A former RAF aviation engineer and software engineer in the financial sector, Steve Baker has been the Conservative MP for Wycombe, Buckinghamshire since 2010. Recently he was elected by his colleagues to the Treasury Select Committee, where he has put questions to Bank of England Governor Mark Carney, and he has also sponsored a Parliamentary debate on ‘Money Creation and Society’. He is an outspoken follower of the Austrian Economic School, and is an advocate of ‘free banking’ and the de-nationalisation of money. In this interview, Steve shares his views on money, banking and economics generally; why he chose to enter into politics; his plans for the next Parliament; and the prospects for sound money and banking in the UK and around the world.
BY WAY OF BACKGROUND…
Steve Baker has been fascinated by machines since his youth growing up in Cornwall. He studied Aerospace Engineering at Southampton University through a University Cadetship programme, entering the RAF on graduation, and served his country in multiple international locations for 10 years.
Also fascinated by information technology, on leaving the RAF in 1999 he studied towards a degree in Computer Science at St Cross College, Oxford. He then worked in a number of IT roles, including at Lehman Brothers in 2006-08, leading into the global financial crisis. His personal website (here) makes plain that, “My work at Lehman Brothers particularly informs my present work on reforming the financial system.” He decided to enter politics in 2007 and was elected to Parliament on his first attempt in 2010.
Steve is hardly the only sitting MP to focus on financial and banking issues. But he is the only Conservative MP to openly advocate for fundamental reform of not just banking, but of money itself. This is due to his outspoken belief in the key tenets of the Austrian Economic School, which teaches that activist monetary and fiscal policies undermine long-term economic health. To begin our discussion, we explore how Steve experienced the 2008 financial crisis and the impression it made.
JB: Steve, you had been working at Lehman Brothers for about two years when the financial crisis hit in 2008. Did you ever have a sense that the firm was dangerously exposed to a potential crisis? That the firm’s high leverage and a reliance on short-term financing could bring it down? That the financial system in general was as fragile as it demonstrably was?
SB: Back when Lehman was posting record quarter after record quarter, I was focussed on delivering value through software and I still believed our masters understood the institutional superstructure of the economy. It was only when the bust came that I realised the Austrian School had crucial insights to offer which were missing from the mainstream.
JB: How exactly did you come to believe that the Austrian Economic School provided the best explanation for the 2008 financial crisis and also for understanding economics more generally? Was this a gradual process or rather something more like a sudden epiphany?
SB: It was a long process. I first read Mises’ The Causes of the Economic Crisis and Hayek’s Monetary Theory and the Trade Cycle in 2000 during my MSc in Computer Science. I was planning to make my fortune in software, but then the dot-com bust happened. I wanted an explanation and found it in these books. However, my priority was business and I didn’t have the confidence to start telling economists where they were going wrong. It was only after working for banks and their regulators that I realised key insights about epistemology and method were absent from mainstream economics in important ways. That caused me to read more deeply, co-found The Cobden Centre with Toby Baxendale and then use my Parliamentary position to promote better economic policies.
JB: Please describe what it is you mean by free banking and money. Most people just take national fiat money and heavily-regulated banking for granted. Of course this was not always the case. But then have free banking and money really ever been the norm? Why is this topic of such importance to you?
SB: By ‘free-banking’ I mean money and a banking system produced by the spontaneous co-operation of free individuals in markets. It is what Hayek proposed in his Denationalisation of Money and HM Treasury briefly worked in that direction as an alternative to the euro. Usually, free banking means gold (or silver) as the base money and banking conducted under the ordinary commercial law, usually with unlimited strict liability. Canada and Scotland historically came closest to free banking. In a future free-banking system, cryptocurrencies or blockchain technologies of some sort are likely to have a role. Sound money is crucial to the justice of social processes.
JB: When and how did it occur to you that, by entering politics, you could contribute to changing the terms of debate around money and banking, when neither major UK party seemed to have any interest in doing so?
