I chanced this morning on the superb collection of essays from Ludwig von Mises, The Causes of the Economic Crisis and Other Essays Before and After the Great Depression (PDF).
In his Stabilization of the Monetary Unit—From the Viewpoint of Theory written in 1923, he showed considerable foresight:
Only the hopelessly confirmed statist can cherish the hope that a money, continually declining in value, may be maintained in use as money over the long run. That the German mark is still used as money today [January 1923] is due simply to the fact that the belief generally prevails that its progressive depreciation will soon stop, or perhaps even that its value per unit will once more improve. The moment that this opinion is recognized as untenable, the process of ousting paper notes from their position as money will begin. If the process can still be delayed somewhat, it can only denote another sudden shift of opinion as to the state of the mark’s future value. The phenomena described as frenzied purchases have given us some advance warning as to how the process will begin. It may be that we shall see it run its full course.
Obviously the notes cannot be forced out of their position as the legal media of exchange, except by an act of law. Even if they become completely worthless, even if nothing at all could be purchased for a billion marks, obligations payable in marks could still be legally satisfied by the delivery of mark notes. This means simply that creditors, to whom marks are owed, are precisely those who will be hurt most by the collapse of the paper standard. As a result, it will become impossible to save the purchasing power of the mark from destruction.
And in 1946, he commented on using easy money and deficit spending to stimulate the economy after a long period of cheap credit (The Trade Cycle and Credit Expansion):
In discussing the situation as it developed under the expansionist pressure on trade created by years of cheap interest rates policy, one must be fully aware of the fact that the termination of this policy will make visible the havoc it has spread. The incorrigible inflationists will cry out against alleged deflation and will advertise again their patent medicine, inflation, rebaptizing it re-deflation. What generates the evils is the expansionist policy. Its termination only makes the evils visible. This termination must at any rate come sooner or later, and the later it comes, the more severe are the damages which the artificial boom has caused. As things are now, after a long period of artificially low interest rates, the question is not how to avoid the hardships of the process of recovery altogether, but how to reduce them to a minimum. If one does not terminate the expansionist policy in time by a return to balanced budgets, by abstaining from government borrowing from the commercial banks and by letting the market determine the height of interest rates, one chooses the German way of 1923.
The Bank of England hopes to avoid all this by manipulating people’s expectations about inflation and GDP growth. I don’t think it can be done – too many commentators can see through it.
Nevertheless, they are going to give it a try. The best that can be said for it in the context of the German experience which Mises predicted and lived through is that at least if coming events are well understood, contemporary errors may at last produce the paradigm shift in economic thought necessary to put us on a more just and moral economic path.
This post originally appeared on www.stevebaker.info.
“…the stoppage of issue in specie at the Bank [in 1797] made no real addition to the financial powers of the country. On the contrary, it diminished considerably the real efficiency of those powers, while it introduced a facility in money-transactions, which has cost the country more in real comfort, and will probably cost it more in lasting expense, than any circumstance that has ever occurred.”
“If there had been less facility, there probably would have been more utility in those transactions; money would have been more valuable and more valued. The [fixed income] stocks probably would have been lower in price, but certainly no less deserving of confidence. There would have perhaps been a larger discount on floating [short-dated] securities; but there would have been fewer complaints of the expense of living; and, above all, the country would have had the unimpaired glory of having resisted all dangers from without, as well as within, without the sacrifice or suspension of any one principle of public faith.”
Reply of Walter Boyd to a letter from a friend sent 9th January, 1801
‘The Future of Finance’ was a conference convened in May by the Knowledge Transfer Network with the support of, among others, the Institute for New Economic Thinking and Oxford’s Said Business School. As part of the programme, a debate was staged between the representatives of four ‘schools’ of economic thought – the Monetarists, as represented by the former ‘Wise Man’ Professor Tim Congdon; the Keynesians, as championed by Christopher Allsopp, formerly of the BoE’s MPC; the Complex Adaptive Systems approach of Professor Doyne Farmer of ‘Newtonian Casino’ fame, and the Austrians whose corner was fought by yours truly.
The following essay attempts to expand upon the arguments I made that night in what was obviously a much more concise form, together with some more general thoughts thrown up by the conference at large. Since the event in question was deliberately – if courteously – adversarial and given that it was consciously staged as a species of entertainment, rather than one of deep academic debate, it will be apparent that none of us protagonists were fully able to develop our views beyond what could be incorporated into a few minutes’ pitch to our audience.
Moreover, none of us were allowed any subsequent opportunity for further attack or rebuttal, but could only respond, in the round, to a sampling of questions posed by the audience. In the circumstances, if the arguments of my opponents seem in anyway superficial as I summarize them here, I trust they will be gracious enough to accept, by way of an apology, the acknowledgement that my own propositions on the night will have seemed no less denuded of context or justification than perhaps did theirs.
Their bloody sign of battle is hung out
Ladies and Gentlemen, if you have heard of us ‘Austerians’ at all, you probably have in mind a caricature of us as loony liquidationists, eager for a Bonfire of the Vanities in which to purge the sins of all those who seem to have enjoyed the late Boom rather more than we did as we paced up and down outside the party, weighed down with our sandwich boards on which were emblazoned the injunction, “Repent Ye now for the End is nigh!”
Naturally, I don’t quite see it like that, nor do I feel shy about proclaiming our virtues over those supposedly possessed by the Tweedledee and Tweedledum of macromancy – the monetarists and the Keynesians – whose alternating and often overlapping policy prescriptions have, in the immortal words of Oliver Hardy, gotten us into one nice mess after another.
The monetarists – or perhaps we should call them the ‘creditists’, since they are not often overly clear about the crucial distinctions which exist between money, the medium of exchange, and credit, a record of deferred contractual obligation – tend to be children of empiricism. I hasten to add that, for an Austrian, there are few greater insults that can be bandied about: Mises himself once waspishly observed that the modern dean of monetarism, Milton Friedman, was not an economist at all, but merely a statistician.
To digress a moment, ‘money’ is different from ‘credit’ and the refusal to consider how, or in what manner is what leads to many errors, not just of thought but also of deed, for if there is one thing that modern finance is pre-eminently equipped to do, it is to transform the second into the first and thereby pervert the subtle webs of economic signalling which are so fundamental to our highly dissociated yet profoundly inter-dependent way of life.
We could of course come over all philosophical about money being a ‘present good’ – indeed, the archetypical present good – and about credit being a postponed claim to such a good. We could then go on to point out that, far from being a scholastic quibble, such a distinction is of great import to the smooth functioning of that vast assembly line which we call the ‘structure of production’ and that to subvert their separation is to call up from the vasty deep the never-quite exorcised demons of the ‘real bills’ fallacy and to begin to set in train the juggernaut of malinvestment which will soon induce a widespread incompatibility among the individually-conceived, yet functionally holistic schemes of which we are severally part and so lead us through the specious triumph of the Boom and into that grim realm of wailing and the gnashing of teeth we know as the Bust.
Later, we shall have more detail to add to this, our Austrian diagnosis of the role of monetized credit in the cycle, but for now let us instead point out that money is a universal means of settlement of debts and thus acts as a much-needed extinguisher of credit. In making this assertion, I have no wish to deny that the latter cannot be novated, put through some kind of clearing mechanism, and hence cross-cancelled, in the absence of money – as was the often nearly attained ideal aim at the great mediaeval fairs, for example – simply that the presence of a readily accepted medium of exchange greatly facilitates this reckoning. Furthermore, though a new crop of expositors has sprung up to make claims that credit is historically antecedent to money (though the plausible use of polished, stone axe-heads as a proto-money which was current all along the extensive Neolithic trade routes of 5,000 years ago might give us renewed cause to doubt this now-fashionable denial), this is hardly to the point in the present discussion.
Money may or may not have sprung up, as is traditionally suggested, to avoid the well-known problems of barter, but, however it arose, what it did do was obviate the even more glaring impediments of credit – namely that, as the etymology of the word reminds us, ‘credit’ requires the establishment of a bond of trust between lender and borrower, a trust whose validation is, moreover, subject to the vicissitudes of an ever-changing world by being a temporally protracted arrangement.
