As I write this, the United States of America today reached its statutory debt ceiling of 14.294 trillion dollars. Treasury has announced that, unless Congress grants the Obama administration an increase in the debt ceiling in the next few weeks, the United States will, from August, begin to default on its debt obligations, in all likelihood precipitating a global financial panic. It’s a sum which rolls off the tongue easily enough, but $14,294,000,000,000.00 gives a little more of an idea of the size of the debt we’re talking about. Many pocket calculators don’t have enough zeros to display this number; it’s that big.
And if there is a global financial panic, triggered by perceptions of financial instability within the United States itself, what then? The U.S. dollar has, for the better part of a century, been the world’s default currency. What if the global financial community loses faith in the U.S. Dollar? What, exactly, is a dollar?
Those of you with a background in economics can probably skip this thread altogether, because a) there’s nothing in it you haven’t already read elsewhere, and b) all my reading on this issue in the last fortnight has convinced me that most instructional texts on the subject are written from a polarized viewpoint that brooks no argument; to my untutored eyes, they verge on indoctrination.
In Medieval Europe, many villagers would entrust their gold to the local goldsmith, as he was typically the only one around who owned a strongbox. The goldsmith would weigh your gold in front of you, and issue a receipt with his signature on it. This receipt was redeemable, at any time, for the stated weight of gold. Gold was a common medium of trade at the time, though it was heavy for its size and was always in danger of theft; before long, therefore, villagers found it more convenient to exchange the goldsmiths’ receipts among themselves in payment of debts, rather than go to the trouble of travelling out to the goldsmith and redeeming the physical gold every time they wanted to buy something. As long as everyone trusted the goldsmith, his receipts were “as good as gold”. The first paper cash had arrived.
Of course, the goldsmith soon worked out that he could simply write out as many receipts for himself as he liked, and use them to either buy “stuff” for himself, or, more lucratively, to loan money out at interest (provided he was Jewish: usury, or the charging of interest on loans, was forbidden, under Vatican Canon Law until 1878, and by Islam—officially, at least—to this day). Goldsmiths thus became exceedingly wealthy, and morphed into Europe’s first commercial bankers; their (flagrantly dishonest) practice of issuing receipts for more gold than they actually held became institutionalized in the swindle known today as fractional-reserve banking.
Such a situation was inherently unsustainable, and without government-backed support at the point of a gun, it all unravelled eventually. The more observant villagers worked out that there were more receipts circulating about town than could possibly be accounted for by the all gold owned by all the villagers put together. Furthermore, the excess of gold receipts didn’t mean there was any more “stuff” in town than before to buy: grain, beer, livestock, and so on. Seeing as everyone had plenty of these receipts, in order to buy something useful—say, a horse—you needed to offer more of them than anyone else around you to secure a purchase. As the number of receipts in circulation increased, so too did the price of everything. Inflation had set in. Still, everyone had so many receipts, and therefore (so they thought) so much gold that, for a long time, they all felt rich, and no-one dared question the existing order.
The end came when those more observant villagers started to suspect wrongdoing, and went straight to the goldsmith with their receipts to claim their gold. The goldsmith was not pleased, but had no choice other than to relinquish their gold, albeit with dark warnings to keep the transaction to themselves. Before long, however, word began to spread that the goldsmith had been cooking the books, could not cover all the receipts in circulation with real gold, and only the few villagers who got in first would have any chance of seeing their gold again. A stampede ensued, replete with waving torches and pitchforks. By which time, of course, the goldsmith had either fled town—or been strung up by the now-ruined villagers. A “run” on the bank had been proximate cause of economic collapse, but the dishonesty and greed of the bankers was the ultimate cause.
