In this article I’m going to serve up two unconventional arguments for why we shouldn’t have a gold backed currency, and furthermore why we need a central bank. I present these ideas with conviction, however, the truth is that I’m on the fence. In fact I would love to hear your opinion! Are these arguments hogwash and merely an excuse for maintaining the status quo, or are they worthy of serious consideration?

1) A gold backed currency threatens national security

Being on a gold standard limits government spending. That’s a good thing, right? In principle yes, putting some limits on the money jockeys in Washington is just what America needs. However, a hard monetary policy may harm the nation if it restricts our ability to respond to national threats. Here’s an example…

Imagine a hypothetical world where instead of spying on its own citizenry and lying to Congress, our intelligence agencies gathered information about credible foreign threats. One fine Thursday morning the CIA discovers that China has had a major breakthrough in their AI program and may be on the cusp of developing an AGI.

An AGI would give China the power to terminate all digital research everywhere else in the world, and the US would be forever locked out of the game. The CIA’s intelligence is reliable and the threat is real. How should the United States respond?

The least-bloody rejoinder, and the one that would reflect the highest ideals of our country, would be to ramp up a domestic development program and out-compete the Chinese. When the Soviets launched Sputnik we didn’t nuke the USSR, we built our own space program and beat the commies to the moon.

Cranking up the innovation dial to eleven is what America does best, but given the magnitude of a threat posed by a Chinese AGI we would likely need to spend trillions in relatively short order. That’s more spending than the private sector can facilitate, which only leaves the government.

Therein lies the problem with a hard currency. If government spending is constrained by the gold standard the Federal Reserve wouldn’t be able to monetize a national research and development program. Limited by a hard currency the United States could lose the most important arms race in history because it’s scared of some inflation. This does not present itself as a good tradeoff.

2) Central banks are a monetary safety net

At the end of this video David Lin points out that the Federal Reserve has made innumerable mistakes in the past couple of decades, and then asks Danielle DiMartino Booth whether we should even have a central bank given the institution’s lousy track record. Here’s how Danielle replied.

If you consider what enemies of the United States have done, let’s say, with our intellectual property, I draw a parallel and say: if our financial system was not safeguarded what on Earth could come to the fate of the fate of America’s financial system if it was to come under attack? Does the Federal Reserve need massive reform, I mean massive reform, absolutely. However, to suggest that we do not need a central bank is in my view naive.

What type of monetary attack might Danielle be envisioning? My first thought is that China could dump its $1 trillion of US Treasuries overnight. Yields would skyrocket, Treasuries would go no bid and the ensuing chaos could be enough to shake the world’s confidence in America’s financial system.

While the United States has some very large banks, I am speculating that collectively even they would be unable to absorb a trillion in Treasuries in twenty-four hours. This is exactly the type of situation the Federal Reserve was created to handle. With its unlimited balance sheet the Fed could buy the Treasuries from China and restore order to the system. This saving function is not theoretical either.

I’ve heard more than a few investors argue that when the Fed did its first round of QE in 2008, that easing was absolutely necessary to save the banking system. By removing toxic assets from bank balance sheets the Federal Reserve restored faith and prevented financial Armageddon.

OK. The Fed as a backstop against monetary meltdown, that seems like a reasonable justification. However, the S&P 500 being down 16% is not the end of the world, and yet magically the Fed’s balance sheet is now north of $8 trillion. How can one justify that monetary transgression?

Walter Bagehot famously posited that a central bank’s function is to lend freely against good collateral at a high rate of interest. We’re so far past that point that it seems quaint to even consider it. And therein lies the problem…

At present it’s not clear if we’re capable of creating an institution that secures the financial system, but does not unduly interfere in a manner which distorts the founding principles of capitalism and free markets.

If our only choice is between no central bank and no security, or a safety net that also manipulates asset prices and enriches the wealthy at the expense of us working schmucks, what are we to choose?

What do you think? As far as I’m concerned the jury is out on this question and I’d love to hear your opinion.