We Have Gold Coins: Why Don’t They Circulate?

The question asked by the title of this article is not rhetorical. It came up in the debate about Arizona Senate Bill 1439, which recognized gold and silver as legal tender. The bill passed in both the Senate and the House but was vetoed by Governor Jan Brewer, who was concerned the state would lose revenues from taxing rare old coins. She recently promoted a major new welfare program, so at least she is consistent.

Dennis Hoffman, an economics professor at Arizona State University, asked the Arizona Republic, “Can you imagine going in to buy clothing or a pizza with a lump of gold? The retailer is going to look at you like you are crazy.”

I must correct Professor Hoffman on something. No one has ever had to be forced to accept gold. Modern laws don’t force us to accept gold; they force us to accept paper. Otherwise, no one would trade the hard-earned product of his labor in exchange for a mere piece of paper, an irredeemable promise. Today, most stores would not accept gold, but that is just reiterating the status quo. It’s not a reason to keep legal obstacles to the use of gold.

This is the short answer to my question. The government has established coercive barriers to gold circulation. Let’s look at some. First is the capital gains tax, as this was the subject of the Arizona bill.

When you sell gold or silver, you must report the gain or loss and pay a tax if there is a gain. You must keep records of your purchases. This is bad enough if you buy and hold for a long period of time. You may have more dollars but each of them is worth proportionally less. Then (in the US) the government takes away 28 percent of that increase in dollars, and most states take also. The end result is a loss measured objectively in gold, even if it appears as a gain measured in shrinking dollars.

Consider the practical concerns of using gold or silver in commerce. If you pay a restaurant bill with a one-ounce silver coin, the IRS considers this a sale of silver at the current market price. You must prove what you paid for that particular bit of metal and pay a tax if the price rose. Unlike in long-term holdings, you might have several small purchase transactions per day (e.g. gasoline, groceries, and coffee.) The reporting alone—not to mention the tax—makes it impractical to use precious metal coins.

Gold and silver coins are for hoarding only.

Hoarding is in the self-interest of every saver who wishes to avoid Cyprus-style losses when an insolvent counterparty defaults. But the trend of hoarding is leading towards a catastrophe: permanent gold backwardation. This is the first step in the process of gold withdrawing its bid on the dollar. Inevitably, gold will become unavailable in exchange for dollars. When that happens then the dollar will collapse.

Gold owners will no longer demand dollars, but the problem is that dollar holders will still want gold. They will buy whatever gold owners do demand, like commodities. Driven purely by their goal to exchange their dollars for gold, they will drive up the price of every good that can be used as an intermediary. Prices will go up faster and faster. At the end, the dollar will have no value.

Another obstacle to gold circulation is legal tender law that forces creditors to accept dollars as payment in full. No one would lend gold to a borrower who had the option to repay in dollars. As an aside, I believe that if this were the only problem, there would be ways to work around the law and write an enforceable contract.

Next, the taxpayer is forced to pay taxes in dollars. While this does not outright prevent the use of gold, it makes it more difficult. If one uses gold as the unit of account, then this dollar expense poses a risk in case the dollar rises during a tax year.

Further, taxpayers must keep their books in dollars. Anyone is free to keep another set of books in gold (for example my fund does), but this costs money and requires some rare and specialized expertise. Most businesses will not go to this length.

Now, let’s consider the concept of savings. After all expenses, one has some money left over. If this surplus is in the form of a gold coin, there are two possible things to do with it: invest it to earn a yield or hoard it. Today, there is no rate of interest on gold, so that forces the gold or silver saver into hoarding.

If people constantly remove metal from circulation then circulation would stop, even if it somehow started in the first place. There must be an interest rate, to lure gold out of hoards and into productive enterprises that spend it into circulation as they pursue profits. Otherwise it will all disappear.

Finally, we have all grown up in a dollar world. If I say, “I bought $10,000 worth of gold” then everyone knows what I mean. Shifting to the gold paradigm, if I said “I bought 7 ounces worth of dollars” then even longtime gold owners would pause. What is 7 ounces worth of dollars? (It’s about $10,000.)

People think of the value of their gold in terms of dollars. It is madness, like thinking of the length of a steel beam in terms of rubber bands. We all know that the dollar changes in value. Mostly, it falls, though there is some occasional volatility like April 12 and 15. And yet we use it to measure our wealth, our profit or loss, and shareholder’s equity.

One pundit who opposes the gold standard dismissed Arizona SB 1439 by demanding how merchants will know the value of gold or silver tendered in payment. How indeed? Of course, he meant the price in dollars, but I wonder how do merchants know the value of the dollar? People will one day be comfortable speaking of value in terms of ounces. Until then, this is a serious obstacle to gold circulation, if self-imposed.

The discussion of why gold does not and cannot circulate today leads to an insight about the price of gold measured in dollars or, as I prefer to think of it, the price of the dollar measured in gold (currently about 21 milligrams). The recent drop in the price of gold is a pointed reminder that the price of gold has little to do with the quantity of dollars.

The gold price derives from the perceived quality of the dollar. While we still use the dollar to measure all economic values, it is hard to accept that the dollar is in terminal decline. The dollar is just an irredeemable promise, and it is based on bad debt that cannot possibly be paid. We measure the price of gold in dollars, and wait for others to bid up the gold price. Sometimes the timing is good and this happens, sometimes not. The chaotic motions of the dollar cause many goldbugs to have moments of doubt and pain.

The price of gold does not necessarily go up in a straight line or a smooth curve. Abrupt dislocations can occur such as the gold price drop on April 12 and 15, or the silver price jump in the early part of 2011.

The above reasons why gold cannot circulate explain why gold is not priced far higher in dollars. Every one of them could suddenly cease to be relevant. Most people are basically law abiding and pay their taxes. But they will feed their families over obeying the tax law, should they be forced to choose.

We should expect many abrupt, if not violent, moves across all financial markets not least of which will be gold.

It will not be the value of an ounce that changes. It will be the value of a dollar.