A new precious metal standard

A lot of economists of the Austrian or "philosophical" (as I like to call them) school yearn to be back on the gold standard. This, it seems, is the gold standard of money supply options. It solves all the problems of inflation, deflation government credit expansion and private credit expansion, so it must be good, right?

Gold

Well, sort of. Most of these people would, I imagine, envision a return to gold coins and private bank notes backed up by 100% reserve requirements. Personally I think that gold is too valuable and will make small transactions tricky. The obvious answer is silver but then you can't go bimetallic with a fixed exchange rate or there will be trouble. The other problem with gold and silver, the most serious problem as I see it, is that they are quite soft and suffer wear, thus lowering their value over time. There are engineering solutions to this, and I believe I have come up with one of them.

Most coins of the last few centuries are pretty similar. Raised images and lettering on both sides, with a raised edge produced through rolling. These days the raised edge is just part of the work hardening of the piece, really, since most coins contain a large amount of copper, but in the past it was there to make coin clipping easily visible. Coin clipping is the practice of cutting pieces off a precious metal coin in order to sell the valuable metal or strike your own coins. Precious metal coins are supposed to be a particular weight and purity, which is certified by the fact that they are struck as coins. Leave most of the coin intact while removing a small piece of it, and you can spend the coin at the same value as before, plus you now have some extra gold to sell.

The fact that a substantial portion of the coin is proud gives us the chance to produce a more durable gold or silver coin. Simply replace the edge and the images with some superalloy like inconel, strike the whole thing together and you have a (mostly) gold coin with that attractive two tone finish that can really handle the ravages of everyday commerce.

Not exactly what I meant but you get the idea

Gold is so much more valuable than inconel that it will represent nearly all of the coin's value, and you may then produce coins with quite a small amount of gold set into them to make smaller denominations. Speaking of which, here comes engineering solution number two.

It is not enough to simply put vanishingly small amounts of gold into a coin. This would cause problems if nickel or any of the other major constituents of inconel were to seriously appreciate in value at some future date. You must therefore use a third, intermediate value metal. Silver fits the bill perfectly. Traditionally, it was necessary to use coins of pure silver or pure gold, to allow transactions to occur in either metal at universal equal value, with a floating exchange rate between the two to avoid the consequences of Gresham's law. I don't think that is necessary. Since by using a nickel alloy we are effectively already on a bimetallic standard with mixed coins, let's introduce the silver gradually down the value scale. Very high denomination coins would be nearly all gold, then as we go to lower denominations there would be an increasing fraction of silver until silver was the only "precious" metal in a particular denomination, and then we could increase the inconel content to get the lower denominations. This pretty much solves the exchange rate problem since we would balance the face value of the coins to be related to the historical average exchange rate (about 40:1, if you were wondering), and the gradual change over of the metals gives the exchange rate actually quite a wide variability without the relative value of denominations close to one another changing significantly. In fact my analysis shows that you can actually modify the exchange rate by a factor of 1.5 and commerce would be virtually unaffected, unless someone tries to get change in 5c pieces of a $1000 coin. Exchange rate problems could occur, in fact, if gold or silver changed significantly in value relative to the other and many people got the idea to exchange high gold for high silver content coins, or vice versa. In this case the face value would be off by enough to make the arbitrage worthwhile. But there is a very simple solution to this as well: float the exchange rate for exchanges of coins with large differences in the magnitude of their face value. It's not really that inconvenient, since such exchanges would be rare and trying to fix the face values for all time would increase the number of such exchanges, so floating that rate makes them unprofitable, unless someone were to have prior knowledge of a relative price spike in either metal which is pretty rare.

Now we come to the sticky subject of bank notes. Under the above monetary system, it would be most efficient to have each bank duly print its own notes or perhaps contract some excellent third party printer, which amounts to the same thing, but, crucially, the bank notes should have the same denomination as the precious metal currency they are standing in for. When someone presents a bank with one of its own notes, say a $5, it should give a $5 coin, or if both parties agree, $5 in other change at whatever floating exchange the two agree on. Banks should in general be willing to accept the notes of other banks, since they can then simply go to the bank in question and demand their specie for use as loans or reserves.

Loans and demand deposits are an interesting one. If all demand notes were to have a specified loan lifetime then the interest the bank earned loaning the money out could pay the storage fee. The note could then be redeemed at any time after the loan expiry but, critically, there would be an incentive to redeem the note as soon as it fell due, since banks could charge a storage fee or keep the money loaned out earning them nice interest for which the bearer could not demand a return. He would then want to redeem the note and perhaps loan the money out again at a better interest rate, save it in his own safe or just spend it. Banks could even redeem demand notes sooner than the due date, for a small fee of course.

All of that would mean that the total money supply might be about double the amount of the actual gold and silver. Now let's consider loans. In this economy, all bank loans would come out of savings in those banks of actual savers who have actually deposited the money there. They could not simply print more demand notes than there was metal, since other banks and people would certainly come to redeem them. They would, however, print loan notes. These would be interest bearing assets given to people who deposit money for a given time at a given interest rate. The loan's value, due date and interest rate would be on the loan note. If the depositor fell on hard times he could liquidate the note by selling it to a bank, or anyone really. The price paid for it would closely relate to all three essential features of a loan: interest, term and principal. These loan notes, then, would not circulate as currency but would be rapidly convertable, making them a kind of money. Their impact on the money supply would not be great, however. The borrower would be given demand notes or specie, what he preferred would make little difference to the bank. Large loans might require a fairly hefty amount of gold so it would be more convenient for someone borrowing money to build a power station, for instance, to get that money as demand notes, but in principle any form of money would be equal.