What can the Sound Money Index teach us about US states and precious metals?

In an earlier article, I discussed the differences between currency and money.

Standard economic texts usually highlight three key features of money – a unit of account, a medium of exchange, and a store of value.

According to sound money proponents, currency lacks one of these properties – the store of value.

While there are plenty of arguments for the merits and demerits of traditional sound money, i.e., the gold standard, versus the prevailing dollar standard, the greenback’s reputation as a store of value has taken a hit in this era of high inflation and incredibly unbalanced fiscal policies.

It was not long ago, in fact, as recently as 2021, that Secretary of the Treasury Janet Yellen, insisted that inflation was transitory.

Readers may also recall that Yellen anticipated inflation to reach 3% by the end of 2021, while the CPI ended up hitting 6.8% YoY, surging higher to 9.1% YoY in June 2022.

In December 2021, core PCE reached 4.7% YoY, before peaking at 5.3% YoY in March 2021. 

Core PCE has been much stickier, stubbornly coming in at above 4% YoY.

Economic judgement is no easy task, even for leading policymakers.

No one has a crystal ball, but following the era of ultra-low rates and easy money policies that dominated global economics post the GFC, sky-high inflation was no surprise to many sound money supporters.

Given the quantum of widespread and targeted fiscal support schemes and payroll protection mechanisms, the economic actions of US authorities amid the pandemic inadvertently fuelled four-decade highs in inflation.

In this scenario, currency holders (including US states) had little choice but to watch on as the purchasing power of their holdings eroded.

Although the US economy and financial system have shown remarkable resilience in the face of hawkish policy, the bad news is that many economists do not believe that we are out of the inflation woods yet.

Folks such as Peter Schiff, CEO and chief global strategist of Euro Pacific Capital, foresee significant upward pressure on headline CPI before the end of the year.

Gold and silver as sound money 

On the other end of the spectrum, gold and silver have long been considered truly sound money, having retained their purchasing power over thousands of years.

This is quite unlike modern paper reserve currencies, that as I mentioned in an earlier piece for Invezz, ‘came, conquered and (have) then been displaced’.

Put differently, their store of value properties evaporated, due to the unintended excesses of policymakers or radical changes in the economic context.

Will the same thing ultimately happen to the US dollar?

History would say it inevitably would, while monetary policymakers have not necessarily helped its cause.

Gold and silver sidestep the dangers of drawing their legitimacy from the goodwill enjoyed by a particular state or institution, and have proved their durability by being the lasting choice of the free market.

Thus, these precious metals are the only sound money, or at least the ‘soundest’ money, we know.

States demand sound money

The following is an excerpt from the above-mentioned article,

First, inflation continues to ravage household budgets and threatens access to essentials such as fuel and food.

Secondly, in July this year, the US government is expected to roll out its Central Bank Digital Currency (CBDC).

Given the programmable nature of this instrument, Robert E. Wright, a Senior Research Fellow at the American Institute for Economic Research warns against excessive centralization of control over purchasing decisions of ordinary citizens.

Wright adds that CBDCs may not qualify as money under the Constitution.

Thirdly, with bonds bleeding over the past two years, an increasing number of states have found their pension funds in dire straits.   

As a result, state legislatures saw a flurry of bills in 2023, which looked to reinstate the recognition of gold and silver as money, which was the case until 1971 and 1964, respectively.

Sound Money Index

The above piece also noted,

The first step towards mainstreaming recognition as legal tender is to eliminate sales tax from precious metals… This is crucial because it eliminates needless transaction costs and unnecessary frictions which can hamper freedom of exchange.

The second major obstacle towards higher acceptance of sound money is the income tax that is imposed on capital gains.

Thus, with state tax regimes as the centrepiece, the Sound Money Defense League and Money Metals Exchange collaborated to publish the 2023 Sound Money Index, in an effort to rank states according to the degree of acceptance or rejection of sound money principles.

