Articles on the Gold Standard

Articles on the Gold Standard

Gold Policy in the 1930s
By Richard H. Timberlake • May 1999 • Volume: 49 • Issue: 5 Related • Filed Under • ShareThis• Print This Post • Email This Post Richard Timberlake is a professor of economics retired from the University of Georgia and author of Monetary Policy in the United States: An Intellectual and Institutional History (University of Chicago Press, 1993). This is the second in a series. Between 1929 and 1933, the Federal Reserve System, which is the central bank of the United States, monetarily starved the country into the worst economic crisis it has ever experienced. Markets, and the market system generally, did not fail, and nothing was inevitable about the collapse that occurred. Rather, the monetary system was so mismanaged that even a healthy and vigorous market system could not correct the disequilibrium that resulted. The popular application of ―market failure‖ to describe the economy during the years of the Great Contraction, 1929–1933, is wrong. Market actions in that era made the politically inspired crisis less severe than it otherwise would have been. Furthermore, ―market failure‖ is a term people often apply to events when they cannot understand the complexities of economic processes that result from ill-conceived government policies. The operations of just about any monetary system, and especially one with a central bank, are always puzzling to the layman. Consequently, when things go wrong owing to monetary mismanagement by central bankers or some other political intervention, the instigators can ring in ―market failure‖ as an excuse for their personal failures to make the right decisions. Failure in other aspects of human endeavor often generates learning that subsequently leads to correction and eventual success.[1] Federal Reserve policy failure in 1929–1933, however, led only to federal legislation that increased the number and power of federal government agencies. The Republican Hoover administration, for example, initiated the expensive Reconstruction Finance Corporation in 1932 to carry out lending policies that the elaborately structured Federal Reserve System had failed to undertake. The Roosevelt administration then took control of the political machinery in 1933 and began a program of federal intervention and bureaucratic propagation that is mind-boggling even today. Two items of Roosevelt-era legislation markedly affected the U.S. banking and monetary system. The first was the so-called Gold Reserve Act of 1934. This legislation gave the president the unconstitutional power to call in all privately owned gold for deposit in the U.S. Treasury. It also gave him the unconstitutional power by his fiat to revalue the price of gold (devalue the dollar) by as much as 60 percent.

Congress‘s constitutional power to ―regulate the value of money‖ was a power that could not be delegated to the executive. Furthermore, ―regulate‖ did not mean a massive change in the monetary values of either gold or silver. Its sole purpose was to provide a means for congressional housekeeping control over the coinage system. Properly used, it allowed Congress to make incremental changes in the legal tender value of either gold or silver so that both metals would stay in circulation. It was put into the Constitution to counteract Gresham‘s Law. Otherwise, changes in the market value of one or the other metal would result in what had now become the cheaper metal going to the mint and the other, dearer, metal going into the markets as a commodity.[2] A New Central Banking Measure The other piece of legislation, the Banking Act of 1935, was more momentous than the original Federal Reserve Act passed in 1913. In fact, the Act of 1935 might better have been labeled ―The Central Banking Act of 1935,‖ because it virtually rewrote the earlier Act. A central bank, like a gold standard, can assume many institutional forms that differ markedly from one another. The 1913 Fed Banks, for example, were regionally autonomous; the Board in Washington was relatively powerless. Board members were treated and paid on a scale similar to government employees in the U.S. Treasury, while the presidents of the regional Fed Banks commanded salaries comparable to those of executives heading major corporations. The Fed Banks‘ gold reserves severely restricted their lending policies, as was proper under an operational gold standard. Finally, the real bills doctrine was supposed to furnish the grounds for Fed Banks‘ accommodation of credit to their client member banks. The Banking Act of 1935 changed the whole paraphernalia of monetary control. It vested the Federal Open Market Committee (FOMC) with complete discretionary control to determine the stock of money in the United States. Regional Fed Bank presidents still had five of the 12 seats on the FOMC, but the Board was now a seven-man majority. From that time on, the FOMC has fashioned monetary policy by authorizing the purchase (or sale) of U.S. government securities in the open market, an operation that the Fed Bank of New York conducts week by week. When the FOMC buys the U.S. securities that the Treasury has previously sold to pay the government‘s bills, it does so by creating money. This new money is either commercial bank reserves or Federal Reserve note currency. Clearly, if a 12-person board is determining the quantity of money that exists, the quantity of gold in the system has little or nothing to do with the money. Either a gold standard specifies the quantity of money in the economy, or a central bank does. A marriage of the two never lasts longer than an unhappy weekend. The Gold Reserve Act of 1934 was the final divorce decree between gold and the monetary system. After January 31, 1934, no private household, bank, or business was allowed to own or hold more than a trivial amount of gold. Gold coin was forbidden for monetary purposes. This Act also authorized the president, Franklin Roosevelt, to raise the price of gold by 60 percent. Roosevelt, however, did not use all the power given him—only 98 percent of it. In early 1934, he increased the official mint price of gold, which had been $20.67 per ounce for 100 years, to $35 per ounce. The Treasury gold stock, valued at $4,033 million in January 1934, became $7,348

million in February 1934, an increase of $3,405 million by the decree of one man.[3] The federal government had also, unconstitutionally, repudiated all gold clauses in its contracts and debts, so it did not have to share any of its newfound wealth with the private sector. In one month Congress and Roosevelt, by their legislative and administrative fiats, created seigniorage revenue from gold equal to one year‘s ordinary tax revenues. In contrast, the federal government of 1834–1837, when it realized one year‘s extraordinary revenue from land sales, returned that surplus to the state governments to be used or distributed as those sovereign governments saw fit.[4] President Roosevelt rationalized this usurpation of private property rights in gold in one of his notorious fireside chats. ―Since there was not enough gold to pay all holders of gold obligations,‖ he claimed, ―the Government should in the interest of justice allow none to be paid in gold.‖[5] This rationalization of government confiscation was fatuous pretension. Gold in banks was then and had always been a fractional reserve against outstanding obligations. When the banks were on their own, they had adequate means to protect their reserves—gold, silver, or other legal tender. The Fed Banks and the U.S. Treasury—government institutions—also held only fractional reserves against their outstanding currencies. Use of gold as a recognized fractional reserve always precluded immediate liquidation of all monetary obligations into gold. So in effect Roosevelt was saying, ―Since there was not enough gold to pay all holders of gold obligations, . . . the federal government should expropriate and keep all of the gold.‖ The increase in the dollar price of gold, though other countries had gone off the gold standard or had also raised the price of gold in their own currencies, started a massive inflow of gold to the United States. Political apprehension in Europe and elsewhere also contributed to the U.S. accumulation. By 1940 the U.S. gold stock totaled $20 billion, or almost 20,000 tons! The contrast was notable between a government awash in gold and a depressed economy denuded of money and functioning with a shell-shocked banking system. Fed Banks and the Treasury still accounted new gold coming into the U.S. system as though the gold were a monetary asset. The Treasury issued ―Gold Certificates‖—currency notes in $100,000 denominations—accounted at the new gold price of $35 per ounce, which it ―deposited‖ in Federal Reserve Banks. Fed Banks then debited their ―Treasury deposit‖ liability account, and credited their ―Gold Certificates.‖ Whoever had received a check for the gold from the Treasury, however, had by now deposited that check in a commercial bank that in turn sent it to the Fed Bank for clearance. The Fed Bank cleared the check against the ―Treasury deposit‖ account and debited the deposit-reserve account of the client bank by the same amount. No one could get the gold out of the Treasury, or touch it, or see it, or use it. (It was now a criminal act to use gold for monetary purposes!) Nonetheless, the gold provided an accounting medium for increasing the basic money stock of bank reserves and Federal Reserve note currency. The Treasury in Control—The Fed Plays Ball With all of the new gold coming into the system, the FOMC did not need to use its newly legislated powers. From 1933 to 1936, the M2 money stock grew at annual rates of 9.5, 14.0, and

13.0 percent.[6] In fact, so much gold was coming into the Fed-Treasury‘s coffers that sentiment in both the Fed and Treasury leaned toward monetary restriction. The Fed had active hands-on control of monetary policy. Not only did it have the power to initiate open-market operations in government securities through the FOMC, but the Banking Act of 1935 also gave the Fed Board extensive control over member bank reserve requirements. Prior to the Banking Act, reserve requirements were statutory at 7, 10, and 13 percent—not based on the size of the bank, but on the size of the city in which the bank was located. The larger the city the higher the legal reserve requirement.[7] The Banking Act of 1935 used the existing set of reserve requirements as the lower end of a new range of requirements: 7–14, 10– 20, and 13–26 percent. Board of Governors‘ decisions in Washington were to specify the precise set of requirements in force at any time. Thus Fed policy could be restrictive by mandating an increase in requirements.[8] Banking Act or not, the Treasury was still very much in the monetary picture. Treasury Secretary Henry Morgenthau, Jr., had recommended to President Roosevelt the appointment of Marriner Eccles to be chairman of the Federal Reserve Board. Eccles outspokenly favored lots of federal spending and fiscal budget deficits. By his stance, he effectively signed over monetary policy to the Treasury. (Morgenthau had recommended Eccles for this reason.) The upshot of the arrangement was that Morgenthau ran the show. Both men favored a dominant fiscal policy that had Federal Reserve support. Although the new Banking Act took the secretary of the Treasury off the Fed‘s Board of Governors (he had been the ex officio chairman), he now had a surrogate as chairman. He was more than satisfied to see his purposes served from behind the throne. Even a surrogate position was not enough for Morgenthau. The realized seigniorage from the gold devaluation had given the Treasury a $2 billion windfall, accounted in an Exchange Stabilization Fund, that the Treasury was supposed to use to ―stabilize‖ the dollar price of foreign currencies. The Treasury thus had a gold ―position‖ and license for conducting gold policy. Federal Reserve policy directed the first increase (50 percent) in reserve requirements in August 1936—from 7, 10, and 13 percent to 101¼2, 15, and 191¼2 percent. A few months later the Treasury initiated its own gold sterilization policy—the same policy the Fed had fostered in the 1920s. Its purpose was ―to halt the inflationary potentialities [sic]‖ of all incoming gold. Beginning December 22, 1936, the Treasury placed its gold purchases in an ―inactive‖ account. Instead of issuing gold certificates and depositing them in Fed Banks to raise the necessary credit balance to pay for the gold, the Treasury paid for the gold by selling government securities in financial markets. By this means, it carried out its own open market operations—sales in this case—with its own ―FOMC.‖ This way the gold remained stockpiled but unmonetized in the Treasury. Besides neutralizing the gold inflows, the policy was further deflationary because it brought more government securities into markets to compete with consumers‘ and investors‘ dollars. It thereby tended to raise interest rates as it inhibited general spending. In March and May of 1937, the Fed complemented this generally deflationary policy by increasing reserve requirements to the maximum allowable percentages: 14, 20, and 26 percent.

Fed-Treasury policy makers had acted deliberately and purposively. They believed in human management of the monetary system. Just before he was appointed Fed chairman, Eccles had boldly stated that the Fed should ―support expansionary fiscal policy through discretionary monetary policy.‖[9] Unfortunately, the discretionary monetary policy now being practiced was anything but expansionary. It was, in fact, extremely repressive. Unprecedented Depression However, the rest of the economy, unlike politically prosperous Washington, was moving at an unprecedentedly slow rate. Never before had a recession-depression been so tenured or so intense. By late 1936 business was picking up, but the price level was still 18 percent below its 1929 value, and unemployment was still 16 percent of the labor force. Nonetheless, the great concern in the Treasury and Federal Reserve was the danger of inflation! Fed and Treasury officials looked at the overhang of excess legal reserves in the banking system and imagined what would happen if the commercial banks expanded all those reserves into an avalanche of checkbook money. Monetary mismanagement had just provoked the most disastrous hyperdeflation in history. Yet, before all the foreclosures had been properly settled, the government‘s monetary managers were contriving to counteract the inflationary potential that they had systematically built into the monetary machinery. Secretary Morgenthau announced in a press release, dated December 20, 1936, that Treasury gold policy was coordinated with the Fed‘s reserve requirement increases.[10] By mid-1937 ―inactive‖ gold in the Treasury was $1,087 million, or about 9 percent of total Treasury gold. Meanwhile, the banking system and the private economy foundered in a new recession. If one were to write a script that chronicled the end of free-enterprise capitalism, the events of 1929– 1938 would logically serve the purpose. Since few people understood the nuances of FedTreasury monetary policies, the common perception was that the Recession of 1937–1938 posed yet another failure of the market system. Dozens of tracts, novels, plays, and newspaper editorials reflected this notion. The appearance of the depression-recession evidently convinced Morgenthau that the ―danger of inflation‖ was passed. In September 1937 he released $300 million of gold from the inactive account thereby restarting the machinery of gold monetization. Gold certificate accounts at Fed Banks responded and gave rise as usual to increases in monetary base items in Fed Banks‘ balance sheets. Finally, on April 19, 1938, Morgenthau announced the discontinuance of the inactive gold account altogether. The time span of the Treasury‘s gold policy was 16 months—December 1936 to April 1938, while the Fed‘s reserve requirement increases occurred in August 1936 and March–May 1937, and continued in force with little change until after World War II. Treasury policy cut off new gold at the initial point of monetization; Fed policy effectively smothered the money-creating potential that old gold had already provided. For the next three years the economy stagnated. By 1941 the price level was still 14 percent below its 1929 value, and unemployment was still 10 percent of the labor force. Treatises appeared analyzing ―the stagnant industrial economy.‖ The

Keynesian notion of less-than-full-employment equilibrium seemed documented beyond reasonable doubt. Fed-Treasury methods in the mid-1930s reflected the prevailing notion of the times—that someone had to run the show, that operations without the rule of men were destined to be ―chaotic.‖ Economists and financial gurus were just as convinced of this argument as politicians and political scientists. One economist, Gove Griffith Johnson, commented in his contemporary book on Treasury policy: ―One may be skeptical of the wisdom with which monetary instruments will be used, but the possibility of abuse extends throughout the whole sphere of governmental activity and is a risk which must be assumed under a democratic or any other form of government.‖ The Treasury‘s gold policy, Johnson continued, ―was an essential instrument for producing desired political aims.‖ Congress had given over the Fed‘s powers of monetary regulation to the Treasury because the central bank had proven ineffectual. These powers had become more democratic because ―they were now exercised by politically responsible officials . . . [and] would eventually be subject to review by the electorate. . . . In large part,‖ he concluded, ―the [Federal Reserve] System has served merely as a technical instrument for effecting the Treasury‘s policies.‖[11] Clearly, the awesome monetary powers the Fed-Treasury had wielded were not the product of either ―wisdom‖ or scientific analysis. They were simply discretionary, seat-of-the-pants responses, sometimes politically motivated, by political authorities who faced no responsibility for their decisions. Furthermore, the ―risk of abuse‖ did not need to be ―assumed‖ under a democratic government suitably restrained by the rule of law. Finally, the electorate knew less about these policies than it knew about Sanskrit, and it had no power at all either to pass judgment on them or to change them . Under a true rule-of-law gold standard, the Treasury would not have had a ―gold policy.‖ The gold standard itself would have been the gold policy and would have been self-regulating through the concerted actions of thousands of households and businesses that bought and sold goods and services in hundreds of markets. The gold, more important, would not have been stockpiled in Treasury vaults unavailable and illegal for human use, like some dangerous drug or weapon. It would have been in commercial banks primarily, serving its conventional function of securing bank-issued money. The monetary mismanagement chronicled here should serve as the all-time example of the failure of discretionary monetary policy. Although a gold standard was still on the books, it was nothing more than a façade for Fed-Treasury manipulations. First the Fed by itself in the 1920s, then the Treasury ten years later, simply fit this ―gold standard‖ into their other hands-on policies. Both agencies saw to it that the gold was safely tucked away where it could do no one any good. Approximately seven thousand banks failed in the early 1930s for want of reserves while the stockpiling went on. Congress then gave the executive the power to enact an unprecedented increase in the price of gold, and added as well significant new powers to the Federal Reserve‘s authority. By 1936 the Fed-Treasury managers, fearing they had overdone

monetary expansion, decided to put on the brakes by again sterilizing gold and doubling bank reserve requirements. The result was a virtual paralysis of the monetary system and the economy. Had the banks held their own reserves or had them available in their own clearinghouses, as they did before the coming of the Fed, bank and clearinghouse executives (who were often the same people) would have parlayed the gold into strategic trouble spots where it would have prevented failures of healthy banks and general monetary destruction. Gold to be effective cannot be declared illegal and buried in the ground where no one can get it. If that is the best that civilization can do, we might as well have left the gold in California, the Klondike, Australia, and South Africa.

