How gold reserves will function under Freegold

For those who want to understand how Freegold reserves will function within the Central Banks, I offer the following in the remarks section of FOFOA’s latest post. Essentially it will work in the same way it does now, only that instead of buying and selling currency they will be buying and selling gold. The key is that their primary reserve asset will be an unencumbered asset as opposed to someone else’s debt. Blondie says it well…

Blondie said…
re: gold “backing” currencies in a Freegold system, discussed earlier in this thread.CB gold reserves are for the management of the currency; this is really a CBs only mandate, good stewardship of the currency.

CB gold reserves do not “back” the currency, although the CB in question may use some of their gold (provided they have some) to purchase their currency from the market, lessening the quantity of currency in circulation and thus “strengthening” their currency. In doing this they are injecting the value from the gold into the currency.

A CB may also do the opposite and print currency (increase the quantity) and use this currency to buy gold from the market. In this way the CB weakens their “overvalued” currency, by extracting the value they regard as excess to requirements and storing it in their newly acquired gold.

Any currency for which the market is willing to exchange gold for is “backed” by gold… by the market’s gold, not the CB’s. The gold a currency is exchangeable for is the gold that “backs” that currency. Any currency should find gold backing at some level, unless the market judges it to have no value at all.

Any currency is only ever backed by the goods and services (value) it is exchangeable for, and in a Freegold system gold is the proxy for all of these, the proxy for value, thus when one knows the current exchange rate of any currency for gold the relative values of all else becomes available.

A CB can use its gold to keep these relative values stable, this stability making their currency more reliable and therefore useful, increasing usage demand for the currency from the market. The market is thus requiring an expansion of currency volume, to cater for increased usage, and the CB issuing such a stable and in demand currency accrues gold reserves as a result.

Ultimately, it is the market driving this process, and the responsible CB is merely responding to the market’s prompting. This is a feedback loop. A good one. There are a number of very positive side effects… I would be interested to see how many of these effects other commenters can think of? Are there any negative ones?

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