Thus, while money’s joint qualities of instantaneity and finality may confer decided advantages upon its users, its main virtue indisputably lies in the impersonal nature of its acceptance in trade for it is this which frees us from the limited confines of our networks of trust and kinship and so greatly magnifies the division of labour and deepens the market beyond all individual comprehension in a mutually beneficial, ‘I, Pencil’ fashion.
For its part, credit certainly may help us get by with less money, never moreso than when we have become drunk on its profusion and giddy at the possibilities this abundance seems to offer amid the boom. Then, we may truck and barter more and more by swapping one claim for another almost to the exclusion of the involvement of money proper but, as the great Richard Cantillon pointed out almost three centuries before Lehman’s sudden demise forcefully impressed the lesson upon us modern sophisticates once more,
…the paper and credit of public and private Banks may cause surprising results in everything which does not concern ordinary expenditure… but that in the regular course of the circulation the help of Banks and credit of this kind is much smaller and less solid than is generally supposed…
Silver alone is the true sinews of circulation.
This article is the first in a series. Continue to Part 2: Scylla & Charybdis.
There exists a certain amount of confusion today about what money truly is, how it originated and who should produce it (the government or private individuals). For this reason, it is useful to provide a brief summary of the origin or money and the differences between the various types of money. In this manner it will become clear that money should only be produced by the market.
According to Ludwig von Mises [i], money evolved from the practice of indirect exchange. Indirect exchange is where the seller of a particular good sells his good for another good, not for the purposes of consuming that that second good but because it is highly marketable. In other words, now that he has obtained this highly marketable good, he has full confidence that he can now sell it to obtain the consumption goods he ultimately desires. This highly marketable good is the common medium of exchange and is generally known as money. There are secondary functions (store of value, measure of value, etc.) but these merely derive from the medium of exchange function.
The question remains, why is this good so highly marketable in the first place? What original characteristics made it so desirable for people to use it as money?
To answer this question we must define what a good is. Carl Menger[ii] identifies the following prerequisites for a good:
- A human need for the item
- Capacity for the item to satisfy this need
- Human knowledge that the item can satisfy this need
- Sufficient control of the item such that one can satisfy their need.
Absent one or all of these prerequisites the thing ceases to become a good. Menger also notes that some items are treated by people as though they were goods even though they lack all four of these prerequisites. This occurs when attributes are “erroneously ascribed to things that do not really possess them” or when “non-existent human needs are mistakenly assumed to exist”. Menger called such items imaginary goods.
Next we must determine what makes a good valuable. Menger[iii] makes it clear that there are two qualities that imbue a good with value. The first is that it should be an economic (i.e. scarce) good. In other words, the requirements (or demand) for a good must be greater than the quantity of the good available. Second, men must be “conscious of being dependent on command of them for the satisfaction of our needs”. To summarise, only scarce goods which we know can satisfy our needs have value.
Now we know what a good is and what gives it value, but what makes it useful as money? According to Jorg Guido Hulsmann[iv], to be used as money the good must be marketable. It must be a commodity; i.e. a valuable good that can be widely bought and sold. One must know that if they sell their produce and receive this commodity in return, that they can instantly sell this commodity to obtain the goods they desire (i.e. food, clothing, etc.).
The monetary use of a commodity is derived from its non-monetary use. When we consider how money comes into being (through indirect exchange) we know this must be the case. This is because (as Hulsmann[v] tells us) the prices initially being paid for a commodity’s non-monetary use allow one to estimate the future price for the commodity when it is resold. This is the basis for its use in indirect exchange.
In the case of gold or silver, it is obvious that these commodities have a value independent of their monetary use. Gold has historically primarily been used as jewellery and today, like silver, it has many industrial uses that establish a non-monetary value.
It is clear now that paper money established by government fiat cannot have any non-monetary value. It is not a good (according to the definition by Menger) or a commodity that can be widely bought and sold. No man desires paper money for its own sake. It cannot satisfy any need of man. As such, the quantity available infinitely exceeds the requirements for it. It is valueless. It is arguably, an imaginary good, as described by Menger. Value has been attributed to it by the government even though none exists.
Paper money is useless to individuals and is only truly useful to the government which can use it to more easily tax us. But if fiat currency has no value why then do people accept it in payment for goods and services rendered?
Over time people became accustomed to accepting “paper” money certificates having previously received and transferred warehouse receipts in the form of banknotes. Nominally, these banknotes were backed by gold and people were generally confident of receiving gold from banks should they wish to redeem the banknote for such. (In truth, however, banks, generally holding fractional reserves, strongly discouraged their customers from redeeming their banknotes).
Later, the practice of fractional reserve banking in which such banks issue banknotes only partially backed by specie was legalised. In time only one bank (i.e. the central bank) was granted a monopoly on the issuance of banknotes governed by a gold standard in which each banknote can be exchanged for a fixed amount of gold.
This bank note monopoly would be reinforced with legal tender laws, put in place by the government. Having taken control of money in this way, the government can “fiddle” the money supply in its favour by manipulating the gold standard (by arbitrarily fixing the exchange rate between bank notes and gold) until finally specie payments are permanently suspended. At this point, the population has already become accustomed to paper money and whether or not it is backed by gold no longer seems important to them. There is no significant protest of what is in effect, an appalling violation of property rights. In the final stage, governments completely remove the gold backing from banknotes, granting them a new and powerful method of taxing the population.
Some critics argue that paper money has value not because of the government but because someone will always accept it. This of course does not take in account the progression described above nor does it consider what would happen in a free market of money. Were the government to cease its intervention in the money market people would attempt to hoard hard money (gold, silver, etc.) and spend only the paper money in an attempt to rid themselves of this worthless “currency”. Everyone would want to spend the paper money and no one would want to accept it. The value of paper money would quickly fall to zero in a free market. Paper money has nominal value today because the government has full control of money production.
Misconceptions of money
Confusion concerning the difference between gold money and paper money is common. To some money is money and what does it matter whether it is made of gold or paper? Going further, some observers suggest that the best way to determine which money is superior is to allow fiat paper money and gold money to circulate in the free market and see what happens. This is nonsense. As we have seen above, paper money has no value and without government support would vanish very quickly. Further, in a free market, there would be no such thing as fiat money.
A further misconception concerns the gold standard. There are those who propose that our monetary problems would be solved if we would only return to a gold standard. Often it seems that people confuse gold money with a gold standard. They are not the same. A gold standard is fundamentally a legal tender law established by the government. It sets up an exchange rate between banknotes and specie (gold) which can be modified to suit the government and suspended at will (in times of war for example) in order to raise funds via inflation or protect favoured banks from bankruptcy.
There are those who consider money to be credit and vice versa. While credit can conceivably serve as part of an indirect exchange (Hulsmann[vi]), it is not money per se. It has certain disadvantages when compared to commodity money. For example, credit is not homogeneous but can vary in terms of maturity, interest rate, amount, and of course the creditworthiness of the borrower. Credit money is unlikely to be widely traded by individuals since it carries credit risk (i.e. the risk that the borrower will be unable of repaying the credit note). Thus, it is unlikely that credit money will ever arise on the free market as the primary money. Rather, it will remain the primary province of investors and money lenders.
Why should money be produced by the market and not the government?
Money should and can only be produced by the market. The market will select the most efficient valuable commodity (gold, silver, etc.) as the optimal money. This protects individuals from the costs of monetary manipulation by government (including the ultimate results we are witnessing now, the collapse not just of major banks but also the governments who are their clients). Market selected money also reduces the likelihood and severity of the business cycle as it places a significant constraint on the fraudulent operations of fractional reserve banks.
Fiat paper money produced by the government represents a massive violation of people’s property rights and effectively amounts to fraud, counterfeiting and theft on a grand scale. There can be no rational ethical or economic argument in favour of government intervention in money. Fiat paper money is the tool by which government surreptitiously transfers wealth from the general population to itself or those whom it favours.
Can gold ever be inflationary?
Inflation is properly defined as an increase in the number of banknotes that is not backed by specie (i.e. gold). Defined thus, we can see immediately that an increase in gold does not cause inflation or result in the business cycle. As Murray Rothbard[vii] tells us and as discussed above, gold provides a non-monetary value in addition to its monetary value, and so an increase in gold implies an increase in the wealth of society (greater amounts of gold for industrial, medical or consumer purposes). Will prices of other goods in terms of gold increase? Possibly, but now we can see the confusion that can occur as a consequence of erroneously defining inflation as merely a rise in prices. An increase in gold would be no more an issue than an increase in the supply of iron ore, oil or any other critical raw material.
