See also Paper Money With Intrinsic Value.

The main thing that most people object to about paper money is its stretchability: that is, the fact that it keeps losing value no matter what we do. Gold or silver, they say, would have solid value and could not be inflated.

BUT, object the paper money mavens, surely gold would be impractical as money; it's worth too much, and carrying around amounts of gold small enough to use would be impossible. Even silver is too valuable to make change with. (not really) Besides, paper money is convenient; bills of widely differing values are all the same size, lightweight, foldable; going back to a precious metal coin system would be too much of a hassle. And anyway, people are used to dollars; changing over might freak them out.

Is there any way we can retain the use of dollars (and other Government fiat paper) while obtaining the value retention of precious metals? Maybe.

The virtue of gold is that, over long periods of time, it really hasn't lost any value. A chart published recently (September 1998) in Forbes Magazine showed that, adjusted for inflation, an ounce of gold is still worth about a dollar - just what it was worth in 1800. Clearly, everyone would like money that kept that kind of value. The trouble is that gold and silver, used in traditional coins, are hard to carry around in any significant amounts, and also hard to make change with, sice even the smallest (1/20 oz.) silver coin would be worth 25 cents nowadays.

One company has partially solved this problem. E-Gold is a service of the Gold & Silver Reserve, Inc. of Wilmington, Delaware. This company holds gold on account for its customers and aloows trading electronically, via the internet. By "trading" I don't men precious metal trading, but buying and selling with gold - just as if it were "real" money.

While G&SR's E-Gold is clever, it has its limitations. It can only be used to trade with other E-Gold customers, and only electronically, not on a cash basis. While E-Gold does transfer paper dollar equivalents to bank accounts for customers, there is a fee for this. In fact, there is a fee for everything on E-Gold. They also don't pay interest, as they are not a bank, but a metal warehousing and exchange service. Since they don't make loans, they must derive all profit from service charges to customers, which is one drawback to using the service.

What's needed is a bank that deals in gold - holding it, loaning it, accepting it - while still maintaining easy convertability into paper money.

Consider the nature of E-Gold's service (visit the link if you haven't already). They primarily hold physical gold for people and allow trading electronically. The reason is simply that the paper money mavens are right, using actual physical gold is a big hassle, and it's easier that way. Plus, you can us much, much finer units of gold when just transferring numbers than when actually physically transferring the metal. E-Gold, then, is more an accounting service than a commodity exchange service.

Why can't this be done by banks, then?

Imagine a bank - let's call it the Goldbank - that keeps all of its accounts in terms of gold. Like any other bank that accepts multiple currencies but keeps accounts in only one, it accepts any paper currency and converts that into gold upon receipt
(not literally - that would require alchemy - but on the books).

All accounts are kept in gold. When you deposit paper money, that is converted into gold, and when you withdraw, the debit is in gold as well. Likewise, loans are made in terms of gold, although they would probably be paid in paper. When those loans are paid back, the interest is calculated in gold, and the amount of paper returned must reflect that.

As you can see, it is possible to retain the solid value of gold just by using it for accounting purposes, without actually using
(or even possessing) the physical metal.

Of course, there would be problems. For one thing, gold does not always rise against every currency; lately it's been falling against the dollar. When people get less paper for their "solid value" accounts, they may want to abandon gold. On the other hand, most people who like gold know all about paper money fluctuations and tend to be philosophically committed, so maybe that's less of a danger than one might expect.

Also, consider what would happen if people tried to withdraw their money in gold. The Goldbank would probably eliminate this option as a condition of opening an account, but people could still demand gold anyway. When reminded of the contracts they signed, they might get irate. It might behoove the Goldbank to keep a supply of gold on hand, just in case.

Third, what would happen if a country's currency were rapidly deflated, like Russia's or Malaysia's, and the people suddenly wanted to withdraw it? Would the bank have enough paper notes to satisfy everyone? Probably not, unless it got a shipment of new currency from the Government. But then, the gold accounts could still be used electronically, so if the people were accustomed to credit cards and ATMs, it might not be a problem.

I believe all of these problems can be solved, and when the first Goldbank opens, it may be the beginning of a whole new era in banking.

The real novelty here is not in using gold as an accounting unit, but in using an accounting unit that is more stable than existing paper currwncies, and is used solely for accounting. Just as the actual, physical gold doesn't need to be held by the bank, units of account such as these do not need to even physically exist. This opens up a lot of possibilities.

Existing Fictitious Currencies
Already in Europe, many banks offer accounts in Euros, the new "international" fiat currency of the European Union. Before the Euro was named, it was considered the "ecu" or European Currency Unit, and was an average of all the EU-member nations' currencies - and there were accounts in that, too. Less well-known is the fact that The Bank For International Settlements keeps its accounts in Gold Francs, a currency that hasn't existed since before World War II. The fact that the BIS posses no actual Gold Francs does not prevent it from dealing in this fictitious unit.

New Averaged Currencies
One option for bankers would be to create a "New Ecu" or "Super Ecu" as an average of several of the World's strongest fiat papers: the "E" would perhaps have to stand for "Ecumenical" (i.e. comprehensive, worldwide) rather than "European." This new unit would not be as strong as its strongest component, but it would be stronger than the weakest. Anyone using those currencies might want to hedge their bets by keeping some of their assets in the averaged pseudo-currency.

Stock And Commodity-Averaged Currencies
Already in World commodity markets, people bet on the price of certain goods going up or down. Commodity traders who want to hedge their bets buy a wide range of goods. What would be so hard about creating a currency that is an average of certain goods? Nothing hard about it at all, since the currncy doesn't even have to "really" exist.

Likewise, people buy into mutual funds that invest in a wide range of stocks to protect against disaster - if one or several go down, others won't. Why not, then, create a currency that is averaged from these stocks? Consider what a "Dow" - based on the Dow-Jones Industrial Average - would be worth right now, if there were such a unit!

As long as people have a choice, they will keep their assets in hard currencies, not weak ones. When private pseudo-money is more stable than the "real" thing, they will have no trouble making the change. First the rich will do this, and then as it becomes more fashionable and well-known, the middle class, and finally the poor.

As people get accustomed to keeping their accounts in these fictitious (and very stable) units, they may come to see fiat paper as an annoying inconvenience. Why should they have to convert to dollars, pounds or francs when their assets are in metal, food or stock averages? Indeed, they may come to see their chosen pseudo-currency as "real" and the Government paper they use as a joke.

Eventually, these fictitious currencies could completely replace Government fiat paper. All that would have to be done would be to print paper notes in the fictitious unit for it to become "real." Once people accept them as real, they will prefer the solidity of their new currencies to the capriciousness of the old.