SB: Originally, it was the scandal of the Lisbon Treaty – the mangled EU Constitution – which prompted me to seek election to deliver an in/out referendum. It seems I may have played my part in reaching that objective but that decision was reached in 2007, before the crash. Once the crash came, when I had no realistic expectation of being elected, I decided to establish an Austrian School think tank. My surprise selection for a Conservative-held seat and election to Parliament changed everything.
JB: Please describe your experience in Parliament to date. What is it like to be something of a ‘maverick’ MP on the issues of money and banking? Is it encouraging? Discouraging?
SB: It’s hugely encouraging but hard work and I always appreciate support. As far as I am aware, I have no original ideas in this field and, being wary of the fringes of debate, I keep close to established literature. As a result, I seem to be attracting colleagues to at least consider the possibility that the Austrian School has a better answer to the question—famously asked by HM the Queen—of how the financial crisis could have happened. People know I am unorthodox but they also know I am grounded in credible literature. They also recognise the call for lower taxes, balanced budgets and sound money as distinctively Conservative. I suppose the difference is I really mean it; I don’t just say such things in hope of being elected.
JB: You recently sponsored a Parliamentary debate on ‘Money Creation and Society’? What was the purpose of the debate and do you believe that it achieved your objectives?
SB: Prominent Constitutional fiat money advocates Positive Money were agitating for a debate and they have strong national support. Despite disagreeing on many things, I am one of their best contacts in Parliament. The timing of the debate corresponded with their campaigning activity. However, of course I have spoken many times in the same vein, beginning with my maiden speech. Positive Money had created sufficient support for a debate in the main chamber to be possible and I was glad to lead it. We meant to move the debate forward and we did: I have received messages of support from around the world.
JB: Having recently achieved selection to the Treasury Select Committee, you have now had the opportunity to engage with Bank of England governor Mark Carney on multiple occasions. While he is obliged to answer your questions, do you find his answers satisfactory? Or evasive? Does it seem to you that the Bank of England is properly accountable to Parliament? Or is it able more or less to set policy on its own? If you could change anything about the existing governance of the Bank of England—other than abolishing it—what would that be?
SB: It is always a huge pleasure and privilege to ask questions of the Governor, who also chairs the G20 Financial Stability Board. Mark Carney is undoubtedly the central banker of his generation, full of talent and statesmanship. He knows where I stand. Perhaps our good-natured jousting can sometimes be seen in the sessions. His answers are mainstream and remember he has a dreadful power to shift markets with every word. He is sometimes breathtakingly honest—for example in relation to the shortcomings of mathematical models—but it is right that he has regard to the potential for his words to reverberate through markets. This factor has no place in a free society, of course, but we are where we are. The Bank is accountable to Parliament and the officials evidently take this seriously. The Bank operates within its mandate and that means it reaches policy decisions independently of politicians.
Given that, like Walter Bagehot [ed. note- Bagehot was Editor-in-Chief of The Economist from 1860 to 1877 and wrote extensively on fundamental economic and financial issues], I think the ideal system would not include central banks, your last question is hard to answer. I would have the Bank produce research that questions their groupthink and they are doing so. It will be a long time yet before we win the argument but having the Bank itself challenge orthodoxy may be an important breakthrough.
JB: Assuming that you and the Conservatives are re-elected in the coming months, what plans do you have for the next Parliament? What goals are realistic? And if you’re optimistic, what might be achieved over the next five years?
SB: Nationally, we must balance the budget. In all the circumstances, this will remain a tough problem. Personally, I would like to be re-elected by my colleagues to the Treasury Committee so I can continue to work on changing the terms of debate.
JB: How do you feel about the growing UK independence movement? Do you believe that the UK is more likely to fundamentally reform money and banking inside or outside the EU?
SB: People across the political spectrum are awakening to the reality that state power has escaped democratic control and that awakening is a good thing. The challenge is to hold politics together while a coalition for democracy and liberty is built, especially bearing in mind that it is the classical liberal and conservative family that is awakening first. A further fragmentation of the centre-right would be bad news for democrats and advocates of liberty.