Toward Radical Monetary Reform
By Lawrence W. Reed • April 1982 • Volume: 32 • Issue: 4 Related • Filed Under • ShareThis• Print This Post • Email This Post
In the late 19th century and early 20th, the issue which occupied center stage of economic controversy was ―the money question.‖ From the time of the Civil War greenbacks through Bryan‘s ―Cross of Gold‖ speech of 1896 until the establishment of the Federal Reserve System in 1913, politicians, academics, editors, and business people squared off in heated debate over the proper monetary policy for the nation. After the dramatic events of the Great Depression and the creation of the post-war monetary system, the issue became relatively dormant as attention turned to other things. But recently, ―the money question‖ has emerged in full force once again. Its resurrection has come, not coincidentally, as an aftershock of a financial earthquake of staggering proportions. What has happened is that the monetary chickens have come home to roost. Decades of government-managed money have produced a frightening flirtation with runaway prices. The American dollar has lost at least 80 per cent of its 1940 value. The bond market has suffered fantastic losses. The devastation of dol-lar-denominated assets— savings, life insurance, pension funds, and the like—in real terms is tremendous. Faith and confidence in the future purchasing power of the dollar are everywhere in question. We have been witness to nothing less than the historic demonetization of fiat money. The damage this process has wrought may yet assign government paper to the status of ―barbarous relic‖ which Keynes once mistakenly ascribed to gold. Who can‘ honestly survey the wreckage and pronounce of the monetary authorities, “This is a job well done‖? It is in this unfortunate set of circumstances that proposals for ―monetary reform‖ are proliferating. It is not the objective of this essay to propose yet another or to endorse any particular one already advanced. Rather, the objective is to illuminate the intellectual path which any meaningful reform must take. The author leaves it to others to chart the specifics. To begin with, monetary reformers must come to grips with something fundamental to the origin and history of money. They must rediscover what the Austrian economist Carl Menger told us in his path-breaking Principles of Economics in 1871: ―Money is not an invention of the state. It is not the product of a legislative act. Even the sanction of political authority is not necessary for its existence.‖ Of Natural Origin The origin of money was entirely natural. It sprang from the awkwardness of barter and the desire for a marketable commodity to facilitate exchange. The first time man traded a good for something which he intended to use not for consumption himself but rather as a means to acquire what he really wanted, a medium of exchange —money—was born. It was a revolutionary invention-the economic counterpart to the wheel—and it made possible trade and a division of labor inconceivable in a barter economy. It was truly an invention of the marketplace, of economizing individuals seeking to improve their well-being. All sorts of commodities have served as media of exchange at one time or another. Cattle, cowry shells, furs and skins, wampum beads, tobacco, whale‘s teeth, cigarettes, and even rats are examples. Primitive though these monies may seem, they had the qualities of familiarity and acceptability which made them marketable and hence, candidates for money.

In most markets of the world, the precious metals emerged as the primary money commodities. Durability, divisibility, high value in small quantities, and relative stability in purchasing power over time were characteristics which no other commodities could match. As early as 650 B.C., coins of gold and silver became almost singularly synonymous with the term ―money‖ in the trading world. Paper arrived later on the monetary scene as a ―money substitute.‖ It took the form of promissory notes which pledged real money in payment for goods. Issued by early banks, for instance, they were redeemable or convertible on demand into the precious metals they represented. Inflation Involves Government Control over Money Governments, afflicted with an insatiable appetite for revenue, have generated history‘s inflations by first assuming control over money. Then gold coins became only partially gold or without gold at all. Paper notes, stripped of their ―backing,‖ became ―fiat‖—their value tied to the whims of the inflating authority. Monetary history records no instance of a people voluntarily choosing in the marketplace to use unbacked fiat paper as their money! The problem with so much of monetary economics today is that it does not fully comprehend the inescapable conclusion that money is a market phenomenon—that it originated in the market, that it evolved in the market, and that the market laws of supply and demand apply to money just as they do to any other commodity traded in the market. I submit that no monetary reform is likely to succeed if it treats money as the invention and exclusive domain of a political monopoly. The essential task of true monetary reform, then, is to find a way to divorce money from politics and make it as much a product of the market as possible. In this vein, the many proposals which call for minor alterations of the government‘s monetary function sound a little like rearranging the deck chairs on the Titanic. Simply putting a different crew in charge of the ship or experimenting with the compass are not radical enough. In this case, the market may be just the lifeboat we should be looking for. The objection may be raised, ―Without a central authority, how will anyone know what t he supply of money should be?‖ Well, does anyone know what the supply of green beans should be? How many quarts of milk should be produced? How many size 36 undershorts there ought to be? How is it that the market is able to provide these things without central planners and in just the right amounts? The answer, of course, is the market‘s mechanism of price. When costs are low and price is high, the signal to producers is, ―Make more!‖ Producers know they should not pile up any more when costs exceed price . Why shouldn‘t money respond similarly? When gold was money, this mechanism certainly did work reasonably well. As long as it was profitable to mine gold, producers did. ―Too much gold‖ on the market caused the value of gold to fall and the cost of minin g to rise— a double whammy that prevented producers from engaging in a continuous inflation. The supply of money, therefore, had something to do with the real market demand for money. With today‘s fiat money, the mechanism is short-circuited. Double digit price inflation is the market‘s way of signaling that there‘s too much of the green stuff around, but the signal never directly strikes the producer. There‘s no chance that he will go broke in the process of creating more than the market demands. For the inflator of fiat money, the incentives are perverse: he grows bigger the more he does the very thing he shouldn‘t be doing! It is no sure bet that the debate over monetary reform will deal fundamentally with this question of political versus market money. We have lived for so long with the former and its ruinous consequences that suggesting the radical alternative may be tantamount to the impossible task of teaching blind people what it would be like to see. Once it was believed that witches, warlocks, and demons were the causes of such calamities as bad weather. Elaborate contrivances were devised to drive them away. When men learned that it wasn‘t so, they looked for more

natural, scientific explanations. Perhaps it is time to relegate to superstition the idea that government should manage money and get on to the task at hand—putting money back in the marketplace where it belongs. [] [Mr. Reed is assistant professor of economics at Northwood Institute in Midland, Michigan, and director of the college's annual Freedom Seminars. He is co-editor and co-author, along with Dr. Dale Haywood, of a new book When We Are Free.]

Gold versus Fractional Reserves
By Henry Hazlitt • May 1979 • Volume: 29 • Issue: 5 Related • Filed Under • ShareThis• Print This Post • Email This Post Henry Hazlitt, noted economist, author, editor, reviewer and columnist, is well known to readers of the New York Times, Newsweek, The Freeman, Barron’s, Human Events and many others. The most recent of his numerous books is The Inflation Crisis, and How to Resolve It. The present worldwide inflation has done, and will continue to do, immense harm. But it may eventually lead to one great achievement. It may make it possible to restore (or perhaps it would be more accurate to say to create) a full 100 percent gold standard. That could come about in a simple manner. Our government has made it once more legal to hold gold, to trade in gold, and to make contracts in terms of gold. This makes it possible for private individuals to buy and sell in terms of gold, and therefore to restore gold as a medium of exchange. If our present inflation, as seems likely, continues and accelerates, and if the future purchasing power of the paper dollar becomes less and less predictable, it also seems probable that gold will be more and more widely used as a medium of exchange. If this happens, there will then arise a dual system of prices—prices expressed in paper dollars, and prices expressed in a weight of gold. And the latter may finally supplant the former. This will be all the more likely if private individuals or banks are legally allowed to mint gold coins and to issue gold certificates. But even of the small number of monetary economists who favor a return to a gold standard, probably less than a handful accept the idea of such a 100 percent gold standard. They want a return, at best, to the so-called classical gold standard—that is, the gold standard as it functioned from about the middle of the nineteenth century to 1914. This did work, one must admit, incomparably better than the present chaos of depreciating paper monies. But it had a grave weakness: it rested on only a fractional gold reserve. And this weakness eventually proved its undoing. Not Enough Gold? The advocates of the fractional gold standard, however, saw—and still see— this weakness as a strength. They contend that a pure gold standard was and is impossible; that there is just not enough gold in the world to provide such a currency. Moreover, a pure gold standard, they argue, would be

unworkably rigid. On the other hand, a fractional reserve system, they say, is flexible; it can be adjusted to "the needs of business"; it provides an "elastic" currency. We will come back to these alleged virtues later, and examine them in detail; but first I should like to call attention to the central weakness of a fractional reserve system: it embodies a long-term tendency to inflation. Let us begin with a hypothetical illustration. Suppose we have a world in which the leading countries have been maintaining a 100 percent gold standard, that they begin to find this very confining, and that they decide to adopt a fractional gold standard requiring only a 50 percent gold reserve against bank deposits and bank notes. The banks are now suddenly free to extend more credit. They can, in fact, extend twice as much credit as before. Previously, assuming they were lent up, they had to wait until one loan was paid off before they could extend another loan of similar size. Now they can keep extending more loans until the total is twice as great. The new credit plus competition causes them to lower their interest rates. The lower interest rates tempt more firms to borrow, because the lower costs of borrowing make more projects seem profitable than seemed profitable before. Credit increases, projects increase, and there is a "boom." So reducing the gold reserve requirement from 100 percent to 50 percent, it appears, has been a great success. But has it? For other consequences have followed besides those just outlined. Production has been stimulated to some extent by lowering the reserve requirement; but production cannot be increased nearly as fast as credit can be. So as a result of increasing the credit supply most prices have practically doubled. Twice the credit does not "do twice the work" as before, because each monetary unit now does, so to speak, only half the work it did before. There has been no magic. The supposed gain from doubling the nominal amount of money has been an illusion. And this illusion has been bought at a price. Lowering the required gold reserve to 50 percent has enabled the banks to double the volume of credit. But as they begin to approach even the new credit limit, available new credit becomes scarce. Some banks have to wait for old loans to be paid off before they can grant new ones. Interest rates rise. New projects have to be abandoned, as well as some incompleted projects that have already been launched. A recession sets in, or even a financial panic.

And then, of course, the proposal is made that the simple way out is to reduce the gold-reserve requirement once again, so as to permit a still further creation of credit. The Federal Reserve Act Historically, this is exactly what has been happening. Space does not permit a detailed review of what has happened in one nation after another, starting, say, after the adoption in England of Sir Robert Peel’s Bank Act of 1844. But we can point to a few sample changes in our own country, beginning with the Federal Reserve Act of 1913. That act set up twelve Federal Reserve Banks, and made them the repositories for the cash reserves of the national banks. The first thing that was done was to reduce the reserve requirements of these commercial banks. Under the national banking system the banks had been classified according to the size of the city in which they were located. They were Central Reserve City Banks, Reserve City Banks, and Country Banks. These were required to keep reserves, respectively, of 25 percent of total net deposits (all in the bank’s own vaults), 25 percent of total net deposits (at least half in the bank’s own vaults), and 15 percent of total net deposits (two-fifths in the bank’s own vaults). The Federal Reserve Act classified deposits into two categories, demand and time, with separate reserve requirements for each. For demand deposits the act reduced the reserve requirements to 18 percent for Central Reserve City Banks, 15 per cent for Reserve City Banks, and 12 percent for Country Banks. In each case at least one-third of the reserve was to be kept in the bank’s own vaults. For time deposits the reserve was only 5 percent for all classes of banks. In 1917, as an aid in floating government war loans, the reserve requirements were further relaxed, to 13, 10, and 7 percent respectively, with only a 3 percent reserve requirement for time deposits. Though the amendment also required that all reserve cash should thereafter be held on deposit with the Federal Reserve Banks, the amount of till or vault cash necessary to meet daily withdrawals was found to be small. In addition to this lowering of the reserve requirements of the member banks, the Federal Reserve System provided for the building of a second inverted credit pyramid on top of the one that the member banks could build. For the Federal Reserve Banks themselves were authorized to issue note and deposit liabilities against their gold reserves, which were required to total only 35 percent against deposits.