That’s what a dollar was, once upon a time: a paper ticket, redeemable for a fixed mass of gold. Gold has been preferred throughout history as a medium of trade, for several reasons: it is scarce, it is durable, and it is fungible (one ounce of gold is as good as any other ounce of gold). It’s also a pain in the neck to carry around with you, which is why paper cash, backed by an absolute weight of gold, was such a good idea. In fact, in the digital age, physical, paper cash is becoming increasingly irrelevant, and dollar wealth can be represented digitally rather than physically. Now, however, a dollar is a paper ticket, backed by…
By what? A promise that the issuing authority will never default on its obligations? Obligations it owes, in terms of those very same dollars which it has forbidden anyone but itself alone to print? Hmmm…
I began my reading for this topic with an essay by Murray N. Rothbard of the Ludwig von Mises Institute, written in 1962 and updated in 1991; I strongly recommend it to all of you. For me, reading it was one of those rare and delightful experiences where you finally get around to reading the professional’s viewpoint on a topic you’ve always been interested in, only to discover it articulates and validates all the amateur notions you yourself have held privately for a long time. The last time this happened for me was about twenty years ago, when I needed to do some complex database design work and started studying the work of C.J. Date. I’ve always privately believed that currency should stand for something tangible, and gold has historically been the medium of choice. Rothbard’s essay not only demolishes, one by one, the traditional arguments put up against a return to the gold standard, but argues compellingly why a gold standard is the only form of money that can deliver long-term economic stability. I’ll be referring to it a number of times below.
Actually, there are two basic forms of gold standard. The first, gold specie, is based on gold and/or silver coins of a value stamped on them by the minting authority, as well as paper currency backed by such specie; both in day-to-day circulation. Such a standard operated in Victorian Britain up until the outbreak of the First World War; a virtual silver standard operated in the United States during most of this period, which equated to a gold standard of sorts, as the commercial silver/gold exchange rate (about 15 to 1) did not vary significantly—at that time (more on this in a moment). Any foreign currency whose exchange rate was pegged to one of the main currencies backed by gold, was itself considered to be gold-standard; although at several times removed, the process of actually redeeming such currencies for specie was beyond the reach of most who held them.
A gold specie standard suffers from the problem that the value stamped, which supposedly corresponds to a designated weight of metal, can become over-valued as the physical coin is worn from usage, or “trimmed” or “shaved” by fraud. Those who own such coins will tend to spend only the worn ones, hoarding the freshly-minted ones, and giving rise to Gresham’s Law: bad currency drives out good currency. The traditional authoritarian position on this is to restrict the minting of coins to government only, effectively reducing the face value of coins to one of government fiat. Rothbard deftly brushes this universally-accepted concept aside:
The first and most crucial act of government intervention in the market’s money was its assumption of the compulsory monopoly of minting—the process of transforming bullion into coin. The pretext for socialization of minting—one which has curiously been accepted by almost every economist—is that private minters would defraud the public on the weight and fineness of the coins. This argument rings peculiarly hollow when we consider the long record of governmental debasement of the coinage and of the monetary standard. But apart from this, we certainly know that private enterprise has been able to supply an almost infinite number of goods requiring high precision standards; yet nobody advocates nationalization of the machine-tool industry or the electronics industry in order to safeguard these standards. And no one wants to abolish all contracts because some people might commit fraud in making them. Surely the proper remedy for any fraud is the general law in defense of property rights.
A second, and opposite problem of specie occurs when the currency value, and not the weight, is stamped, and then the value of the metal contained may, in some circumstances, actually exceed the stamped face value, which then becomes under-valued and leads to the destruction of the coinage. Following the 1849 Californian gold rush and the subsequent rapid expansion of the amount of gold in circulation, the value of silver appreciated to the point where a U.S. silver half-dollar was worth 53 cents melted down. Treasury responded in 1853 by reducing the weight of silver coins by seven percent. This merely solved one problem by creating another.
The second, and more “pure” gold standard, is the bullion, or absolute weight standard of gold. Gold bullion is produced either in the form of bullion coins (such as the American Gold Eagle, the Australian Gold Nugget, or the South African Krugerrand), which are not used in circulation as currency, or as certified-weight ingots or bars. In each case, the value is not a currency value, but its mass on the scales, certified and physically stamped into it. A bullion standard backs its currency with a fixed weight of gold; for example, in 1900 the U.S. Congress under president McKinley passed the Gold Standard Act, which fixed the dollar at a freely exchangeable “twenty-five and eight-tenths grains of gold nine-tenths fine”, equivalent to $20.67 per ounce of 24-carat gold.
