The Case For Monetary Freedom And Free Banking

There has been no greater threat to life, liberty, and property throughout the ages than government. Even the most violent and brutal private individuals have been able to inflict only a mere fraction of the harm and destruction that have been caused by the use of power by political authorities.

The pursuit of legal plunder, to use Frédéric Bastiat’s well-chosen phrase, has been behind all the major economic and political disasters that have befallen mankind throughout history.

Government Spending Equals Plundering People

We often forget the fundamental
truth that governments have nothing 
to spend or redistribute that they do not first take from society’s producers. The fiscal history of mankind is nothing but a long, uninterrupted account
of the methods governments have devised for seizing the income and wealth of their citizens and subjects.

Parallel to that same sad history must be an account of all the attempts by the victims of government’s legal plunder to devise counter-methods to prevent or at least limit the looting of their income and wealth by those in political power.

Every student who takes an economics course learns that governments have basically three methods for obtaining control over a portion of the people’s wealth: taxation, borrowing, and inflation––the printing of money.

It was John Maynard Keynes who pointed out in his 1919 book, The Economic Consequences of the Peace:

“By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method they not only confiscate, but they also confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some . . .

“There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.”

Limiting Government with the Gold Standard

To prevent the use of inflation by governments to attain their fiscal ends, various attempts have been made over the last 200 years to limit the power of the State to print money to cover its expenditures. In the nineteenth and early twentieth centuries the method used was the gold standard. The idea was to place the creation of money outside the control of government.

As a commodity, the amount of gold available for both monetary and non-monetary uses is determined and limited by the same market forces that determine the supply of any other freely traded good or service: the demand and price for gold for various uses relative to the cost and profitability of mining and minting it into coins or bullion, or into some other commercial form.

Any paper money in circulation under the gold standard was meant to be money substitutes––that is, notes or claims to quantities of gold that had been deposited in banks and that were used as a convenient alternative to the constant withdrawing and depositing of gold coins or bullion to facilitate everyday market exchanges.

Under the gold standard, the supply of money substitutes in circulation was meant to increase and decrease to reflect any changes in the quantity of gold in a nation’s banking system. The gold standard that existed in the late nineteenth and early twentieth centuries never worked as precisely or as rigidly as it is portrayed in some economics textbooks. But, nonetheless, the power of government to resort to the money printing press to cover its expenditures was significantly limited.

Governments, therefore, had to use one of the two other methods for acquiring their citizens’ and subjects’ income and wealth. Governments had to either tax the population or borrow money from financial institutions.

But as a number of economists have pointed out, before World
War I many of the countries of North
America and western and central Europe operated under an “unwritten
fiscal constitution.” Governments, except during times of national emergency, were expected to more or less 
balance their budgets on an annual 

If a national emergency
 (such as a war) compelled a government to borrow money to cover its
 unexpected expenditures, it was expected to run budget surpluses to
pay off any accumulated debt when the emergency had passed.

This unwritten balanced-budget rule was never rigidly practiced either, of course. But the idea that needless government debt was a waste and a drag on the economic welfare of a nation served as an important check on the growth of government spending.

When governments planned to do things, the people were more or less explicitly presented with the bill. It was more difficult for governments to promise a wide variety of benefits without also showing what the taxpayer’s burden would be.

World War I Destroyed the Gold Standard

This all changed during and after World War I. The gold standard was set aside to fund the war expenditures for all the belligerents in the conflict. And John Maynard Keynes, who in 1919 had warned about the dangers of inflation, soon was arguing that gold was a “barbarous relic” that needed to be replaced with government-managed paper money to facilitate monetary and fiscal fine-tuning.

In addition, that unwritten fiscal constitution which required annual balanced budgets was replaced with the Keynesian conception of a balanced budget over the phases of the business cycle.

In practice, of course, this set loose the fiscal demons. Restrained by neither gold nor the limits of taxation, governments around the world went into an orgy of deficit spending and money creation that led some to refer to a good part of the twentieth century as the “age of inflation.”

Politicians and bureaucrats could now far more easily offer short-run benefits to special-interest groups through growth in government power and spending, while avoiding any mention of the longer-run costs to society as a whole, in their roles as taxpayers and consumers.

Obama and Santa Cartoon

The Counter-Revolution Against Keynesianism

Beginning in the late 1960s and 1970s a counter-revolution against Keynesian economics emerged, especially in the United States, which came to be identified with Milton Friedman and monetarism.

To restrain government’s ability to create inflation, Friedman proposed a “monetary rule”: the annual increase in the money supply should be limited to the average annual increase in real output in the economy. Put the creation of paper money on “automatic pilot,” and governments would once more be prevented from using the printing press to capriciously cover their expenditures.

But in the years after receiving the Nobel Prize in economics in 1984, Friedman had second thoughts about the effectiveness of his monetary rule. He stated that Public Choice theory – the use of economic theory to analyze the logic and incentives in political decision-making – persuaded him that trying to get central banks to pursue a monetary policy that would serve the long-run interest of society was a waste of time.

Just like the rest of us, politicians, bureaucrats, and central bankers have their own self-interested goals, and they will use the political power placed at their disposal to advance their interests.

Said Friedman: “We must try to set up institutions under which individuals who intend only their own gain are led by an invisible hand to serve the public interest,” He also concluded that after looking over the monetary history of the twentieth century, “Leaving monetary and banking arrangements to the market would have produced a more satisfactory outcome than was actually achieved through government involvement.”

Separating Money from Government Control

Though Milton Friedman was unwilling to take his own argument that far, the logical conclusion of his admission that the control of money can never be trusted in the hands of the government is the need to separate money creation from the State. What is required is the denationalization of money, or in other words, the establishment of monetary freedom in society.

Under a regime of monetary freedom the government would no longer have any role in monetary and banking affairs. The people would have, to use a phrase popularized by the Austrian economist F. A. Hayek, a “choice in currency.” The law would respect and enforce all market-based, consensual contracts regardless of the currency or commodity chosen by the market participants as money. And the government would not give a special status to any particular currency through legal-tender laws as the only “lawful money.”

Monetary freedom encompasses what is known as “free banking.” That is, private banks are at liberty to accept deposits in any commodity money or currency left in their trust by depositors and to issue their own private banknotes or claims against these deposits.

To the extent these banknotes and claims are recognized and trusted by a growing number of people in the wider economic community, they may circulate as convenient money substitutes. Such private banks would settle their mutual claims against each other on behalf of their respective depositors through private clearinghouses that would have international connections as well.

Few advocates of the free market have included the privatization of the monetary system among their proposed economic policy reforms. The most notable advocate of monetary freedom and free banking in the twentieth century was the Austrian economist Ludwig von Mises, who demonstrated that as long as governments and their central banks have monopoly control over the monetary system inflations and the business cycle are virtually inevitable, with all of their distorting and devastating effects.

But the last 30 years have seen the emergence of a body of serious and detailed literature on the desirability and workability of a fully private and competitive free-banking system as an alternative to government central banking.

Self-Interest and Monetary Freedom

Its political advantage is that it completely removes all monetary matters from the hands of government. However effective the old gold standard may have been before the First World War, it nonetheless remained a government-managed monetary system that opened the door to eventual abuse.

Furthermore, a free-banking system fulfills Milton Friedman’s recommendation that the monetary order should be one that harnesses private interest for the advancement of the public interest through the “invisible hand” of the market process.

The interests of depositors in a reliable banking system would coincide with the self-interest of profit-seeking financial intermediaries. A likely unintended consequence would be a more stable and adaptable monetary system than the systems of monetary central planning the world labors under now.

Of course, a system of monetary freedom does not do away with the continuing motives for government to grow and spend. Even limits on the government’s ability to create money to finance its expenditures does not preclude fiscal irresponsibility, with damaging economic consequences for a large segment of the population through deficit spending and growing national debt.