Realistically, monetary reform is likely to come from either spontaneous market action or global reform of the post Bretton-Woods system. I don’t think the UK is likely to reform sterling unilaterally but this could happen provided we retain our own currency. I imagine Switzerland is culturally better-placed to reform independently, especially now they have decoupled from the euro. Maybe Russia will dramatically disrupt geopolitics with the reform you describe in your book. [Ed. note- I have suggested that Russia might respond to escalating international tensions by backing the rouble with gold. See here.]
JB: Do you regard the government’s ‘austerity’ policies to have been a success? How would you define ‘success’?
SB: Success would be a balanced budget. More work is required and the longer I spend in politics, the clearer it becomes that turning around a democracy is not like turning around a private company. The Chancellor has been more successful than most other finance ministers. I will continue to support him in so far as I can.
JB: To expand on the above, you are more aware than most about the deteriorating state of UK public finances and of the large imbalances in the economy more generally, such as the excessive reliance on property and financial services, and the chronic trade deficit with the rest of the world. Is it hard to be optimistic for the future when history suggests that the UK economy is going to remain weak for many years even in a relatively benign, non-crisis scenario in which these imbalances and excesses are worked off?
SB: In truth, it is often hard to be optimistic when you have “taken the red pill” of Austrian School economics. On the one hand, I am glad so many more people are now in private sector employment but on the other, as I have explained many times, the trajectory of debt and the continuing abuse of currencies is of grave concern. The future of our civilisation may be at stake.
JB: You co-founded the Cobden Centre, the leading sound money and banking think-tank in the UK. What do you see as the CC’s core mission? How exactly do you see the CC making a difference in future? Through education? Practical policy recommendations?
SB: The Cobden Centre’s core mission is to promote classical liberalism and specifically the Austrian School, that is, social progress through honest money, free trade and peace. It does not do politics but ideas and education. There is much more to do. Those interested in learning more can visit the website at www.cobdencentre.org and potential donors are welcome to send an email to email@example.com!
JB: Thanks so much for your time Steve. Before we conclude, are there any other thoughts you would like to share with our readers, many of whom work in the financial industry and would be profoundly affected by the sort of money and banking policies you advocate. What sort of impression would you hope they would take away from our discussion today?
SB: I hope readers will read your reports and your book, The Golden Revolution, and Detlev Schlichter’s complimentary work Paper Money Collapse. I hope they will read Mises and Hayek. If financial professionals cease opposing honest money and banking will we achieve the greatest institutional reform of our age: money and banking subject to competition and free of ruinous state control.
JB: Thank you so much Steve for your time.
POST-SCRIPT: REAL REFORMS REQUIRE
The value of Steve’s prominent role in promoting sound money and banking cannot be overstated. His leadership is an inspiration to all who would seek a better economic future. The best hope for real reform is to pressure the system both from within and from without. I encourage all readers to support Steve in his efforts in Parliament; through the educational resources of the Cobden Centre; and through their own private initiatives, whatever they might be.
Currently serving as the Chief Investment Officer of a commodities
fund, John was previously Managing Director and Head of the Index Strategies Group at Deutsche Bank in London, where he was responsible for the development and marketing of proprietary, systematic quantitative strategies for global interest rate markets.
A cum laude graduate of Occidental College in California, John holds a Masters Degree in International Finance and Economics from the Fletcher School of Law and Diplomacy, associated with Harvard and Tufts Universities.
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25 January 15 | Tags: Bank of England, Central Banking, Honest Money, Insight, monetary policy, Steve Baker MP | Category: Economics | Leave a comment
Pyongyang, evidence shows, effected a spectacular data breach of Sony Pictures to express its wrath over Evan Goldberg and Seth Rogan’s The Interview, a movie about an attempt to assassinate Kim Jong-un. Neither the United States Secret Service nor the North Korean authorities take portrayals of the assassination of our respective incumbent supreme leaders lightly. But there is something more going on here.
North Korea’s actions were characterized by RedState as “unequivocally an act of 21st-century state-sponsored cyberwarfare and, indeed, state-sponsored terrorism.” This is overstated. North Korea really upped the ante by vigilante (rather than vandalism) action.