As a result of such changes, if the average reserves held by the commercial banks against their deposits were taken as 10 percent, and the gold reserves held by the System against these reserves at 35 percent, the actual gold held against the commercial deposits of the System could be reduced to as low as 3.5 percent. What actually did happen is that between 1914 and 1931, total net deposits of member banks increased from $7.5 billion to $32 billion, or more than 300 percent in less than two decades.’ These figures continued to grow. Gold reserve requirements were finally removed altogether. In August, 1971, when the United States officially went off the gold standard, the money stock, as measured by combined demand and time deposits plus currency outside of banks, was $454.5 billion. The U.S. gold reserves were then valued at $10.2 billion. This meant that the money stock of the country had been multiplied more than sixty times over that of 1914, and the gold reserve against this money stock had fallen to only 2.24 percent. Put another way, there was then $44 of bank credit issued against every $1 of gold reserves. Exhausting the Gold Reserve The situation was actually more ominous than these figures suggest. For under the gold-exchange system of the International Monetary Fund, it was not merely the American dollar, but the total currencies of practically all the nations in the Fund, that were supposed to be ultimately convertible into the U.S. monetary gold stock. The miracle is not that this gold exchange system collapsed altogether in August of 1971, but that it did not do so much sooner. In short, the fractional gold standard tends almost inevitably to become more and more attenuated, and while it does so it permits and encourages progressive inflation. When the gold standard is abandoned completely and officially, inflation usually accelerates. This has been illustrated in the more than seven years since August, 1971. At the end of 1978, the money stock, counting both demand and time deposits, had risen to $871 billion—nearly double the figure at which it stood in August, 1971. But what happens as long as the fractional gold standard is being nominally maintained is that the milder rate of inflation is less noticed, and even many monetary economists are inclined to view it with complacency. This is partly because they have a reassuring theory of what is happening. The amount of

currency and credit, they say, is responding to the "needs of business." The loans on which the deposits or Federal Reserve Notes are based represent "real goods." A manufacturer of widgets, for example, borrows a six-month loan from his bank to meet his payroll and other production costs, then when he sells his goods he pays off the loan with the proceeds, and the credit is cancelled. It is "self-liquidating." The money is therefore "sound"; it cannot be over-issued, because it increases and contracts with the volume of business activity. What this theory overlooks is that while the individual loan may be selfliquidating, this is not what happens to the total volume of credit outstanding. Manufacturer Smith’s loan has been repaid. But under the fractional reserve system, the bank, as a result of this repayment, now has "excess reserves," which it is entitled to re-lend. Of course if the bank is fully lent up, even under a fractional reserve system, it cannot extend credit further. But when a substantial number of banks are seen to be nearing this point, pressure comes from all sides—from the banks and their would-be borrowers, and from the government monetary authorities and the politicians who have appointed them—to lower the reserve requirements further. If nothing has gone wrong so far with the existing fractional reserve, indeed, there seems to be no harm in reducing the fraction further. It will permit a further expansion of credit, reduce interest rates, and prevent a threatened business recession. In sum, to repeat, a fractional-reserve gold system, once accepted, must periodically bring about business and political pressure for a further reduction of the fractional reserve required. The Harmful Consequences We have now to examine the harm that the system does whether or not the pressure to reduce the reserve requirements is continuously successful. Let us begin with a situation in, say, Ruritania, which has a fractionalreserve gold standard and a central bank, but in which business activity has not been fully satisfactory. The central bank then either lowers the discount rate, or creates more member-bank reserves by buying government securities, or it does both. As a result, business is encouraged to increase its borrowing and to launch on new enterprises, and the banks are now able to extend the new credit demanded. As a consequence of the increased supply of money and credit, prices in Ruritania rise, and so do employment and money incomes. As a further result, Ruritanians buy more goods from abroad. As another result, Ruritania

becomes a better place to sell to, and a poorer place to buy from. It therefore develops an adverse balance of trade or payments. If neighboring countries are also on a gold basis, and inflating less than Ruritania, the exchange rate for the rurita declines, and Ruritania is obliged to export more gold. This reduces its reserves and forces it to contract its currency and credit. More immediately, it obliges Ruritania to increase its interest rates to attract funds instead of losing them. But this rise in interest rates makes many projects unprofitable that previously looked profitable, shrinks the volume of credit, lowers demand and prices, and brings on a recession or a financial crisis. If neighboring countries are also inflating, or expanding the volume of their money and credit at as fast arate, a crisis in Ruritania may be postponed; but the crisis and the necessary readjustment are all the more violent when they finally occur. The Cycle of Boom and Bust The fractional-reserve gold standard, in short—especially when it exists, as it usually does, with a central bank, a government and a public opinion eager to keep expanding credit to start a "full employment" boom or to keep it going—brings about what is known as the business cycle, that periodic oscillation of boom and bust that socialists and communists attribute, not to the monetary and credit system and central banking, but to some inherent tendency in the capitalist system itself. I need describe here only in a general way the process by which credit expansion brings about the boom and the inevitable subsequent bust. The credit expansion does not raise all prices simultaneously and uniformly. Tempted by the deceptively low interest rates it initially brings about, the producers of capital goods borrow the money for new long-term projects. This leads to distortions in the economy. It leads to overexpansion in the production of capital goods, and to other malinvestments that are only recognized as such after the boom has been going on for a considerable time. When this malinvestment does become evident, the boom collapses. The whole economy and structure of production must undergo a painful readjustment accompanied by greatly increased unemployment. This is the Austrian Theory of the trade cycle, which I need not expound here in all its complex detail because that has already been done fully and brilliantly by such writers as Mises, Hayek, Haberler, and Rothbard.2

The World Adrift in Turbulent Seas of Paper Money My chief concern in this article has been to show that in addition to being the principal institution responsible for bringing about the cycle of boom-andbust that has plagued the civilized world since the early nineteenth century, the fractional-reserve standard, once its principle of "economizing the use of gold" has been fully accepted, itself encourages an inflation that has no logical stopping place until gold has been "phased out" altogether, and the world is adrift in the turbulent seas of paper money. In emphasizing this weakness of a fractional-reserve standard, I do not intend to imply that I have solved the baffling problem of creating an ideal money—assuming that that problem is even soluble. An opportunity now exists—for the first time in a couple of centuries—to introduce a 100 percent gold reserve standard. But if sufficient new gold supplies were not regularly available, such a standard could conceivably result over time in a troublesome fall in commodity prices. Moreover, unless there were rigid prohibitions against it, a private no less than a government money would soon tend to become a fractional-reserve standard. And if we allowed this, would we not soon be on the road once more to a constantly diminishing fraction, and at least a constant mild inflation? I confess I do not have confident answers to these questions. But that does not invalidate my criticisms of a fractional-reserve standard. I should like to point out, incidentally, that expanding the money supply through a fractional-reserve standard—mainly for the purpose of holding down the exchange-value of the individual currency unit and thereby preventing a fall in prices—could also be accomplished under a full gold standard by constantly or periodically reducing the weight of gold into which the dollar (or other ‘unit) was convertible. Such a proposal was once actually made by the economist Irving Fisher. I am unaware of any economist who accepts such a proposal today. But it is no different in principle from steadily expanding the money supply—under either a paper or a fractional-reserve gold standard—for the purpose of holding down the purchasing power of the monetary unit. Is this a power we would want to trust to the politicians? As a result of what has already happened, I regret that I cannot join some of my fellow champions of the full gold standard in urging their respective national governments to return immediately to such a standard. I believe such a step at the moment to be both politically and economically impossible. Confidence in the monetary good faith of governments has been destroyed. If any one government were to attempt to return to gold convertibility, at even today’s free market price for gold, it would probably be bailed out of its gold within a few weeks.

That is because holders of the currency would doubt not only that government’s determination but its ability to maintain that conversion rate. People have seen their governments casually abandon the gold standard, and they are more aware of how slim and insecure the new gold-backing might be against the enormous volume of credit and paper money now outstanding. Gold convertibility of an individual currency could probably now be restored only after a few years of balanced budgets and refrainment from further currency expansion. Meanwhile, if governments would permit private individuals or banks to mint gold coins and to issue gold certificates, a dual currency system could come into existence that could eventually permit a smooth transition back to a sound gold currency.

Central Banks, Gold, and the Decline of the Dollar
By Robert Batemarco • November 1995 • Volume: 45 • Issue: 11 Related • Filed Under • ShareThis• Print This Post • Email This Post
Are inflation, currency depreciation, and business cycles inevitable facts of life? Are they part of the very laws of nature? Or do their origins stem from the actions of man? If so, are they discoverable by economic science? And, if economics can teach us their origins, can it also teach us how to avoid them? The particular need which all money, even fiat money which we now use, serves is to facilitate exchange. People accept money, even if it is not backed by a single grain of precious metal, because they know other people will accept it in exchange for goods and services. But people accept the U.S. dollar today in exchange for much less than they used to. Since 1933, the U.S. dollar has lost 92 percent of its domestic purchasing power.1 Even at its "moderate" 1994 inflation rate of 2.7 percent, the dollar will lose another half of its purchasing power by 2022. In international markets, the dollar has, since 1969, depreciated 65 percent against the Deutsche Mark, 74 percent against the Swiss franc, and 76 percent against the yen.2 Many economists claim that this is the price for "full employment." If so, I‘d like to ask who among you thinks we‘ve gotten our money‘s worth. We‘ve experienced 11 recessions3 since the advent of inflation as the normal state of affairs in 1933, with the unemployment rate reaching 10.8 percent as recently as 1982. Clearly, the demise of the business cycle–a forecast made during every boom since the 1920s–is but a mirage. Other things being equal, if the quantity of anything is increased, the value per unit in the eyes of its users will go down. The quantity of U.S. money has increased year in and year out every year since 1933. The narrow M1 measure of the quantity of U.S. money (basically currency in circulation and balances in checking accounts) stood at $19.9 billion in 1933. By 1940, it had doubled to $39.7 billion. It surpassed $100 billion in 1946, $200 billion in 1969 (and 1946-1969 was considered a non-inflationary period), $400 billion in 1980, $800 billion in 1990, and today it stands at almost $1.2 trillion. That is over 60 times what it was in 1933. For all practical purposes, the quantity of money is determined by the Federal Reserve System, our central bank. Its increase should come as no surprise. The Federal Reserve was created to make the quantity of money "flexible." The theory was that the quantity of money should be able to go up and down with the "needs of business." Under the Fed, "the demands of government funding and refunding… unequivocally have set the pa ttern for American money management."4 Right from the start, the Fed‘s supposed "independence" was compromised whenever the Treasury asserted its need for funds. In World War I, this was done indirectly as the Fed loaned reserves to banks at a lower discount rate to buy war bonds. In 1933, President Roosevelt ordered the Fed to buy up to $1 billion of Treasury bills and to maintain them in its portfolio in order to keep bond prices from falling. From 1936 to 1951, the Fed was required to maintain the yields on Treasury bills at 3/8 percent and bonds at 2.5 percent. Thereafter, the Fed was required to maintain "an orderly market" for Treasury issues.5 Today, the Federal Reserve System owns nearly 8 percent of all U.S. Treasury debt outstanding.6 The Fed granted access to unprecedented resources to the federal government by creating money to finance (i.e., to monetize) its debt. It also served as a cartellization device, making it unnecessary for banks to compete with each other by restricting their expansion of credit. Before the emergence of the Fed upon the scene, a bank which expanded credit more rapidly than other banks would soon find those other banks presenting their notes or deposits for redemption. It would have to redeem these liabilities from its reserves. To safeguard their reserve holdings was one of the foremost problems which occupied the mind of bankers. The Fed, by serving as the member banks‘ banker, a central source of reserves and lender of last resort, made this task much easier. When the Fed created new reserves, all banks could expand together.

And expand they did. Before the Fed opened its doors in November 1914, the average reserve requirement of banks was 21.1 percent.7 This meant that at a maximum, the private banking system could create $3.74 of new money through making loans for every $1 of gold reserves it held. Under the Fed, banks could count deposits with the Fed as reserves. The Fed, in turn, needed 35 percent gold backing against those deposits. This increased the available reserve base almost three-fold. In addition, the Fed reduced member bank reserve requirements to 11.6 percent in 1914 and to 9.8 percent in 1917.8 At that point, $1 in gold reserves had the potential of supporting an additional $28 of loans. Note that at this juncture in time, gold still played a role in our monetary system. Gold coins circulated, albeit rarely, and banknotes (now almost all issued by the Federal Reserve) and deposits were redeemable in gold. Gold set a limit on the extent of credit expansion, and once that limit was reached, further expansion had to cease, at least in theory. But then limits were never what central banking was about. In practice, whenever gold threatened to limit credit expansion, the government changed the rules. Cutting off the last vestige of gold convertibility in 1971 rendered the dollar a pure fiat currency. The fate of the new paper money was determined by the whim of the people running the Fed. The average person looks to central banks to maintain full employment and the value of the dollar. The historical record makes clear that a sound dollar was never the Fed‘s intention. Nor has the goal of full employment done more than provide them with a plausible excuse to inflate the currency. The Fed has ertainly not covered itself with glory in achieving either goal. Should this leave us in despair? Only if there is no alternative to central banking with fiat money and fractional reserves. History, however, does provide us with an alternative which has worked in the past and can work in the future. That alternative is gold. There is nothing about money that makes it so unique that the market could not provide it just as it provides other goods. Historically, the market did provide money. An economy without money, a barter economy, is grossly inefficient because of the difficulty of finding a trading partner who will accept what you have and who also has exactly what you want. There must be what economists call a "double coincidence of wants." The difficulty of finding suitable partners led traders to seek out commodities for which they could trade which were more marketable in the sense that more people were willing to accept them. Clearly, perishable, bulky items of uneven quality would never do. Precious metals, however, combined durability, homogeneity, and high value in small quantity. These qualities led to wide acceptance. Once people became aware of the extreme marketability of the precious metals, they could take care of the rest without any government help. Gold and silver went from being highly marketable to being universally accepted in exchange, i.e., they became "money." If we desire a money that will maintain its value, we must have a money that cannot be created at will. This is the real key to the suitability of gold as money. Since 1492 there has never been a year in which the growth of the world gold stock increased by more than 5 percent in a single year. In this century, the average has been about 2 percent.9 Thus with gold money, the kind of inflations that have plagued us in the twentieth century would not have occurred. Under the classic gold standard, even when only a fractional reserve was held by the banks, prices in the United States were as low in 1933 as they had been 100 years earlier. In Great Britain, which remained on the gold standard until the outbreak of World War I, prices in 1914 on the average were less than half of what they were a century earlier.10 Traditionally, the gold standard was not limited to one or two countries; it was an international system. With gold as money, one need not constantly be concerned with exchange rate fluctuations. Indeed, the very notion of an exchange rate is different under a gold standard than under a fiat money regime. Under fiat money, exchange rates are prices of the different national currencies in terms of one another. Under a gold standard, exchange rates are not prices at all. They are more akin to conversion units, like 12 inches per foot, since under an international gold standard, every national currency unit would represent a specific weight of the same substance, i.e., gold. As such, their relationships would be immutable. This constancy of exchange rates eliminates exchange rate risk and the need to employ real resources to hedge such risk. Under such a system, trade between people in different countries should be no more difficult than trade among people of the several states of the United States today. It is no accident that the closest the world has come to the ideal of free international trade occurred during the heyday of the international gold standard.

