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Exchange Rates -- Who Decides?

In his article, Sound Money, Gold Fever, and Crackpot Ideas, Mike Shedlock ("Mish") takes a quick fly over The Utah Sound Money Act. While critical of the Salt Lake Tribune attack piece on the bill, Mish concludes that the act is "fatally flawed" because the State Treasurer sets exchange rates, not the free market. What he apparently missed is that the Treasurer is to take market conditions into account in setting rates and those rates would only apply to transactions to which the state is a party. All other Utahns are free to set a mutually agreeable rate for their own transactions.

Mish goes on to opine that "as a practical matter, gold owners would not pay dollar debts in gold in the first place." Of course they would. In today's world, everything is denominated in dollars. Certainly, state taxes and fees are assessed in dollars. Hence the need for a predetermined exchange rate. Mish is quite right that under the bill the State Treasurer may only alter the state rate once a day. But the "London Fix" which for decades has facilitated enormous world-wide transactions in gold and silver on a daily basis occurs at a set rate as well, not spot.

Mish also complains about the State Rate being restricted to only 1% variation per day. Notwithstanding his stated concern, 1% actually allows for a significant amount of variability over a relatively short period, but without wild swings. This provision would tend to smooth out the exchange rate, so a Utahn's water bill doesn't jump drastically in a single day. The monetization of precious metal coins normally yeilds this smoothing effect in any event. Bear in mind that under the bill taxpayers always have the option of paying in dollars. So, they can choose whatever medium of exchange makes the most sense for them at a given time. Also, a safety valve exists in the legislature's power to reset the rate in the event of "order of magnitude" changes in the market.

Also note that the established historical trend, over the past four thousand years, is for precious metal coins to retain their purchasing power. So taking the long view, minor variations in exchange rates don't really matter that much. Admittedly, the 1% increment restriction on changes in the State Rate will likely create arbitrage opportunities for those dealing with the State on a frequent basis. But that's a good thing for Utah taxpayers and will tend to create ebbs and flows of specie transactions which will keep the specie exchange commercial infrastructure in functioning and in use.

Mish appears to have enlisted in the "Look to Washington for Solutions" camp. And while I applaud the idea of an eventual return to a gold-backed dollar, the feds have dug themselves into such a deep debt hole, any such return in the near term is highly impractical. What makes the most sense on a national level is to first allow the sanity sound money at the state level brings to snap congressional policy makers back to reality. Then stop printing debt-backed federal reserve notes and replace those with debt-free treasury notes. Next, dial back the factional reserve requirements to bring dollar creation more firmly within governmental control. Only then, once the system is stabilized, would it make sense to consider reinstating a precious metal backing for the dollar.

View original Mish article.
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