Obama as Santa Cartoon

Monetary Freedom and a Philosophy of Liberty

In the long run, the only way to limit the growth of government spending and power over society is to change political and ideological thinking. As long as many people want government to use its power to tax and regulate to benefit them at the expense of others, it will retain its power and continue to grow.

Monetary and fiscal reform is ultimately inseparable from the rebirth and implementation of a philosophy of freedom that sees government limited to the protection of each individual’s right to his life, liberty, and honestly acquired property.

As Ludwig von Mises expressed it ninety years ago in the aftermath of the First World War and during the Great German Inflation of the early 1920s:

“What is needed first and foremost is to renounce all inflationist fallacies. This renunciation cannot last, however, if it is not firmly grounded on a full and complete divorce of ideology from all imperialist, militarist, protectionist, statist, and socialist ideas.”

If the belief in and desire for personal and economic liberty can gain hold and grow once more in people’s hearts and minds, monetary freedom and fiscal restraint will eventually come by logical necessity.

[Editor’s note: this piece first appeared here]


Deflating the Inflation Myth

[Editor’s Note; this interview, with Cobden Centre contributor Jesus Huerta de Soto, was by Malte Fischer of Handelsblatt]

Professor Huerta de Soto, the inflation rate in the euro zone is now only 0.4 percent. Is deflation threatening us, as many experts maintain?

Deflation means that the money supply is shrinking. This is not the case in the euro zone. The M3, the broadly defined supply of money, is growing by about two percent, while the more narrowly defined money supply, M1, by more than six percent. Although the inflation rate in the euro zone is below the European Central Bank’s target of barely two percent, that’s no reason to stir up fears of deflation like some central bankers are doing.

By doing so, they are suggesting that lowering prices is something bad. That is wrong. Price deflation is not a catastrophe, but rather a blessing.

You’ll have to explain that.

Take my homeland, Spain. At the moment, the consumer prices there are decreasing. At the same time, the economy is growing by around two percent on a yearly basis. Some 275,000 new jobs were created in 2013 and unemployment fell from 26 to 23 percent. The facts contradict the horror scenarios of deflation.

Does that mean we should be happy about deflation?

Certainly. It is particularly beneficial when it results from an interplay of a stable money supply and increasing productivity. A fine example is the gold standard in the 19th century. Back then, the money supply only grew by one to two percent per year. At the same time, industrial societies generated the greatest increase in prosperity in history. That is why the ECB should use the gold standard as an example and lower the target for the growth of the M3 money supply from 4.5 to around 2.0 percent.

If the euro economy were to grow by about three percent – which it is capable of doing if it were freed from the shackles of state regulations – prices would decrease by about one percent per annum.

If deflation is so beneficial, why are people afraid of it?

I don’t believe that the average person is frightened by falling prices. It is the representatives of mainstream economics fomenting a deflation phobia. They argue that deflation allows the actual debt burden to increase, and thus strangles the overall economic demand. The deflation alarmists fail to mention that creditors benefit from deflation, which stimulates demand.

Isn’t there a danger consumers will roll back their spending if everything is cheaper tomorrow?

That is an abstruse argument you hear again and again. Look at how fast the latest smartphones sell, although consumers know that the phones will be sold at a lower cost a few months afterwards. America was dominated by deflation for decades after the Civil War. In spite of that, consumption increased. If people were to put off buying because of lower prices, they ultimately would starve to death.

But lowering prices drives down sales figures and lessens the willingness of companies to invest. Do you want to ignore that?

Sales figures are not crucial for companies, but rather their earnings, meaning the difference between revenues and costs. Sinking sales prices increase pressure to reduce costs. The companies, therefore, replace manpower with machines. That means more machines need to be produced, which increases the demand for manpower in the capital goods sector. In this way, workers who lost their jobs in the wake of price deflation find new work in the capital goods sector. The capital stock grows without resulting in mass unemployment.

Aren’t you making that too easy for yourself ? In reality, the gap between the qualifications of the unemployed and the needs of companies is, at times, quite large.

I’m not claiming the market is perfect. That means it’s crucial that the labor market is flexible enough to offer incentives for creative employers to hire new workers.

What role does politics play?

The problem is that politicians have a short time horizon. That is why we need a monetary policy framework that holds both politicians and unions in check. The euro has this job in Europe. The common currency has removed the option of governments to devalue the currency to cover for their misguided economic policies. Economic policy mistakes are seen directly in the affected country’s loss of competitiveness, which forces politicians to make harsh reforms. Two governments in Spain within one and half years have implemented reforms that I hadn’t even dared to dream of. Now, the economic situation is improving and Spain is reaping the harvest of the reforms.

You may be right in the matter of Spain, but there have been no signs of fundamental reforms in Italy and France…

Which is why conditions there will first have to get worse before reforms come. We have learned from experience that the more miserable the economic situation, the stronger the pressure to reform. The reform successes that Spain and other euro countries have achieved increase the pressure on Paris and Rome. High unemployment in Spain had pushed down labor costs. At an average of €20, or $24.90, per hour, they are now half the rate as in France. That is why the French cannot avoid a drastic economic policy cure, even if the people oppose it. Germany should hold to its budgetary consolidation to keep up pressure on France and Italy.

The ECB is coming under increasing pressure to open the monetary floodgates and devalue the euro. The pressure is coming from academics, financial markets and politicians.

The economic mainstream of Keynesianism and monetarism explains the Great Depression of the 1930s with a shortage of money, which allowed an anti-deflation mentality to develop among academics. Politicians use the academic sounding board to pressure the ECB to reinflate the economy. Governments love inflation because it gives them the opportunity to live beyond their means and pile up huge mountains of debt that the central bank devaluates through inflation. It is no wonder it just happens to be the opponents of austerity policies who warn about deflation and demonize the euro’s set of stability policy regulations. They are afraid of presenting the true costs of the welfare state to the electorate.

The head of the ECB, Mario Draghi, succumbed to the pressure with his promise to save the euro if needs be by firing up the money printing presses. A mistake?

Careful. Until now, Mr. Draghi has been mainly making promises, but has barely acted. Although the ECB has initiated generous money lending transactions, and lowered the prime lending rate, the actual yield for 10-year government bonds of ailing euro zone members is above those in America. Measured on the balance sheet totals, the ECB has done less than other Western central banks. As long as the guardians of the euro are only talking but not acting, the pressure will remain on Italy and France to reform. That is why it is crucial the ECB resists the pressure of the governments and the Anglo-Saxon financial world and buys no state bonds.

What role do the Anglo-Saxon financial markets play?

The Anglo-Saxon press and the financial markets are ostentatiously conducting a crusade against the euro and the austerity policy in continental Europe necessitated by it. I am really no believer in conspiracy theories, but the out-and-out attacks against the euro by Washington and London suggest a hidden agenda. The Americans are afraid that the days of the dollar as a global currency are numbered if the euro survives as a hard currency.

Can the euro survive without political union?

A political union will not draw majority support in the population. It also isn’t desirable because it reduces the pressure for fiscal austerity. The best monetary regime for a free society is the gold standard, with all deposits covered by full reserves and without state central banks. As long as we don’t have that, we should defend the euro because it deprives governments of access to the money printing presses and forces them to consolidate their budgets and make reforms. In a certain way, it has the effect of the gold standard.


How the ‘Reserve’ Dollar Harms America

[Editor’s Note: this piece, by Lewis E. Lehrman And John D. Mueller, first appeared in the Wall Street Journal It was kindly brought to our attention by Cobden Centre contributor Ralph Benko.]


For more than three decades we have called attention on this page to what we called the “reserve-currency curse.” Since some politicians and economists have recently insisted that the dollar’s official role as the world’s reserve currency is instead a great blessing, it is time to revisit the issue.

