home Ownership Strategy: Partners in the American Dream. This relaxation in credit standards eventually led to an increase in private housing debt to a peak of 127% of household GDP.
Eventually it led to mass defaults on housing loans. Companies such as AIG, which bet billions on the success of these mortgages through credit default swaps, now defaulted on their obligations to sell these credit default swaps. To make matters worse, in order to dig these companies out of their own grave, the government shifted the debt from the private sector to the public sector by giving those Wall Street banks billions of dollars of taxpayers’ money and raised the national debt from 66% of national GDP in 2008 to 103% by the end of 2012. And unfortunately, this trend continues today. PragerU shows the ominous extent of our debt problem in their video, “America’s Debt Crisis Explained”:
This is an excellent example of how, without a gold standard, the increase in credit with no tangible value behind it creates these speculative bubbles that eventually burst. However, that’s not to say that the gold standard is perfect.
Between 1900 and 1931, the USA, under the gold standard, endured extremely volatile inflation and growth. Moneyandbanking.com explains in their article, “Why A Gold Standard is a Very Bad Idea,” that during the period the U.S. had a gold standard, and during the Bretton Woods system (a variation of the gold standard), inflation was extremely volatile with a standard deviation of 5.6%. After the elimination of the gold standard, inflation had a standard deviation of 3.04%, a much less volatile number.
Likewise, the article points out that economic growth in terms of gross national product since the implementation of the gold standard had a similar volatile behavior. While the gold standard was in place, the standard deviation of economic growth was 4.46%, while under the current fiat banking system, up until 2010, it has been at 2.06%.
It is clear that the gold standard creates more short term volatility in the market than a fiat currency does.
While the gold standard generally induces long-term price stability, it often struggles to keep pace with economic growth. Since the quantity of gold is finite and we can only mine so fast, the quantity of gold would struggle to keep up with economic growth. Therefore, the economy would face deflationary pressure and prices in the economy would plummet. This causes a decrease in consumption (demand) and a drop in investment and production (supply), which in turn leads to higher unemployment, debt defaults, decreasing liquidity and credit, and many other issues that eventually lead to a complete financial meltdown.
A great example of the effects of deflation is the Great Depression. During the Great Depression, deflationary pressure on the dollar caused a reduction in investment in U.S. banks. Losing some of their reserves, the commercial banks converted some of their currency into gold in 1931, further reducing the supply of gold, causing the dollar to deflate in value. There was mass panic as people rushed to get their money out of the banks and sell off their assets before prices got too low. This may not have been the cause of the Great Depression, but it was certainly one of the mechanisms that played a large part in the severity and longevity of it and demonstrated how a gold standard can limit the ability of a central bank to make corrective maneuvers.
Interestingly, the countries that abandoned the gold standard first were the fastest to recover. America and France were two of the last to abandon it and two of the last to recover, while Sweden, the first to dump the gold standard, had the quickest recovery.
Regardless of your opinion on the effectiveness of the gold standard, this Texas Depository is certainly an interesting option as an investment. Buying and holding gold could be a great choice in assets for storing value, while completing transactions with gold provides another commodity to trade to compete with the dollar. We live in uncertain times, and this could help protect your wealth against rampant inflation or deflation and provide a safe store of value when the next bubble bursts. At the very least, creating some competition in the currency market will give the people the ability to regulate the actions of the Federal Reserve, which is especially important in the highly unpredictable markets we see today.