Inflation is a result of some form of fraud (fractional reserve banking) or counterfeiting. Consider the recent stories of tungsten filled gold bars – if true, then someone is getting something for nothing. The buyer of the gold bars is paying in anticipation of receiving the value of a certain quantity of gold but in reality is receiving significantly less. The buyer is receiving a “fraction” of the value he expects. The value of this “gold” bar has been inflated and losses will result. It follows therefore that losses will result from the fractional reserve system of banking, especially when the buyer of a gold certificate discovers that there is insufficient gold to cover the value of his certificate.
To conclude, we have found that the optimal money derives its value from its prior non-monetary use (i.e. that of being a valuable commodity). Paper money has no prior non-monetary use and thus derives its value from government legal tender laws. In other words, it has merely an imagined value. In free market, there would be no fiat paper money. Government has no place in the production of money. Free money protects the population from the costs of fractional reserve banking and stunts the growth of government. Furthermore, with free market gold money (or similar) inflation will be limited to the illicit activities of fractional reserve banks thus the length and depth of the business cycle will be greatly reduced.
Ludwig von Mises, The Theory of Money and Credit
(New Haven: Yale University Press, 1953) 30-37.
[ii] Carl Menger, Principles of Economics (Ludwig von Mises Institute, 2007) 52-53.
[iii] Ibid. 114-115.
[iv] Jorg Guido Hulsmann, The Ethics of Money Production (Ludwig von Mises Institute, 2008) 23-24.
[vi] Ibid. 28-29.
[vii] Murray Rothbard, The Mystery of Banking (Ludwig von Mises Institute, 2008) 47-48.
Previously published at Paper Money Collapse on Wednesday, 4 October.
In today’s Financial Times Mark Williams argues that the recent correction in gold means the gold “bubble” is finally bursting. Unfortunately, he does not provide a single reason for why the 10-year bull market in the precious metal constitutes a “bubble”, nor why this rally must end now.
According to the narrative of this article, investing in gold must have always been quite an irrational endeavour. Such folly was simply made easier with the advent of liquid ETFs (exchange-traded funds), which made the gold market more accessible to the small investor and trader. From than on, an irrational rally must have just fed on itself. Quote Mr. Williams:
“By 2005, more and more investors tried to rationalise why gold was no longer a fringe investment. It was a hedge against a weak dollar, global turmoil, incompetent central bankers and inflation. As trust in the financial system declined, gold would naturally rise, they reasoned.”
How silly! How could they believe that?
So according to Mr. Williams, gold has been going up because….it had been going up before. The investors simply rationalized it with hindsight. But gold recently went down, and down quite hard. Measured in US dollars, gold is down 16% from its peak on September 5. And now it has to go down further, so reasons Mr. Williams. If people bought it because it was going up, they must now sell it because it is going down.
Toward the end of his article we get the usual bon mot – by now repeated ad nauseam by Warren Buffett – that gold does not produce anything, does not create jobs, and does not pay a dividend. Yawn.
Gold is money
To compare gold with investment goods is wrong. Gold is money. It is the market’s chosen monetary asset. It has been the world’s foremost monetary asset for thousands of years. It has been remonetised over the past 10 years as the global fiat money system has been check-mating itself into an ever more intractable crisis. Faith in paper money as a store of value is diminishing rapidly. That is why people rush into gold. It doesn’t replace corporate equity or productive capital. It replaces paper money.
At every point in time you can break down your total wealth into three categories: consumption goods, investment goods and money. If you buy gold as jewellery, it is mostly a consumption good. If you buy gold as an industrial metal to be used in production processes, it is mostly an investment good. However, most people buy gold today as a monetary asset, as a store of value that is neither a consumption good nor an investment good. Therefore, you have to compare it with paper money. That is the alternative asset.
The paper dollars and electronic dollars that Mr. Bernanke can create at zero cost and without limit, simply by pressing a button, equally do not produce anything, do not create jobs, and do not pay dividends either. Although, sadly, the reflationists and advocates of more and more quantitative easing – many of them writing for the FT – seem to think that this is what paper money does. Alas, it doesn’t. It only fools the public into believing that lots of savings exist that need to be invested, or that enormous real demand exists for financial and other assets. Expanding money is a trick that is beginning to lose its magic.
The dollars in your pockets do not generate a dividend, neither does the gold in your vault or your ETF. So why do you even hold money?
Because of uncertainty. You want to stay on the sidelines but want to maintain your purchasing power without spending it on consumption and investment goods in the present environment and at current prices.
Stocks, bonds and real estate have been boosted for decades by persistent fiat money expansion. Now that the credit boom has turned into a bust it is little wonder that people are reluctant to buy more of these inflated assets. (Some real estate and some stock markets are currently already deflating, which is urgently needed. But bonds are not. If there is a “bubble” at all, it is in government bonds, although that bubble seems to begin to deflate as well — one European sovereign at a time.)
People want to preserve spending power for when the bizarrely inflated debt edifice has finally been liquidated and things are cheap again. But policymakers and their economic advisors do not want that to happen (“Oh no, that dreadful deflation! No! Anything but a drop in prices!”) and they are using the printing press to avoid, or better postpone the inevitable at all cost, even at the cost of destroying their own paper money in the process. And that is why you cannot hold paper money and have to revert to eternal money: gold.
Gold versus paper money
Mr. Williams quotes the market value of the world’s largest gold ETF, GLD, at $65 billion at present, apparently considering this already proof of how mad things have become in the world of gold investing. Well, consider this: in just the first 8 months of the year 2011, Bernanke created $640 billion – out of thin air – and handed it to the banks. Since the collapse of Lehman Brothers, the Fed has created reserve dollars to the tune of $1,800 billion, or more than twice as much as the Fed had created from its inception in 1913 up to the Lehman collapse in 2008. Or, if you like, 27 GLDs at present market value. The money supply in the M2 definition has gone up also by $1,750 billion since Lehman. Mr. Williams, why is anybody still holding these absurd amounts of paper cash? Isn’t that the more interesting question rather than the tiny amounts that they hold in the form of physical gold?
The biggest owner of gold is allegedly the United States government. I say ‘allegedly’ because they have not done a proper audit for a while. Supposedly, the U.S. has 261 million ounces of gold in their vaults at Fort Knox. At current market price that is a market value of $423 billion. Bernanke created more paper money between last Christmas and last Easter!
And those who, like Mr. Buffett, feel like joking that the entire stock of gold fits under the Eiffel tower – ha! ha! ha! – let they be reminded that the trillions that Mr. Bernanke created fit on the SIM cards in their mobile phones. It is all electronic money – and when Mr. B turns into a monetary Dr. Strangelove and goes bonkers with those nuclear buttons, there will be much more fiat money around.
Let me be clear on this point: the fact that money today consists of paper or is even immaterial money and consists of no substance at all is, no pun intended, immaterial to me. It doesn’t matter. As an Austrian School economist, the concept of “intrinsic value” that some gold bugs cite in defence of gold money is meaningless to me. Money does not need a substance to be money. The problem with modern money is not its lack of substance but its perfectly elastic supply. The privileged money producers create – for political reasons – ever more of it. That is the problem. And that is why the market remonetises gold. Nobody can produce it at will.
Here is Mr. Bernanke again:
“The U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost…We conclude that under a paper-money system, a determined government can always generate higher spending and hence positive inflation.”
But to Mr. Williams, paper dollars are now a safer bet than gold:
“Fears of a Greek default and eurozone turmoil are now prompting investors to buy US dollars – which many are starting to see as a safer bet than the euro or volatile gold.”
Hmmm. Safer? Are you sure?
What’s next for gold?
Mr. Williams may, of course, be right in predicting that the gold price may go down from here. For that to happen the faith in paper money has to be restored, at least to some degree. The printing presses have to stop and liquidation must be allowed to proceed. And that is precisely what happened under Fed chairman Volcker in 1979. That is what caused the previous correction in the gold “bubble”.