The 1922 Genoa conference, which was intended to supervise Europe’s post-World War I financial reconstruction, recommended “some means of economizing the use of gold by maintaining reserves in the form of foreign balances”—initially pound-sterling and dollar IOUs. This established the interwar “gold exchange standard.”

A decade later Jacques Rueff, an influential French economist, explained the result of this profound change from the classical gold standard. When a foreign monetary authority accepts claims denominated in dollars to settle its balance-of-payments deficits instead of gold, purchasing power “has simply been duplicated.” If the Banque de France counts among its reserves dollar claims (and not just gold and French francs)—for example a Banque de France deposit in a New York bank—this increases the money supply in France but without reducing the money supply of the U.S. So both countries can use these dollar assets to grant credit. “As a result,” Rueff said, “the gold-exchange standard was one of the major causes of the wave of speculation that culminated in the September 1929 crisis.” A vast expansion of dollar reserves had inflated the prices of stocks and commodities; their contraction deflated both.

The gold-exchange standard’s demand-duplicating feature, based on the dollar’s reserve-currency role, was again enshrined in the 1944 Bretton Woods agreement. What ensued was an unprecedented expansion of official dollar reserves, and the consumer price level in the U.S. and elsewhere roughly doubled. Foreign governments holding dollars increasingly demanded gold before the U.S. finally suspended gold payments in 1971.

The economic crisis of 2008-09 was similar to the crisis that triggered the Great Depression. This time, foreign monetary authorities had purchased trillions of dollars in U.S. public debt, including nearly $1 trillion in mortgage-backed securities issued by two government-sponsored enterprises, Fannie Mae and Freddie Mac. The foreign holdings of dollars were promptly returned to the dollar market, an example of demand duplication. This helped fuel a boom-and-bust in foreign markets and U.S. housing prices. The global excess credit creation also spilled over to commodity markets, in particular causing the world price of crude oil (which is denominated in dollars) to spike to $150 a barrel.

Perhaps surprisingly, given Keynes ’s central role in authoring the reserve-currency system, some American Keynesians such as Kenneth Austin, a monetary economist at the U.S. Treasury; Jared Bernstein, an economic adviser to Vice President Joe Biden ; and Michael Pettis, a Beijing-based economist at the Carnegie Endowment, have expressed concern about the growing burden of the dollar’s status as the world’s reserve currency. For example, Mr. Bernstein argued in a New York Times op-ed article that “what was once a privilege is now a burden, undermining job growth, pumping up budget and trade deficits and inflating financial bubbles.” He urged that, “To get the American economy on track, the government needs to drop its commitment to maintaining the dollar’s reserve-currency status.”

Meanwhile, a number of conservatives, such as Bryan Riley and William Wilson at the Heritage Foundation, James Pethokoukis at the American Enterprise Institute and Ramesh Ponnuru at National Review are fiercely defending the dollar’s reserve-currency role. Messrs. Riley and Wilson claim that “The largest benefit has been ‘seignorage,’ which means that foreigners must sell real goods and services or ownership of the real capital stock to add to their dollar reserve holdings.”

This was exactly what Keynes and other British monetary experts promoted in the 1922 Genoa agreement: a means by which to finance systemic balance-of-payments deficits, forestall their settlement or repayment and put off demands for repayment in gold of Britain’s enormous debts resulting from financing World War I on central bank and foreign credit. Similarly, the dollar’s “exorbitant privilege” enabled the U.S. to finance government deficit spending more cheaply.

But we have since learned a great deal that Keynes did not take into consideration. As Robert Mundell noted in “Monetary Theory” (1971), “The Keynesian model is a short run model of a closed economy, dominated by pessimisticexpectations and rigid wages,” a model not relevant to modern economies. In working out a “more general theory of interest, inflation, and growth of the world economy,” Mr. Mundell and others learned a great deal from Rueff, who was the master and professor of the monetary approach to the balance of payments.

Those lessons are reflected in the recent writings of Keynesians such as Mr. Austin, who has outlined what he calls the “iron identities” of international payments, which flow from the fact that global “current accounts, global capital accounts, and global net reserve sales, must (and do) sum to zero.” This means that a trillion-dollar purchase, say, of U.S. public debt by the People’s Bank of China entails an equal, simultaneous increase in U.S. combined deficits in the current and capital accounts. The iron identities necessarily link official dollar-reserve expansion to the declining U.S. investment position.

The total U.S. international investment position declined from net foreign assets worth about 10% of gross domestic product in 1976 to minus-30% of GDP in 2013—while the books of U.S. private residents went from 10% of U.S. GDP in 1976 down to balance with the rest of the world in 2013. The entire decline in the U.S. net international investment position was due to federal borrowing from foreign monetary authorities—i.e., government deficit-financing through the dollar’s official reserve-currency role.

Ending the dollar’s reserve-currency role will limit deficit financing, increase net national savings and release resources to U.S. companies and their employees in order to remain competitive with the rest of the world.

Messrs. Riley and Wilson argue that “no other global currency is ready to replace the U.S. dollar.” That is true of other paper and credit currencies, but the world’s monetary authorities still hold nearly 900 million ounces of gold, which is enough to restore, at the appropriate parity, the classical gold standard: the least imperfect monetary system of history.

Messrs. Lehrman and Mueller are principals of LBMC LLC, an economic and financial market consulting firm. Mr. Lehrman is the author of “The True Gold Standard: A Monetary Reform Plan Without Official Reserve Currencies” (TLI Books, 2012). Mr. Mueller is the author of “Redeeming Economics: Rediscovering the Missing Element” (ISI Books, 2014).


Russia’s monetary solution

The hypothesis that follows, if carried through, is certain to have a significant effect on gold and the relationship between gold and all government-issued currencies.

The successful remonetisation of gold by a major power such as Russia would draw attention to the fault-lines between fiat currencies issued by governments unable or unwilling to do the same and those that can follow in due course. It would be a schism in the world’s dollar-based monetary order.

Russia has made plain her overriding monetary objective: to do away with the US dollar for all her trade, an ambition she shares with China and their Asian partners. Furthermore, in the short-term the rouble’s weakness is undermining the Russian economy by forcing the Central Bank of Russia (CBR) to impose high interest rates to defend the currency and by increasing the burden of foreign currency debt. There is little doubt that one objective of NATO’s economic sanctions is to harm the Russian economy by undermining the currency, and this policy is working with the rouble having fallen 30% against the US dollar this year so far with the prospect of further falls to come.

Russia faces the reality that pricing the rouble in US dollars through the foreign exchanges leaves her a certain loser in a currency war against America and her NATO allies. There is a solution which was suggested in a recent paper by John Butler of Atom Capital, and that is for Russia to link the rouble to gold, or more correctly put it on a gold exchange standard*. The proposal at first sight is so left-field that it takes a lateral thinker such as Butler to think of it. Separately, Professor Steve Hanke of John Hopkins University has alternatively proposed that Russia sets up a currency board to stabilise the rouble. Professor Hanke points out that Northern Russia tied the rouble to the British pound with great success in 1918 after the Bolshevik revolution when Britain and other allied nations invaded and briefly controlled the region. What he didn’t say is that sterling would most likely have been accepted as a gold substitute in the region at that time, so running a currency board was the equivalent of putting the rouble in Russia’s occupied lands onto a gold exchange standard.

Professor Hanke has successfully advised several governments to introduce currency boards over the years, but we can probably rule it out as an option for Russia because of her desire to ditch US dollar relationships. However, on further examination Butler’s idea of fixing the rouble to gold is certainly feasible. Russia’s public sector external debt is the equivalent of only $378bn in a $2 trillion economy, her foreign exchange reserves total $429bn of which over $45bn is in physical gold, and the budget deficit this year is likely to be roughly $10bn, considerably less than 1% of GDP. These relationships suggest that a rouble to gold exchange standard could work so long as fiscal discipline is maintained and credit expansion moderated.

