FreeGold: An overview

I have talked about the 3 functions of Money, in the "What is Money?" article. The Unit of Account (UoA), the Medium of Exchange (MoE), and the Store of Value (SoV).

Freegold is basically a situation where gold is the preferred SoV of the world, while Paper currencies serve the function of UoA and MoE. Gold in this situation is free to float against currencies. Gold can only float freely if there is no paper that does the function of physical gold, ie no paper gold.

Till 1930s, all the three functions were fulfilled by Gold, as part of Gold Standard.

Since 1971, all three functions have been fulfilled by Paper currency.

Now we are near the transition to Freegold. Previously transitions had been smooth, as Dollar slowly shifted from being Gold based to being plain unbacked paper. Now the reserve system based on Dollar is going to go away. This is happening because of the underlying problem of unbacked paper. You cannot make enduring castles on paper.

So the system is just stacking more paper over more paper. This will continue till the whole system collapses under its own weight.

This transition is not about only a collapse of the IMFs. But a collapse in the faith of people in Paper backed promises.

Till now people have been "saving" their excess production in paper, in banks. This is not really saving. It is investing, people are investing in the ability of banks to pay an interest on the capital you have invested in the bank. After transition most people will prefer to save in valuable commodities, like precious metals, property, antiques, rare objects, pieces of art, etc. An object that can act as a suitable Store of Value, is something that does not have any other uses. Gold is the only precious metal that has no (or very limited) other uses. And the fungible properties of a metal makes it superior to other forms of SoVs.

Remember stocks are not plain paper, as they are backed by means of production. But Currency, Treasuries, Debt are all backed only by more currencies. This whole system is backed only by paper.

When you read the promise of the Governor of RBI on a 1000Rs note, where he promises to pay 1000Rs, what does that actually mean. Can the governor give you anything other than the same paper currency that you hold? No it is just a paper promise backed by nothing.

During the transition quite a few currencies will fail. It is expected that USD and Pound will fail. There may be a few surprise casualities, including our Rupee. In any case the world will be split into two types of situations, some countries will undergo hyperinflation and will lose their currencies, other will have massive deflation. ie there will be wide spread loss of jobs and living standards will drop significantly.

Due to the crash in currencies many people will lose everything they have saved. Also most countries will lose their social security net. The money that was saved in social security will be lost.

All these damages will force people to realize that saving in paper is not a wise thing. And people will move back to saving in precious metals and land, as Indians have been doing for a long time.

Since the reserve system will fail, the countries will start trading in their individual currencies. The money will be received by the people, and the excess production will be converted to precious metals and land (due to the loss of faith). Gold will rise to prominence as it is the best medium for storing value. It is kept stored by central banks because of this reason. When excess production is moved into gold, gold will need to be imported.

Due to the loss of faith, banks will not be getting excess production. So they will be short on money. They will need to charge a lot more interest, and will need to make sure that they get paid. There will be two effects due to this, first the interest on loans will rise, and the banks will not give loans easily. Basically loans for consumption will cease. People will not be able to get loans easily for buying houses. The prices of houses will drop. The ratio between rent to Price of houses will rise. Currently there is no benefit in owning houses for giving out as rent, but this situation will improve in the future. This also means that property prices will drop, compared to other precious metals. Gold will be the major benefactor of the transition.

Since it will not be easy to get loans for consumption, consumption will require selling precious metals and property. Gold will flow out of a high consumption zone.

Gold flow will define the value of a currency. A country where gold is moving in, will see a rise in the currency value with respect to gold and with respect to other currencies. While their will be a drop of value of currency where this gold moves out from. A higher currency value will make exports more difficult, as it will be more expensive for other countries to import them, while making imports cheaper. The situation will be reverse in the high consumption zone.

This will allow a normalization of trade naturally.

When people will not save their excess production in banks, the govts will not be able to get the benefit they get currently when they devalue the currency. Any excess deficit comes from printing of excess currency. If the excess currency is absorbed by the banks, through the savings of people, then it does not result in inflation. When the excess currency does not get absorbed because it does not go into the banking system, then it causes inflation. People do not like inflation, and the govts are wary of inducing inflation. When deficits directly get related to inflation, the govts will try to avoid creating budget deficits.

If you have followed the above, freegold is a utopia. It depends on producers to save their excess production in gold and not in banks. Of course like all utopia, things don't happen as the ideal situation. But the transition will make people understand that there is benefit in not saving excess production in banks, which will take us closer to the utopia.