It is common to speak of the "collapse" of the gold standard, with the implication that it did not work. In fact, governments abandoned the gold standard because it worked precisely as it was supposed to: it prevented governments and their central banks from surreptitiously diverting wealth from its rightful owners to themselves. The commitment to maintain gold convertibility restrains credit creation, which leads to gold outflows and threatens convertibility. If government were not able to resort to the issue of fiat money created by their central banks, they would not have had the means to embark on the welfare state, and it is possible that the citizens of the United States and Europe might have been spared the horrors of the first world war. If those same governments and central banks had stood by their promises to maintain convertibility of their currencies into gold, the catastrophic post-World War I inflations would not have ensued. In recent years, some countries have suffered so much from central banks run amok, that they have decided to dispense with those legalized counterfeiters. Yet they have not returned to the gold standard. The expedient they are using is the currency board. Argentina, Estonia, and Lithuania have all recently instituted currency boards after suffering hyperinflations. A currency board issues notes and coins backed 100 percent by some foreign currency. The board guarantees full convertibility between its currency and the foreign currency it uses as its reserves. Unlike central banks, currency boards cannot act as lenders of last resort nor can they create inflation, although they can import the inflation of the currency they hold in reserve. Typically, this is well below the level of inflation which caused countries to resort to a currency board in the first place. In over 150 years of experience with currency boards in over 70 countries, not a single currency board has failed to maintain full convertability.11 While currency boards may be a step in the right dection for countries in the throes of central-bank-induced monetary chaos, what keeps such countries from returning to gold? For one thing, they have been taught by at least two generations of economists that the gold standard is impractical. Let‘s examine three of the most common objections in turn: 1. Gold is too costly. Those who allude to the high cost of gold have in mind the resource costs of mining it. They are certainly correct in saying that more resource s are expended to produce a dollar‘s worth of gold than to produce a fiat dollar. The cost of the former at the margin is very close to a dollar, while the cost of the latter is under a cent. The flaw in this argument is that the concept of cost they employ is too narrow. The correct concept economically speaking is that of opportunity cost, defined as the value of one‘s best sacrificed alternative. Viewed from this perspective, the cost of fiat money is actually much greater than that of gold. The cost of fiat money is not merely the expense of printing new dollar bills. It also includes the cost of resources people use to protect themselves from the consequences of the inevitable inflation which fiat money makes possible, as well as the wasted capital entailed by the erroneous signals emitted under inflationary circumstances. The cost of digging gold out of the ground is minuscule by comparison.12 2. Gold supplies will not increase at the rate necessary to meet the needs of an expanding economy. With flexible prices and wages, any given amount of money is enough to accomplish money‘s task of facilitating exchange. Having the gold standard in place in the United States did not prevent industrial production from rising 534 percent from 1878 to 1913.13 Thus it is a mistake to think that an increase in the quantity of money must be increased to assure economic development. Moreover, an increase in the quantity of money is not tantamount to an increase in wealth. For instance, if new paper or fiat money is introduced into the economy, prices will be affected as the new money reaches individuals who use it to outbid others for the existing stocks of sport jackets, groceries, houses, computers, automobiles, or whatever. But the monetary increase itself does not bring more goods and services into existence. 3. A gold standard would be too deflationary to maintain full employment. As for the relationship of a gold standard to full employment, the partisans of gold have both theory and history on their side. The absolute "level" of prices does not drive production and employment decisions. Rather the differences between prices of specific inputs and outputs, better known as profit margins, are keys to these decisions. It is central bank creation of fiat money which alters these margins in ways that ultimately send workers to the unemployment line. Historically, the gradual price declines which characterized the nineteenth century made way for the biggest boom in job creation the world has ever seen.

The practical issues involved in actually returning to a gold standard are complex. But one of the most common objections, determining the proper valuation of gold, is fairly minor. After all, the market values gold every day. Any gold price other than that set by the market is by definition arbitrary. If we were to repeal legal tender laws, laws which today require the public to accept paper Federal Reserve Notes in payment of all debts, and permit banks to accept deposits denominated in ounces of gold, a parallel gold-based monetary system would soon arise and operate side-by-side with the Federal Reserve‘s fiat money.14 A more difficult problem than that would be how to get the gold the government seized in 1934 back into the hands of the public. But even that surely can‘t be more difficult than returning the businesses seized by the Communists in Eastern Europe to their rightful owners. If the Czech Republic can do that, we should be able to get government-held gold back into circulation. In all likelihood, the biggest problem gold proponents face is that people simply aren‘t ready to go back to gold. Most people aren‘t aware of the extent of our monetary disarray and many of those who are don‘t understand its source. Two generations of Americans have known nothing but unbacked paper as money; few realize that there is an alternative. In contrast, when the United States restored gold convertibility in 1879 and when Britain did so in 1821 and 1926, gold money was still seen as the norm. That is no longer the case. It might take a hyperinflationary disaster to shake people‘s faith in fiat money. Let‘s hope not. In addition to the horrendous costs of such a "learning experience," it‘s not even a sure thing that it would lead us back to gold. Recent hyperinflations in places as disparate as Russia and Bolivia have not done so. The desire to get something for nothing dies hard. Governments use central banks with the unlimited power to issue fiat money as their way to get something for nothing. By "sharing" some of that loot with us, those governments have convinced us that we too are getting something for nothing. Until we either wise up to the fact that governments can‘t give us something for nothing or, better yet, when we realize the moral folly of taking government handouts when offered, we will continue to get money as base as our desires.

How Gold Was Money–How Gold Could Be Money Again
By Richard H. Timberlake • April 1995 • Volume: 45 • Issue: 4 Related • Filed Under • ShareThis• Print This Post • Email This Post
1. Gold and Silver: The Money of the Constitution Students, scholars, and some curious people who occasionally stray into the text of the U.S. Constitution are properly puzzled by what seems to be that document‘s "plain language" and some of the things they see around them in the world today. One such thing is the paper money and checks everyone uses to make ordinary transactions. The Constitution stipulates that, "No state shall . . . coin money, . . . or make anything but gold and silver coin a tender in payment of debts . . ." (Article I, section 10). Yet on every unit of paper money the U.S. government asserts without apology: "This note is legal tender for all debts public and private." By what political alchemy has gold and silver become paper? Not only is the paper money legal tender, meaning that it must be accepted as payment for any debt owed by any person to another person or to a government, but the gold and silver specified in the Constitution are nowhere to be seen. Gold and silver coins rarely appear, and then only as collectible artifacts not as money. This seeming contradiction between the fundamental monetary law of the constitution and real life conditions might suggest to a thinking person that gold and silver had somehow disappeared from the face of the earth in the 200-plus years since the Framers included that simple clause. However, such is not the case. The world‘s governments own more than 35,000 tons of gold as bullion and coin, and private persons own another (estimated) 50,000 tons. Silver is even more plentiful. Its current market price, reflecting its abundance, is only about one-eightieth the price of gold.1 The absence of gold money correlates with the accumulation of gold hoards in the possession of government central banks and treasuries. If it‘s there, it obviously cannot be out in markets transacting business dealings, or in banks serving as a base for bank-issued notes and checks. It was not always this way. Until the time of the Civil War in the United States, banks routinely held gold and silver as redemption reserves for their outstanding notes and deposits while the federal government held just enough to expedite its minting operations. Congress had the constitutional power to "coin money," but that power did not presuppose that it keep any stock of gold and silver beyond the inventory requirements of its mints. Indeed, even though Congress had the power it was not required to coin money at all. Private mints flourished until the Civil War, often minting coins of slightly greater gold content than government mints. 2. Paper Money and Gold after the Civil War Civil War policies, however, changed fundamentally both the monetary system and the polity norms for governmental management of money. Congress authorized two new paper moneys, U.S. notes, or "greenbacks," which were declared full legal tender, and national bank notes that were legal tender for debts due to and payment due from the federal government. For all practical purposes, both these issues of paper money were obligations that the U.S. Treasury had to redeem in gold on demand after 1879. In addition, silver money at the specified mint price began to decline in real value starting about 1875 due to the burgeoning supplies of silver from the American West, so that it, too, was a viable currency only because it was redeemable in Treasury gold. Gold held for monetary purposes in the 1880s and 1890s therefore became concentrated in the U.S. Treasury and sub-treasuries, whereas 50

years earlier several thousand commercial banks had held the gold to meet the demands of their local depositors and note holders. The laws that authorized the three major fiat currencies changed the character of the gold standard from a widely dispersed gold standard, kept operational by thousands of local banks, to a "collectivist" gold standard operating from Washington and New York. Almost all the pressure for redemption of paper currency was transmitted to the U.S. Treasury and its sub-treasury offices. During the Panic of 1893, for example, the Treasury allowed its gold reserve to decline from $259 million (average for 1892) to $126 million (average for 1895), or by 51 percent.2 The Federal Reserve Act that Congress passed in late 1913 continued and aggravated the centralization of gold. The Treasury still held gold as a reserve against its paper currencies outstanding, and the twelve new Federal Reserve Banks received the gold deposits of their "member" banks and gave them in return a bookkeeping reserve asset labeled "Reserve Bank credit." Presumably, the member banks could get these deposits converted into gold whenever they needed it–much as an ordinary householder or businessman could write a check against his deposit at a commercial bank to get cash. The events of World War I witnessed an extraordinary gold flow into the United States to pay for war materials and services. By 1922 total gold in the U.S. Treasury, including the amount held for the Federal Reserve Banks, was $2,109 million, or 3,188 tons. Treasury gold fluctuated somewhat during the 1920s, but by 1929 was at $3,278 million or 4,956 tons. 3. New Deal Gold Policy: The Government’s Great Hoard of Gold As the Great Contraction began in 1929, the Treasury and Fed increased their hoards of gold –as though the stockpiling of gold in government vaults would serve as some kind of magical panacea that would reverse the disastrous ongoing contraction of money, bank credit, and employment. By 1931, Treasury goldwas $3,696 million – over 5,500 tons, while commercial banks were failing literally by the thousands for want of reserves. The compulsion of the U.S. Treasury and Federal Reserve Banks to hoard gold between 1929 and 1933 was in sharp contrast to Treasury policy between 1892 and 1896. In the earlier period the Treasury felt duty-bound to redeem its paper currencies with gold and in so doing lost over 50 percent of its gold reserves. All through the 1929-1933 period, except for a brief interval in the middle of 1932, the Treasury and Fed added to their gold holdings while the banking system collapsed as its reserves disappeared. The net change in Treasury gold holdings was a minuscule decline of 1.8 percent.3 Given the gold flow into the United States at this time, the commercial banks would have had significantly greater reserves for redemption purposes and credit expansion if the Treasury and Federal Reserve had not existed! Rather than an "engine of inflation," the Federal Reserve System at this time was an absorber of gold and an "engine of contraction." Between 1929 and 1933 it allowed the economy‘s monetary stock of hand -to-hand currency and bank deposits to decline from $26.2 billion to $19.2 billion, or by 27 percent.4 Instead of relieving the depressed monetary and credit conditions of 1933 by getting the gold out of the hands of the Treasury and Federal Reserve Banks and into commercial banks and households, New Deal monetary legislation only made matters worse. Congress and the Roosevelt Administration passed several acts in 1933-1934 that added more gold to the government‘s holdings and at the same time induced the surviving banks to be even more squeamish about extending new credit. On May 12, 1933, Congress passed the Thomas Amendment to the Agricultural Adjustment Act. This provision, among other things, gave the President the power to raise the dollar value of gold by 60 percent. Then on June 5th, three weeks later, Congress passed the Act Abrogating the Gold Clause, which repudiated all gold clauses in all contracts public and private, including the bonds issued by the government itself to help finance World War I. Next came the expropriation of privately held gold. By the Gold Reserve Act of January 30, 1934, President Roosevelt called into the U.S. Treasury all domestically owned gold and paid for it at the official mint price of $20.67 per ounce. Then, by the fiat power of proclamation given to him in the Gold Reserve Act, he raised the mint

price of gold by 59 percent to $35 per ounce. Since the government now owned all of the gold, none of the "profit" from the gold price increase went to private households, to banks, or to business firms where it was desperately needed. Rather it enhanced the already bloated hoard of gold in the U.S. Treasury. Treasury gold, which was valued at $4,033 million in January 1934 was accounted at $7,438 million in February 1934!5 The political uncertainty in Europe, in addition to the enhanced price of gold in the United States, caused significant exports of gold to the United States in the 1930s. By 1941, Treasury gold had reached $23 billion, which even at the new price amounted to over 20,000 tons! At the same time, private persons and businesses by the Act of 1934 were not allowed to own gold or to use gold for monetary purposes. And certainly the Treasury gold was not their gold. 4. Treasury Gold Policy after World War II The gold in fact had become nothing more than a balance sheet adornment for the Treasury Department and the Federal Reserve Banks. Government spokesmen dishonestly claimed that the Treasury‘s hoard of gold "backed" Federal Reserve Banks‘ notes and reserves. But what does "backed" mean if no one is allowed to own or use the gold? It meant in this case that the U.S. government through its Federal Reserve Banks could issue almost as much paper money as it pleased. Paradoxical as it might seem, foreigners, unlike U.S. citizens, could legally claim the U.S. Treasury‘s gold through their central banks and treasuries. Consequently, in accordance with balance of payments adjustments in the 1950s and 1960s, more than half of the Treasury‘s gold stock was exported to other countries. This continued outflow prompted President Nixon to discontinue even the pretense of a gold standard. On August 15, 1971, he barred any further gold redemptions to foreigners who held dollar claims. The price of gold then became an object of world market forces, but the U.S. Treasury holding since 1971 has remained almost constant at around 260 million ounces, or 8,125 tons.6 5. Why the Gold Should Be Separated from Government What should be done with all this gold–the 8,000-plus tons the U.S. Treasury holds as well as the other 27,000 tons that other governments sequester? It seems obvious from the history of the relationship between gold and the state that the more gold there is in the hands of governments the less surely the gold serves as money. Therefore, the only way to restore gold and silver as media of exchange is to get the metals out of the possession and control of governments. Certainly the gold has no current monetary or fiscal function for its government owners. It generates no revenue of any sort. It has no effect whatsoever on central bank monetary policies nor on the credit volume of the private banking system. In its present status as a government-owned "surplus" commodity, it is the "barbarous relic" that John Maynard Keynes characterized it in 1923. It may serve in the minds of Treasury beaureaucrats as psychological starch for something or other that the government does, but the role it could play, and did play in earlier eras, as a viable money is completely absent.7 The gold cannot be forced into a monetary role. No government, including especially the U.S. government, is going to re-establish a gold standard by specifying the gold content of gold coins and declaring them legal tender. Treasury spokesmen would claim with some validity that it would be impossible to estimate the gold value of the current Federal Reserve dollar. They would argue that the indeterminacy of gold‘s monetary value was a good excuse for doing nothing. So the gold would lie there, a useless heap similar in its non-function to other surplus commodities the government has stockpiled. Even if the Treasury went through the formality of giving dollars a fixed gold value, it would insist on keeping the gold in the Treasury‘s vaults in order to "back" the existing monetary aggregates that would now be "based" on gold. Central bank policies would continue to operate much as they do today. Rather they would now have an undeserved aura (literally) of respectability behind which Treasury and Federal Reserve managers could conduct business as usual.