Once a rate is set, the Russians would not be restricted to just buying and selling gold to maintain the rate of gold exchange. The CBR has the power to manage rouble liquidity as well, and as John Butler points out, it can issue coupon-bearing bonds to the public which would be attractive compared with holding cash roubles. By issuing these bonds, the public is in effect offered a yield linked to gold, but higher than gold’s interest rate indicated by the gold lease rates in the London market. Therefore, as the sound-money environment becomes established the public will adjust its financial affairs around a considerably lower interest rate than the current 9.5%-10% level, but in the context of sound money it must always be repaid. Obviously the CBR would have to monitor bank credit expansion to ensure that lower interest rates do not result in a dangerous increase in bank lending and jeopardise the arrangement.

In short, the central bank could easily counter any tendency for roubles to be cashed in for gold by withdrawing roubles from circulation and by restricting credit. Consideration would also have to be given to roubles in foreign ownership, but the current situation for foreign-owned roubles is favourable as well. Speculators in foreign exchange markets are likely to have sold the rouble against dollars and euros, because of the Ukrainian situation and as a play on lower oil prices. The announcement of a gold exchange standard can therefore be expected to lead to foreign demand for the rouble from foreign exchange markets because these positions would almost certainly be closed. Since there is currently a low appetite for physical gold in western capital markets, longer-term foreign holders of roubles are unlikely to swap them for gold, preferring to sell them for other fiat currencies. So now could be a good time to introduce a gold-exchange standard.

The greatest threat to a rouble-gold parity would probably arise from bullion banks in London and New York buying roubles to submit to the CBR in return for bullion to cover their short positions in the gold market. This would be eliminated by regulations restricting gold for rouble exchanges to legitimate import-export business, but also permitting the issue of roubles against bullion for non-trade related deals and not the other way round.

So we can see that the management of a gold-exchange standard is certainly possible. That being the case, the rate of exchange could be set at close to current prices, say 60,000 roubles per ounce. Instead of intervention in currency markets, the CBR should use its foreign currency reserves to build and maintain sufficient gold to comfortably manage the rouble-gold exchange rate.

As the rate becomes established, it is likely that the gold price itself will stabilise against other currencies, and probably rise as it becomes remonetised. After all, Russia has some $380bn in foreign currency reserves, the bulk of which can be deployed by buying gold. This equates to almost 10,000 tonnes of gold at current prices, to which can be added future foreign exchange revenues from energy exports. And if other countries begin to follow Russia by setting up their own gold exchange standards they likewise will be sellers of dollars for gold.

The rate of increase in the cost of living for the Russian population should begin to drop as the rouble stabilises, particularly for life’s essentials. This has powerfully positive political implications compared with the current pain of food price inflation of 11.5%. Over time domestic savings would grow, spurred on by low welfare provision by the state, long-term monetary stability and low taxes. This is the ideal environment for developing a strong manufacturing base, as Germany’s post-war experience clearly demonstrated, but without her high welfare costs and associated taxation.

Western economists schooled in demand management will think it madness for the central bank to impose a gold exchange standard and to give up the facility to expand the quantity of fiat currency at will, but they are ignoring the empirical evidence of a highly successful Britain which similarly imposed a gold standard in 1844. They simply don’t understand that monetary inflation creates uncertainty for capital investment, and destroys the genuine savings necessary to fund it. Instead they have bought into the fallacy that economic progress can be managed by debauching the currency and ignoring the destruction of savings.

They commonly assume that Russia needs to devalue her costs to make energy and mineral extraction profitable. Again, this is a fallacy exposed by the experience of the 1800s, when all British overseas interests, which supplied the Empire’s raw materials, operated under a gold-based sterling regime. Instead, by not being burdened with unmanageable debt and welfare costs, by maintaining lightly-regulated and flexible labour markets, and by running a balanced budget, Russia can easily lay the foundation for a lasting Eurasian empire by embracing a gold exchange standard, because like Britain after the Napoleonic Wars Russia’s future is about new opportunities and not preserving legacy industries and institutions.

That in a nutshell is the domestic case for Russia to consider such a step; but if Russia takes this window of opportunity to establish a gold exchange standard there will be ramifications for her economic relationships with the rest of the world, as well as geopolitical considerations to take into account.

An important advantage of adopting a gold exchange standard is that it will be difficult for western nations to accuse Russia of a desire to undermine the dollar-based global monetary system. After all, President Putin was more or less told at the Brisbane G20 meeting, from which he departed early, that Russia was not welcome as a participant in international affairs, and the official Fed line is that gold no longer plays a role in monetary policy.

However, by adopting a gold exchange standard Russia is almost certain to raise fundamental questions about the other G20 nations’ approach to gold, and to set back western central banks’ long-standing attempts to demonetise it. It could mark the beginning of the end of the dollar-based international monetary system by driving currencies into two camps: those that can follow Russia onto a gold standard and those that cannot or will not. The likely determinant would be the level of government spending and long-term welfare liabilities, because governments that leech too much wealth from their populations and face escalating welfare costs will be unable to meet the conditions required to anchor their currencies to gold. Into this category we can put nearly all the advanced nations, whose currencies are predominantly the dollar, yen, euro and pound. Other nations without these burdens and enjoying low tax rates have the flexibility to set their own gold exchange standards should they wish to insulate themselves from a future fiat currency crisis.

It is beyond the scope of this article to examine the case for other countries, but likely candidates would include China, which is working towards a similar objective. Of course, Russia might not be actively contemplating a gold standard, but Vladimir Putin is showing every sign of rapidly consolidating Russia’s political and economic control over the Eurasian region, while turning away from America and Western Europe. The fast-track establishment of the Eurasian Economic Union, domination of Asia in partnership with China through the Shanghai Cooperation Organisation, and plans to set up an alternative to the SWIFT banking payments network are all testaments to this. It would therefore be negligent to rule out the one step that would put a stop to foreign attempts to undermine the rouble and the Russian economy: by moving the currency war away from the foreign exchanges and into the physical gold market were Russia and China hold all the aces.

*Technically a gold standard is a commodity money standard in which the commodity is gold, deposits and notes are fully backed by gold and gold coins circulate. A gold exchange standard permits other metals to be used in coins and for currency and credit to be issued without the full backing of gold, so long as they can be redeemed for gold from the central bank on demand.


Swiss Gold Initiative: Good Idea with Unintended Consequences

[Editor’s Note: The Swiss voted no to the “semi-gold standard” that was proposed. However, important issues were raised that are relevant to all nations and any future consideration of the gold standard, or something similar. Here is published Keith Weiner’s perceptive analysis from last week. Please also see today’s article by Tim Price on the Swiss decision]

There is now a very interesting initiative on the Swiss ballot, which will require the Swiss National Bank (SNB) to hold 20 percent of its reserves in gold. The voters will decide on November 30. I won’t predict the vote, but I want to discuss the likely impact of a yes vote.

Much of the analysis of this initiative is about the price of gold. A typical prediction is that it will go up, as SNB buying will exceed supply. However Mike Shedlock notes that, “Nearly all of the gold ever mined is available…” That’s because gold is not consumed. The SNB is small compared to worldwide gold inventories, so it won’t move the price much. Shedlock adds, “It is entirely possible that SNB purchases could significantly alter perceptions…” I agree sentiment is ripe for a change.

The price isn’t very interesting, unless you’re a gold trader. It’s much more important that the referendum brings the first positive monetary change in decades. It reintroduces a link between gold and banking, and imposes a barrier to currency debasement. For this, the Swiss are heroes.

There is a key flaw in our system of floating currencies. Every financial asset is someone’s liability. When a currency moves, it creates winners and losers. Big moves can harm banks with loan portfolios outside their home.