What an absolute gold standard, coupled with full-reserve banking does, is to take arbitrary monetary policy out of the hands of government. It also effectively ends the government monopoly on money: provided that a currency is freely exchangeable for gold, it takes draconian laws for a government to compel the monopoly use of its own currency within its jurisdiction. Which (it will not surprise you) is precisely what the U.S. government eventually did; first, by its creation in 1913 of the U.S. Federal Reserve, then stipulating that the U.S. dollar, and no other currency, is legal tender for settlement of all debts within its jurisdiction. The legality of the insertion of gold clauses in private contracts has been tested in American courts as recently as 2008. With the seemingly inevitable financial instability of the United States and loss of faith in the dollar, these clauses are likely to increasingly become part of commercial contracts, particularly long-term ones, in future.
To the extent that a gold standard prevents governments, through the agency of their central banks, creating paper money “out of thin air”, it also ties their hands in dealing with economic slowdowns. This is one of the main arguments used by Keynesians in opposing a return to the gold standard. Keynesians, as far as I can make out from reading the man himself and his champions, are thinly-disguised control freaks who view monetary policy as their plaything, the livelihoods of others as their playground, and the supreme power to dictate to others as their right. Typically of totalitarians, they presuppose their own diktats don’t apply to themselves, of course, and are suffused with personal venality—but all that’s another thread.
I don’t propose to argue in detail against the entire body of Keynesian, big-government economics here (but you’re welcome to do so below, of course); for one thing, I’m not personally equipped to do so, and I’m fairly sure that any attempt I made at it would leave me looking about as silly as the cut-and-paste trolls at the DT who try to argue science over there. Suffice it to say that many authors I have read recently have argued that, far from the existence of the gold standard prolonging the Great Depression, it was the uncertainty of the markets that the U.S. Government would fail to adhere to the gold standard strictly enough that was the root cause.
Another device used over the years by governments was to persuade the public not to use gold in their daily transactions; to do so was scorned as an anachronism unsuited to the modern world. The yokel who didn’t trust banks became a common object of ridicule. In this way, gold was more and more confined to the banks and to use for very large transactions; this made it very much easier to go off the gold standard during the Great Depression, for then the public could be persuaded that the only ones to suffer were a few selfish, antisocial, and subtly unpatriotic gold hoarders. In fact, as early as the Panic of 1819 the idea had spread that someone trying to redeem his bank note in specie, that is, to redeem his own property, was a subversive citizen trying to wreck the banks and the entire economy; and by the 1930s it was thus easy to denounce gold hoarders as virtual traitors.
And so by imposing central banking, by suspending specie payments, and by encouraging a shift among the public from gold to paper or bank deposits in their everyday transactions, the governments organized inflation, and thus an ever larger proportion of money substitutes to gold (an increasing proportion of liabilities redeemable on demand in gold, to gold itself). By the 1930s, in short, the gold standard—a shaky gold base supporting an ever greater pyramid of monetary claims—was ready to collapse at the first severe depression or wave of bank runs.
The reductio ad absurdum of this kind of thinking was reached on April 5th, 1933, when U.S. President Franklin D. Roosevelt signed Executive Order 6102, confiscating all gold holdings of private citizens and effectively outlawing contract gold clauses. The pretext for this was the supposed threat posed by a claimed flight of gold from the United States during the Great Depression. I have come to form the view that the confiscation of gold and the related measures taken at the time (Such as the 1933 Emergency Banking Act, signed into law only a few weeks earlier), were themselves pretexts for long-term plans by big-government advocates to commandeer the private wealth of the nation (its citizens, and their descendents yet to be born) to act at the behest and caprice of these self-selected elites: to speed the economy up, or to slow it down, at their whim—or even, to go to war. For those of you who may feel my conclusion is going too far, follow the links above and read the text of these instruments for yourselves.