Therefore, sound money advocates should not waste their resources lobbying for a gold standard, which by definition would include the state as overseer and manager of a gold currency, specifier of a gold price in terms of dollars, custodian of the gold, and continuing manipulator of a central bank-issued paper money. No. The only way to ensure that gold becomes a viable money is first to separate the gold from the state and the state from any further role in the operation of a gold money. Indeed, the separation of gold and the state would begin as an economizing measure–a form of privatization. Here are all those thousands of tons of gold lying idle and useless. Give them back to the people from whom the gold was unconstitutionally snatched in 1934. 6. Redistributing the Treasury Gold to the People The Treasury Department collects and disburses money for the federal government through its Internal Revenue Service (IRS). In some given taxable year, say 1996, the IRS would note the total number of dependents on the various income tax forms– 1040, 1040A, and 1040 E-Z. It would then issue one one-ounce gold certificate for each listed dependent to the heads of households who had filed the returns. The stored gold is in the form of ingots each of which weighs 400 troy ounces (27-plus pounds), and is worth somewhat more than $15,000 at the current market price of gold. The Treasury would offer to exchange (sell) these bars in the open market for the appropriate number of gold certificates to any private firm or individual tendering them in the proper quantities. It would leave the actual disposition of the gold completely in the hands of private wholesalers and brokers. In order to get the gold bars from the Treasury, a wholesaler would have to collect enough gold certificates to make his effort worthwhile. Very quickly, the gold market would establish a dollar price for the gold certificates. The price would be slightly less than the spot gold price currently posted in markets because the wholesaler-distributor would have to get some return for his services, which would include shipping, handling, storing, and packaging the gold. Taxpayers who received the gold certificates would be elated. After all these decades of paying taxes, they were finally getting something in return. True, it would be far less than what they had paid in, but at least the gesture would reflect a disposition on the part of a grateful government to reward its supporters by returning to them some real wealth that the government cannot use and that cost it nothing in the first place. The new gold owners–virtually all of us–would next ponder what to do with their windfalls. Some would at first want to deposit their gold certificates in banks as gold demand accounts until they were more certain of its value and utility to them. Because many people might want this option, banks would cater to their wishes by offering golddeposit accounts distinct from conventional checking accounts. The banks would use the gold certificates to claim the gold bars from the U.S. Treasury, and the gold would then become a true reserve backing the gold demand deposits. Industrial users would also want the gold to make art objects as well as other gold items. And some amount of the gold would probably be used in medical technology and the physical sciences. Finally, some certificate holders might want to exchange their certificates for gold coins that would be something like the half-eagles, eagles, and double eagles of the pre-1914 era. (The double eagle was a "twenty-dollar gold piece" and contained slightly less than one ounce of gold.) To satisfy the demand for coins, private coin-smiths would buy bunches of one-ounce certificates from the taxpayers who had received them and exchange them at Treasury offices for ingots. The coinage specialists would then produce coins in convenient denominations and sell them to their numismatic clients. 7. How the People’s Gold Would Become Money The gold redistribution would find everyone a winner. True, the U.S. Treasury would lose the gold. But since Treasury executives realized no travail in collecting the gold, and since the gold currently has no fiscal or monetary function to the government or any other use, parting with the gold should cause no more concern than clearing out

obsolete records and other trash. Its departure would in fact markedly reduce the administrative costs of Treasury operations. The now-privatized gold that had become the basis for special bank-administered checking accounts would develop monetary functions. Gold depositors who wished to transact in this medium would have checkbooks appropriately identified with gold logos, and would write checks to anyone who would accept title to the designated quantity of gold as payment for a debt. Gold reserve banks would clear gold balances with each other based on their daily or weekly debits and credits. They would perforce redeem deposits on demand in gold for any gold depositor who so wished. Eventually, borrowers might base their loans on gold, whereupon the gold would complete its restoration as a viable money. Gold would not become the monetary standard. It would continue to have a dollar-price in the world‘s gold market but it would not have a mint price specified by Congress. No government department for bureau would own gold. Federal Reserve notes as currency and Federal Reserve Bank reserve-deposit accounts for commercial banks would still be the only legal tender (in spite of the Constitution) and available as they are now for those who want conventional fiat paper money. The gold would simply be an alternative money for people who chose to use it for transactions and contracts. 8. The New Gold Money as a Check on Federal Reserve Policies>/font> A final interesting feature of the privatized gold would be the effect of its market price in paper dollars on present-day Federal Reserve policy. Some responsible Federal Reserve officials on the policy-making Federal Open Market Committee (FOMC) are currently trying to implement a policy of long-term price level stability, that is, a policy of zero inflation. However, they are constantly badgered by monetary "activists" in Congress and the Administration who want the FOMC to revert to a short-run inflationary "cure" for unemployment and economic slumps. If the privatized gold became fairly widely used as money side-by-side with Federal Reserve fiat money, the price of gold in Federal Reserve dollars would tend to be an instant check on the state of inflation–much more so than it is today. When the market price of gold rose, everyone would know that the Fed was inflating –that the real value of the paper dollar was falling–and would substitute private gold money for Federal Reserve money. The market price of gold, therefore, would be a constant check on too much monetary activism by the FOMC. It would thereby contribute significantly to the Fed’s desired policy of price level stability. To achieve a gold based money, the gold must be held ubiquitously so that individual people may endow the gold with monetary properties and monetary functions. But to have this effect, the gold must be in every-one’s possession so that everyone "can get the idea." For the last 60 years the Treasury has hoarded thousands of tons of gold, and has only disbursed it to foreign central banks and governments; and for the last 20-plus years the gold has been a largely inert mass of no use to anyone. Even Treasury officials are largely ignorant of its physical details. Suppose, however, that an astute politician promised to return the gold to the people as a means of economizing on the inventory of "surplus" government commodities. Can anyone imagine that such a plank in a political platform would be unpopular? "No, no," the candidate would declaim, "I am not buying votes with gold. I would not stoop to that. I simply want to economize government operations and, at the same time, return a useful commodity to the public so that people can use it as money if they wish to do so." Yes, Mr. Candidate, you have my vote. 1. Lewis Lehrman and Ron Paul, The Case For Gold, Washington: The Cato Institute, 1982, pp. 160-161. 2. Richard H. Timberlake, Monetary Policy in the United States, Chicago: University of Chicago Press, pp. 158-159. 3. Ibid., pp. 280-281. 4. Milton Friedman and Anna J. Schwartz, A Monetary History of the United States, 1867-1960, National

Bureau of Economic Research, Princeton: Princeton University Press, 1963, pp. 712-713. 5. Timberlake, ibid. Also, Horace White, Money and Banking, rev. and encl. by Charles Tippets and Lewis Froman, New York: Ginn & Co., 1935, pp. 696-721. 6. Paul & Lehrman, The Case for Gold, pp. 159-161. 7. Treasury officials and other government spokesmen often speak reverently about the "country’s gold reserves." This reference is at least 66 percent inaccurate. The gold does not belong to the "country"; it belongs to the federal government. And the gold is not a "reserve" for anything. It is an inert stockpile of precious metal. I do not doubt, however, that it is truly gold, and that it exists. Nevertheless, I would like a little more on-the-spot confirmation of this presumption. A final interesting feature of the privatized gold would be the effect of its market price in paper dollars on present-day Federal Reserve policy. Some responsible Federal Reserve officials on the policy-making Federal Open Market Committee (FOMC) are currently trying to implement a policy of long-term price level stability, that is, a policy of zero inflation. However, they are constantly badgered by monetary "activists" in Congress and the Administration who want the FOMC to revert to a short-run inflationary "cure" for unemployment and economic slumps. If the privatized gold became fairly widely used as money side-byside with Federal Reserve fiat money, the price of gold in Federal Reserve dollars would tend to be an instant check on the state of inflation–much more so than it is today. When the market price of gold rose, everyone would know that the Fed was inflating–that the real value of the paper dollar was falling–and would substitute private gold money for Federal Reserve money. The market price of gold, therefore, would be a constant check on too much monetary activism by the FOMC. It would thereby contribute significantly to the Fed‘s desired policy of price level stability. To achieve a gold-based money, the gold must be held ubiquitously so that individual people may endow the gold with monetary properties and monetary functions. But to have this effect, the gold must be in every-one‘s possession so that everyone "can get the idea." For the last 60 years the Treasury has hoarded thousands of tons of gold, and has only disbursed it to foreign central banks and governments; and for the last 20-plus years the gold has been a largely inert mass of no use to anyone. Even Treasury officials are largely ignorant of its physical details. Suppose, however, that an astute politician promised to return the gold to the people as a means of economizing on the inventory of "surplus" government commodities. Can anyone imagine that such a plank in a political platform would be unpopular? "No, no," the candidate would declaim, "I am not buying votes with gold. I would not stoop to that. I simply want to economize government operations and, at the same time, return a useful commodity to the public so that people can use it as money if they wish to do so." Yes, Mr. Candidate, you have my vote. 1. Lewis Lehrman and Ron Paul, , Washington: The Cato Institute, 1982, pp. 160-161. 2. Richard H. Timberlake, , Chicago: University of Chicago Press, pp. 158-159. 3. Ibid., pp. 280-281. 4. Milton Friedman and Anna J. Schwartz, , 18671960, National Bureau of Economic Research, Princeton: Princeton University Press, 1963, pp. 712-713. 5. Timberlake, ibid. Also, Horace White, Money and Banking, rev. and encl. by Charles Tippets and Lewis Froman, New York: Ginn & Co., 1935, pp. 696-721. 6. Paul & Lehrman, , pp. 159-161. 7. Treasury officials and other government spokesmen often speak reverently about the "country‘s gold reserves." This reference is at least 66 percent inaccurate. The gold does not belong to the "country"; it belongs to the federal government. And the gold is not a "reserve" for anything. It is an inert stockpile of precious metal. I do not doubt, however, that it is truly gold, and that it exists. Nevertheless, I would like a little more on-the-spot confirmation of this presumption.

Gold Standard
By Ludwig Von Mises • September 1981 • Volume: 31 • Issue: 9 Related • Filed Under • ShareThis• Print This Post • Email This Post
A metallic currency is not subject to government manipulation. The gold standard was an efficacious check upon credit expansion, as it forced the banks not to exceed certain limits in their expansionist ventures. The gold standard‘s own inflationary potentialities were kept within limits by the vicissitudes of gold mining. The significance of the fact that the gold standard makes the increase in the supply of gold dependent upon the profitability of producing gold is, of course, that it limits the governme nt‘s power to resort to inflation. The gold standard makes the determination of money‘s purchasing power independent of the changing ambitions and doctrines of political parties and pressure groups. This is not a defect of the gold standard; it is its main excellence. Nationalists are fighting the gold standard because they want to sever their countries from the world market and to establish national autarky as far as possible. Interventionist governments and pressure groups are fighting the gold standard because they consider it the most serious obstacle to their endeavors to manipulate prices and wage rates. But the most fanatical attacks against gold are made by those intent upon credit expansion. The purchasing power of gold is not stable. But the very notions of stability and unchangeability of purchasing power are absurd. In a living and changing world there cannot be any such thing as stability of purchasing power. It is an essential feature of money that its purchasing power is changing. The international gold standard works without any action on the part of governments. It is effective real cooperation of all members of the world-embracing market economy. There is no need for any government to interfere in order to make the gold standard work as an international standard. What governments call international monetary cooperation is concerted action for the sake of credit

The Gold Standard and Fractional-Reserve Banking
By Joe Cobb • September 1975 • Volume: 25 • Issue: 9 Related • Filed Under • ShareThis• Print This Post • Email This Post
Joe Cobb is Chief Budget and Fiscal Officer of the Industrial Commission of Illinois. He has written a number of articles on economic matters since graduation from the University of Chicago in 1966. This article is reprinted by permission from The Gold Newsletter, Vol. IV, No. 6, 1524 Hillary Street, New Orleans, Louisiana 70118. There is little doubt that a gold-oriented monetary system is superior to a fiat monetary system, from the perspective of the average citizen and businessman. Monetary systems which are managed by central banks or governments, as opposed to systems which arise in the market and are self-equilibrating, are prone to inflation and repudiation. The arguments against "managed" currency are clearly set forth in the Theory of Money and Credit by Ludwig von Mises, and it is not our purpose to argue against the gold standard. The argument of this essay is that the U.S. Dollar should not be "backed" by gold or "tied" to gold or otherwise officially connected to gold in any way. The free economy must have a metallic monetary standard (and gold is probably the best metal for that purpose), but the people who support an Act of Congress which pegs the price of gold in terms of dollars, or which defines the dollar in terms of gold, are making a big mistake. Like Oedipus, they are putting out their eyes and surrendering their monetary assets to the secret management of the U.S. Treasury without the ability to detect mismanagement. The assumption that a gold dollar is not a "managed" currency is an illusion. While it may be true that the quantity of money may be determined by the stock of gold in the nation at any point in time, the total volume of credit — including Federal credit, local government debt, and bank credit — is subject to control and management. The problem arises because the unit of money (let us call it "one dollar" in gold) has the same name and is traded at a fixed price with the unit of credit (let us call it "one dollar" in deposits). We all understand the process by which banks create credit: the depositor brings in a quantity of gold coin and the banker puts this in his vault, issuing certificates to the depositor (or establishing a checking account in his name). At this moment, the banker has 100 per cent reserves for his deposits. The next customer in the bank, however, is someone who wants to borrow — let’s assume the borrower will buy a house. The banker accepts a secured mortgage from the borrower (the banker’s non-monetary asset) and issues to the borrower some certificates identical to the ones he issued to the depositor. The total number of certificates is now greater than the supply of gold in the vault, so the banker’s reserves are only a fraction of his total outstanding certificates "payable in gold." There is nothing fraudulent about this; the banker’s assets equal his liabilities, and everybod y knows that bankers are in business to make loans with their depositors’ money. Banks perform a valuable service by accumulating small deposits and making large loans. It is not our point here to rant and rave against fractional reserve banking, but we need to understand the difference because there is a critical implication for any proposals to reform the monetary system and re-establish the gold coin standard.