The question is this: How likely is this now?
In my view the present sell-off in gold is the result of the market going through another deflationary liquidation phase, yet at the same time the central bankers seem reluctant to throw more money at the problem. The ECB is buying unloved Italian sovereign bonds rather joylessly at present, and Bernanke seems for the time being happy to reorganize his bond portfolio rather than to print more money. Alas, I don’t think it will last. I am fairly confident it won’t last. They won’t have the stomach to sit tight.
Pressure is already building everywhere for more quantitative easing. Ironically, on the very same page of the FT, on which Mr. Williams argues that the gold bubble has burst, Harvard economist Kenneth Rogoff presents his case that this time is not so different, and that we can simply kick the can down the road once more by easing monetary policy, just as we have done for decades. In China, in Europe, everywhere, just print more money. And I already made ample references to Martin “Bring-out-the-bazooka” Wolf, who desperately urges the central banks to print more money.
Will the central bankers ignore these calls, as they should? I don’t think so. Remember, the dislocations are now astronomically larger than they were in 1979. The system is more leveraged and much more dependent on cheap credit. In the next proper liquidation, sovereign states and banks will default – no central banker will be able or willing to sit on his hands when that happens. But in order to postpone it (they won’t avoid it) they need to print ever more ever faster.
We are in a gold bull market for a reason, and a very good reason indeed. Unless the underlying fundamentals change (or policy changes fundamentally), I consider this sell-off in gold rather a buying opportunity.
Over at ConservativeHome, I have promoted Douglas Carswell’s ten minute rule Bill on legal tender laws and currency choice:
People today have unprecedented choice. They can shop around online. They can tune into numerous television and radio channels. They can even decide between different hospitals for medical treatment.
But why are people not allowed to decide for themselves in which currency to transact their business and store their own wealth?
Today, Douglas Carswell introduces a Bill designed to make a range of different currencies legal tender in the UK. It would mean that, with the click of a mouse, people would be able to store wealth and pay taxes in a range of different currencies of their choice.
The BBC are covering it here. Read the full article.
Banking theory remains one of the most heatedly debated areas of economics within Austrian circles, with two camps sitting opposite each other: full reservists and free bankers. The naming of the two groups may prove a bit misleading, since both sides support a free market in banking. The difference is that full reservists believe that either fractional reserve banking should be considered a form of fraud or that the perceived inherent instability of fiduciary expansion will force banks to maintain full reserves against their clients’ deposits. The term free banker usually refers to those who believe that a form of fractional reserve banking would be prevalent on the free market.
The case for free banking has been best laid out in George Selgin’s The Theory of Free Banking. It is a microeconomic theory of banking which suggests that fractional reserves will arise out of two different factors,
- Over time, “inside money” — banknotes (money substitute) — will replace “outside money” — the original commodity money — as the predominate form of currency in circulation. As the demand for outside money falls and the demand for inside money rises, banks will be given the opportunity to shed unnecessary reserves of commodity money. In other words, the less bank clients demand outside money, the less outside money a bank actually has to hold.
- A rise in the demand to hold inside money will lead to a reduction in the volume of banknotes in circulation, in turn leading to a reduction of the volume of banknotes returning to issuing banks. This gives the issuing banks an opportunity to issue more fiduciary media. Inversely, when the demand for money falls, banks must reduce the quantity of banknotes issued (by, for example, having a loan repaid and not reissuing that money substitute).
Free bankers have been quick to tout a number of supposed macroeconomic advantages of Selgin’s model of fractional reserve banking. One is greater economic growth, since free bankers suppose that a rise in the demand for money should be considered the same thing as an increase in real savings. Thus, within this framework, fractional reserve banking capitalizes on a greater amount of savings than would a full reserve banking system.
Another supposed advantage is that of monetary equilibrium. An increase in the demand for money, without an equal increase in the supply of money, will cause a general fall in prices. This deflation will lead to a reduction in productivity, as producers suffer from a mismatch between input and output prices. As Leland Yeager writes, “the rot can snowball”, as an increase in uncertainty leads to a greater increase in the demand for money. This can all be avoided if the supply of money rises in accordance with the demand for money (thus, why free-bankers and quasi-monetarists generally agree with a central bank policy which commits to some form of income targeting).
Monetary (dis)equilibrium theory is not new, nor does it originate with the free bankers. The concept finds its roots in the work of David Hume and was later developed in the United States during the first half of the 20th Century. The theory saw a more recent revival with the work of Leland Yeager, Axel Leijonhufvud, and Robert Clower. The integration of monetary disequilibrium theory with the microeconomic theory of free banking is an attempt at harmonizing the two bodies of theory. If a free banking system can meet the demand for money, then a central bank is unnecessary to maintain monetary stability.
The integration of the macro theory of monetary disequilibrium into the micro theory of free banking, however, should be considered more of a blemish than an accomplishment. It has unnecessarily drawn attention away from the merits of fractional reserve banking and instead muddled the free bankers’ case. Neither is it an accurate or useful macroeconomic theory of industrial misbalances or fluctuations.
The Nature of Price Fluctuations
The argument that deflation resulting from an increase in the demand for money can lead to a harmful reduction in industrial productivity is based on the concept of sticky prices. If all prices do not immediately adjust to changes in the demand for money then a mismatch between the prices of output and inputs goods may cause a dramatic reduction in profitability. This fall in profitability may, in turn, lead to the bankruptcy of relevant industries, potentially spiraling into a general industrial fluctuation. Since price stickiness is assumed to be an existing factor, monetary equilibrium is necessary to avoid necessitating a readjustment of individual prices.
Since price inflexibility plays such a central role in monetary disequilibrium, it is worth exploring the nature of this inflexibility — why are prices sticky? The more popular explanation blames stickiness on an entrepreneurial unwillingness to adjust prices. Those who are taking the hit rather suffer from a lower income later than now. Wage stickiness is also oftentimes blamed on the existence of long-term contracts, which prohibit downward wage adjustments.
Austrians can supply an alternative, or at least complimentary, explanation for price stickiness. If equilibrium is explained as the flawless convergence of every single action during a specific moment in time, Austrians recognize that an economy shrouded in uncertainty is never in equilibrium. Prices are set by businessmen looking to maximize profits by best estimating consumer demand. As such, individual prices are likely to move around, as consumer demand and entrepreneurial expectations change. This type of “inflexibility” is not only present during downward adjustments, but also during upward adjustments. It is “stickiness” inherent in a money-based market process beset by uncertainty.
It is true that government interventionism oftentimes makes prices more inflexible than they would be otherwise. Examples of this are wage floors (minimum wage), labor laws, and other legislation which makes redrawing labor contracts much more difficult. These types of labor laws handicap the employer’s ability to adjust his employees’ wages in the face of falling profit margins. Wages are not the only prices which suffer from government-induced inflexibility. It is not uncommon for government to fix the prices of goods and services on the market; the most well-known case is possibly the price fixing scheme which caused the 1973–74 oil crisis. There is a bevy of policies which can be enacted by government as a means of congesting the pricing process.
But, let us assume away government and instead focus on the type of price rigidity which exists on the market. That is, the flexibility of prices and the proximity of the actual price to the theoretical market clearing price is dependent on the entrepreneur. As long as we are dealing with a world of uncertainty and imperfect information, the pricing process too will be imperfect.
Price rigidity is not an issue only during monetary disequilibrium, however. In our dynamic market, where consumer preferences are constantly changing and re-arranging themselves, prices will have to fluctuate in accordance with these changes. Consumers may reduce demand for one product and raise demand for another, and these industries will have to change their prices accordingly: some prices will fall and others will rise. The ability for entrepreneurs to survive these price fluctuations depends on their ability to estimate consumer preferences for their products. It is all part of the coordination process which characterizes the market.
The point is that if price rigidity is “almost inherent in the very concept of money”, then why are price fluctuations potentially harmful in one case but not in the other? That is, why do entrepreneurs who face a reduction in demand originating from a change in preferences not suffer from the same consequences as those who face a reduction in demand resulting from an increase in the demand for money?
