I will try to explain how a gold standard in practice is the same as a credit-system since the only practical way of using gold as a medium of exchange is to use paper gold (or digital gold) – that is to say that IOU:s on gold (hence credit) will be used I will also try to show that a fiat currency is the only way to avoid a central bank as an intermediary (this is in total contradiction to gold bugs who claim that a fiat currency equals a central bank).
I have made some animations which I hope will help the reader understanding my arguments.
Very few gold bugs are holding on to the thought that actual transaction between people would take place with physical gold. It would be unpractical to carry gold and very few (if any) suggest that transactions through for instance internet should involve physical gold. In practice the following would happen (I know it’s seems trivial but lets start from scratch):
1) A costumer put his gold into bank 1
2) The costumer will receive a receipt (digital or physical)
3) Lets say that the bank 1 customer wants buy a TV through Internet. He will send his receipt (probably digitally) to the bank (2) where the Internet shop hold their gold deposits and receive the TV as shown below.
4) Bank 2 now got the claim on gold that bank 1 is forced ta hand over to bank 2, as shown below:
This has to be done for EVERY transaction and would naturally lead to enormous transaction costs for customers. Below is a system with only four banks showing all transport routes that are needed for making transactions between these four banks. As you can see the needed transportation possibilities are almost untraceable even if there are only 4 banks involved. Imagine all possible transactions for, lets say, 100 banks! It shows that it’s a practical impossibility to handle gold as a medium of exchange in this manner – shipping gold and receipts to each and every bank located at different locations for every single transaction. Yellow arrows represent streams of gold, black arrows represent streams of receipts.
The only way to avoid the mess shown in the illustration above is to create a central clearing system. The individual banks would then hold their gold in a central clearing house vault and when a bank get a claim from another bank the bank would only need to ship gold from one vault to the other banks vault within the clearing house. The yellow areas are the banks vaults at the clearing house. The blue areas are the banks receipts – costumers claims on gold – aka credit.
To make it even more simple, so that the banks don’t need to drag gold with wheelbarrows for each and every transactions between the vaults, the banks would wait until afternoon and clear their debts to each other, some debt would cancel others so that the actual amount of gold that needed to be transported between the banks vaults would usually be insignificant.
But what is this? It’s a central bank! Gold money need to have a central clearing house in order to work since the banks between each other doesn’t accept another banks debt on gold, the credit (the receipt) as valid payment from another bank, they demand to get the real stuff – the gold – from the other bank.
This is basically the same as the present fiat backed system. Costumers deposits are costumers claims on the banks on central bank money – that is to say: physical cash and digital cash. Costumers can only get their hands on the physical cash (coins and notes) – only certain banks are able to use the digital central bank money, digital cash, that are stored in the central bank (equals the yellow area in the animation above). One bank can’t see another banks debt on central bank money to customers (=credit) as money – just as little as one bank see another banks debt to a costumer (=credit) on gold as gold in a gold backed system. The procedure is actually the same. So a gold system must be constructed as a credit system in order to work (we need to ship gold all over the place otherwise).
If the banks, on the other hand, in a fiat system, were forbidden to create credit, the clearing system above would be unnecessary – people and companies could make their transaction directly with physical cash (totally bypassing the central bank) – or with digital cash if people got direct access to the central bank money by having central bank deposits. People could make a choice – either to use physical cash or digital cash depending on the situation and their preference .
To prove my point that the banks must exchange their debt receipts (credit -the numbers written on a customers account) into central bank money in transactions between banks in the present system – here’s an interesting excerpt from a BIS study. Note that one bank don’t see or accept another banks credit as valid money. A bank need to convert credit money into central bank money and hand over to another bank (just as the bank need to convert into gold under a gold backed system as shown in the animation above) . So banks credit could actually be seen as different “currencies” within the system that other banks don’t recognize as money (but customers are fooled into believing that credit is money) – the only money the banks see as money is the fiat currency, that is to say the central bank money (aka physical or digital cash).
”The most familiar issuers of money are central banks, which provide central bank money in the form of both banknotes and deposit liabilities, and commercial banks, which generally issue private money (commercial bank money) in the form of deposit liabilities.”
”An important feature of this coexistence is that, in a given currency, central and commercial bank monies are convertible into each other at par. Conversion at par removes the very high transaction costs that could arise for users of a currency if there were multiple issuers whose monies were exchanged at different values. Conversion between commercial and central bank monies takes place in a tangible manner when a commercial bank depositor withdraws banknotes from an account.
Conversion between different commercial bank monies takes place through payment systems when a customer of one bank makes a payment to a customer of another bank, using central bank money as the bridge in most cases. ”
A consequence of the fact that different banks cant see each others credit as money – that the banks need a common denominator (either a fiat currency or for instance gold) in order to convert, exchange. Steve Keen is missing this part in his modeling. Steve Keen makes 100% credit money models that exclude fiat money (or gold) as a common denominator– but this is not possible as shown above – the only case when his assumption is valid is when there is only one bank creating credit – only then there’s no need to have a common denominator. Steve Keen totally ignore the fact that banks need to use a clearing system exchanging each others credit – that different banks credits can’t be exchanged directly with each other
Seems like Steve Keen is trying to address these issues in his newest blog post. But he’s still only using one private bank.
I’m from Sweden so excuse me for misspelling and/or grammatical mistakes. If you find passages that you think could be expressed better – please help me correct these passages and make them more readable.