Tuesday, June 1, 2010

Dollar Good As Gold

Which country in the world might be first to convert from fiat currency to a gold or silver universal currency standard? Is this feasible? What are the implications? This story is presented in three parts: a gold standard proposal, transition from fiat to gold-backed money and consequences.

The Chronicle newspaper, in the Commonwealth of Dominica, published the following brief article by the author, as a letter to the editor, December 12, 2008:
Dollar Good as Gold

Countries all over the world are printing money in the unfolding worldwide economic crisis. This will lead to greatly increased inflation -- price increases on everything -- a process that readers know has already begun.

With more dollars chasing the same goods, prices rise according to the law of supply and demand. This is the same as saying the value of the dollar decreases.

Dominica and other Eastern Caribbean Central Bank (ECCB) countries have fixed exchange rates with the US dollar (USD) and EC dollar (XCD). Thus, with inflation, each USD and each XCD is worth less in its purchasing power.

Economists describe this as "importing inflation" to countries such as Dominica that have a fixed USD-XCD exchange rate.

Dominica is not causing the inflation, since the U.S. is printing fiat dollars "out of thin air".

The solution requires the ECCB to move to the gold standard. For thousands of years up to the present, gold has been used as a reliable store of value, a stable form of money, maintaining its purchasing power. In contrast, all fiat currencies have always failed eventually becoming worthless. Gold as money is not a promise from anybody or any government. Thus, gold retains its value even when people and governments fail to fulfil their promises and obligations.

The ECCB should immediately take steps to move to a gold standard. Subsequent articles, hopefully, guided by reader questions, will explore details on how to do this and the benefits to ECCB countries.

For one thing, if the XCD were backed by gold instead of the USD, which is destined to loose value, then ECCB countries and residents would have a stable, secure currency. If the ECCB is the first to make this transition, huge amounts of money would be converted to XCD and no doubt lead to considerable new investment in the ECCB countries and promote economic prosperity for all.

The next article will explore how the ECCB could move to EC dollars "good as gold" and free its citizens and residents from the coming extreme inflation other countries will experience.

Please direct questions and comments to keenej_at_cwdom.dm. Thank you.
James J Keene PhD
The Eastern Caribbean Currency Union is
a development of the Organization of Eastern Caribbean States, this organization is composed of Antigua and Barbuda, Dominica, Grenada, St. Kitts and Nevis, St. Lucia, and St. Vincent and the Grenadines. It is under the supervision of the Eastern Caribbean Central Bank. The member countries use a common currency, the East Caribbean dollar, which is pegged at EC $2.7169 to US $1. The resources and reserves of the member states have been pooled to improve the economic ability of all.
1. According to March 31, 2009, data, the ECCB has about $744 million EC dollars of currency in circulation. The ECCB is required by law to maintain foreign exchange reserves such as US dollars (USD), pounds, euros, etc, equivalent to 60 percent of the EC currency in circulation.

Since the foreign currency reserves are exchangeable at current market rates, for our conceptual purpose we can assume these reserves are all in USD. The total EC currency in circulation is equivalent to $273,841,510 USD ($744,000,000 / 2.7169). Sixty percent of that is $164,309,906 USD.

2. Now let us buy some gold using one half of the reserves. At current gold prices of about $1,200 per Troy once (oz), we acquire some 68,462 oz. A decent amount of this gold is then distributed to major banks regulated by the ECCB. The procedure is the same as that used for US dollar reserves. One can walk into a bank and "buy" US dollars, and banks keep some on hand for the convenience of their customers. Likewise, one can "sell" US dollars and receive EC dollars in payment. For these transactions, banks post a bid-ask price spread for currency exchanges. Gold is just another currency -- indeed, the primary, universal currency, and bid-ask spreads would also apply for bank-customer exchanges for non-EC dollar gold coins (Canadian Maple Leafs, British Sovereigns, U.S. Eagles, etc).

3. This transition is world-class history in the making, so the ECCB may well choose to commemorate this move by minting its own bars and coins with their own distinctive designs, as seen on its present paper money and coinage.

4. Next the EC currency is fixed to gold, and allowed to float regarding the US dollar and other fiat currencies. At present rates, this works out to be about $326 EC dollars per one tenth oz coins plus the customary premium (due to minting costs).

For example, a one-tenth oz gold coin might be marked as $350 EC dollars for use as legal tender. Alternatively, a new $500 EC dollar gold coin could be created with the appropriate gold melt weight (about 0.15 oz).

5. Last but not least is the political arrangements, to achieve agreement from the governments under the EC dollar, to coordinate the transition with participating banks, and finally, to announce the first fully gold-backed currency in the world of our generation. Ideally, the above steps prior to the public announcement would be done in secrecy, since other countries (or currency blocks) might attempt to beat the ECCB into the history books by shifting to the gold standard first. Alas, such secrecy is probably not possible in this case, with many countries in the EC dollar system.

