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Gold backed currencies are not the answer; gold is

Greece remaining in the eurozone monetary system and keeping the euro as its currency appears less likely at the end of every marathon meeting of eurozone prime ministers and Greek representatives.

Many analysts are of the opinion that dumping the euro and going back to the drachma would alleviate some of Greece’s pain. Of course, it would mean that Greece would default on much of its debt, but advocates of the returning to the drachma assert that doing so would put Greeks in charge of solving their problems–not bureaucrats in Brussels and at the IMF.

Frank Hollenbeck, professor of finance and economics at the International University of Geneva, says that giving up the euro, Europe’s dominant currency, will create problems in itself. Further, he notes “excessive government regulations, spending, and taxation” are the problem across all Europe, not the euro.

In his easy to understand essay, Hollenbeck discusses labor and capital costs, which suggests that the free flow of capital and labor–along with reduced regulations and subsidies–would help solve the problem. Astonishingly though, he says that “If anyone should dump the euro it should be Germany.”

Here’s my concern with Hollenbeck’s position: He says that “Germany would be wise to join like-minded countries on monetary policy and create a northern euro backed by gold.”

Sadly, currencies backed by gold eventually end up backed by nothing as governments renege on promises to either redeem their little pieces of paper for physical gold (specie) or to adhere to the limitations as to how much money they can print relative to the amount of gold they hold. I need go no further than the US dollar to illustrate.

Up until April 5, 1933, when President Franklin Roosevelt issued Executive Order 6102, Americans could redeem paper $20 bills for $20 gold coins (Double Eagles), each of which contained .9675 oz of gold. The redemption right ended with EO 6102.

Afterwards, for decades, the amount of money that the Fed could print (or the Treasury could authorize) was determined by the amount of physical gold held by the Treasury. However, during this time, foreign countries and central banks could still redeem paper dollars for gold.

This resulted in the US loosing half its gold reserves from the end of World War II and August 15, 1971, when President Richard Nixon “closed the gold window,” as our default is euphemistically called.

Now, the Fed can print all money it wants. Further, at this time, there is no cap on our national debt.

Such machinations have occurred many times since the advent of paper money, even when “backed by gold.” The problem with a “gold backed currency” is that politicians are involved. To this we must remember what F.A. Hayek warned in The Road to Serfdom: when it comes to governments, the worst get on top. So, why trust the worst to keep the money honest?

Countries should go with gold as their official monies, not contrived currencies–even if supposedly backed by gold. The annual rate of increase in gold being mined is about two percent. As we’ve seen with the dollar, and now the euro and the yen, increases can be unlimited.

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