The lashing out against The Interview presents as an “occult war” by the pre-modern culture (and government) of Pyongyang. The Interview Incident has strong echoes of an almost forgotten event, from the 1960s, when Indonesia’s President Sukarno also acted out. As recounted by the late (and very wise) British career civil servant Austin Coates, in his book China, India and the Ruins of Washington:
Konfrontasi consisted principally of creating continuous threatening uproar by radio, by hostile speeches and clamor in the Indonesian newspapers. Minor disturbances were created along the frontiers of Sarawak and Sabah … and acts of sabotage occurred…. … … The entire thing was in fact a modern version of the medieval practice whereby kings endeavored to overcome their rivals by occult means; and in that Sukarno succeeded by these occult means (radio, press, and speeches in the United Nations) in restoring Irian Barat, or West New Guinea, to Indonesia, the method revealed itself as being not entirely ineffective in the twentieth century.
In fact, Sukarno is the most interesting survival phenomenon in the contemporary Orient. His speeches at the time of Konfrontasi were so imbued with the simulated concept of centrality as to sound like an echo from another age.
It would be flying in the face of historical evidence to imagine that this will be the last attempt to imitate the center. … But all such endeavors will be pointless.
Without, in any way, exonerating international vigilantism — by the modern “occult” means of black hat hacking and “threatening uproar” — this implies, among other things, that Sony Pictures acted responsibly. It had not intended, and was not prepared to fight, an “occult war” with Pyongyang.
“Occult” — primarily, here, meaning symbolic, or psychological — warfare hardly is unknown in the West, ballots having replaced bullets. For instance, an “occult war” has been and continues to be waged by a “threatening uproar” in the media over the gold standard. Entirely coincidentally, around the time the donnybrook over The Interview began North Korea itself briefly enlisted, sotto voce, in the “occult war” against the gold standard.
The North Korea Times (the “Oldest online newspaper in North Korea”) engaged under the dramatic headline Spectre of gold standard banished on December 2, 2014. The Times republished this letter from Thailand’s The Nation:
Thanong Khanthong delivers an excellent insight on gold but offers the scary conclusion that “Europe is tilting towards a gold standard of some sort [and] the days of the fiat currency regime could be numbered”.
Fortunately, on Sunday, 77 per cent of Swiss voters overwhelmingly rejected the call for their currency to be anchored by gold reserves. Switzerland’s finance minister hailed the vote as a show of confidence in the central bank and a realisation that “gold is no longer as important as it once was as a tool to back up paper money”. In other words, gold is important only if people do not trust their central bank. In the modern world, trust is the basis of the fiat currency regime that superseded the long-gone gold standard. The return of that standard will come only when the end of the world is nigh.
Thanong Khanthong, managing editor of the Nation Multimedia Group in Thailand, had written a column entitled Gold rush in Europe as concern over money printing rises, subheadlined “Many European countries are now moving to repatriate their gold holdings from storage abroad. They are also looking to increase the proportion of gold in their international reserves to assure currency and financial stability.” The North Korean Times‘s echo of a riposte against a growing trend away from central, to decentralized, monetary policy assuredly was meant to help exorcise this phenomenon.
Kim Jong-un’s regime quietly adds its voice to that of other potent “occult” adversaries on the left of the gold standard. These adversaries include Paul Krugman, Brad DeLong, Nouriel Roubini, Charles Postel, Thomas Frank, Think Progress’s Marie Diamond, the Roosevelt Institute’s Mike Konczal, Brookings Institutions’ Barry Bosworth, The New York Times’s economics blogger Bruce Bartlett, the Washington Post’s Matt O’Brien, Slate’s Christopher Beam, andUS News & World Report’s Pat Garofalo, and … 40 out of 40 elite academic economists polled some time ago by the Booth School.
It is not unfair to call the left’s opposition to gold “occult.” Our elite intelligentsia, relying on dogma, unleashes hostile words in the media — rather than engaging in reasoned argument — to assassinate the reputation of the gold standard. Our own culture is not always so modern as usually supposed.
