The Investment Scientist

The Gold Standard

Posted on: July 12, 2019

The June module at Oxford was all about macro-economics. The course was taught by a world-renowned economist, Professor Oren Sussman. There was so much I learned in the class that I can’t wait to share with my clients and readers.

The first topic I’d like to discuss is the Gold Standard. This will help us understand President Trump’s trade policy.

The gold-standard dollar
Below is a 100 dollar bill issued in 1888. Printed on the right side are the words “Gold Certificate.” From top to bottom, it reads “This certifies that there have been deposited in the Treasury of the United States One Hundred Dollars in Gold Coin.” Right below it is the italic “repayable to the bearer on demand.”

Back then, the Treasury didn’t just print paper money out of thin air. A dollar bill was a certificate of deposit of gold that entitled you, the bearer of the paper money, to exchange it for gold on demand.

The trade deficit: the mercantilist view
Now imagine the US was running a persistent huge trade deficit with China in 1888. The Chinese merchants would redeem the paper dollar bills for gold and ship the gold back to China. When the last gold coin was shipped to China, America would lose the entire base for its currency, and there would be no dollar bills left in circulation. The conclusion: if the trade deficit was unrestrained, America would lose all its wealth and eventually its economy would collapse. The trade deficit is an existential threat.

Now I must note that this view was not shared by free marketers at the time like Adam Smith and David Hume. That’s the subject of another article.

How to restrain the trade deficit?
The British Empire had an answer 150 years ago. To restrain and reverse its persistent deficit with China in the early 1800s due to its insatiable demand for Chinese porcelain and silk, Great Britain launched two opium wars and forced China to open its market to a unique British Indian product – opium.

Trump grew up in the gold standard era. His logic and thinking are very much shaped by mainstream thinking popular at that time. But now we no longer have the gold standard. What has changed? In my next article, I will write about the fiat money, that is, pure paper money.

(Feel free to share if you find it insightful.)

-MZ

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Author

Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC.

Twitter: @mzhuang

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