Most students of economics have heard of Gresham’s Law: "Bad money drives out good money." What this means is that any holder of both gold coins and paper dollars will tend to spend the paper dollars and hold on to the gold coins. He will not spend the gold coins, unless the seller demands them instead of paper. The vicious aspect of legal tender laws is that they strip the seller of the right to demand coins instead of paper. Yet, Gresham’s law only holds true when there is a fixed price between the "good" money and the "bad" money. When there is a floating price, both forms of money circulate with equal frequency and the "price" of one in terms of the other adjusts according to the demand. This is a simple phenomenon arising from the two separate uses for money — the medium of exchange, and the store of value functions. The gold coins would be preferred as a store of value, and the paper dollars would be preferred as a medium of exchange. If sellers wanted coins instead of dollars, they would offer discounts for payment in gold. These discounts can be observed in every country which is experiencing a high rate of inflation. A discount on purchases is the same thing as a floating rate between gold and paper money. In the United States today, the medium of exchange consists primarily of checks, credit cards, and Federal Reserve Notes. The medium of exchange is entirely made up of credit. To refer back to the work of Ludwig von Mises, "money" is not in circulation at all —even though many of us are relying on gold as our store of value almost exclusively. What circulates is credit certificates, and it is the rapid expansion of credit which is causing double-digit inflation. It is always assumed by advocates of a "gold-backed" money that the quantity of gold ("money") will hold the supply of credit ("dollars") in bounds which will prevent excessive credit expansion. I submit that this is a false assumption. It is true that when the runs on the banks begin, the bankers will be exposed to failure and disgrace; but the bankers are smart enough to know that the government will rescue them. This is why the Federal Reserve System was created. To be sure, maybe we ought to abolish the Federal Reserve System and freeze the ability of the government to expand the supply of credit. This is a tall order, and it is doubtful that those of us with some knowledge of economics have sufficient political influence to triumph over (1) those who have a vested interest in the present system of credit expansion, and (2) the ignorant who would be persuaded by the first group that we are either nutty or evil. There is, however, a more direct and easily achieved solution. Happily enough, also, the monetary authorities are playing into our hands on this one. The solution involves the utilization of two differently-named units for the two different kinds of financial assets. Let the store of value be known as "ounces of gold" and let the medium of exchange be known as "dollars" of credit. Let the buyers and traders in a free market use gold-weight coins for their store of value. The solution to the problem of inflation, of course, would remain putting an end to credit expansion by the Treasury and the Federal Reserve System. However this small change in tactics would make an enormous long-run difference. It is convenient that the Krugerrand is approximately one troy ounce because its availability as an international coin makes the above proposal even easier to implement. When the unit of credit is called by the same name as the unit of money ("dollar" for example), the citizen simply must take the word of the Treasury that the assets are in the vault and that credit expansion is not being indulged in. The indirect consequences of credit expansion, such as rising prices for goods and services, occur only after a lag in time. Even then it is not always clear what may be happening. Aggregate supply and aggregate demand move up and down for many diverse reasons, and prices adjust accordingly. The

political system takes advantage of this random, or unpredictable, free market process. The government long ago learned that it can increase aggregate demand by printing bonds, using the bonds as assets against which to create Federal Reserve Notes and demand deposits in the banking system. As we have observed during the period since 1967, on the other hand, the market price of gold in terms of the unit of credit adjusts to reflect credit expansion. This, then, would be the key to a secure gold coin standard: The coins would be measured by their common weight, and they would command a market value in terms of the unit of credit. A policy of zero credit expansion should be mandated by law, perhaps, but as a check-and-balance, the traders in the market would keep their eye on the price of gold in terms of credit. If the credit price of gold should rise, there would be strong and compelling evidence that inflation were afoot, unless proven otherwise by reports of physical movements of gold. With the introduction of weight-measured gold coins, we might expect to see an increasing number of securities and contracts made in terms of gold-weight coins. This should be encouraged, as a manifestation of the free market principle that people will do what is in their own best interests regardless of government policy. Indeed, the greater utilization of gold coins will increase the demand of gold assets and improve the value of private gold holdings (unless the central banks start to dump their gold holdings, but even this should produce only a short term downward movement and represent an excellent opportunity for private investors to buy). Any attempt by the government to "fix" the value of the depreciated unit of credit in terms of gold, however, should be vigorously resisted by anyone who values either economic freedom or private gold reserves.

Back to Gold?
By Henry Hazlitt • October 1965 • Volume: 15 • Issue: 10 Related • Filed Under • ShareThis• Print This Post • Email This Post
Mr. Hazlitt is the well-known economic and financial analyst, columnist, lecturer, and author of numerous books, including What You Should Know About Inflation (Princeton, N. J.: D. Van Nostrand, 1960; second edition, 1965). In February of this year President de Gaulle of France startled the financial world by calling for a return to an international gold standard. American and British monetary managers replied that he was asking for the restoration of a world lost forever. But some eminent economists strongly endorsed his proposal. They argued that only a return to national currencies directly convertible into gold could bring an end to the chronic monetary inflation of the last twenty years in nearly every country in the world. What is the gold standard? How did it come about? When and why was it abandoned? And why is there now in many quarters a strong demand for its restoration? We can best understand the answers to these questions by a glance into history. In primitive societies exchange was conducted by barter. But as labor and production became more divided and specialized, a man found it hard to find someone who happened to have just what he wanted and happened to want just what he had. So people tried to exchange their goods first for some article that nearly everybody wanted so that they could exchange this article in turn for the exact things they happened to want. This common commodity became a medium of exchange—money. All sorts of things have been used in human history as such a common medium of exchange—cattle, tobacco, precious stones, the precious metals, particularly silver and gold. Finally gold became dominant, the "standard" money. Gold had tremendous advantages. It could be fashioned into beautiful ornaments and jewelry. Because it was both beautiful and scarce, gold combined very high value with comparatively little weight and bulk ; it could therefore be easily held and stored. Gold "kept" indefinitely ; it did not spoil or rust; it was not only durable but practically indestructible. Gold could be hammered or stamped into almost any shape or precisely divided into any desired size or unit of weight. There were chemical and other tests that could establish whether it was genuine. And as it could be stamped into coins of a precise weight, the values of all other goods could be exactly expressed in units of gold. It therefore became not only the medium of exchange but the "standard of value." Records show that gold was being used as a form of money as long ago as 3,000 B.C. Gold coins were struck as early as 800 or 700 B.C. One of gold’s very advantages, however, also presented a problem. Its high value compared with its weight and bulk increased the risks of its being stolen. In the sixteenth and even into the nineteenth centuries (as one will find from the plays of Ben Jonson and Moliere and the novels of George Eliot and Balzac) some people kept almost their entire fortunes in gold in their own houses. But most people came more and more into the habit of leaving their gold for safekeeping in the vaults of goldsmiths. The goldsmiths gave them a receipt for it.

The Origin of Banks Then came a development that probably no one had originally foreseen. The people who had left their gold in a goldsmith’s vault found, when they wanted to make a purchase or pay a debt, that they did not have to go to the vaults themselves for their gold. They could simply issue an order to the goldsmith to pay over the gold to the person from whom they had purchased something. This second man might find in turn that he did not want the actual gold; he was content to leave it for safekeeping at the goldsmith’s, and in turn issue orders to the goldsmith to pay specified amounts of gold to still a third person. And so on. This was the origin of banks, and of both bank notes and checks. If the receipts were made out by the goldsmith or banker himself, for round sums payable to bearer, they were bank notes. If they were orders to pay made out by the legal owners of the gold themselves, for varying specified amounts to be paid to particular persons, they were checks. In either case, though the ownership of the gold constantly changed and the bank notes circulated, the gold itself almost never left the vault ! When the goldsmiths and banks made the discovery that their customers rarely demanded the actual gold, they came to feel that it was safe to issue more notes promising to pay gold than the actual amount of gold they had on hand. They counted on the high unlikelihood that everybody would demand his gold at once. This practice seemed safe and even prudent for another reason. An honest bank did not simply issue more notes, more IOU’s, than the amount of actual gold it had in its vaults. It would make loans to borrowers secured by salable assets of the borrowers. The bank notes issued in excess of the gold held by the bank were also secured by these assets. An honest bank’s assets therefore continued to remain at least equal to its liabilities. There was one catch. The bank’s liabilities, which were in gold, were all payable on demand, without prior notice. But its assets, consisting mainly of its loans to customers, were most of them payable only on some date in the future. The bank might be "solvent" (in the sense that the value of its assets equaled the value of its liabilities) but it would be at least partly "illiquid." If all its depositors demanded their gold at once, it could not possibly pay them all. Yet such a situation might not develop in a lifetime. So in nearly every country the banks went on expanding their credit until the amount of bank-note and demand-deposit liabilities (that is, the amount of "money") was several times the amount of gold held in the banks’ vaults. The Fractional Reserve In the United States today there are $11 of Federal Reserve notes and demand-deposit liabilities—i.e., $11 of money—for every $1 of gold. Up until 1929, this situation—a gold standard with only a "fractional" gold reserve—was accepted as sound by the great body of monetary economists, and even as the best system attainable. There were two things about it, however, that were commonly overlooked. First, if there was, say, four, five, or ten times as much note and deposit "money" in circulation as the amount of gold against which this money had been issued, it meant that prices were far higher as a result of this more abundant money, perhaps four, five, or ten times higher, than if there had been no more money than the amount of gold. And business was built

upon, and had become dependent upon, this amount of money and this level of wages and prices. Now if, in this situation, some big bank or company failed, or the prices of stocks tumbled, or some other event precipitated a collapse of confidence, prices of commodities might begin to fall ; more failures would be touched off ; banks would refuse to renew loans ; they would start calling old loans ; goods would be dumped on the market. As the amount of loans was contracted, the amount of bank notes and deposits against them would also shrink. In short, the supply of money itself would begin to fall. This would touch off a still further decline of prices and buying and a further decline of confidence. That is the story of every major depression. It is the story of the Great Depression from 1929 to 1933. From Boom to Slump What happened in 1929 and after, some economists argue, is that the gold standard "collapsed." They say we should never go back to it or depend upon it again. But other economists argue that it was not the gold standard that "collapsed" but unsound political and economic policies that destroyed it. Excessive expansion of credit, they say, is bound to lead in the end to a violent contraction of credit. A boom stimulated by easy credit and cheap money must be followed by a crisis and a slump. In 1944, however, at a conference in Bretton Woods, New Ham-shire, the official representatives of 44 nations decided—mainly under the influence of John Maynard Keynes of Great Britain and Harry Dexter White of the United States—to set up a new international currency system in which the central banks of the leading countries would cooperate with each other and coordinate their currency systems through an International Monetary Fund. They would all deposit "quotas" in the Fund, only one-quarter of which need be in gold, and the rest in their own currencies. They would all be entitled to draw on this Fund quickly for credits and other currencies. The United States alone explicitly undertook to keep its currency convertible at all times into gold. This privilege of converting their dollars was not given to its own citizens, who were forbidden to hold gold (except in the form of jewelry or teeth fillings) ; the privilege was given only to foreign central banks and official international institutions. Our government pledged itself to convert these foreign holdings of dollars into gold on demand at the fixed rate of $35 an ounce. Two-way convertibility at this rate meant that a dollar was the equivalent of one-thirty-fifth of an ounce of gold. The other currencies were not tied to gold in this direct way. They were simply tied to the dollar by the commitment of the various countries not to let their currencies fluctuate (in terms of the dollar) by more than 1 per cent either way from their adopted par values. The other countries could hold and count dollars as part of their reserves on the same basis as if dollars were gold. International Monetary Fund Promotes Inflation The system has not worked well. There is no evidence that it has "shortened the duration and lessened the degree of disequilibrium in the international balances of payments of members," which was one of its six principal declared purposes. It has not maintained a

stable value and purchasing power of the currencies of individual members. This vital need was not even a declared purpose. In fact, under it inflation and depreciation of currencies have been rampant. Of the 48 or so national members of the Fund in 1949, practically all except the United States devalued their currencies (i.e., reduced their value) that year following devaluation of the British pound from $4.03 to $2.80. Of the 102 present members of the Fund, the great majority have either formally devalued since they joined, or allowed their currencies to fall in value since then as compared with the dollar. The dollar itself, since 1945, has lost 43 per cent of its purchasing power. In the last ten years alone the German mark has lost 19 per cent of its purchasing power, the British pound 26 per cent, the Italian lira 27 per cent, the French franc 36 per cent, and leading South American currencies from 92 to 95 per cent. In addition, the two "key" currencies, the currencies that can be used as reserves by other countries—the British pound sterling and the U. S. dollar—have been plagued by special problems. In the last twelve months the pound has had to be repeatedly rescued by huge loans, totaling more than $4 billion, from the Fund and from a group of other countries. Balance of Payments The United States has been harassed since the end of 1957 by a serious and apparently chronic "deficit in the balance of payments." This is the name given to the excess in the amount of dollars going abroad (for foreign aid, for investments, for tourist expenditures, for imports, and for other payments) over the amount of dollars coming in (in payment for our exports to foreign countries, etc.). This deficit in the balance of payments has been running since the end of 1957 at a rate of more than $3 billion a year. In the seven-year period to the end of 1964, the total deficit in our balance of payments came to $24.6 billion. This had led, among other things, to a fall in the amount of gold holdings of the United States from $22.9 billion at the end of 1957 to $13.9 billion now —a loss of $9 billion gold to foreign countries. Other changes have taken place. As a result of the chronic deficit in the balance of payments, foreigners have short-term claims on the United States of $27.8 billion. And $19 billion of these are held by foreign central banks and international organizations that have a legal right to demand gold for them. This is $5 billion more gold than we hold altogether. Evenof the $13.9 billion gold that we do hold, the Treasury is still legally obliged to keep some $8.8 billion against outstanding Federal Reserve notes. This is why officials and economists not only in the United States but all over the Western world are now discussing a world monetary reform. Most of them are putting forward proposals to increase "reserves" and to increase "liquidity." They argue that there isn’t enough "liquidity"—that is, that there isn’t enough money and credit, or soon won’t be—to conduct the constantly growing volume of world trade. Most of them tell us that the gold standard is outmoded. In any case, they say, there isn’t enough gold in the world to serve as the basis for national currencies and international settlements. The Minority View But the advocates of a return to a full gold standard, who though now in a minority include some of the world’s most distinguished economists, are not impressed by these arguments

for still further monetary expansion. They say these are merely arguments for still further inflation. And they contend that this further monetary expansion or inflation, apart from its positive dangers, would be a futile means even of achieving the ends that the expansionists themselves have in mind. Suppose, say the gold-standard advocates, we were to double the amount of money now in the world. We could not, in the long run, conduct any greater volume of business and trade than we could before. For the result of increasing the amount of money would be merely to increase correspondingly the wages and prices at which business and trade were conducted. In other words, the result of doubling the supply of money, other things remaining unchanged, would be roughly to cut in half the purchasing power of the currency unit. The process would be as ridiculous as it would be futile. This is the sad lesson that inflating countries soon or late learn to their sorrow. The Great Merit of Gold The detractors of gold complain that it is difficult and costly to increase the supply of the metal, and that this depends upon the "accidents" of discovery of new mines or the invention of better processes of extraction. But the advocates of a gold standard argue that this is precisely gold’s great merit. The supply of gold is governed by nature; it is not, like the supply of paper money, subject merely to the schemes of demagogues or the whims of politicians. Nobody ever thinks he has quite enough money. Once the idea is accepted that money is something whose supply is determined simply by the printing press, it becomes impossible for the politicians in power to resist the constant demands for further inflation. Gold may not be a theoretically perfect basis for money ; but it has the merit of making the money supply, and therefore the value of the monetary unit, independent of governmental manipulation and political pressure. And this is a tremendous merit. When a country is not on a gold standard, when its citizens are not even permitted to own gold, when they are told that irredeemable paper money is just as good, when they are compelled to accept payment in such paper of debts or pensions that are owed to them, when what they have put aside, for retirement or old-age, in savings banks or insurance policies, consists of this irredeemable paper money, then they are left without protection as the issue of this paper money is increased and the purchasing power of each unit falls ; then they can be completely impoverished by the political decisions of the "monetary managers." I have just said that the dollar itself, "the best currency in the world," has lost 43 per cent of its purchasing power of twenty years ago. This means that a man who retired with $10,000 of savings in 1945 now finds that that capital will buy less than three-fifths as much as it did then. But Americans, so far, have been the very lucky ones. The situation is much worse in England, and still worse in France. In some South American countries practically the whole value of people’s savings—92 to 95 cents in every dollar—has been wiped out in the last ten years. Not a Managed Money The tremendous merit of gold is, if we want to put it that way, a negative one : It is not a managed paper money that can ruin everyone who is legally forced to accept it or who puts his confidence in it. The technical criticisms of the gold standard become utterly trivial when compared with this single merit. The experience of the last twenty years in practically every