In a recent interview at the Lehrman Institute’s gold standard website, which I edit, the estimable economic historian Prof. Brian Domitrovic made these observations:
Academic economic history has hitched its wagon to a particular star, the trashing of the gold standard. The funny thing is that this stuff really didn’t intensify, in academic economic history, until the 1980s, when the conditions were actually beautiful for a return to the gold standard. Students of economic history were not so foolish as to endorse fiat currency in the 1940s, as Bretton Woods was gathering, even though Keynes was urging just that. Paul Samuleson and a few others were trashing gold in the 1950s and 60s, but that was not the norm. …
The publication of Barry Eichengreen’s Golden Fetters, his essays from the 1980s, was a decisive event in cementing the anti-gold standard position in the academy. And Ben Bernanke was such a lionizer of Eichengreen’s that it would prove very fateful if he were accorded high governmental office, which happened twice (Chair of the Council of Economic Advisors and the Fed). So the anti-gold view became part of the dominant political culture.
The central command and control management of the dollar by the Fed, in place since President Nixon, has done and is doing vastly more damage to the American (and world) economy than the hacking and harassment of Hollywood by another command-and-control power. This does not exonerate Pyongyang, nor does it imply that Paul Krugman is receiving secret overnight telegrams from Kim Jong-un. It simply observes that our own intelligentsia consistently ignores the empirical data and behaves in pre-modern ways.
The left, whether based in Pyongyang or City College, too often relies very much on “occult means” — such as vituperation — to make its points. “But all such endeavors will be pointless.”
Meanwhile, back in the realm of the “occult,” skirmishing continues. The Hobbit’s dragon Smaug — from Peter Jackson’s movie — recently gave Steven Colbert his endorsement of the gold standard (and Rand Paul):
Stephen Colbert: Now Smaug, I think that we both have a lot in common. We both live in gated communities, and we’re both fiscal conservatives who sleep on giant piles of money.
Smaug (voiced by Benedict Cumberbatch): Quite right! Time to return to the gold standard. Rand Paul 2016 Yea! Get some Rand!
While this was meant as public ridicule — am “occult” technique — by Colbert it bears an interesting subtext. As Kenneth Schortgen Jr wrote of this exchange in examiner.com:
Although scripted and made for television, the interview between a fictional dragon from ancient times and a comedic pundit in the 21st century was fascinating in many aspects, and in many ways showed that the real time events we experience in our modern world are no different than similar events that were played out by different characters and plot lines from hundreds or thousands of years ago. …
They say that history doesn’t just repeat itself, but it also rhymes, and watching this fictional made for television interview shows that indeed, there is nothing new under the sun. And while technologies may be different, and the stock of human existence may be better or worse today than in the past, what occurred during the lifetime of a storybook dragon and civilization proves the old axiom that truth is quite often stranger than fiction, or perhaps, it simply mirrors it in imagination and reality.
“The word is slowly, if almost unnoticeably, moving back to embrace the gold standard. Russia, China and India are leading the drive by accumulating gold reserves” and Song Xin, president of the China gold Association … wrote in Sina Finance in July this year: ‘Gold is money par excellence in all circumstances and will help support the renminbi [yuan] to become an international currency, as gold forms the very material basis for modern fiat currencies.’”
Dogma really is medieval. Reality — the very fine track record of the gold standard in establishing equitable prosperity — surely will, in time, prevail. “The world is slowly, if almost unnoticeably, moving back to embrace the gold standard.”
Ralph Benko is senior advisor, economics, for American Principles in Action, in Washington, DC, specializing in the gold standard and advisor to and editor of the Lehrman Institute's The Gold Standard Now. He is editor-in-chief of thesupplyside.blogspot.com. With Charles Kadlec, he is co-author of The 21st Century Gold Standard: For Prosperity, Security, and Liberty available for free download here. Benko and Kadlec are co-editors of the Laissez Faire Books edition of Copernicus's Essay on Money. He also manages the Facebook page The Gold Standard. Follow him on Twitter as TheWebster. | Contact us
2 January 15 | Tags: Ben Bernanke, gold standard, Honest Money, Paul Krugman | Category: Politics | Comments are closed
On November 3, the Manhattan Institute hosted the fall meeting of the Shadow Open Market Committee (SOMC). This is a 40-year old group, with many illustrious economists among its membership, starting with its founder, Allan Meltzer.