In short, how willing are individual states to allow investing and transacting in precious metals to safeguard against the potential depreciation of the dollar? 

Index design

To be as objective as possible, the index is made up of 13 key features which together add up to a maximum of 100 points and are listed below:

• State Sales Tax on Gold and Silver (16 points)
• State Sales Tax on Platinum and Palladium (4 points)
• State Sales Tax Rate (2 points)
• State Income Tax (16 points)
• State Income Tax Rate (2 points)
• Gold and Silver’s Status as Money (8 points)
• Gold and Silver Clause Contracts (4 points)
• State Gold and Silver Bullion Depository (8 points)
• State Reserve Funds (8 points)
• State Public Pension Funds (8 points)
• (Invested in or issued) State Gold Bonds (4 points)
• Precious Metals Dealer and Investor Harassment Laws (10 points)
• State Specie Tender Mechanisms (10 points)

The details of the methodology and how points are scored for each category can be found in the main report.

As mentioned above, taxation plays an outsized role in terms of sound money policies, contributing to 40% of the index.

Results

Wyoming leads the pack with an overall score of 56%, closely followed by South Dakota, Alaska, and New Hampshire, which are each at 50%.

At an aggregate level, the study yielded the following results for each state:

Very broadly speaking, low-ranked states were concentrated in the east, while the trend became more pro-sound money reform while moving westward, and into the centre of the country.

There are notable exceptions, of course.

New Hampshire, which ranked fourth, is on the east coast.

The west coast, comprising California and Oregon performed relatively poorly on the index.

Wyoming, South Dakota, Utah, Arizona and Nevada, are five adjoining states in the center of the country, which all appear in the top 10 of the Sound Money Index.

Sales tax 

The report argues that sales tax is an unnecessary impediment to owning precious metals as a store of value.

In some senses, by buying gold or silver, the customer is merely exchanging one form of currency (in its broader sense) for another.

As a result, potential customers are likely to steer clear of precious metals investing in favour of other financial instruments which sidestep sales tax.

In conversation with Keith Weiner, Founder and CEO of Money Metals Exchange; JP Cortez, Policy Director at the Sound Money Defense League, argued that sales taxes on precious metals are illogical because these assets are held for resale.

Unlike biscuits or tennis balls, the buyer is not the final point of consumption and makes these purchases as an investment with the specific aim of resale in the future.

Cortez was emphatic when he said, 

We believe that the taxes are the biggest impediment to gold and silver’s use.

Apart from Florida and New York, all states in the top 36 received a full 16 points for not applying any sales tax to gold or silver either as coins or bullion.

Only 8 states, the highest ranked of which was Florida at number ten, instituted partial exemptions, while 8 other states which were all in the bottom ten had no exemptions.  

In terms of palladium or platinum, 28 states including South Dakota and Alaska completely avoided sales tax on these other metals which have also been historically viewed as a store of value.

Wyoming, which took the top spot, and 11 other states, such as Texas, Utah, and Florida, legislated only partial exemptions in this category.

In total, 43 states, the most recent of which is Mississippi, have either no sales tax or partial exemptions on precious metals.

This is a significant proportion of the country, with New Mexico, Hawaii, Wisconsin, Kentucky, Maine, Vermont, and New Jersey being the only states where sales tax continues to fully apply. 

In some of these states, legislative actions to repeal this practice are currently in process.

The report also assessed the overall sales tax rate applied in a state, i.e. not just on precious metals.

This was either nil or below the national average in 23 states and was treated favourably in the index.

Unsurprisingly, these included Wyoming, South Dakota, Alaska, and New Hampshire, which made up the top 4 states on the Sound Money Index.

The lowest-ranked state to receive a full 2 points in the category was Maine, which was at number 48.

Income tax 

The removal of income tax on gold and silver is another important component of sound money policies.

With so much progress having been made vis-à-vis sales tax on precious metals, it is natural for lawmakers to turn their attention towards income taxes.