country proves that the monetary managers are the pawns of the politicians, and cannot be trusted. Many people, including economists who ought to know better, talk as if the world had already abandoned the gold standard. They are mistaken. The world’s currencies are still tied to gold, though in a loose, indirect, and precarious way. Other currencies are tied to the American dollar, and convertible into it, at definite "official" rates (unfortunately subject to sudden change) through the International Monetary Fund. And the dollar is still, though in an increasingly restricted way, convertible into gold at $35 an ounce. Indeed, the American problem today, and the world problem today, is precisely how to maintain this limited convertibility of the dollar (and hence indirectly of other currencies) into a fixed quantity of gold. This is why the American loss of gold, and the growing claims against our gold supply, are being viewed with such concern. The $35 Question The crucial question that the world has now to answer is this: As the present system and present policies are rapidly becoming untenable, shall the world’s currencies abandon all links to gold, and leave the supply of each nation’s money to be determined by political management, or shall the world’s leading currencies return to a gold standard—that is, shall each leading currency be made once again fully convertible into gold on demand at a fixed rate? Whatever may have been the shortcomings of the old gold standard, as it operated in the nineteenth and the early twentieth century, it gave the world, in fact, an international money. When all leading currencies were directly convertible into a fixed amount of gold on demand, they were of course at all times convertible into each other at the equivalent fixed cross rates. Businessmen in every country could have confidence in the currencies of other countries. In final settlement, gold was the one universally acceptable currency everywhere. It is still the one universally acceptable commodity to those who are still legally allowed to get it. Instead of ignoring or deploring or combating this fact, the world’s governments might start building on it once more.

Money and Gold in the 1920s and 1930s: An Austrian View
By Joseph T. Salerno • October 1999 • Volume: 49 • Issue: 10 Related • Filed Under • ShareThis• Print This Post • Email This Post Joseph Salerno is a professor of economics in the Lubin School of Business at Pace University. In consecutive issues of The Freeman, Richard Timberlake has contributed an interesting trilogy of articles advancing a monetarist critique of the conduct of U.S. monetary policy during the 1920s and 1930s.[1] In the first of these articles, Timberlake disputes the late Murray Rothbard‘s ―Austrian‖ account of the boom-bust cycle of the 1920s and 1930s. Timberlake contends that Rothbard proceeds on the basis of a ―new and unacceptable meaning‖ for the term ―inflation‖ and a contrived definition of the money supply to ―invent‖ a Fed-orchestrated inflation of the 1920s that, in fact, never occurred. Moreover, Timberlake alleges, Rothbard‘s account was marred by a ―mismeasurement of the central bank‘s monetary data‖ as well as by a misunderstanding of the nature and operation of the Fed-controlled pseudo-gold standard by which U.S. dollars were created during this period. In the two subsequent articles, Timberlake also takes issue, respectively, with the U.S. Treasury‘s policy of neutralizing gold inflows and the Fed‘s policy of sharply raising reserve requirements in the mid-1930s, arguing that these complementary policies aborted an incipient economic recovery and brought on the recession of 1937–38. In what follows I will address the weighty charges brought against Rothbard and, in the process, offer an evaluation of the Federal Reserve System‘s culpability for the economic events of these tragic years that diverges radically from Timberlake‘s. The Meaning of ―Inflation‖ Let me begin with Timberlake‘s contention that Rothbard imputes a meaning to the word ―inflation‖ that is both new and unacceptable. In fact Rothbard‘s definition of inflation as ―the increase in money supply not consisting in, i.e., not covered by, an increase in gold,‖ is an old and venerable one. It was the definition that was forged in the theoretical debate between the hard-money British Currency School and the inflationist British Banking School in the midnineteenth century. According to the proto-Austrian Currency School, which triumphed in the debate, the gold standard was not sufficient to prevent the booms and busts of the business cycle, which had continued to plague Great Britain despite its restoration of the gold standard in 1821.[2] Briefly, according to the Currency School, if commercial banks were permitted to issue bank notes via lending or investment operations in excess of the gold deposited with them this would increase the money supply and precipitate an inflationary boom. The resulting increase in domestic money prices and incomes would eventually cause a balance-of-payments deficit financed by an outflow of gold. This external drain of their gold reserves and the impending

threat of internal drains due to domestic bank runs would then induce the banks to sharply restrict their loans and investments, resulting in a severe contraction of their uncovered notes or ―fiduciary media‖ and a decline in the domestic money supply accompanied by economy-wide depression. To avoid the recurrence of this cycle, the Currency School recommended that all further issues of fiduciary media be rigorously suppressed and that, henceforth, the money supply change strictly in accordance with the inflows and outflows of gold through the nation‘s balance of payments. The latter provided a natural, noncycle-generating mechanism for distributing the world‘s money supply strictly in accordance with the international pattern of monetary demands. Following the triumph of the Currency School doctrine and the implementation of its policy prescription by the Bank of England, its definition of inflation became accepted in the Englishspeaking world, especially in the United States, where there existed a much more radical and analytically insightful American branch of the School. The term ―inflation‖ was now used strictly to denote an increase in the supply of money that consisted in the creation of currency and bank deposits unbacked by gold. Thus for example, the American financial writer Charles Holt Carroll wrote in 1868 that ―The source of inflation, and of the commercial crisis, is in the nature of the system which pretends to lend money, but creates currency by discounting such bills when there is no such money in existence.‖[3] Even earlier, in 1858, Carroll had written, ―Instead of using gold and silver for currency they are merely used as the basis of the greatest possible inflation by the banks,‖ and that ―we should prevent any artificial increase of currency to prevent a future . . . catastrophe.‖[4] So it was the ―artificial increase of currency‖ only— through the creation of unbacked bank notes and deposits—that constituted inflation. The leading monetary theorist in the United States in the last quarter of the nineteenth century was Francis A. Walker. According to Walker, writing in 1888, ―A permanent excess of the circulating money of a country, over that country‘s distributive share of the money of the commercial world is called inflation.‖[5] While this version of the definition is applicable to inconvertible paper fiat currency, Walker also believed that inflation was an inherent feature of the issuance of convertible bank notes and deposits that lacked gold backing. In Walker‘s words, ―there resides in bank money, even under the most stringent provisions for convertibility, the capability of local and temporary inflation.‖[6] Unfortunately, however, because the writers of the British Currency School, unlike their American cousins, neglected to consider bank deposits as part of the money supply, their policies as adopted in Great Britain failed to prevent inflation and the business cycle. Consequently, and tragically, the School‘s doctrines and policies fell into profound disrepute by the late nineteenth century, and its definition of inflation was replaced by that of the opposing Banking School, which saw inflation as a state in which the money supply exceeds the needs of trade. Early American quantity theorists following the proto-monetarist Irving Fisher, in particular, seized upon and adapted this definition to their peculiar analytical perspective. Thus, Edwin Kemmerer wrote in 1920 that, ―Although the term inflation in current discussion is used in a variety of meanings, there is one idea common to most uses of the word, namely, the idea of a supply of circulating media in excess of trade needs.‖[7] Kemmerer went on to define inflation as

a state in which, ―at a given price level, a country‘s circulating media—money and deposit currency—increase relatively to trade needs.‖ From here it was a short step to the currently prevailing definition of inflation as an increase in the price level.[8] So Rothbard‘s theory is surely not new and to say that it is ―unacceptable‖ is simply to express one‘s agreement with the long-entrenched preference among orthodox quantity theorists, including contemporary monetarists, for the Banking School over the Currency School. Defining Money Timberlake also challenges Rothbard‘s statistical definition of the money supply for including savings and loan share capital and life insurance net policy reserves, alleging that Rothbard contrived this definition in order to make the rate of monetary growth appear larger than it actually was during the 1920s. Timberlake argues that the two items in question are not money because ―they cannot be spent on ordinary goods and services. To spend them, one needs to cash them in for other money—currency or bank drafts.‖[9] Let us take these items one at time. In the case of savings and loan share capital, there are two responses to Timberlake. First, the ―share accounts‖ offered by savings and loan associations are and always have been economically indistinguishable from the savings deposits offered by commercial banks, included in the older (pre-1980) definition of M2 that Timberlake apparently upholds as the appropriate definition of the money supply.[10] In practice depositors could withdraw their savings deposits from commercial banks on demand, because the law that permitted the banks to insist on a waiting period was rarely if ever invoked. Similarly, while savings and loan associations were contractually obligated to ―repurchase‖ their ―shares‖ at par on request of the shareholder, they could legally delay such repurchase for shorter or longer periods depending on their individual bylaws. Nonetheless such delays rarely occurred and ―for many years savings and loan associations have made the proud boast ‗every withdrawal paid upon demand‘ or some similar statement.‖[11] Moreover, while Timberlake is right that ―shareholders‖ had to trade their share accounts in for currency or bank drafts (at par and on demand) before they could spend them on goods and services, this was equally true of savings depositors at commercial banks. Thus the public has always considered dollars held in savings and loan share accounts or savings accounts as readily spendable as dollars held in commercial bank savings deposits. Second, Timberlake curiously does not object to Rothbard‘s inclusion of the savings deposits of mutual savings banks in the money supply, although they also are not included in the M2 definition he favors.[12] What makes Timberlake‘s position even more puzzling is that mutual savings banks were practically identical in economic function to savings and loan associations and were also technically ―mutually‖ owned by their depositors.[13] So why, then, does Timberlake insist so vehemently on treating the liabilities of these two institutions differently? A resolution of this mystery can perhaps be found in the work of Milton Friedman and Anna Schwartz, who excluded the share accounts of savings and loans (and of credit unions) from their definition of the money supply on the grounds that these institutions are technically not banks as

defined ―in accordance with the definition of banks agreed upon by federal bank supervisory agencies‖ since ―holders of funds in these institutions are for the most part technically shareholders, not depositors.‖ Despite this legal technicality, however, even Friedman and Schwartz were forced to admit that those who place funds with these institutions ―clearly . . . may regard such funds as close substitutes for bank deposits, as we define them.‖[14] Life Insurance Reserves This brings us to the issue of the net policy reserves of life insurance companies. Rothbard claimed that the cash surrender values of life insurance companies, that is, the immediately cashable claims possessed by policyholders against life insurance companies, statistically approximated by the companies‘ net policy reserves, represent a source of currently spendable dollars and should be included in the money supply. Once again the question is not whether insurance companies superficially resemble banks or can be technically classified as such according to some arbitrary regulatory definition. It is whether they essentially function like depository institutions, receiving funds from the public with which to make loans and investments, while contractually promising that such funds are available for withdrawal on demand by the policyholder. In Rothbard‘s view, the policyholder is economically in precisely the same position as a bank depositor (and thrift institution shareholder) in holding an immediately cashable par-value claim to dollars. Now admittedly, Rothbard‘s inclusion of this item in the money supply is controversial, much more so than his inclusion of savings and loan share accounts. However, he was hardly alone in maintaining this position. A number of mainstream writers of money and banking textbooks in the 1960s and 1970s recognized that cashable life insurance reserves possessed some of the characteristics of money. For example, Walter W. Haines characterized insurance companies as ―savings institutions‖ and noted that these savings ―can be withdrawn at any time‖ simply by allowing the policy to lapse, a feature that marks them as a ―near-money‖ on a par with savings accounts.[15] M.L. Burstein maintained that the cash value of a life insurance policy offered ―ready convertibility‖ into cash, was ―almost as liquid as a mattressful of currency,‖ and satisfied the ―precautionary motive‖ for holding liquid assets no less than savings and loan accounts and savings bonds.[16] Albert Hart and Peter Kenen included the ―net cash values of life insurance‖ in the broadest class of financial assets possessing the attribute of ―moneyness,‖ while Thomas F. Cargill ranked them on a liquidity spectrum immediately below large certificates of deposit, which are included in the current M3 definition of the money supply.[17] More important, however, even if we grant for the sake of argument that net life insurance reserves should be excluded from the money supply, we find that it makes very little difference to Rothbard‘s characterization of the 1920s as an inflationary decade. With this item included, the increase in Rothbard‘s M between mid-1921 and the end of 1928 totaled about 61 percent, yielding an annual rate of monetary inflation of 8.1 percent a year; with this item left out (but savings and loan share accounts included), the money supply increased by about 55 percent over the period or at an annual rate of 7.3 percent.[18] Mirabile dictu, by using a definition of the money stock that arbitrarily excludes savings and loan share accounts while including mutual savings bank deposits on the basis of an inexplicable adherence to a legalistic regulatory

definition of banks, it turns out that it is Timberlake (and Friedman and Schwartz) who have mismeasured money supply growth during the 1920s. Flawed Institutions Timberlake also criticizes Rothbard for ―ignorance of the flawed institutional framework within which the gold standard and the central bank generated money‖ and also of ―mismeasurement of the central bank‘s monetary data.‖[19] But this is surely a curious charge to level against Rothbard, steeped as he was in Currency School doctrine. In fact, Rothbard was quite cognizant that the U.S. monetary regime of the 1920s and 1930s was not a genuine gold standard in which the supply of money was determined exclusively by market forces, that is, by the balance of payments and the mining of gold, but a hybrid system in which the Fed possessed substantial power to manipulate the money supply by pyramiding paper bank reserves atop its stock of gold reserves. Indeed, Rothbard went much further than Timberlake in rigorously and completely separating those factors affecting the money supply that were subject to Fed control from those that the Fed had no control over.[20] In analyzing the central bank monetary data, Timberlake starts with the monetary base or ―Total Fed,‖ which is equal to currency in circulation plus member bank reserves. From this aggregate he properly subtracts the Fed‘s legal-tender reserves, mainly the gold stock, whose size depends on balance-of-payments flows and is not under the immediate control of the Fed. What remains is the ―net monetary obligations‖ of the Fed or ―Net Fed,‖ which, according to Timberlake, ―faithfully indicates the intent of Fed policy.‖[21] From 1921 to 1929, this aggregate declined by 8 percent per year, leading Timberlake to conclude that the intent of Fed policy was decidedly deflationary during this period. The motive for this deflationary policy bias was, Timberlake suggests, to aid Great Britain in re-establishing and maintaining gold convertibility for the pound sterling. However, as important as it is, the gold stock is not the only factor that lay beyond the Fed‘s control. For as Rothbard points out, currency in circulation, which improperly remains in Timberlake‘s Net Fed aggregate, is not controlled by the Fed at all but by the banking public. Any time a depositor withdraws cash from a bank, currency in circulation increases and bank reserves decline, dollar for dollar. Under a fractional-reserve banking system, this loss of reserves causes a multiple contraction of bank deposits that far exceeds the original increase in currency in circulation that induced it and therefore results in a net deflation of the money supply. Conversely, a decline in the amount of currency held by the public causes an overall increase in bank reserves and an overall inflation of the money supply. This is not all, however—Timberlake also ignores the fact that under the prevailing policy regime the banks themselves could autonomously reduce the amount of bank reserves and thus the quantity of money in existence by deliberately reducing their indebtedness to the Fed. During this period, it was the chosen policy of the Fed to lend liberally and continuously to all banks at an interest, or ―discount,‖ rate below the market rate. While the Fed was legally authorized to make such loans to its member banks, it was not mandated to do so. Furthermore, it also retained complete power to set the ―discount rate‖ it charged on these loans. Hence, if it had chosen to, the Fed could have restricted its lending to emergency situations and charged a penalty rate