The SOMC is not shy about criticizing the Federal Reserve, though they remain committed Monetarists. These students of the Chicago School make a great show of their dispute with the followers of John Maynard Keynes. Monetarists lean more towards free markets, but both schools share one key idea: fiat currency.
It’s interesting that most people assume that former Fed Chairman Ben Bernanke and current Chair Janet Yellen are cut from the same cloth. That’s because their policies have been indistinguishable in practice. However, Bernanke is a Monetarist who openly credits Milton Friedman and Yellen is part of the New Keynesian School.
Distinguished Professor of Economics at Rutgers University, Michael Bordo spoke on a panel at the SOMC meeting. In his remarks, he made an offhand dismissal of gold. The SOMC had considered the gold standard, but rejected it.
During the Questions and Answers period, I had an opportunity to ask a question. I began by noting that the Fed is the central planner of money and credit. I asked why the SOMC didn’t favor gold and a free market in money. Professor Bordo didn’t want to respond, so the panel moderator, Carnegie Mellon economics professor Marvin Goodfriend, responded. He told the audience and me that we could revert to the gold standard as a last resort. But, he said, he is an “optimist” (his word) and believes that the Fed can do better.
Forget the endless debasement of the value of the dollar. Forget the economic alphabet soup of GDP economy, CPI inflation, M0 money supply, and U6 unemployment. Eyes glaze over when these technical topics are debated, and they’re just a distraction from a timeless question. Can men be trusted to conduct their own affairs voluntarily? Or should some be appointed to rule the affairs of others by force?
In other words, free markets or central planning.
Philosophers and armies have battled over these two opposite visions for millennia. Through most of the 20th century in much of the world, central planning won. So did the Grim Reaper. The socialist experiments in Russia, China, and so on racked up a body count of well over a hundred million. America isn’t there yet, but it’s trending in that direction. Just ask the family of Eric Garner, a man recently choked to death by the police, in an incident that began over a cigarette tax.
The Russians and Chinese didn’t die merely because the wrong people were in charge. However, if central planning puts the Stalins and Maos in control, then that’s a compelling argument against central planning by itself.
They died because central planning cannot even deliver food. Food requires plowing, planting, harvesting, and distribution. These are simple activities, yet socialism is unable to organize them. The socialists inherited food-producing countries, and made it impossible to produce food.
Most countries are smart enough not to again attempt central planning of food. Instead, they think they can make it work with something much more complex: money and credit.
I want to shine a spotlight on that curious word of Professor Goodfriend. Optimism, he said, was the basis for his belief in central planning. I think we are way past the point where that claim deserves any serious merit. Whatever word one may use to describe a belief in central planning, it is not optimism.
Let’s not get distracted with debating the details of central banking, such as the ideal money supply growth. Central banking is the monetary system of socialism, which is why Karl Marx included it in his ten planks. By contrast, gold is the monetary system of the free market.
That’s the issue. Freedom or socialism. Gold or fiat currency. A free market or the Fed’s central planning. Life and happiness, or poverty and death. Take your pick.
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 basis.
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.
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.
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 http://www.epictimes.com/richardebeling/2014/12/the-case-for-monetary-freedom-and-free-banking/]
[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.
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).
Max Rangeley is the Editor of The Cobden Centre. He is the CEO of ReboundTAG Ltd, which produces microchip luggage tags and has been showcased by Lufthansa and featured on BBC World among other media outlets. Max has a Master’s in economics, following this he was given a scholarship to do a PhD at the London School of Economics, but decided instead to go straight into business. | Contact us
4 December 14 | Tags: gold standard, Honest Money, Inflation, Jacques Rueff, monetary policy | Category: Economics | Comments are closed
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.
[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.
“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:
“THE MOST IMPORTANT ATTRIBUTE FOR SUCCESS IN VALUE INVESTING IS PATIENCE, PATIENCE, AND MORE PATIENCE. THE MAJORITY OF INVESTORS DO NOT POSSESS THIS CHARACTERISTIC.”
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.”
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.
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?
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.