The argument made by Cortez is that the reason gold and silver see nominal gains is due to the erosion of purchasing power of federal reserve notes and other currencies.

He asks why taxpayers should be liable for income tax when they are unable to deduct losses incurred while dollars depreciate in value due to inflation.

The Sound Money Index report claims that this is a ‘phantom gain’ as a result of metals responding to inflation, due to their store of value properties.

In other words, the report argues that precious metals are not worth more. It is currencies that are worth less.  

Weiner concurred, and noted,

…you bought gold in 1970. You’re selling it now. You don’t have a gain of…$1975 minus $35…(say,) $1940. You simply avoided the loss in the dollar during that time.

Sound money proponents argue that the income tax is in effect, penalizing investors who saw the potential pitfalls of economic policies and actively worked to safeguard against it.

He added,

…I used some numbers from Texas and then imputed Arizona’s rates…you are looking at a low six-figure amount per year that the state would be missing out on if you repeal the capital gains tax. This is not a big number… (but due to) the sales tax that the dealers can’t do business in your state…look at how much business you’re turning away. I mean that’s potentially hundreds of millions of dollars in revenues.

Throughout the country, only 10 states scored a full 16 points for not applying the income tax to precious metals. 

These states happened to also be the top 10 performing states in the index, once again, underlying the importance of taxation to sound money policies.

The bottom 40 states continue to charge income tax on gold and silver.

Beyond precious metals, the top 10 states, either do not have a state income tax at all, or tax incomes at a rate below the national average.

17 states impose an overall income tax which is above the national average and include Delaware and Montana, which are ranked 14^th and 15^th in the index, respectively.

California, Minnesota, Maine, New Jersey and Vermont, each charge a rate higher than the national average and make up the bottom five states in the index.

Reaffirmed gold and silver as money 

As discussed above, gold and silver were deemed by the free market to be the most resilient forms of money.

In 2023, there was an explosion of active grassroots efforts to re-recognise gold and silver as money in several states, under the Constitution’s Article 1 Section 10.

Yet, so far, only Wyoming, which is ranked first, Utah, which is ranked sixth, and Oklahoma, which is ranked twelfth in the index, have officially reaffirmed gold and silver as money.

Other categories

State gold and silver bullion depository

In an earlier article, I discussed the potential dangers that come with physical gold storage in larger commercial vaults, particularly when connected with an active exchange.

At this time, only Texas has fully-functioning in-state precious metal depositories, scoring full points.

Other than providing security for their bullion holdings, the state expects in-house depositories to create crucial savings while generating fresh jobs.

Idaho scored 4 out of 8 points in this category, as it enacted policies to enable private depositories to function within the state under a degree of government supervision.

Under these frameworks, any bullion that changes hands could also be exchanged for dollars and then transferred to a regular bank.

These solutions would encourage private citizens to save in gold or silver, as well as transact in precious metals with a greater level of confidence.

Ron’s Basement, a channel operated by physical precious metals investor, Ronald Branstetter, estimated that the state of Missouri (which is ranked 19^th on the index) would need to purchase $9 million worth of bullion to meet the criteria laid out in a sound money bill that was under discussion in April 2023.

With other states seeing similar legislative movements, there is a higher likelihood that more depository-related frameworks and associated infrastructure will be rolled out.

In particular, the state of North Carolina is looking to conduct a feasibility study to assess the pros and cons of starting an in-state precious metals (and listed bitcoin) depository.

State Pension Public Funds 

Ohio, which is ranked 22^nd in the index, is the only state to hold physical gold and silver in its state pension fund.

The Ohio Police and Fire Pension Fund holds a sizable 5% of its portfolio in these metals, amounting to approximately $16 billion.

The report notes that with inflation being a major threat and continuing concerns around bank runs, it is the fiduciary duty of portfolio managers to maintain safe haven metals for diversification purposes.

