Banking 17: What happened to the gold?

I think now might be a good
time to address another question that is probably
circulating in your head– and that is, what happened
to the gold? Remember when we started this
reserve bank, all of these national banks or whatever we
want to call them, they had gold as a reserve. And then at some point, they
said, well, why are we each holding gold? Why don’t we just all
concentrate our gold in one reserve bank? And then that reserve bank can
issue– and it was the only person that could issue– it
could issue bank notes that could be tradeable into gold. And then we said, over time,
people just got used to the notion of using the bank notes
themselves as reserves. And that’s what the reserve
ratios were all based on, based on the bank notes
themselves. And we talked about that if the
Fed or the reserve bank wanted to increase the money
supply, it could essentially just print new notes and it
would have offsetting notes, outstanding liabilities, and
then it could use those to perform open market transactions
and it essentially allows it to grow
the monetary base with the economy or with the needs of
different projects out there so that those projects happen. And in that whole discussion,
you might have noticed that this yellow stuff was
just sitting here. It had nothing to do
with the economy. It was just sitting there and if
you really wanted to force me to say what it was doing,
well, it was giving a little bit of confidence behind what
this thing was, right? It gives you a little
bit of confidence. Because at first, at least,
when we said that it was backed by the gold– there was
maybe a similar amount of gold as there was there. Maybe a little bit later, we
said, this could be exchanged for gold at some rate–
maybe $35 per ounce. I think that’s what it
was when we were last on the gold standard. But if you think about
it, it’s a couple of weird things here. First of all, almost from the
get-go when we did this, the whole purpose of having this
flexible money supply is so you can grow and contract money
with the needs of the economy and we would, for the
most part, have notes outstanding because this was a
fractional reserve system. We would have notes outstanding
more than the actual amount of gold. And this has been the
case even when we were on the gold standard. You had more dollars than you
actually had gold, but you had to keep a little bit of gold
there just in case people wanted to call your bluff. In case X percentage of people
wanted their gold back. So they would come back to
the central bank and say, give us our gold. But the gold fundamentally–
it had no other function. It wasn’t in the economy. It wasn’t helping transactions
happen. It wasn’t doing anything. It was just sitting in Fort Knox
or wherever it happens to be sitting and to some degree,
it’s more of a pain than any kind of real value because you
have to keep up this notion that these things, these
dollar bills, could be translated into gold, it kind
of forced a reserve ratio requirement on the central
bank itself. And that reserve ratio
requirement– if you think about it, it’s kind
of arbitrary. It’s dependent on how
much gold is found in the world, right? In order to increase the money
supply with GDP because people are inventing computers and
railroads and cars and highways are being built and
we’re all becoming more efficient– in order to keep the
money supply up with that extra economic activity, if we
stay on the gold standard and if we want to keep these ratios
between the money and gold, we’d have to grow our
gold with the economy. And that’s kind of arbitrary. Maybe we’d find a big bunch of
gold or maybe we’d find no gold– and that really should
have no bearing on our technological progress and
how hard we’re working. And it makes a lot of sense. You could imagine in a world
where all of a sudden, an asteroid made of gold lands in
the middle of the U.S., does that all of a sudden– because
gold is less valuable, should that make the dollar
less cheap? Or in another world where for
whatever reason we can’t find any more gold, should that all
of a sudden decrease our ability to circulate
money around? And when it becomes– and I
said three videos ago that these dollar bills aren’t just
the liabilities or the obligations of this
central bank. They’re actually obligations
of the U.S. government. So let me ask you a question. Would you rather have something
backed by gold or backed by the U.S. government? And I know many of you, your gut
reaction is to say, gold. Gold is real value. The U.S. government– what
are they good for? They’re a bunch of crooks. They lie, cheat, and steal. They misallocate wealth
all the time. But think about it. Gold really isn’t wealth. It can be used to represent
wealth only because it’s pretty, only because
at some period– and it doesn’t corrode. At some period in the past,
someone says, I’m willing to plow your field if you give me
that cool rock that you found. That’s the only value
gold has. It can’t do work. It can’t be eaten. It doesn’t make us
more motivated. It doesn’t make us happier. It’s not real wealth. Now what about the
