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2. The Demand for Gold

As in the case of the demand for cash in the form of Central Bank notes, an increase in the public’s

demand for gold will be a factor of decrease in lowering bank reserves, and a fall in the demand for gold will

have the opposite effect. Under the gold standard, with a Central Bank (as in the U.S. from 1913 to 1933),

almost all of the gold will be deposited in the Central Bank by the various banks, with the banks getting

increased reserves in return. An increase in the public’s demand for gold, then, will work very similarly to an

increased demand for Central Bank notes. To obtain the gold, the public goes to the banks [p. 150] and

draws down demand deposits, asking for gold in return. The banks must go to the Central Bank and buy the

gold by drawing down their reserves.

The increase in the public’s demand for gold thus decreases bank reserves by the same amount, and

will, over several months, exert a multiple deflationary effect over the amount of bank money in existence.

Conversely, a decrease in the public’s demand for gold will add the same amount to bank reserves and exert a

multiple inflationary effect, depending on the money multiplier.

Under the present fiat standard, there are no requirements that the Central Bank redeem in gold, or

that gold outflows be checked in order to save the banking system. But to the extent that gold is still used by

the public, the same impact on reserves still holds. Thus, suppose that gold flows in, say, from South Africa,

either from outright purchase or as a result of an export surplus to that country. If the importers from South

Africa deposit their gold in the banks, the result is an increase by the same amount in bank reserves as the

banks deposit the gold at the Central Bank, which increases its gold assets by the same amount. The public’s

demand for gold remains a factor of decrease of bank reserves. (Or, conversely, the public’s increased

deposit of gold at the banks, that is, lowered demand for gold, raises bank reserves by the same amount.)

So far, we have seen how the public, by its demand for gold or nowadays its demand for cash in the

form of Central Bank notes, will help determine bank reserves by an equivalent factor of decrease. We must

now turn to the major instruments by which the Central Bank itself helps determine the reserves of the banking system.