As the Second World War progressed, these “elites” were looking beyond, to an era of peace (or at any rate, non-war) and economic growth, which they intended to control themselves. Seemingly oblivious of the irony, their vehicle of choice was the Bank for International Settlements, formed in the wake of the 1929 Young Plan and charged with the administration of German reparation payments from the First World War, and thus directly having a hand in the onset of the Great Depression and World War Two. Less than three weeks after the D-Day landings in Normandy in 1944, the BIS staged the United Nations Monetary and Financial Conference in Bretton Woods, New Hampshire. Great Britain was represented at this conference by Keynes himself, while the United States was represented by one of his disciples, Harry Dexter White (who parenthetically, four years later, in the face of an avalanche of physical, documentary and testimonial evidence, denied under oath before the House Un-American Activities Committee to being a Soviet spy; two days afterwards, he took an overdose of medication and died).
This conference had far-reaching outcomes which directly affect all of us, right up until today. At this conference was established the General Agreement on Tariffs and Trade (GATT), the International Monetary Fund (IMF), and the World Bank. Also established was the so-called Bretton Woods Agreement on international currency exchange. Under it, the U.S. dollar was fixed to gold at $35/oz (the level to which Roosevelt had raised it, from the $20.67 it had been under McKinley); signatory nations’ currencies were then pegged to the dollar, within a narrow (1%) range of flexibility, which could be altered only by application (supplication?) to the IMF. It thus created a virtual absolute gold standard, but with several fatal flaws.
First, the Bretton Woods Agreement did not enforce gold convertibility, nor did it mandate the creation of national reserves, or an ultimate U.S. reserve. What happened in practice is that member nations would hold U.S. dollar reserves in lieu of gold, and wave the Agreement in the face of anyone presumptuous enough to demand gold for their peso, krona or franc, while pushing dollars into their hand. But that simply kicked the problem onwards, and upwards. An open market in gold still remained. By 1961, spot gold had reached $US40 on the commodities markets, and in the uncertainties of the Cold War, was forceast to rise further. While a boon for the “elites” and their friends (cronies of military dictatorships at the time, in particular, did exceedingly well) the situation was self-evidently unsustainable.
Furthermore, the U.S. was during the entire period of the Agreement spending (not to mention giving away) more than it was earning. Between Marshall Plan outlays (probably equivalent to half a trillion dollars in today’s terms), funding wars in Asia and the Cold War in Europe and at home, U.S. gold reserves were seriously depleted. Member states (France in particular) increasingly broke the “gentlemen’s agreement” not to demand gold redemption for dollars. And the open-market price of gold continued to rise. In March 1968, a run on gold on the London Gold Pool forced a 14% devaluation of the pound sterling, and U.S. president Lyndon Johnson pressured the British to close the London market permanently. Once again, government policy which flies in the face of a free market can only be made to work for a time, and then only at the expense of draconian legislation and the stifling of free capitalism. The framers of Bretton Woods, so confident in the beginning they could enforce from above a gold-standard-that-wasn’t, succumbed to the reality: the end was only a matter of time.
Finally, in 1971, the Bretton Woods Agreement collapsed. In that year, the United States under president Richard Nixon did two things simultaneously that set us on the path to the fully-fiat currency system we have today. First, he increased the supply of paper dollars by 10%, sending most of them overseas to pay for the Vietnam War and other Cold War-related commitments; and secondly, on August 15th, in a speech imposing a 90-day wages freeze and 10% tariff on all imports (the Nixon Shock) he “closed the gold window”; that is, he permanently suspended the convertibility of dollars to gold. Not that it was possible to maintain any longer; the open-market spot price of gold had by then surged well beyond the $35 stipulated by Bretton Woods.
World reaction was immediate. Australia, whose dollar was pegged to the pound sterling under Bretton Woods, immediately switched to pegging to a basket of international currencies, the Trade-Weighted Index, finally floating the dollar under the Hawke Labor government (!) in December 1983. One of the best decisions a “socialist” government, anywhere, has ever made. The 1973 OPEC oil embargo and subsequent quadrupling of oil prices (made under the pretext of opposition to American military aid to Israel during the Yom Kippur War, but fooling no-one) was a direct result of this devaluation of the dollar. Less than a year after the Nixon Shock, gold on world commodity markets hit $US70/oz, double the level set by Bretton Woods. In the forty years since, it has doubled again, and again, and again, and again: as I write this sentence, it is sitting just below $US1500 on the American commodities markets.