Price Discoordination and Entrepreneurship
In an effort to illustrate the problems of an excess demand for money, some have likened the problem to an oversupply of fiduciary media. The problem of an oversupply of money in the loanable funds market is that it leads to a reduction in the rate of interest without a corresponding increase in real savings. This leads to changes in the prices between goods of different orders, which send profit signals to entrepreneurs. The structure of production becomes more capital intensive, but without the necessary increase in the quantity of capital goods. This is the quintessential Austrian example of discoordination.
In a sense, an excess demand for money is the opposite problem. There is too little money circulating in the economy, leading to a general glut. Austrian monetary disequilibrium theorists have tried to frame it within the same context of discoordination. An increase in the demand for money leads to a withdrawal of that amount of money from circulation, forcing a downward adjustment of prices.
But there is an important difference between the two. In the first case, the oversupply of fiduciary media is largely exogenous to the individual money holders. In other words, the increase in the supply of money is a result of central policy (either by part of the central bank or of government). Theoretically, an oversupply of fiduciary media could also be caused by a bank in a completely free industry but it would still be artificial in the sense that it does not reflect any particular preference of the consumer. Instead, it represents a miscalculation by part of the central banker, bureaucrat, or bank manager. In fact, this is the reason behind the intertemporal discoordination — the changing profit signals do not reflect an underlying change in the “real” economy.
This is not the issue when regarding an excess demand for money. Here, consumers are purposefully holding on to money, preferring to increase their cash balances instead of making immediate purchases. The decision to hold money represents a preference. Thus, the decision to reduce effective demand also represents a preference. The fall in prices which may result from an increase in the demand for money all represent changes in preferences. Entrepreneurs will have to foresee or respond to these changes just like they do to any other. That some businessmen may miscalculate changes in preference is one thing, but there can be no accusation of price-induced discoordination.
The comparison between an insufficient supply of money and an oversupply of fiduciary media would only be valid if the reduction in the money supply was the product of central policy, or a credit contraction by part of the banking system which did not reflect a change in consumer preferences. But, in monetary disequilibrium theory this is not the case.
None of this, however, says anything about the consequences of deflation on industrial productivity. Will a rise in demand for money lead falling profit margins, in turn causing bankruptcies and a general period of economic decline?
Whether or not an industry survives a change in demands depends on the accuracy of entrepreneurial foresight. If an entrepreneur expects a fall in demand for the relevant product, then investment into the production of that product will fall. A fall in investment for this product will lead to a fall in demand for the capital goods necessary to produce it, and of all the capital goods which make up the production processes of this particular industry. This will cause a decline in the prices of the relevant capital goods, meaning that a fall in the price of the consumer good usually follows a fall in the price of the precedent capital goods. Thus, entrepreneurs who correctly predict changes in preference will be able to avoid the worst part of a fall in demand.
Even if a rise in the demand for money does not lead to the catastrophic consequences envisioned by some monetary disequilibrium theorists, can an injection of fiduciary media make possible the complete avoidance of these price adjustments? This is, after all, the idea behind monetary growth in response to an increase in demand for money. Theoretically, maintaining monetary equilibrium will lead to a stabilization of the price level.
This view, however, is the result of an overly aggregated analysis of prices. It ignores the microeconomic price movements which will occur with or without further monetary injections. Money is a medium of exchange, and as a result it targets specific goods. An increase in the demand for money will withdraw currency from this bidding process of the present, reducing the prices of the goods which it would have otherwise been bid against. Newly injected fiduciary media, maintaining monetary equilibrium, is being granted to completely different individuals (through the loanable funds market). This means that the businesses originally affected by an increase in the demand for money will still suffer from falling prices, while other businesses may see a rise in the price of their goods. It is only in a superfluous sense that there is “price stability”, because individual prices are still undergoing the changes they would have otherwise gone.
So, even if the price movements caused by changes in the demand for money were disruptive — and we have established that they are not — the fact remains that monetary injections in response to these changes in demand are insufficient for the maintenance of price stability.
Implications for Free Banking
To a very limited degree, free banking theory does rely on some aspects of monetary disequilibrium. The ability to extend fiduciary media depends on the volume of returning liabilities; a rise in the demand for money will give banks the opportunity to increase the supply of banknotes. However, the complete integration of monetary disequilibrium theory does not represent theoretical advancement — if anything, it has confused the free bankers’ position and unnecessarily contributed to the ongoing theoretical debate between full reservists (many of which reject the supposed macroeconomic benefits of free banking) and free bankers.
We know that an increase in the demand for money will not lead to industrial fluctuations, nor does it produce any type of price discoordination. Like any other movement in demand, it reflects the preferences of the consumers which drive the economy. We also know that monetary injections cannot achieve price stability in any relevant sense. Thus, the relevancy of the macroeconomic theory of monetary disequilibrium is brought into question. Free banking theory would be better off without it.
This suggests, though, that a rejection of monetary disequilibrium is not the same as a rejection of fractional reserve banking. It could be the case that a free banking industry capitalizes on an increase in savings much more efficiently than a full reserve banking system. Or, it could be that the macroeconomic benefits of fractional reserve banking are completely different from those already theorized, or even that there are no macroeconomic benefits at all — it may purely be a microeconomic theory of the banking firm and industry. These aspects of free banking are still up for debate.
George A. Selgin, The Theory of Free Banking: Money Supply under Competitive Note Issue
(Totowa, New Jersey: Rowman & Littlefield, 1988). Also see George A. Selgin, Bank Deregulation and Monetary Order
(Oxon, United Kingdom: Routledge, 1996); Larry J. Sechrest, Free Banking: Theory, History, and a Laissez-Faire Model
(Auburn, Alabama: Ludwig von Mises Institute, 2008); Lawrence H. White, Competition and Currency
(New York City: New York University Press, 1989).
 Leland B. Yeager, The Fluttering Veil: Essays on Monetary Disequilibrium (Indianapolis, Indiana: Liberty Fund, 1997), pp. 218–219.
 Ibid., p. 218.
 Clark Warburton, “Monetary Disequilibrium Theory in the First Half of the Twentieth Century,” History of Political Economy 13, 2 (1981); Clark Warburton, “The Monetary Disequilibrium Hypothesis,” American Journal of Economics and Sociology 10, 1 (1950).
 Peter Howitt (ed.), et. al., Money, Markets and Method: Essays in Honour of Robert W. Clower (United Kingdom: Edward Elgar Publishing, 1999).
 Steven Horwitz, Microfoundations and Macroeconomics: An Austrian Perspective (United Kingdom: Routledge, 2000).
 Some of the criticisms presented here have already been laid out in a forthcoming journal article: Phillip Bagus and David Howden, “Monetary Equilibrium and Price Stickiness: Causes, Consequences, and Remedies,” Review of Austrian Economics. I do not support all of Bagus’ and Howden’s criticisms, nor do I share their general disagreement with free banking theory.
 Yeager 1997, pp. 222–223.
 Laurence Ball and N. Gregory Mankiw, “A Sticky-Price Manifesto,” NBER Working Paper Series 4677, 1994, pp. 16–17.
 Horwitz 2000, pp. 12–13.
 Yeager 1997, p. 104.
 Yeager 1997, p. 223. Yeager quotes G. Poulett Scrope’s Principles of Political Economy, “A general glut — that is, a general fall in the prices of the mass of commodities below their producing cost — is tantamount to a rise in the general exchangeable value of money; and is proof, not of an excessive supply of goods, but of a deficient supply of money, against which the goods have to be exchange.”
 Joseph T. Salerno, Money: Sound & Unsound (Auburn, Alabama: Ludwig von Mises Institute, 2010), pp. 193–196.
 This is Menger’s theory of imputation; Carl Menger, Principles of Economics (Auburn, Alabama: Ludwig von Mises Institute, 2007), pp. 149–152.
The advent of a European Union with a single currency was hailed by Nobel laureate Robert A. Mundell as
a great step forward, because it will bring forth new and for once meaningful ideas about reform of the international financial architecture. The euro promises to be a catalyst for international monetary reform.
Unfortunately, by underwriting member countries’ financial risk with impunity, the EU made the euro the catalyst of unsound monetary policies that are now leading the Union into an economic maelstrom. Still less has euroization set the pace for an international reform of the monetary machinery.