The result is that anybody can exchange EC dollars for gold, or visa versa, at any time. For example, since our hypothetical $500 EC gold coin above would be legal tender, it could be used to buy things in stores or exchanged among individuals -- $500 in paper EC money for one $500 EC gold coin. $500 coins, in reasonable, good condition, could be deposited at full face value in EC bank accounts and so forth.

It would be logical that those selling gold in other forms, such as gold coins from other countries, for EC dollars would need to meet specifications set by the ECCB.
For example, the ECCB via its agent banks might conservatively accept only gold clearly in its original packaging to protect against tampering and other risks. For circulated non-EC gold coins, an appropriate discount may apply to account for lost metal due to wear. In any case, the customary bid-ask spread for non-EC gold should, on balance, be a profit center and cover some losses (say, due to worn coins).
It is anticipated that the public will test the new system to the point that all are convinced that, in fact, the EC dollar is as good as gold. Once that understanding becomes wide-spread, most people will opt to continue using the paper currency and coinage for convenience.

Notice that we started with only 30 percent of the currency in circulation (one half of the reserves of 60 percent). This might well be much more than sufficient, since the public already needs most of the currency in circulation for daily transactions. EC dollar gold coins could also be used as payment and legal tender. As they become worn, banks with the ECCB would recycle them for new coins, as done with the current currency.

6. The ECCB would open the mint to the general public. This jargon means that anybody in the world can bring their gold in whatever form, for purification and minting into the ECCB's coins, such as the $500 EC coin mentioned above, at no charge. The positive economic implications are almost beyond description.

1. The formal shift to gold-backed money will be sensational news world-wide, incredibly favorable to the EC dollar Caribbean nations. This bonanza of free publicity can be most beneficial to the major tourism industry in the region.

2. Since the ECCB cannot "print" gold, these EC dollar nations will experience an immediate and permanent boost, almost of rocket-launch proportions, in international investor confidence for a variety of reasons. For one thing, all will know that the participating governments must practice fiscal discipline. Politicians will know that they cannot make unreasonable promises to, in effect, buy votes. Investment will pour into these nations, creating a quantum leap forward in employment opportunities and wealth creation (production exceeding consumption) for their populations.

3. Banks will be flush with cash, since international money will flow into the EC dollar nations like never before. In essence, these EC dollar nations will become safe havens for capital almost over-night. If these banks use this new cash on account in prudent lending for business development, it means more jobs, more wealth for the citizens and residents.

4. In terms of market dynamics, this incoming cash signifies strong bids for EC dollars. In short, the now floating EC dollar will increase in relative value. In other words, one might expect, say, to see the EC dollar trading at 0.736 US dollars (2 / 2.7169), double the current, fixed exchange rate. This is like saying that EC dollars in these island nations would buy twice as much goods and services from the US as previously. This is equivalent to saying that the wealth of the average holder of EC dollars effectively doubles.

A further major benefit is that both private debt in, and sovereign debt of, the EC dollar countries, if denominated in foreign fiat currencies (US dollars, euros, pounds, etc), will be much easier to pay down. In this process, those foreign currencies are purchased (with more valuable EC dollars) and used to pay the creditors. In short, if the EC dollar exchange value doubles, it is equivalent to halving existing debt denominated in foreign currencies.

5. All fiat currencies are declining in purchasing power which results in increasing poverty in those nations that choose to reject gold-backing. In contrast, the new gold-backed EC dollar will tend to maintain or even increase purchasing power thereby increasing the wealth of all EC dollar holders.

6. By pegging the EC dollar to gold and not to any weakening fiat currency, the EC dollar nations will cease to "import" inflation. Therefore, greater price stability will result for goods purchased in these nations.

7. Countries with stronger currencies can buy relatively more imports, as mentioned above. In contrast, a stronger currency tends to hurt exports, but only if the nominal price is maintained. This is properly the subject for a whole additional article (or even a whole book). However, these broad truisms need not lead to any sort of disaster, as one might think.

If the EC dollar doubles in value in its exchange rate with currency X, the buyer country with currency X will not pay more if the EC exporter cuts its price by one half, so the X currency buyer continues to pay the same. Although the EC dollar exporter is getting the same amount of EC dollars as before the transition to gold-backing, remember that those EC dollars now buy twice as much when spent by that exporter.

Will the Organization of Eastern Caribbean States win the gold metal in the race for economic prosperity via gold-backing of its currency? The prize is there for the taking.
© 2010 James J Keene

1 comment:

  1. I agree with you but history has proven this move to be a difficult one.