This brings us to the second major argument put up against a return to gold as an absolute standard of money: the argument that there isn’t enough of it. All the gold ever mined in history, a bit less than 150,000 tonnes by most estimates, would form a cube about sixty-four feet along one side (incidentally, the man standing for comparison at the base of this cube at the top of the page is the current U.S. president; see, he’s useful for something). There is somewhere between ten and twenty times this amount of money floating (literally) around the world today, so the argument runs. And that’s even before you start talking about the amount of money said to exist in the international derivatives market, a sum so staggeringly vast, and growing with every millisecond, that within a few years, the word quadrillion will start entering the daily lexicon of economics and financial writers.
I’d say this argument gets its thinking exactly upside-down; it’s not that there isn’t enough gold, it’s that there are too many dollars. As a result, all the dollars are worth less; worse, in order to keep up with its spiralling debt, the United States government (not just the current administration, but its next few successors at a minimum) will be forced to print more and more dollars, just to service the interest bill on all these debts. With the U.S. now only three months away from technical insolvency, facing an almost-certain loss of confidence in its own currency, matters appear to be coming, at long last, to a head.
The problem isn’t one of existing on an absolute gold standard itself, it’s the transition back to it. As Rothbard notes, it will involve one of two equivalent paths.
Since we have many times the number of dollars as we have gold dollars at the present fixed weight of the dollar, we have essentially two alternative, polar routes toward 100 percent gold: either to force a deflation of the supply of dollars down to the currently valued gold stock, or to “raise the price of gold” (to lower the definition of the dollar’s weight) to make the total stock of gold dollars 100 percent equal to the total supply of dollars in the society. Or we can choose some combination of the two routes.
As I’ve said repeatedly, I’m not an economist. But surely, the fairest way of achieving these outcomes is to announce a transition period, sufficiently long as to allow the price of gold to appreciate gradually, and to ensure savers are not unfairly disadvantaged, by giving them plenty of time to convert to gold, which will naturally appreciate in value many times, but will ultimately be convertible at the end of the transition period, back to dollars equivalent to the same initial value. Changes to contract law, particularly in respect of long-term contracts extending beyond the transition period, would need to be made allowing re-drafting of all contracts to reflect the new standard and allow gold clauses. That ring on my finger could mean a new car (Ow! …just kidding, honey)
Of course, some people would be unfairly advantaged at the outset, by virtue of their holding gold at the time. Shares in gold mining ventures would rise appreciably. Gold for non-monetary uses—electronics, dentistry and so on—would become more expensive. But compared to the inequities of the current system, which exists to enrich bankers and empower self-righteous social engineers in perpetuity, these one-off anomalies are surely the lesser of two evils, by a long way. And if someone eventually does find a way to devalue gold, by, say, extracting it cheaply from seawater, then… we will switch to another commodity with the same characteristics: silver, platinum, whatever.
The potential benefits are enormous. A permanent end to long-term inflation and devaluation of the currency; savers rewarded for their thrift, instead of having their currency’s purchasing power eroded away; power taken from the hands of the monetarists, socialists and crony capitalists and put squarely back into the hands of those in the private sector who actually produce wealth by creating real goods and services. A careful and persistent media campaign, stretching back nearly two centuries, has existed to marginalize and portray those advocating the gold standard as radical, backward or even deranged. The fact that, prior to my own recent reading on the subject, I have never seen a genuine debate on the issue in the mass media, tends to suggest that campaign is alive and well today. I don’t pretend for a moment to have the last word on the subject; but I hope that, on this forum, this first and tentative exploration of the issue will spark interest among those for whom Liberty, in the face of ever-increasing government control of our lives, is worth breaking a few conventions.