That’s why the SNB currently doesn’t allow the euro to fall below 1.2 francs. To maintain this currency peg, the central bank sells francs and buys euros. There is no limit to this deliberate franc devaluation, which robs Swiss savers, investors, and businesses.

Big exporters, like Swatch and Nestle, may have lobbied for a weaker franc, hoping to make their products more competitive, but that’s a sideshow. The real purpose of franc devaluation is to shield the Swiss banks from euro devaluation. They’re vulnerable, because they do a lot of lending outside the country. They have assets denominated in euros and liabilities denominated in francs. They suffer losses when the euro falls, or the franc rises.

Two examples help illustrate the problem. First, say Jens in Germany borrows a million euros from Credit Suisse. As the euro falls, Jens repays the bank in smaller and smaller euros. On the franc-denominated books of Credit Suisse, the value of the loan drops like a stone. Jens is happy but Credit Suisse is not.

Second, let’s look at Adriana in Italy who also borrows money, but not in euros. She gets a million francs from UBS. As the euro falls, Adriana experiences it as a rising franc. Her monthly payment goes up and up. UBS is happy, at least initially, because Adrian’s loan is in francs. However Adriana is getting squeezed. When she defaults, then UBS becomes unhappier than Credit Suisse.

Either way, the capital of the Swiss banks is eroding. If the euro falls enough, then the banks could go bust. Only they know where the line is, but it’s likely not too far below the current peg of 1.2 francs.

Depositors won’t feel the currency pain, at first. They are happy to own Swiss francs, especially if the franc is rising. Instead, they should worry about the unintended consequences of breaking the euro peg. Their strong francs will not be good in the case of bank insolvency.

Unfortunately the regime of paper money imposes a bitter dilemma on the Swiss people. They have a choice of slow losses by devaluation, or total losses by bankruptcy. They deserve a better option, a practical roadmap to the gold standard.

It’s great that the Swiss people are striving to move towards gold. I am a passionate advocate of the gold standard, and I want to cheer for my Swiss friends. Yet I must caution them today. I realize they have spent a lot of money and political capital to come so far, but I don’t want to win this battle and lose the war. They need a new initiative, which takes into account the banks’ euro-denominated loans.


Striking gold

“Sir, Martin Wolf in his article “Radical cures for unusual economic ills” suggests an abandonment of free market capitalism, as it has been practised these past couple of hundred years, and instead wants some kind of witch-doctoring economic quackery to take its place. Savings are the capital that forms the basis of capitalism. You can’t have capitalism without capital. And without interest rates pegged at levels that encourage savings, you won’t generate the quantities of savings necessary to sustain a capitalist economy.

“We need to stop the insanity. For example, savings rates in the US fluctuate around zero per cent along with interest rates set by the Fed. To hide this stab in the back to savers, the Federal Reserve simulates savings with ersatz monetary hokum like quantitative easing designed to create the illusion of a solvent economy that can run fine without actually having any savings.

“Despite the evidence proving the failure of this approach, Mr Wolf continues to recommend attacking savers, including the so-called “savings glut” held by countries in the east that hold large cash reserves as protection against the reckless policies like those suggested by Mr Wolf, who appears ignorant of the history of why these reserves exist in the first place: to protect these countries and currencies from the unorthodox (read “failed”) policy suggestions of pundits and academics who would do us all a great favour by simply admitting that their prescriptions for global growth have completely, unequivocally, failed.”

–       Letter to the Financial Times from Mr Max Keiser, London W1, 28 November 2014.



So the Swiss have decided not to force their central bank into underpinning its reserves with harder assets than increasingly worthless euros. At least they had the chance to vote. But in the bigger picture, the rejection of the “Save Our Swiss Gold” initiative flies in the face of a broader trend towards repatriation and consolidation of sovereign bullion holdings – following on the heels of similar attempts by the Bundesbank, the Dutch central bank, for example, recently announced that it had moved a fifth of its total gold reserves from New York to Amsterdam. And the physical metal continues its inexorable exodus eastwards, into stronger hands that are unlikely to relinquish it any time soon.

The Swiss vote was preceded by some fairly extraordinary black propaganda, most notoriously by Willem Buiter of the banking organisation that now styles itself ‘Citi’. Once again we were treated to the intriguing claim that gold is nothing more than “a six thousand year-old bubble”, and a “fiat commodity currency” (whatever that might mean) that has “insignificant intrinsic value”. Izabella Kaminska for the FT’s Alphaville republished much of Buiter’s ‘research’; the resultant to-and-fro between FT readers on the paper’s website makes for a fascinating scrap between goldbugs and paperbugs. Among the highlights was Vlady, who wrote:

“When a social construct (gold as money) survives for 6,000 years I would expect curious people to inquire as to whether it is tied to some immutable underlying law, or otherwise investigate if there is something more here than meets the eye.  Not so curiously inclined, our court economists prefer to write this off as a 6,000 year old delusion. That says a lot about the sorry state of the economics discipline today.”

Another was the artfully named ‘Financially Repressed by Central Banks’, who wrote:

“I think that the reason bankers and governments dislike gold backed hard currencies is that it limits their ability to devalue their fiat currency and redistribute wealth in order to stay in power.

The governmental solution to all the debt in the world is to try to inflate it away and slowly take money away from the people via currency depreciation and manipulating interest rates such savers and forced owners of government debt (such as pension schemes) make a negative return.

I think this is robbery – Pure and simple.   The market is not free, it is controlled.

A move away from fiat currency and back to using gold backed currency would remove the ability of governments to print money and this in turn would remove their ability constantly try to avoid facing the consequences of building up huge debts, which in term means they would have to face the music and actually have a plan to repay it.

It is the central banks and private banks who are complicit in this government sponsored process of stealing and their rewards are their ability themselves big bonuses and the occasional tax payer funded rescue..

Mr  Buiter works for a bank.  What a surprise that he dislikes Gold and is presumably very concerned when a central bank (Switzerland) looks like it might do something silly like buying some gold.  Don’t they realize that in acknowledging the concerns of holders of fiat currency (the people of Switzerland) that their actions might encourage others to think that maybe just maybe fiat currency is not quite as useful as gold?

/ rant on / I am not a gold bug, but I am a hard working tax payer who is getting pretty fed up with having my savings earning no interest and possibly being devalued (see Japan) and of not being able to find any sensible place to invest my hard earned due to central bank policies making it impossible to make any return anywhere without taking crazy risks. / rant off /” [Emphasis ours.]

The financial markets feel increasingly unhinged. All-time low bond yields co-exist with all-time high stock markets. Oil has collapsed along with much of the commodities complex. Emerging market currencies have been hit for six. China threatens the West with another strong deflationary impulse. Speaking of matters Chinese, Doug Nolandwrites:

“With global “hot money” now on the move in major fashion, it’s time to start paying close attention to happenings in China. It’s also time for U.S. equities bulls to wake up from their dream world. There are trillions of problematic debts in the world, including some in the U.S. energy patch. There are surely trillions more engaged in leveraged securities speculation. Our markets are not immune to a full-fledged global “risk off” dynamic. And this week saw fragility at the global bubble’s periphery attain some significant momentum. Global currency and commodities markets are dislocating, portending global instability in prices, financial flows, credit and economies.”

Gold is difficult to value at the best of times, in large part because it’s not a productive asset, and partly because it’s conventionally priced in a currency (the dollar) that, like all others, is destined to lose its purchasing power over time. Viewed purely through the prism of price, gold increasingly feels like something close to a ‘value’ investment, given that ‘value’ investing is essentially about picking up dollar bills for something closer to fifty cents. We’re currently reading Christopher Risso-Gill’s biography of the legendary ‘value’ investor Peter Cundill, and some of Cundill’s diary entries seem to be peculiarly relevant to this strange, dysfunctional environment in which we are all trapped. One in particular stands out, which Cundill himself wrote in upper case to make his point:


And there’s another, originally from Horace, that was also used by the godfather of ‘value’ investing, Ben Graham himself:

“Many shall be restored that now are fallen, and many shall fall that are now held in honour.”


