How Credit Suppresses the Gold Price (with Alice and Bob)

Alternative title: How Credit Creates Inflation
Alternative title: How Gresham’s Law Destroys the Gold Standard

Our small closed economy has five main protagonists, Alice the Automobile Saleswoman, Bob the Banker, Charlie the Capitalist, Dave the Debtor, and Steve the Saver. This small economy is on a gold coin standard, i.e. gold coins circulate as cash. In order to see how the real price of gold (measured in Ferrari sports cars) depends on the creation of credit, we consider the following scenarios.

• A cash based economy without any lending and without any banks.
• An economy with banks, but without lending.
• An economy with banks and with fractional reserve lending.
• An economy without banks, but with private-to-private lending.
• An economy without banks, but with commercial Real Bills.

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The Many Values Of Gold

The present article gives an overview of various ideas on how much an ounce of gold might be worth.

We know the price of an ounce of gold. Last week, on 3 February 2012, the price of gold was US$ 1734.00 per ounce (London pm fixing). So much about the price. But what is its value?

Bullion Banking with Alice and Bob

We are not long. We are not short. We just borrow and lend.

This is a sketch of how a bank might lend against a reserve of physical bullion. We look at a number of simplified balance sheets that illustrate the changes in the reserve ratio, and we point out the two main risks: bad loans and a run on the bank. This article contains nothing new. There are just a number of examples to illustrate the common transactions.

In future articles, we will ask what an owner of physical bullion can do in order to earn interest using his or her bullion, and how a bullion bank might try to defend against a run on their physical reserve.