Milton Friedman was more cautious about this super currency. The euro’s real Achilles heel, he said, would prove to be political: a system under different governments subject to very different political pressures could not endure a common currency. Without political integration, the tension and friction of the national institutional systems would condemn it to failure. Indeed the problem is always political, but not in the sense meant by Friedman. Regardless of the degree of political integration, governments’ spending and dissipation, which are unalterable tendencies of any political organism, make irredeemable paper monies act as transmission belts for financial and economic disruptions.
At the outset of the 2010 Greek crisis that triggered the European domino effect, Professor Mundell pointed out that there was nothing inherently bad in the euro as such; the problem lay in the country’s public debt spiralling out of control. However, being a strong advocate of financial and monetary “architectures” as means for pursuing monetary and non monetary ends, he should have acknowledged that irredeemable currencies cannot be examined independently of the political framework in which they are embedded, because politics inevitably extends the role of money beyond its original function as a medium of exchange, making it trespass into the field of “economic policies”. Official theory does not see money as a neutral device, but as an instrument of policy for purposing ends which conflict with its primary goal: to retain the value of the monetary unit. Failing this primary goal, monetary architectures no matter how they are framed make for economic devastation.
Is a monetary order a constitution?
Robert Mundell’s assertion — that a monetary order is to a monetary system what a constitution is to a political or electoral system — unintentionally sheds light on the authoritarian nature of today’s irredeemable money governance and its fraudulent practices. Where is the flaw in this catching parallel? The flaw is that if a monetary order stands for a constitution, i.e. a democratic framework of laws and regulations, it does not provide for a separation of powers. The money order as a legislative system coincides with the executive power, the money system, embracing the range of practices and policies pursued for monetary and non monetary ends. Moreover, the judicial system is concentrated in the same hands because monetary authorities are not accountable to anyone. With the exception of governments that, being their source of power, may be considered “ghost writers” of monetary constitutions, no one else can influence money legislation. In other words, in this framework there is no room for an “electorate” (producers and consumers). What basic law regulates the relationships between individuals and their monetary orders by guaranteeing fundamental rights?
The basic law of the gold standard was the free convertibility of currencies, allowing individuals to redeem paper into gold on demand. This acted as protection against money misuse by banks or governments. Convertibility was for producers and consumers the means to express their vote on the degree of money reliability. Money was an instrument of saving. Paper money, or fiduciary circulation, as opposed to the banknote which was a title of credit, could be issued too but it had to comply with the law of gold circulation whereby the total volume of currency, coins, banknotes and paper notes had to correspond exactly to the quantity of metallic money necessary to allow economic exchanges. This being the purpose of the monetary system, banks, to avoid insolvency risks and gold reserves outflow had to adjust, through the discount rate policy, the issue of fiduciary papers to the real needs of economy.
Therefore gold was a barrier against the use of money as an instrument of power. Its value was fixed on the world market where gold was always in demand. Gold then had the same value in each country, and that’s why it was a stable international means of payment. Finally exchange rates were stable, not because they were arbitrarily controlled by government but because they were always gravitating towards the gold parity, the rate at which currencies were exchanged, and this was determined by their respective gold content. Roughly stated, the gold standard was an order providing for a separation of powers: the fundamental law of metallic circulation was the constitution, the banking system was the executive power which was controlled by producers and consumers representing the judicial power to sanction abuses. In today’s monetary order, producers and consumers have become legally disarmed victims of monetary legislation, deprived of the weapon of defence against money manipulation.
A trail of broken monetary arrangements
Central banks are the pillars of the monetary order because they are the source of the world’s supply and they regulate it. They control circulation, expand and restrict credit, stabilize prices and, above all they act as instruments of State finances. They are both “anvil and hammer”, trying to adapt the system to all occasions, remedying abuse by a still greater abuse, and considering themselves immune from the consequences. For these reasons, the leading architects of the world financial order should explain how the very same institutions that are pursuing unsound policies domestically might realistically think to establish a sound monetary order at a higher level.
The most important architecture, after the Second World War, was the Bretton Woods Agreement (1944). A “managed” form of gold standard was designed to give a stable word monetary order by a fixed exchange rate system with the dollar as the key currency, redeemable in gold only to central banks, and with member countries’ currencies pegged to the dollar at fixed rates and indirectly redeemable in gold. But the huge balance of payments deficit and high inflation in the US should have made gold rise against the dollar. A crisis of confidence in the reserve currency pushed foreign countries’ central banks to demand conversion into the metal, panicking the US, which promptly closed the gold window.
After the end of Bretton Woods in 1971, fiat currencies began to rule the world
The Smithsonian Agreement (1971-1973) which followed Bretton Woods was hailed by President Nixon as the “greatest monetary agreement in the history of the world” (!). It was an order based on fixed exchange rates fluctuating within a narrow margin, but without the backing of gold. Again, countries were expected to buy an irredeemable dollar at an overvalued rate. The system ended after two years.
Within the West European block, fixed exchange rates remained, but floating within a band against dollar. “The snake”, as the arrangement was called, died in 1976. Major shocks, including the 1973 oil price spike and the 1974 commodity boom, caused a series of currency crises, repeatedly forcing countries out of the arrangement. But this did not persuade them to abandon the dream of intra-European currency stability. The snake was replaced in 1979 by the European Monetary System (EMS) with its basket of arbitrarily fixed-but-adjustable exchange rates floating within a small band and pegged to the European currency unit (ecu), the precursor of euro.
Yet the arrangement ultimately failed, again due to a series of severe shocks (a global recession, German economic and monetary unification, liberalization of capital controls). Rather than abandoning the system, European governments adopted much wider fluctuation bands, reaffirming their commitment to an order based on fixed rates and irredeemable currencies.
So we arrive at an arrangement without historical precedent: sovereign nations with a single legal tender issued by a common central bank — the Euro entered into function in 1999. The stated aims of the single currency were noble: to facilitate trade and freedom of movement, providing for a market large enough to give each country better insulation against external shocks. Unfortunately, it couldn’t provide the member states with a system of defence against the internal shocks inherent to any irredeemable currency.
History confirms that currencies cannot rest on stability pacts and similar restrictions. Mainstream economists have long argued that the euro crisis has arisen from the lack of common social and fiscal policies, but the architects of the European currency were also well aware of this. Their aim was always to forge a European people, and a socialist European superstate, on the back of the euro. They had not the patience for a European state to naturally emerge in the same manner as the US, from a population sharing the same culture and language. “Europe of the people and for the people” was a misleading disguise to give an economic prison the honest appearance of a democratic and liberal project.
So in the end, Euroland has been working as a hybrid framework of institutions to which members countries delegate some of their national sovereignty in exchange for access to a larger market, capital, and low interest rates. But they entered an region of anti-competitive practices, antitrust regulations, redistributive policies, lavish subsidies, and faux egalitarianism — a perfect economic environment in which to run astronomical debts. The euro system represents one of the most significant attempts to place a currency at the service of political and social objectives, and it is for this reason that it will remain a source of problems.
Descent into the maelstrom
Today’s monetary orders are shaped to pursue what Rothbard has called the economics of violent intervention in the market. They are, in essence, based on a socialist idea of money. Accordingly they make for a framework of laws, conventions, and regulations fitting the interests of the rulers. In this framework it is the public debt that has utmost importance. Indeed, it is the monetary order that has developed the concept of debt in the modern sense. Because the management of public finances have become the supreme direction of economic policy, treasuries are now in charge of the national economies. Through the incestuous relationships they maintain with central banks, they are able to create the ideal monetary conditions in which to borrow ad libitum. Purely monetary considerations such as providing a stable currency are disregarded. Political, fiscal and social ends prevail over everything else.
In the last eighty years, monetary orders have allowed an abnormal increase in finance, banking, debt, and speculation completely unrelated to a development of sound economic activity and wealth production, but due instead to government’s overloading of central banking responsibilities. Unfortunately, the outcome is the de facto insolvency of the world monetary order. The ensuing adverse effects may be still delayed with the aid of various measures, interventions and expedients, but not much time is left. The stormy sea of debt has already produced a whirlpool that will be sucking major economies into a maelstrom, and the larger they are, the more rapid will be their descent. It remain to be seen what shape they will take after the shipwreck. Gloomy as the situation may appear, it is not hopeless because such an event might be the sole opportunity to cause a decisive change. It might be that instead of resuming the art of monetary expedients to create irredeemable money, governments and banks let them fade into oblivion. This would allow people to take their monetary destiny back into their own hands.
