A friend of mine in the LP asked some questions on the board regarding gold and how using gold for money once again would work. I thought he had some really good questions that a lot of people might have, so I will post it all here. Hope it clears something up for somebody out there.

Maybe you money theorists can help me wrap my head around the
concept... I have holes in my knowledge and understanding of the
practical implications of a gold system. I direcr the following
questions to our resident monetary theorists. :)

1) If I had $10k in gold, could I float $10k in paper currency,
assuming it was legal, and lend this currency to Tom, who could use it
to pay Dave?

2) If someone wants to cash in their paper for gold, am I obliged to give
gold in return based on market rates or fixed rates defined by my
currency?

3) if gold drops or rises in price, do I have an obligation to constrict
my money supply or can I expand it?

4) Can a gold system have a reserve rate -- say 50%, so I can float $20k
on a $10k gold reserve? Does that solve price fluctuation issues (but
not protect me from a gold crash)?

1) If you had $10K in gold, which is money, the answer is yes you could issue paper, a money substitute, in exchange for the paper. The agreement would probably be that your paper could be exchanged for gold on demand. Dave may take this paper currency, but this is only if he knew of your reputation for redeeming the paper in gold - the money substitute (paper) for actual money (gold/silver/whatever).

2) Your exchange would be of a paper certificate to a specific quantity of commodity. Today we think of money in numeric terms, one penny is 1c, a nickle is 5c, a $5 bill, etc. Everyone understands that. But historically, money was though of in terms of weight. The coinage act (http://en.wikipedia.org/wiki/Coinage_Act_of_1792) defined a dollar as 21.4g of pure silver. A dollar was a dollar if it had a certain weight of silver within it. For example a one dollar coin did not equal a dollar just because they printed a one on it. It had to contain 24.1g of pure silver.

So, your exchange would be for a certain weight of gold. The value in terms of good and services is irrelevant for the purposes of your contract. In this case (which is confusing because the banking system we have now is so ass-backwards), you would be acting more as a warehouse for gold and silver. Instead of lugging around bags of gold like a bunch of leprechauns, people would go to you (and pay for your services), to store their gold. If you build up a reputation, people might take your paper tickets for payment instead of gold. If they don't know your business, they would probably have to follow the paper holder to your warehouse and have the gold taken out and transferred that way.

3) I'll try to assume what you mean. If gold drops or rises in price in terms of what? Goods and services? I think you can answer your own question. Think of it this way - if people thought you were going to play all kinds of funky tricks with the rates of gold, etc - then they would keep it under their beds or offer it to another competitor that offers a better deal and more security for their property.

If you mean can you print more paper tickets than you have gold in reserve - then you have just found the root of economic boom-bust cycles.

4) Your last question is about fractional-reserve banking. When you print more gold tickets by 50%, you are creating 50% more money substitutes for which there is no backing of actual money. This does not solve price fluctuation but rather causes it. When I want to understand something, I take it to a ridiculous extreme. Let's try that.

Let's say we have an island of 10 people, you are the one gold safe deposit bank. Everyone has an account at the Bank of Brian and everyone on the island trusts you and knows you always pay in full upon demand, so they all use your paper for transactions. Everything is going along wonderfully in the community of gold town. Now one day you decide, "hey I think I should issue more paper because that is what everyone uses for money and that will make everyone happier and better off". Maybe your motives are more greed driven, but we'll assume the best intentions.

Now you issue lets say double the amount of paper in new loans. Now back to extremes - You issue all of the new paper to one person, they spend it around town like crazy. It seems everything is fine, except that stuff is getting consumed much faster all of a sudden. People are eating more pineapples, eating more fish at the restaurant, drinking more rum. The problem is there hasn't been an increase in the quantity of rum. Now the price goes up, which is supply and demand.

More so, you are only fine until someone thinks you might not have all the gold on hand anymore to pay back those paper receipts. Although you never let anyone down before, you might have done it now, so someone cashes out. Someone sees him and he has gold, he tells them yeah I cashed out. Wow maybe I should - he cashes out. The problem is you can't cash out everybody now, because you have printed twice the amount of money substitute (paper) for the amount of money (gold) you actually had. This is a bank run. You go out of business, you probably get excommunicated from the island because you just threw everything out of whack. Everyone ate all the pineapples and fish because they thought they were rich, and now they must go starving until they get back on their feet. A boom and a bust.

Our current banking system does what the Bank of Brian does in this example - except the reserve requirement is under 10%. And it is protected by law that the banks are too big to fail, don't have to pay, and will be bailed out by a "lender of last resort" - the Federal Reserve, who will just simply print more paper tickets to cover the debt that can't be repaid. Causing another cycle of eat the pineapples, eat the fish, then starve. Moral hazard my friends.. Moral hazard.

I hope that helped in some way.