Understanding the Money Creation and Society Debate

Together with colleagues spanning four parties – Michael Meacher (Lab), Caroline Lucas (Green), Douglas Carswell (UKIP) and David Davis (Con) – I have secured a debate on Money Creation and Society for Thursday 20 November. Here’s a quick guide to understanding the debate.

First, we have a system of paper or “fiat” money: it exists due to legal mandate as opposed to being a physical commodity like gold. Reserves, notes and coins are created by the state but claims on money are created by the banks when they lend. Most of the money we have was created by banks lending.

This excellent video from Dominic Frisby is a great place to begin:

There was once a time when the literature about money creation was sufficiently off the mainstream to be dismissed. The Bank of England now explains:

I published a short paper on what is wrong with the current system and what to do about it, first inBanking 2020 and then Jesús Huerta de Soto kindly republished it in his journal Procesos De Mercado Vol.X nº2 2013. A further monetary economist privately reviewed the paper but errors and omissions remain my own. You can download it here:

Recent emergency monetary policy has been dominated by Quantitative Easing: the Bank of England has provided a report on The distributional effects of asset purchases (PDF). However, the financial system has been chronically inflationary throughout my lifetime, ever since the Bretton Woods currency system ended.

If QE has distributional effects, why not all money creation?

Here is a historic price index from the Office for National Statistics and House of Commons Library: Consumer Price Inflation since 1750 (PDF).

Price Index 1750-2003

And here is the growth of broad money from 1982 to date via the Bank of England (series LPMAUYM). Note that the money supply stopped accelerating in the course of the crisis, during the period of QE:

M4: 1982-2014

No one can argue prosperity has not increased over the period but if distributional effects matter at all, one must ask “Who benefits?” Via Positive Money, here’s where the new money went:

Sectoral lending

As I said in debate on 6 Dec 2011:

Why are we in this debt crisis? I have just checked the M4 money supply figures—I am sorry to return to aggregates, but needs must. When Labour came to power the money supply was about £700 billion and it is now about £2.1 trillion, so it has tripled over the past 14 years. Unfortunately, most economists talk about money flowing into the economy as if it were water poured into a tank that found its own level immediately, but what if it is like treacle or honey? What if it builds up in piles when poured into the economy and takes a while to spread out? What if that money was loaned into existence in response to individual choices led by the excessively low interest rates pushed by the central bank? What if it was loaned into existence in particular sectors, such as the housing sector, where prices have more than doubled over the same period, and what if it was the financial sector that received the benefit of that new money first? Would that not explain why financiers and bankers are so much wealthier than everyone else, and why economic activity and wealth has been reorientated towards the south-east?

This debate will explore the effects on society of long-term money creation by private banks’ lending in the context of the present financial system.

Further reading:


The Gold Standard Did Not Cause The Great Depression, Part 2

As noted in my previous column, AEI’s James Pethokoukis and National Review‘s Ramesh Ponnuru — among many others — appear to have fallen victim to what I have called the “Eichengreen Fallacy.”  This refers to the demonstrably incorrect proposition that the gold standard caused the Great Depression.

Pethokoukis proves exactly right in observing that “Benko is a gold-standard advocate and apparently doesn’t much like the words ‘Hitler’ or ‘Nazi’ to be in the same area code of any discussion of once again linking the dollar to the shiny yellow metal.”  “Doesn’t much like” being falsely linked with Hitler?  Perhaps an apology is more in order than an apologia.

My objecting to a demonstrably false implication of the (true) gold standard in the rise of Nazism does not constitute a display of ill will but rather righteous indignation.  To give Pethokoukis due credit he thereupon generously devoted anAEIdea blog to reciting Peter Thiel’s praise for the gold standard, praise which triggered a hysterical reaction from the Washington Post‘s Matt O’Brien.

Pethokoukis’s earlier (and repeated) vilification of gold was followed by a column in the Washington Times by a director of the venerable Committee for Monetary Research and Education Daniel Oliver, Jr., Liberty and wealth require sound money. In it, Oliver states:

What if liberty and riches at times diverge, though? A shibboleth of mainstream economists, repeated recently in The National Review, of all places, is that countries recovered from the Great Depression in the order that they abandoned the gold standard. … No doubt, money printing — the modern equivalent of leaving the gold standard — can plug the holes in banks’ balance sheets when the demand deposits at the base of the credit structure are withdrawn. This is the policy recommended by National Review Senior Editor Ramesh Ponnuru and other “market monetarists” such as the American Enterprise Institute’s James Pethokoukis ….

I am not in complete accord with all of Oliver’s propositions therein. Ponnuru is on solid ground in contradicting Oliver’s imputation of sentiments to him he does not hold and does not believe.  Yet Ponnuru weakens his defense by citing, among other things, a

recent summary of the history of gold standards in the United States that George Selgin wrote for the Cato Institute. It is a very gold-friendly account, but it ‘concludes that the conditions that led to the gold standard’s original establishment and its successful performance are unlikely to be replicated in the future.’

“Unlikely to be replicated in the future?”  Prof Selgin is a brilliant economist, especially in the elite field of monetary economics.  Yet as Niels Bohr reportedly once said, “Prediction is very difficult, especially about the future.” This citation in no way advances Ponnuru’s self-defense.

Let it be noted that Cato Institute recently announced a stunning coup in recruiting Prof. Selgin to head its impressive new Center For Monetary and Financial Alternatives. As stated in its press release, “George Selgin, a Professor Emeritus of Economics at the University of Georgia and one of the foremost authorities on banking and monetary theory and history, gave up his academic tenure to join Cato as director of the new center.” Cato’s recruitment, from the Mercatus Institute, of a key former House subcommittee aide, the formidable Lydia Mashburn, to serve as the Center’s Manager also shows great sophistication and purpose.

Prof. Selgin hardly would give up a prestigious university post to engage in a quixotic enterprise.  I, among many, expect Selgin rapidly to emerge as a potent thought leader in changing the calculus of what is, or can be made, policy-likely.  Also notable are the Center’s sterling Council of Economic Advisors, including such luminaries as Charles Calomiris; its Executive Advisory Council; Senior Fellows; and Adjunct Scholars.  It is, as Prof. Selgin noted in a comment to the previous column, “a rather … diverse bunch.”

The Center presents as an array of talent metaphorically reminiscent of the 1927 Yankees. These columns do not imply Cato to be a uniform phalanx of gold standard advocates but rather a sophisticated group of thought leaders committed to monetary and financial alternatives, of which the classical gold standard is one, respectable, offering.  Prof. Selgin’s own position frankly acknowledging the past efficacy of the true gold standard represents argument from the highest degree of sophistication.

Ponnuru is on the weakest possible ground in citing the “commonplace observation that countries recovered from the Great Depression in the order they left gold.”  This is as misleading as it is commonplace. Ponnuru, too, would do well to break free of the Eichengreen Fallacy and assimilate the crucial fact that a defective simulacrum, not the true gold standard, led to and prolonged the Great Depression.

The perverse effects of the interwar “gold” standard led to a significant rise in commodities prices … and the ensuing wreckage of a world monetary system by the, under the circumstances, atavistic definition of the dollar at $20.67/oz of gold.  The breakdown of the system meticulously is documented in a narrative history by Liaquat Ahamed, Lords of Finance: The Bankers Who Broke The World, which received the Pulitzer Prize in history.  That road to Hell tidily was summed up in a recent piece in The Economist, Breaking the Rules: “The short-lived interwar gold standard … was a mess.”  As EPPC’s John Mueller recently observed, in, “the official reserve currencies which Keynes advocated fed the 1920s boom and 1930s deflationary bust in the stock market and commodity prices.”