A view from America, previously published at Forbes.com on August 15th
Is it possible that the ghastly unemployment, stagnant growth (and possible double-dip recession), and financial market convulsions all can be traced back to one single decision? Perhaps.
Monetary policy is the most recondite yet most pervasive and powerful of economic forces. Keynes, in The Economic Consequences of the Peace, wrote, “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.”
The converse also is true. Restoring real monetary integrity engages all the hidden forces of economic law on the side of prosperity. And forces for monetary reform are very much in motion.
The dollar has fallen in value by more than 80% from the day when Richard Nixon took the world off the tattered remnants of the gold standard. Aug. 15 marks the 40th anniversary of the avowedly “temporary” abandonment of the gold standard by President Richard Nixon.
“Closing the gold window” was part of a series of dramatic but shocking and destructive tactics by Washington, including wage-price controls, a tariff barrier, and other measures, all leading to economic and financial markets hell. All such measures save one stand discredited. The only piece of the Nixon Shock still in force was the piece most ostentatiously designated as temporary. Nixon: “I have directed Secretary Connally to suspend temporarily the convertibility of the dollar into gold….”
Suspending convertibility was no trivial matter. Nixon speechwriter William Safire recalled: “On the helicopter headed for Camp David, I was seated between [Herb] Stein and a Treasury official. When the Treasury man asked me what was up, I said it struck me as no big deal, that we would probably close the gold window. He leaned forward, put his face in his hands, and whispered, ‘My God!’ Watching this reaction, it occurred to me that this could be a bigger deal than I thought….”
It proved to be a very big deal. How ironic that the most staunch defenders of a pure paper standard, the sole remnant of Nixonomics, are a few influential “progressives” such as Paul Krugman, Joseph Stiglitz and Thomas Frank. Call them “the Nixonians.” The poor jobs growth and stagnation of today’s “world dollar standard” are not, unsurprisingly, dissimilar to the results of the Nixon Shock.
There is ample evidence that restoring gold convertibility would put the world back on the path of jobs, growth, and a balanced federal budget. Politicians do not like messing around with monetary policy. But gold, recently rediscovered by the Tea Party, has an impressive technical, economic, and political pedigree. Gold convertibility has a very well established track record of job-creation, properly applied, during many eras.
The silver lining to the whipsawing Dow is that it makes politicians open to new ideas, even new old ideas. Monetary statesmen from Alexander Hamilton forward have faced circumstances far more dire than those of today and turned things around. Modern example? The German economic miracle, the Wirtschaftswunder.
That miracle was founded in currency reform. On the very day when Ludwig Erhard’s currency reform was put into place, the economic paralysis ended. The “rightest” economist of the 20th century, Jacques Rueff, wrote (with André Piettre) about the turnaround beginning on the very day of the reform:
Shop windows were full of goods; factory chimneys were smoking and the streets swarmed with lorries. Everywhere the noise of new buildings going up replaced the deathly silence of the ruins. If the state of recovery was a surprise, its swiftness was even more so. In all sectors of economic life it began as the clocks struck on the day of currency reform. Only an eye-witness can give an account of the sudden effect which currency reform had on the size of stocks and the wealth of goods on display. Shops filled with goods from one day to the next; the factories began to work. On the eve of currency reform the Germans were aimlessly wandering about their towns in search of a few additional items of food. A day later they thought of nothing but producing them. One day apathy was mirrored in their faces while on the next a whole nation looked hopefully into the future.
Rueff took a similar approach, including a dramatic currency reform, to reviving the French economy. As economist and Lehrman Institute senior advisor John Mueller summarizes:
Despite the unanimous opposition of his cabinet, de Gaulle adopted the entire Rueff plan, which required sweeping measures to balance the budget and make the franc convertible after 17.5% devaluation – though not without qualms. ‘All your recommendations are excellent,’ de Gaulle told Rueff. ‘But if I apply them all and nothing happens, have you considered how much real pain it will cause across this country?’ Rueff replied, “I give you my word, mon General, that the plan, if completely adopted, will re-establish equilibrium in our balance of payments within a few weeks. Of this I am absolutely sure; I accept that your opinion of me will depend entirely on the result.’ (It did: ten years later, de Gaulle awarded Rueff the medal of the Legion of Honor.)
Today, on this the 40th anniversary of the closing of the gold window, a group of Americans issued a statement reading, in its conclusion:
[W]e support a 21st century international gold standard. America should lead by unilateral resumption of the gold standard. The U.S. dollar should be defined by law as convertible into a weight unit of gold, and Americans should be free to use gold itself as money without restriction or taxation. The U.S. should make an official proposal at an international monetary conference that major nations should use gold rather than the dollar or other national currencies to settle payments imbalances between one another. A new international monetary system, based on gold, without official reserve currencies, should emerge from the deliberations of the conference.
Many of the signatories are associated with the American Principles Project, chaired by Sean Fieler, and the Lehrman Institute (with both of which this writer is professionally associated), chaired by Lewis E. Lehrman. Signatories also include such important thought leaders as Atlas Foundation’s Dr. Judy Shelton and Forbes Opinions editor John Tamny.
Politicians may have forgotten the power that real money, such as currency convertible into gold, has to reverse an economic crisis. But the people have not. Earlier this year, the government of Utah restored, to international attention, the recognition of gold and silver coins as legal money. Now news emerges that the largest and most respected political party in Switzerland is supporting the work of the Goldfranc Association, led by citizen Thomas Jacob, to introduce a gold-convertible Swiss franc as a parallel currency.
Proponents are using the Swiss political process to put the creation of a gold franc in the Swiss Constitution. Jacob finds himself in the very distinguished company of Rueff and Erhard.
While London burns Switzerland thrusts gold-based currency reform toward the center of the international debate on how to rescue the euro, end the debt crisis, and turbocharge economic growth and job creation with integrity, not Nixonian manipulation.
Will a world Wirtschaftswunder — an economic miracle — follow a restoration of gold convertibility? History shows how practical such a miracle can be.
It is with no feelings of joy that we republish this article, first posted on 8 February 2010
Guest contributor Anita Acavalos, daughter of Advisory Board member Andreas Acavalos, explains the political and economic predicament in Greece.
In recent years, Greece has found itself at the centre of international news and public debate, albeit for reasons that are hardly worth bragging about. Soaring budget deficits coupled with the unreliable statistics provided by the government mean there is no financial newspaper out there without at least one piece on Greece’s fiscal profligacy.
Although at first glance the situation Greece faces may seem as simply the result of gross incompetence on behalf of the government, a closer assessment of the country’s social structure and people’s deep-rooted political beliefs will show that this outcome could not have been avoided even if more skill was involved in the country’s economic and financial management.
The population has a deep-rooted suspicion of and disrespect for business and private initiative and there is a widespread belief that “big money” is earned by exploitation of the poor or underhand dealings and reflects no display of virtue or merit. Thus people feel that they are entitled to manipulate the system in a way that enables them to use the wealth of others as it is a widely held belief that there is nothing immoral about milking the rich. In fact, the money the rich seem to have access to is the cause of much discontent among people of all social backgrounds, from farmers to students. The reason for this is that the government for decades has run continuous campaigns promising people that it has not only the will but also the ABILITY to solve their problems and has established a system of patronages and hand-outs to this end.
Anything can be done in Greece provided someone has political connections, from securing a job to navigating the complexities of the Greek bureaucracy. The government routinely promises handouts to farmers after harsh winters and free education to all; every time there is a display of discontent they rush to appease the people by offering them more “solutions.” What they neglect to say is that these solutions cost money. Now that the money has run out, nobody can reason with an angry mob.
A closer examination of Greek universities can be used as a good illustration of why and HOW the government has driven itself to a crossroad where running the country into even deeper debt is the only politically feasible path to follow. University education is free. However, classroom attendance is appalling and there are students in their late twenties that still have not passed classes they attended in their first year. Moreover, these universities are almost entirely run by party-political youth groups which, like the country’s politicians, claim to have solutions to all problems affecting students. To make matters worse, these groups often include a minority of opportunists who are not interested in academia at all but are simply there to use universities as political platforms, usually ones promoting views against the wealthy and the capitalist system as a whole even though they have no intellectual background or understanding of the capitalist structure.
