Thursday, March 17, 2011

A Gold Currency for North Carolina?

In a recent N&O article (found here), it is reported that a state legislator, Glen Bradley-R Youngsville, has introduced a bill to create a State currency backed by gold and silver.  The reporter is perplexed by such an odd bill, and he basically ridicules the sponsor.  In the article, he talked to an economist at the State University, the Democratic State Treasurer and a Democratic State Legislator.  (I guess that's "Fair and Balanced.")

While I know that this bill is going nowhere today, it is worth thinking about.  What would happen if a state decided to go on the gold standard without the rest of the nation?  (I know that the bill says gold and silver, but bimetalism is a whole different set of problems, so let's just focus on the gold standard.)

The advantages of a gold standard, at least nationally, is that it forces the government to live within its means and is a brake on hyperinflation.  Additionally, it reduces the ability of the Federal Government to grow the Welfare/Warfare state.  While it might not eliminate the business cycle, it does help reduce the artificial bubble (boom) the preceeds the painful, but necessary, liquidation process.

Why should a State like North Carolina consider it?  The benefit of owning a currency that is not depreciating is obvious to the guy who has the gold coins in his pocket.  In fact, I'd rather be paid in such a currency.  Furthermore, the adoption of a sound currency would mean a big positive jump in investment into the NC economy.  If the people of the state adopt the gold currency, then it would attract businesses the world over who are afraid of doing business in a coming hyperinflation.  (While those in power cannot forsee a collapse of the US dollar, does not mean that such a thing is all that far off.  I doubt the Germans in 1922 forsaw the inflation awaiting them in the next year.)  And finally, since the State already has a balanced budget rule, the impact on the budgetary process would be small. 

The problem of going it alone, when we have legal tender issues, is that of Gresham's Law.  The law says that with legal tender laws, bad money drives out good money.  (It also says, but is less commonly known, that good money drives out bad money in a competitive market.)

So, unfortunately, Gresham's Law will fully apply to North Carolina.  Why?  Suppose that Bradley is correct on the dollar's purchasing power falling through the floor.  Now to pay my taxes I have the choice of choosing between using a state gold coin or a depreciated dollar.  I will always choose to pay in the least valuable currency.  So I will hoard the state gold coins and spend the increasingly devalued fiat dollars. 


The only way that the Gresham's Law will work to the advantage of the state gold coins is if it is allowed to compete with the US paper dollar.  If the paper dollar and state gold coins value are fixed, then the paper money will drive out the gold.  However, if value of the state gold coin was allowed to float against the paper dollar, then it would, indeed, drive out the use of the paper money.  Not entirely, of course, but to the extent that residents of North Carolina can demand payment in gold coins, it would. 

And that is the catch.  The paper dollar says that it is good for all debts public and private.  So that means you have to accept it.  If the buyer can force the seller to accept the paper, then there is no chance of its success.


T. L. Davis said...

What would this do for people who already own gold? Would they now have less value? I would for see not since now the demand for gold would be higher than supply until suppliers can catch up. Would inter-state commerce as well as international commerce be affected and if so in what way? To keep the seller from having to accept the paper vs. the dollar, could the seller not just up the price and offer a discount for gold? Could a tax on gold even out the problem?

Glen Bradley said...

Thank you for posting this - my only real goal here is to recognize Article 1 Section 10 of the US Constitution as effective in North Carolina, and to set about a study commission to figure out how to lessen the effects of a Federal Reserve collapse on North Carolina.

P F Cwik said...

T.L., The key to what would happen to the value of gold is determined by its relative value. If the value of gold is allowed to float and fluctuate relative to dollars (and everything else) then the gold money would be an effective hedge against the devaluation of the dollar

I think that the overall impact from the increased demand from NC on the world price of gold should be fairly small.

Interstate and international trade again depends upon in the gold currency's value is fixed to something (e.g., the dollar) or if it is allowed to float. If it floats, then it'll be like changing currencies in Europe. However, we still have to deal with national legal tender laws.

Your idea on adjusting the price for acceptance of gold might very well work, but I don't see why NC firms can't do that right now. I don't think that there is a legal barrier to such pricing. The economic barrier is Gresham's Law, as I described it above.

Travis L. Davis said...

I am just dropping in, I just got out of an all night class so I am not thinking critically, and I seriously need some sleep. I just want to get this off my plate before I forget and I want to apologize if it is not very well thought out. NC firms have no incentive to accept gold right now. They do have an incentive to use paper on account of its light, easier to track and its commonplace. If say Walmart got incentive to use gold such as a tax break for paying in gold then that would cause people to get the savings past on to them and the incentive to use gold would be in place. I worry about the unseen as you taught me. What would happen to the dollar? If gold was so great why did it disappear in the first place? Demand would shoot through the roof and supply would not be able to keep up. All gold from the rest of America would come pouring into NC like a tsunami. I wonder, would the price of other things go up like bread to reflect the inconvenience of carrying gold coins to the bank? Would the price of silver go up? People figure out ways around laws all the time. This law would be no different.

P F Cwik said...

You ask why did gold disappear? Excellent question. The answer is not that it failed the "market test." It was banned by the US government. In a series of laws in 1933, FDR first revalued the dollar and then made it illegal for US citizens to do business in gold.

The problem that faces the remonetization of gold are the laws that make it illegal to coin our own money, i.e., private mints to create coins for circulation. There is a high profile case in NC on this very point.

If NC went on a "gold standard" it would first have to get around these laws. Then it would have to overcome Gresham's Law. To do so would be allowing the gold NC currency to "float" against the US dollar. Since the gold dollar would appreciate relative to the paper dollar, there will be additional transaction costs. (These costs would get worse as inflation accelerates.)

There would be no need for any special tax break for gold. As long as the market value is allowed to float we would see a moderate inflow of gold, but not anything like a tsunami. But what if a alot of gold came into NC? Why would this be different than a flood of direct foreign investment into the state? Or at least the NC banking industry?

The bottom line is that there might be some difficulties, but overall I don't see NC adopting a competitive currency as something that should be dismissed out of hand.

T. L. Davis said...

Dr. Cwik I need your help. I am doing a outer space economics term paper in one of my classes. I just got the topic approved today. I think there is real gold out there or better and I want to figure out how to make money off of it. I think that entrepreneurship should carry us into the future. Please e-mail me at I am a graduate student with Embry Riddle and no longer have MOC mail. Thank you

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