U.S. government? Well, it has the right,
the authority, to tax. I know taxes are bad words and
I don’t like them myself, but it essentially– can extract
these rents from the U.S. economy, right? Tax the U.S. economy. And U.S. economy– that’s
real wealth. That’s labor, ideas,
land, resources. Everything that makes us tick. Our labor, our goods and
services, our ability to educate ourselves, and innovate,
and come up with technology, and become
more productive. That’s real wealth. So if you really think about
it– I know I’m getting a little abstract here, but I
really want to hit this point home because a lot of people,
I think, are still under the notion that somehow something is
somehow tradeable for gold, that it is of a sounder
currency, while if it’s an obligation of a government with
a very dynamic economy, but not gold, it’s somehow
backed by less wealth, but I’d argue that this is
actually a more profound amount of wealth. I mean, we’ve had currencies in
ancient history that were backed by gold, but
in a lot of cases, you still had inflation. When the Spanish currency in the
15th century was backed by gold, but all of a sudden they
discover that Central America had a lot of gold and you had
a ton of inflation and that gold really didn’t give any real
wealth to the Spaniards of the time. It just made everything more
expensive for them. It did allow them to buy a
little bit more from other countries, but it really didn’t
create any innovation. It didn’t really make their pie
that bigger, except they did steal some pie pieces from
other parts of the world– but we’ll leave that
aside for now. But this is real wealth– a
currency backed by a whole nation’s ability to generate
wealth, in some ways, is a lot more valuable. But gold was a stepping stone
and it was necessary because in order to get this whole thing
started and in order for people to really have trust in
this currency, just the way people are trained to think,
you had to originally sell them on gold, right? So if you think about it, gold
didn’t play any role. So in 1971, when Richard Nixon
decides to go off of the gold standard, if– and this is a
big if– if you trust the government’s ability to manage
the money supply effectively, that they’re not going to print
so much money that we have hyperinflation or they’re
not going to print so little money that we end up with
a deflationary spiral. If you trust the government’s
ability to do that, it really doesn’t matter that we went
off of the gold standard. And it really just kind of gets
rid of a little nuisance. And if you actually look at the
Federal Reserve’s balance sheet today, there still is
some gold sitting on their balance sheet because it is
really not obvious what they needed to do with it so
they just kept it. Anyway, we’ll we’ll talk a lot
about this– what is wealth and what isn’t wealth
in the future. One example I often tell people
is– let’s say your plane is going down– you’re the
pilot of a plane and it’s it’s going down. It’s burning and you see two
islands in the horizon and you have to ditch your plane on
one of those islands. So one of those islands
it just has a big pile of gold on it. And then another island– you
can see with your telescope from the plane, it has cows on
it, it has– I don’t know– all these random fruit
trees on it with these luscious fruits. You see– I don’t know– it has
a big random pool of– I can’t draw oil because oil
is black on a blackboard. It has a pool of oil. It has another big nice lake
of fresh water that’s away from the oil so it doesn’t
get contaminated. And you can see from your
telescope that it has a bunch of hard working, innovative,
smart people on it who can– I don’t know– do all sorts
of interesting things. They have roads and
they have horses. They have all sorts of stuff. Which island would you ditch
your plane on, assuming that you’ll never be able to get
back to civilization? Well, the obvious answer is
you’d rather ditch your plane on that island because that
island has more wealth. And so when we went off of the
gold standard– I know it seems like this big horrible
thing in the whole scheme of the world– and gold has become
a lot more expensive. It’s no longer $35 an ounce. It’s whatever– $700 or
$800 an ounce now. So you might think, there’s
been all this inflation. It would’ve been great if we
were on the gold standard. But think about what’s
happened since 1971. Other than some of this excess
credit that was given out maybe over the last 10 or 15
years– other than these bubbles, we’ve seen a
tremendous amount of innovation and we haven’t seen
hyperinflation and that’s all in the world of– you can call
it a fiat currency, a currency that’s not backed by any
kind of hard asset. It’s backed by people’s trust
in the ability of the U.S. economy to support debt
to pay off the value of this currency. We’ll talk more about
that in the future. I don’t want to get too circular
in my conversations. But I’ll see you in
the next video. I just wanted to touch on that
point that we are now off the gold standard.

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