The predicament — caused by the gold-exchange standard adopted in Genoa in 1922 — required a revaluation of the dollar to $35/oz, duly if eccentrically performed by FDR under the direction of commodities price expert economistGeorge Warren.  That revaluation led to a dramatic and rapid lifting of the Great Depression.  Thereafter, as Calomiris, et. al, observe in a publication by the Federal Reserve Bank of St. Louis, the Treasury sterilized gold inflows.  That sterilization, together with tax hikes, most likely played a major role in leading to the double dip back into Depression.

The classical gold standard — an early casualty of the First World War — was not, indeed could not have been, the culprit.  There is a subtle yet crucial distinction between the gold-exchange standard, which indeed precipitated the Great Depression, and the classical gold standard, which played no role.There is much to be said for the classical gold standard as a policy conducive to equitable prosperity.  It commands respect, even by good faith opponents.

For the discourse to proceed we first must lay to rest the Eichengreen Fallacy (and all that is attendant thereon). Once having dispelled that toxic fallacy let the games begin and let the best monetary policy prescription win.

Originating at


The Gold Standard Did Not Cause The Great Depression, Part 1

AEI’s James Pethokoukis and National Review’s Ramesh Ponnuru — among many others — appear to have fallen victim to what I have called “the Eichengreen Fallacy,” the demonstrably incorrect proposition that the gold standard caused the Great Depression.  This fallacy is at the root of much confusion in the discourse.

Both these conservatives find themselves, most incongruously, in the company of Professors Paul Krugman, Brad Delong, and Charles Postel; Nouriel Roubini; Thomas Frank; Think Progress’s Marie Diamond; the Roosevelt Institute’s Mike Konczal and other leading thinkers of the left pouring ridicule on the gold standard.  Most recently, Matt O’Brien, of the Washington Post, hyperbolically described the gold standard as “the worst possible case for the worst possible idea,” echoing a previous headline of a blog by Pethokoukis “The case for the gold standard is really pretty awful.”

Mssrs. Pethokoukis and Ponnuru appear to have been misled by an ambient fallacy (reprised recently by Bloomberg View‘s Barry Ritholtz) that there is an inherent deflationary/recessionary propensity of the gold standard. Thus they are being lured into opposition to such respected center-right thought leaders as Lewis E. Lehrman (whose Institute’s monetary policy website I professionally edit); Steve Forbes, Chairman of Forbes Media; Sean Fieler, chairman of American Principles in Action (for which I serve as senior advisor, economics) and the Honorable Steve Lonegan, APIA’s monetary policy director.

They also put themselves sideways with Cato Institute president John Allison; Professors Richard Timberlake, Lawrence White, George Selgin and Brian Domitrovic; Atlas Economic Research Foundation’s Dr. Judy Shelton; Ethics and Public Policy Center’s John Mueller; public figures such as Dr. Ben Carson and, perhaps, Peter Thiel; journalists such as George Melloan and James Grant; and commentators John Tamny, Nathan Lewis, Peter Ferrara, and Jerry Bowyer, among others.

At odds, too, with such esteemed international figures as former Indian RBI deputy governor S.S. Tarapore; former El Salvadoran finance minister Manuel Hinds; and Mexican business titan Hugo Salinas Price. And, at least by way of open-mindedness and perhaps even outright sympathy, The Weekly Standard editor-in-chief William Kristol; Cato’s Dr. James Dorn; Heritage Foundation’s Dr. Norbert Michel; the UK’s Honorable Kwasi Kwarteng and Steve Baker … among many other respected contemporary figures.   Not to mention libertarian lions such as the Honorable Ron Paul.

Gold advocates and sympathizers from the deep past include Copernicus and Newton, George Washington, Alexander Hamilton, Thomas Jefferson, John Witherspoon, John Marshall and Tom Paine, among many other American founders; and, from the less distant past, such important thinkers as Carl Menger, Ludwig von Mises and Jacques Rueff, as well as revered political leaders such as Ronald Reagan and Jack Kemp.

Alan Greenspan recently, in Foreign Affairs, while not discerning gold on the horizon, recently celebrated the “universal acceptability of gold” while raising a quizzical avuncular eyebrow, or two, at what he describes as “fiat” currency.

Let not pass unnoticed the recent statement by Herr Jens Wiedmann, president of the Bundesbank,

Concrete objects have served as money for most of human history; we may therefore speak of commodity money. A great deal of trust was placed in particular in precious and rare metals – gold first and foremost – due to their assumed intrinsic value. In its function as a medium of exchange, medium of payment and store of value, gold is thus, in a sense, a timeless classic.

Nor let pass unnoticed the Bank of England’s 2011 Financial Stability Paper No. 13 assessing the long term performance of the Federal Reserve Note standard and assessing its real outcomes — in every category reviewed, including job creation, economic growth, and inflation — to have proven itself, over 40 years, as deeply inferior in practice to the gold and even gold-exchange standards.

Seems a puzzling mésalliance on the part of Mssrs. Pethokoukis and Ponnuru.The Eichengreen Fallacy — that the gold standard caused and protracted the Great Depression — has led the discourse severely astray. It is imperative to set matters straight.  As I previously have written:

Prof. Eichengreen, author of Golden Fetters, was and remains non-cognizant of a subtle but crucial aspect of world monetary history — and, apparently, of the works of Profs. Jacques Rueff and Robert Triffin elucidating the implications.  Eichengreen blundered by attributing the Great Depression to the gold standard.  This, demonstrably, is untrue.

As Lehrman puts it, the true gold standard repeatedly has proven, in practice, the least imperfect of monetary regimes tried. Robust data actually recommend the gold standard as a powerful force for equitable prosperity.

Just perhaps it can be bettered.  So let the games begin. That said, proposing alternatives to the gold standard is very different from denigrating it.

Pethokoukis (whose writings I regularly follow and with appreciation) recently presented, at AEIdeas, The gold standard is fool’s gold for Republicans. This was a riposte to my here calling him to task for insinuating a connection between the gold standard and the rise of the Nazis and Hitler.  And to task for making statements in another of his AEIdea blogs taking Professors Beckworth and Tyler Cowen out of context.  He also therein conflated the “weight of the evidence” with “weight of opinion.”  It appears that he has fallen prey to the Eichengreen Fallacy.

In self-defense Pethokoukis cites scholarly materials which tend to prove the innocence of the gold standard rather than his insinuation.  For example: he cites Prof. Beckworth’s statement that “the flawed interwar gold standard … probably … led to the Great Depression which, in turn, guaranteed the rise of the Nazis….”

Prof. Beckworth’s characterization “flawed” is entirely consistent with the characterization by the great French monetary official and savant Jacques Rueff, whose work informs my own, of the gold-exchange standard as “a grotesque caricature” of the gold standard.

Similarly, his reference to Prof. Sumner overlooks the obvious fact that Prof. Sumner would appear fully to grasp the key distinction.  Sumner, as quoted by Pethokoukis:

The gold standard got a bad reputation after the Great Depression, when it was seen as contributing to worldwide deflation.  Kurt Schuler points out that the interwar gold standard didn’t follow the rules of the game, which is true.

Pethokoukis speculates,

Perhaps advocates are so sensitive to charges that the gold standard played a key role in the Great Depression, that nuance gets lost in their knee-jerk counterattacks. After all, many gold bugs think their moment is approaching once again. As Ron Paul wrote in his 2009 book “End the Fed”: ” … we should be prepared for hyperinflation and a great deal of poverty with a depression and possibly street violence as well.”  And when the stuff hits the fan, nations will again return to the gold standard for stability. Or so goes the theory over at Forbes.

Notwithstanding my high regard for Dr. Ron Paul I have not shared in prognostications of hyperinflation, poverty, and possible street violence.  If such sentiments have occurred at, whose columnists trend to the classical liberal rather than Austrian model preferred by Dr. Paul, they are vanishingly rare.  To indict by imputing Dr. Paul’s views here suggests a lack of familiarity with these publications.  There are some crucial distinctions to which his attention hereby is invited.