Metals Dealer and Investor Harassment 

The report stresses that bullion dealers themselves are often subject to burdensome regulations which lead to higher out-of-pocket costs and may dissuade investment in gold and silver.

In this regard, administrations operate independently and we see a real mixture of regulations which can differ from state to state.

The high bar of regulatory requirements can include,

…collecting of fingerprints, physical measurements, hair and eye colour, social security numbers, or other forms of identification (such as notable tattoos and facial features) – coupled with requirements to submit sensitive information to law enforcement on a daily routine… (Some states) make it illegal for dealers to sell their inventory for days or weeks (severely harming businesses and tying up their capital) … A few states also prohibit the use of cash when buying or selling precious metals.

These measures are not only huge obstacles for parties wanting to freely engage in commerce but can lead to significantly higher insurance costs, paperwork, privacy concerns, regulatory liabilities, exposure to volatile market prices and squash the already incredibly tight margins of dealers.  

As is clear from the above map, states have taken very different approaches to the issue of easing transaction costs for bullion dealers.

18 states scored 10 out of 10 points including the top-4 of Wyoming, South Dakota, Alaska, and New Hampshire.

Interestingly, this list also includes five of the bottom 10 states – New Mexico, Hawaii, Mississippi, Wisconsin, and Kentucky.

Nebraska and Massachusetts scored 8 out of 10 points each; Missouri, Oregon, Connecticut, Maine, and New Jersey scored 6 points; Texas, Colorado, Virginia, Kansas, Rhode Island, and Vermont each received 4 points; while 18 states only received 2 points, which included Utah, Arizona, Nevada, and Tennessee, states which were ranked from 6^th to 9^th in the index.

Minnesota, which ranked 47^th, was the only state to score 0 out of 10 points.

Zero categories

All states scored 0 points in 4 of the 13 categories.

These include Gold and Silver Contract Clauses (4 possible points), State Reserve Funds (8 possible points), State Gold Bonds (4 possible points), and State Specie Tender Mechanisms (10 points).

The last category tests to see if any states accept or remit taxes in gold and silver.

Next steps

Due to the recent surge in inflation, catastrophic bank runs earlier this year, and the continued hawkishness of the Fed, the average consumer is becoming acutely aware of the importance of physical precious metals in their personal portfolios. 

At the same time, state governments are fearing further losses in the dollar and mounting fiscal burdens, particularly in regard to the oncoming flood of state pension payouts.

Given uncertainties around elevated inflation, any economic planning, personal or public, especially over the long term is now under threat.

For governments and advocacy groups, the Sound Money Index not only charts a potential path for their own legislation but highlights the role of state competition in ensuring financial resilience and supporting bullion businesses and a wider sound money ecosystem.

Thus, we can expect more pressure on legislatures to take up the removal of taxes and shift towards sound money as a companion, if not an alternative to the dollar.

In particular, Texas, Utah, Arizona, Nevada, and Tennessee, which were ranked from 5^th to 9^th in the index, could potentially vie for top-5 spots by easing hurdles on precious metals dealers.

In terms of state competition in the promotion of sound money policies, four zero categories may lend themselves to a first-mover advantage.

As per Cortez, Arkansas recently passed into law a sound money bill which included language relating to enforcing contracts that allow for payment in gold or silver.

In such a case, gold or silver payment if agreed upon would need to be made in the metals themselves, and not in the equivalent currency amounts.

This is a mechanism that specifically guards against the possibility of high inflation in the dollar, particularly in relation to longer-term plans that may last two-to-three decades.

This change has not been included in this year’s report, but as per my current understanding, should make it to the following report.

There are also some bills at the federal level which are attempting to bring in sound money legislation across the country, in a single stroke, which we shall continue to monitor going ahead.

Lastly, the following year’s Sound Money Index will also examine the impact of commercial activity taxes on precious metals dealers and will be incorporated as a fourteenth category.

Annexure

The post What can the Sound Money Index teach us about US states and precious metals? appeared first on Invezz.

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