This problem is exacerbated by the fact that there is no genuine free market opposition. In Greece, right wing political parties also favour statist solutions but theirs are criticised as favouring big business. The mere idea that the government should be reduced in size and not try to have its hand in everything is completely inconceivable for Greek politicians of all parties. The government promises their people a better life in exchange for votes so when it fails to deliver, the people naturally think they have the right or even the obligation to start riots to ‘punish’ them for failing to do what they have promised.
Moreover, looking at election results it is not hard to observe that certain regions are “green” supporting PASOK and others “blue” supporting Nea Dimokratia. Those regions consistently support certain political parties in every election due to the widespread system of patronages that has been created. By supporting PASOK in years where Nea Dimokratia wins you can collect on your support when inevitably after a few election periods PASOK will be elected and vice versa. Not only are there widely established regional patronage networks but there are strong political families that use their clout to promise support and benefits to friends in exchange for their support in election years.
Moreover, in line with conventional political theory on patronage networks, in regions that are liable to sway either way politicians have a built in incentive to promise the constituents more than everyone else. The result is almost like a race for the person able to promise more, and thus the system seems by its very nature to weed out politicians that tell people the honest and unpalatable truth or disapprove of handouts. This has led people to think that if they are in a miserable situation it is because the government is not trying hard enough to satisfy their needs or is favouring someone else instead of them. When the farmers protest it is not just because they want more money, it is because they are convinced (sometimes even rightly so) that the reason why they are being denied handouts is that they have been given to someone else instead. It is the combination, therefore, of endless government pandering and patronages that has led to the population’s irresponsible attitude towards money and public finance. They believe that the government having the power to legislate need not be prudent, and when the government says it needs to cut back, they point to the rich and expect the government to tax them more heavily or blame the capitalist system for their woes.
After a meeting in Brussels, current Prime Minister George Papandreou said:
Salaried workers will not pay for this situation: we will not proceed with wage freezes or cuts. We did not come to power to tear down the social state.
It is not out of the kindness of his heart that he initially did not want to impose a pay freeze. It was because doing so would mean that the country may never escape the ensuing state of chaos and anarchy that would inevitably occur. Eventually he did come to the realisation that in the absence of pay freezes he would have to plunge the country into even further debt and increase taxes and had to impose it anyway causing much discontent. Does it not seem silly that he is still trying to persuade the people that they will not pay for this situation when the enormous debts that will inevitably ensue will mean that taxes will have to increase in perpetuity until even our children’s children will be paying for this? This minor glitch does not matter, though, because nobody can reason with a mob that is fighting for handouts they believe are rightfully theirs.
Greece is the perfect example of a country where the government attempted to create a utopia in which it serves as the all-providing overlord offering people amazing job prospects, free health care and education, personal security and public order, and has failed miserably to provide on any of these. In the place of this promised utopian mansion lies a small shack built at an exorbitant cost to the taxpayer, leaking from every nook and cranny due to insufficient funds, which demands ever higher maintenance costs just to keep it from collapsing altogether. The architects of this shack, in a desperate attempt to repair what is left are borrowing all the money they can from their neighbours, even at exorbitant costs promising that this time they will be prudent. All that is left for the people living inside this leaking shack is to protest for all the promises that the government failed to fulfil; but, sadly for the government, promises will neither pay its debts nor appease the angry mob any longer. Greece has lost any credibility it had within the EU as it has achieved notoriety for the way government accountants seem to be cooking up numbers they present to EU officials.
Dismal as the situation may appear, there still is hope. The Greeks many times have shown that it is in the face of dire need that they tend to bond together as a society and rise to the occasion. Family ties and social cohesion are still strong and have cushioned people from the problems caused by government profligacy. For years, the appalling situation in schools has led families to make huge sacrifices in order to raise money for their children’s private tuition or send them to universities abroad whenever possible. This is why foreign universities, especially in the UK, are full of very prominent and hard working Greek students. Moreover, private (as opposed to public) levels of indebtedness, although on the rise, are still lower than many other European countries.
However, although societal bonding and private prudence will help people deal with the consequences of the current crisis, its resolution will only come about if Greek people learn to listen to the ugly truths that sometimes have to be said. They need to be able to listen to statesmen that are being honest with them instead of politicians trying to appease them in a desperate plea to get votes. The time for radical, painful, wrenching reform is NOW.
There are no magic wands, no bail-outs, no quick and easy fixes. The choice is between doing what it takes to put our house in order ourselves, or watching it collapse around us. This can only come about if Prime Minister George Papandreou uses the guts he has displayed in the past when his political stature and authority had been challenged and channels them towards making the changes the country so desperately needs. Only if he emerges as a truly inspired statesman who will choose the difficult as opposed to the populist solution will Greece be up again and on a path towards prosperity. He needs to display a willingness to clean up the mess made after years of bad government and get society to a point where they are willing to accept hard economic truths. One can only hope…
From Paper Money Collapse, 23 May 2011.
The widely-read Lex column in today’s Financial Times ran an article on gold ETFs (exchange-traded funds) that regurgitates a couple of assumptions on gold that are popular in the mainstream media and financial market circles. They are: 1) gold must be in a bubble and 2) this bubble must soon pop.
As Lex put it:
“Predicting the top of the gold bubble is foolhardy. It is safer to predict that the bubble’s popping will be especially nasty.”
In order for gold to be in a bubble I would suggest that two conditions have to be met: First, some erroneous but popular belief as to the merit of and ongoing demand for this asset has to capture the general public. (“On the national level, house prices in the United States never go down.” “All dot.com stocks will have market caps of billions of dollars.” “Those tulips will always be in demand.” “Governments can and will always pay debt in their own currency.”) Second, the bubble has to be inflated with easy money. I would even argue that this second condition is the more important one. If you pump enough new money into the economy and provide enough cheap credit, some irrational belief will soon emerge and bubbles will get inflated.
There is obviously plenty of easy money around – and it is certainly the reason for the gold rally, but not in the way that cheap credit created the housing bubble or stock market bubble. Gold is not rallying because it is so easy to buy gold on credit and because banks are falling over one-another to put it on their balance sheets or use it as collateral for their fractional-reserve lending business. Indeed, a key message of the Lex article seems to be that gold ETFs are – contrary to some reports – indeed solidly gold-backed and thus pretty much as good as direct bullion investment. This means they are not over-inflated derivative structures around some small core gold holding, or in any other form the result of financial trickery. Whether this is indeed the case or not is a different topic. I do not want to comment on it here other than to point out that I personally still prefer direct investment in physical gold. Be that as it may, gold appears not to be rallying in response to financial leverage in the gold market, and that is an important difference to all other recent bubbles (such as real estate in the U.S. pre 2007, in Japan pre 1989, or in China today).
What I do find interesting, however, is that the Lex-writer uses the ETF story to argue that gold must still be in a bubble. The rationale seems to be as follows: ETFs have lowered the barriers to entry for gold investing. ETFs constitute a fairly low cost, liquid, and easily accessible way to bet on a rising gold price and thus have drawn a new set of investors to this precious metal. The new demand caused the price to rise, and the rising price has continued to attract ever more buyers. The rally is now feeding on itself. The latter point is not dissimilar to the one used by Warren Buffett to dismiss the gold rally when he
“…tells shareholders that he understands why rising prices can create excitement and draw in buyers, but it’s not the way to create lasting wealth.” (CNBC)
So according to this narrative, gold is not rising because of financial leverage but because of a fashion for ETFs. That fashion shows signs of petering out as – according to Lex – evidenced by the data from the World Gold Council that shows outflows from these instruments.
Yeah? So what?
According to the World Gold Council, in Q1 of 2011 outflows from ETFs and similar products totalled 56 tonnes.
At the same time, inflows into bullion and coins totalled —366.4 tonnes. That is a 52% year-on-year increase in physical demand and almost a doubling of demand if measured in rapidly declining paper dollars.
Continue reading at Paper Money Collapse