There are some civil disputes amongst various camps of gold standard proponents.  They are far less material than the demonstrably incorrect fallacy that the authentic gold standard has deflationary tendencies which precipitated the Great Depression.  Once this fallacy is dispelled, James Pethokoukis and Ramesh Ponnuru may find it congenial to adopt a different posture in the — steadily rising — debate over the gold standard.  They, as do Profs. Beckworth and Sumner, might find themselves arguing for their version of a better policy rather than denigrating the case for gold standard as, in Pethokoukis’s words, “pretty awful.”

To be continued.

Originating at


Janet Yellen, Politicizing the Fed?

Janet Yellen gave a widely noted speech, Perspectives on Inequality and Opportunity from the Survey of Consumer Finances, at the Conference on Economic Opportunity and Inequality held  by the Federal Reserve Bank of Boston on October 17th.

The speech presented as a if ghostwritten for her by Quincy Magoo, that beloved cartoon character described by Wikipedia as “a wealthy, short-statured retiree who gets into a series of comical situations as a result of his nearsightedness compounded by his stubborn refusal to admit the problem.” What was most interesting was how political was the speech… and what Madame Yellen didn’t say.

Her omission even raised an eyebrow of one of the commentariat’s most astute Fed sympathizers, The Washington Post‘s Ylan Q. Mui. Mui:  “Yellen did not address in her prepared text whether the Fed has contributed to inequality. Nor did she weigh in on whether it may actually be slowing down economic growth, an idea that is gaining traction among economists but which remains controversial.”

Yellen’s speech drew a public comment from the Hon. Steve Lonegan, director of monetary policy for American Principles Project and project director of its sister organization’s grass roots campaign (which I professionally advise):

There is a strong correlation between the post-war equitable prosperity to which Madam Yellen alluded and the post-war Bretton Woods gold-exchange standard.  And there is a strong correlation between the increase in inequality under the Federal Reserve Note standard put into effect by President Richard Nixon to supplant Bretton Woods.

The monetary policy of the United States has a profound impact on wage growth and prices, both domestically and internationally.  Hence the importance of a thorough, objective, and empirical look at its policies — from Bretton Woods through the era of stagflation, the Great Moderation, and the “Little Dark Age” of the past decade.

That is why the Brady-Cornyn Centennial Monetary Commission, and the Federal Reserve Transparency Act which recently passed the House with a massive bipartisan majority, are critical steps forward to ending wage stagnation and helping workers and median income families begin to rise again.  As President Kennedy once said, “Rising tide lifts all boats.”

Madam Yellen addresses four factors in what she calls “income and wealth inequality.”  Madame Yellen stipulates that “Some degree of inequality in income and wealth, of course, would occur even with completely equal opportunity because variations in effort, skill, and luck will produce variations in outcomes. Indeed, some variation in outcomes arguably contributes to economic growth because it creates incentives to work hard, get an education, save, invest, and undertake risk.”

Even with that ostentatious stipulation, the Fed Chair’s speech is amplifying one of the Democratic Party’s foremost election themes, “income inequality.”  The New York Times‘s Neil Irwin observed of this speech: “Nothing about those statements would seem unusual coming from a left-leaning politician or any number of professional commentators. What makes them unusual is hearing them from the nation’s economist-in-chief, who generally tries to steer as far away from contentious political debates as possible.”

Her speech could be read as an Amen Corner to Elizabeth Warren’s stump speech, on behalf of Sen. Al Franken’s reelection effort, that The game is riggedand the Republicans rigged it.Her speech could be read as a little election-season kiss blown to Sen. Franken (D-Mn), who voted for her confirmation and then glowed on Madame Yellen very publicly.

One cringes at the thought that the Fed even might be giving the appearance of playing politics.  To align the Fed, even subtly, with either party’s election themes during an election season would seem a deeply impolitic, and unwise, violation of the Fed’s existential principle of political independence.  House Financial Services Committee chair Jeb Hensarling and Sen. Mike Crapo (R-Id), should he accede to the chairmanship of the Senate Banking Committee, might just wish to call up Madam Yellen for a public conversation about avoiding even the appearance of impropriety.

The Fed’s independence is as critical as it is delicate. To preserve it demands as much delicacy by the officials of the Federal Reserve System as by the Congress. As Barack Obama might say, here is a “teachable moment” for our new Fed chair.

Also troubling is the decision by the Chair to focus her mental energy, and remarks, on four areas entirely outside the Fed’s jurisdiction: resources available for children; higher education that families can afford; opportunities to build wealth through business ownership; and inheritances.  These might be splendid areas for a president’s Council of Economic Advisors (which Madame Yellen chaired, commendably, under President Clinton).  Good topics for a professor emerita at the University of California, Berkeley, Haas School of Business, as is Madam Yellen.

They are, however, at best mere homilies from the leader of the world’s most powerful central bank. We would like to hear Madam Yellen talk about monetary policy and its possible role in the diminishing of economic mobility. It does not seem like too much to ask.

Since Madame Yellen, rightly, is considered an eminent Keynesian (or Neo-Keynesian), why not begin with Keynes? In The Economic Consequences of the Peace, Chapter VI, Keynes addressed this very point. The brilliant young Keynes was addressing the insidious power of inflation, not now in evidence and not portended by the data.  Yet let it be noted that there is more than one way to debauch a currency:

Lenin is said to have declared that the best way to destroy the capitalist system was to debauch the currency. … By this method they not only confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some. The sight of this arbitrary rearrangement of riches strikes not only at security, but at confidence in the equity of the existing distribution of wealth. Those to whom the system brings windfalls, beyond their deserts and even beyond their expectations or desires, become ‘profiteers,’ who are the object of the hatred of the bourgeoisie, whom the inflationism has impoverished, not less than of the proletariat. …

Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.

America and the world needs, and rightly expects, the chair of the Federal Reserve to be that one in a million able to diagnose.  Madame Yellen is called upon to step up her game and pivot from pious homilies to the heart of the matter.  If Keynes could call out how bad monetary policy can strike “at confidence in the equity of the existing distribution of wealth,” perhaps so too ought his followers.

What is to be done? Wikipedia also observes of Mr. Magoo that “through uncanny streaks of luck, the situation always seems to work itself out for him, leaving him no worse than before.”  We devoutly hope that Madame Yellen — and, thus, the economy — will be the beneficiary of “uncanny streaks of luck.”  Hope is not a strategy.  Relying on luck tautologically is a dicey way of bringing America, and the world, to a renewed state of equitable prosperity.

Rely on luck?  It really is time to shift gears.  An obvious place for Madame Yellen to begin would be to register active support for the Brady-Cornyn Centennial Monetary Commission designed to conduct a thorough, empirical, bipartisan study of what Fed policies have worked.   What policies of the Federal Reserve have proven, in practice, or credibly portend to be, conducive to equitable prosperity and healthy economic mobility?

Should the correlation between the (infelicitously stated if technically accurate) “40 years of narrowing inequality following the Great Depression” and the Bretton Woods gold-exchange standard be ignored?  Why ignore this?  Should the tight correlation of “the most sustained rise in inequality since the 19th century” with the extended experiment in fiduciary dollar management be ignored? Why ignore that?

What might be learned from the successes of the Great Moderation inaugurated by Paul Volcker?  Is Volcker’s recent call for a “rules-based” system, a position from which Madam Yellen staunchly dissents, pertinent? Discuss.

Madame Yellen?  Let’s have a national conversation about monetary policy and its effects on economic mobility.  It really is time to bring to a decisive end many decades of Magooonomics and the disorders that derive therefrom.  Fire Magoo.  Show the world that you are Keynes’s one in a million.

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