substantially above the market rate, so as to discourage all but the most seriously troubled banks from applying for loans. In short, it could have almost completely neutralized the inflationary impact of its discounting operations. This ―emergency lending‖ policy had been urged by some prominent officials within the Fed establishment itself.[22] The fact that the Fed chose instead to pursue a ―continuous lending‖ policy meant that the increase in bank reserves that resulted from the origination of new Fed loans to member banks via the rediscounting of business bills or advances on collateralized bank promissory notes was under the exclusive control of the Fed. But it also meant that the reduction in bank reserves entailed by the net repayment of discounted bills was uncontrolled by the Fed, because it depended solely on the decisions of the banks. Given the Fed‘s indiscriminate, below-market rate discount policy, the banks were always in a position to maintain or augment their debts to the Fed if they so desired simply by discounting additional bills with the Fed. Thus, as Rothbard concluded, when ―Bills Repaid‖ exceeded ―New Bills Discounted,‖ banks were deliberately and autonomously diminishing their level of indebtedness to the Fed and this must be counted as an uncontrolled deflationary influence on bank reserves. Real Fed Intent If we follow Rothbard, then, in identifying currency in circulation and the reduction of bank indebtedness to the Fed along with the gold stock as the main ―uncontrolled‖ factors affecting bank reserves, we get a picture of the Fed‘s intent during the 1920s and early 1930s that is poles apart from the one suggested by Timberlake. Indeed, we find that from the inception of the monetary inflation in mid-1921 to its termination at the end of 1928, ―uncontrolled reserves‖ decreased by $1.430 billion while controlled reserves increased by $2.217 billion. Since member bank reserves totaled $1.604 billion at the beginning of this period, this means that controlled reserves shot up by 138 percent or 18.4 percent per year during this seven-and-one-half year period, while uncontrolled reserves fell by 89 percent or 11.9 percent per year. Thus Rothbard correctly concluded that the 1920s were an inflationary decade and that it was indeed the intention of the Federal Reserve System that it be so.[23] The Fed‘s inflationary intent is perfectly consistent, moreover, with its motive of helping Great Britain re-establish and maintain the pre-war parity between gold and the British pound. While Timberlake properly recognizes this motive underlying Fed policy, he is incorrect in suggesting that it necessitates a deflationary policy on the part of the Fed. In fact, the precise opposite is required. The British pound in the mid-1920s was overvalued vis-à-vis gold and the U.S. dollar, causing British products to appear relatively overpriced in world markets. As a result, Great Britain experienced imports chronically in excess of exports accompanied by persistent balanceof-payments deficits and outflows of gold reserves. Had the Fed deflated the U.S. money supply, thus lowering U.S. prices even more relative to British prices as Timberlake claims was its intention, it would have exacerbated, and not resolved, Great Britain‘s gold drain. Clearly, then, the Fed‘s desire to aid Britain in reversing its balance-of-payments deficits and rebuilding its gold stocks called for an inflationary policy intended to pump up U.S. prices, thereby rendering British products relatively cheap and enhancing the demand for them on world markets.[24]

This point about the motive for the Fed‘s easy-money policy in the 1920s was not only advanced by Rothbard, but by other economists, including monetarists such as Kenneth Weiher. According to Weiher: Great Britain was calling for help [in 1924] and Benjamin Strong [president of the New York Fed] heard the call. Expansionary monetary policy in the U. S. would drive prices up and interest rates down in this country, which would tend to send gold flowing toward Great Britain, where prices were lower and interest rates higher. These changes would help America‘s ally build up its stock of gold. . . . [T]here can be no question that the Fed would not have moved when it did were it not for concern over the gold standard and the plight of Great Britain. . . . By 1927, the stagnant British economy needed help from the United States and the rest of Europe. . . . Just as had been the case in 1924, monetary policy was shifted to an expansionary program in an effort to aid Great Britain‘s struggles to return to the gold standard.[25]

Rothbard‘s reinterpretation of the monetary data also cuts against Timberlake‘s claim that the Fed ―monetarily starved the country into the worst economic crisis it has ever experienced.‖[26] On the contrary, the factors controlled by the Fed continued to exercise a highly inflationary impact on bank reserves and the money supply from late 1929 through 1932, as the Fed attempted desperately to ward off the depression precipitated by the termination of the bank credit inflation that it had orchestrated in the 1920s. The deflation of the money supply, therefore, was caused wholly by factors beyond the control of the Fed. First, there was a loss of confidence in the Fed-dominated phony gold standard among the domestic public and foreign investors. As a result there occurred an increase in currency in circulation and a decline in the Fed‘s gold stock, both of which caused bank reserves to decline. Second, U.S. banks prudently attempted to save themselves and their depositors by restricting their loans to overcapitalized and failing businesses and instead using these funds to pay down their indebtedness to the Fed, which gave further impetus to the ―uncontrolled‖ reduction of bank reserves. Third, in the second quarter of 1932, the banks also began to increase their liquid reserves beyond the legal minimum. The accumulation of ―excess reserves,‖ as they were called, constituted a separate uncontrolled factor that reinforced the deflationary influence of the uncontrolled decline in bank reserves on the money supply. From the end of December 1929 to the end of December 1931, bank reserves fell from $2.36 billion to $1.96 billion causing RM (for Rothbard‘s money supply) to drop from $73.52 billion to $68.25 billion or at an annual rate of 3.6 percent. But this monetary deflation was not caused by the Fed, which pumped up controlled reserves by $672 million or at an annual rate of 17 percent during the period, while uncontrolled reserves declined by $1,063 million or by 27 percent per year. During 1932, RM continued to decline, falling to $64.72 billion or by 5.2 percent. But bank reserves increased sharply during the year from $1.96 billion to $2.51 billion, as the Fed furiously inflated controlled reserves. In the last ten months of the year, controlled reserves rose by a staggering $1,165 million, or at an annual rate of 76 percent. Fortunately, this attempted massive inflation of the money supply was undone by the domestic public, foreign investors, and

the banks as uncontrolled reserves dwindled by $495 million and banks began to accumulate substantial excess reserves. The story was much the same in 1933 as a determined inflationary campaign conducted by the Fed in the early part of the year—controlled reserves rose by $785 million in February alone— was defeated by the public and the banks, and RM declined by over $3 billion, or by almost 5 percent.[27] So once the data have been properly arranged and interpreted, it becomes clear that the Fed does not deserve praise for the bank credit deflation of 1930–1933. This honor goes to private dollarholders, domes-tic and foreign, who attempted to reclaim their rightful property from a central bank-manipulated and inflationary financial system masquerading as a gold standard that had repeatedly betrayed their trust. ―Sterilizing‖ Gold In two follow-up articles, Timberlake extends his attack on what he considers to be the ―deflationary‖ monetary policies pursued by the Treasury and Fed in the mid-1930s. In particular, he criticizes the Treasury‘s policy of ―neutralizing,‖ or ―sterilizing,‖ the effect of the inflow of gold on bank reserves from late 1936 to early 1938 and the Fed‘s policy of increasing reserve requirements in 1936 and 1937. But neither of these policies caused a contraction of the money supply. They merely temporarily interrupted a massive monetary inflation caused by the abolition of the gold standard and subsequent devaluation of the dollar engineered by the Roosevelt administration. It is important to recognize that this influx of gold was not a result of the ―uncontrolled‖ operation of the gold standard, which had been abolished in 1933. Rather, it was the result of the deliberate and steady increase in the price at which gold was purchased by the U.S. Treasury and the Reconstruction Finance Corporation. By January 1934, the price of gold had risen from $20.67 to $35.00 per ounce, or by almost 70 percent, where it was officially pegged by the Gold Reserve Act of 1934. The Treasury was now legally mandated to maintain this devalued exchange rate between gold and the dollar by freely purchasing all the gold offered to it at this price. In effect, then, Treasury gold purchases were now economically identical to inflationary Fed open market purchases, substituting demonetized gold for government securities. Consequently, in response to this unilateral increase in the price of gold above its world price, there occurred a prodigious influx of gold into the United States—a ―golden avalanche‖ it was called at the time—which vastly increased bank reserves. The result was an unprecedented inflation of the money supply (M2) during 1934, 1935, and 1936 at annual rates of 14 percent, 14.8 percent, and 11.4 percent, respectively.[28] With respect to its influence on the supplies of bank reserves and money, the demonetized gold stock thus had been transformed into a factor ―controlled‖ by monetary—in this case Treasury— policy. Given that the use and ownership of gold money by the public had been legally suppressed, gold was effectively demonetized and its continued purchase by the Treasury was purely a matter of discretionary monetary policy. Accordingly—and contrary to Timberlake‘s assertion—when during 1937 the Treasury began to finance its purchases of gold in a manner

that neutralized their effect on bank reserves, it was not engaging in deflation. The simultaneous sales of government securities to finance these purchases were simply and properly eliminating any extraneous effects of a demonetized asset on the money supply. Even if gold were permitted to continue in its monetary function, however, Timberlake would still be wrong in criticizing the policy of neutralizing its effect on bank reserves. For under a genuine, Currency School-type gold standard, a country‘s money supply would increase by exactly the amount of the gold inflow from abroad. This is not inflationary and represents precisely the proper amount by which the money supply should expand, because it is the outcome of the deliberate actions of the country‘s residents who are decreasing their purchases of foreign imports and increasing their sales of exports in order to satisfy their desires for greater money holdings. This balance-of-payments mechanism is a natural part of the market economy and works continually on all levels—including the region, state, town, and even household—to efficiently adapt money supply to relative changes in money demand. A problem arises, however, when these benign, money demand-driven gold inflows are used, as they were in the 1920s and early 1930s, as bank reserves to create unbacked notes and deposits. In this case, as F. A. Hayek has so aptly described, international gold flows will regularly cause a serious distortion of the free-market interest rate and investment pattern in the affected countries, leading to a business cycle.[29] The reason is that the needed adjustment in national money supplies upward or downward now entails creating or destroying fiduciary media by expanding or contracting bank loans in defiance of the preferences of the economy‘s consumers and savers. Thus, a policy of neutralizing the effect of gold flows on bank reserves in the context of a fractional-reserve banking system dominated by a central bank does not constitute a gross violation of the rules of the gold standard; to the contrary, it tends to facilitate the operation of the natural money-supply mechanism that prevails under a genuine gold standard. Not surprisingly, in the third article of the trilogy, Timberlake also objects to the Fed‘s policy of raising reserve requirements in 1936 and 1937, which was undertaken to mop up the massive amounts of excess reserves held by the banking system. Timberlake advances two criticisms against this policy. First, the policy was unnecessary because, even if all the excess reserves that existed on the eve of its implementation were subsequently fully loaned out by the banks, the inflationary potential was relatively minor. Appealing to the Banking School definition of inflation, Timberlake pronounces the 52 percent increase in the money supply that would have resulted as only mildly inflationary because the larger money supply would have exceeded the needs of trade of a fully employed economy by 5.6 percent at 1929 prices, which were about 25 percent higher than prices prevailing in June 1936.[30] In plain language, Timberlake is literally defining away a potential money and price inflation of gargantuan proportions because of its perceived expedience in expanding employment and output and extricating the economy from a depression. But as Timberlake himself admits in a footnote—and as Rothbard and other Austrians have never ceased to argue—what impeded the economy‘s natural and noninflationary recovery from the depression was the existence of ―government programs [that] had actively worked against money price declines for ten years.‖[31] Growing Money Supply

In his second criticism, Timberlake contends that the increase in reserve requirements went beyond closing off a potential avenue of recovery for the economy and ―turned what had been an ongoing recovery into another cyclical disaster.‖ But if we once again turn to Timberlake‘s data we find that the money supply (M2) continued to grow, from $43.3 to $45.2 billion or by 4.4 percent, between June 30, 1936, and June 30, 1937, the year in which this policy was implemented. Even if we focus on the last six months of the period, there was hardly a wrenching deflation, as the money supply increased at an annual rate of 0.8 percent.[32] Even from Timberlake‘s monetarist standpoint, then, it is difficult to blame the ―recession within a depression‖ of 1937–1938 on deflationary Fed policy. Unfortunately Timberlake‘s strained and narrow emphasis on Fed deflationism as the cause of all the woes of the 1930s causes him to ignore a plausible ―Austrian‖ explanation of the relapse of 1937. As a result of a spurt of union activity due to the Supreme Court‘s upholding of the National Labor Relations Act of 1935, money wages jumped 13.7 percent in the first three quarters of 1937. This sudden jump in the price of labor far outstripped the rise in output prices and, with labor productivity substantially unchanged, brought about a sharp decline in employment beginning in late 1937.[33] The large upward spurt in excess reserves and the accompanying decrease in the money supply that we observe in Timberlake‘s data between June 30, 1937, and June 30, 1938, therefore, can be explained as the result, and not the cause, of the recession.[34] As business profits were squeezed by the run-up of labor costs and the economy slipped into recession, banks prudently began to contract their loans and pile up liquid reserves to protect themselves against prospective loan defaults and bank runs. To offset this uncontrolled decline of the money supply, beginning in mid-1938 the Fed (and the Treasury) once again resorted to an inflationary policy, reversing the reserve requirement increase and allowing gold inflows to once again pump up bank reserves. As a result, M2 increased by 5.9 percent, 10.1 percent, and 12.5 percent in 1938, 1939, and 1940, respectively.[35] Our conclusion, then, is that the Fed‘s monetary policy, except for very brief periods in 1929 and 1936–1937 when it turned mildly disinflationist, was consistently and unremittingly inflationist in the 1920s and 1930s. This inflationism was the cause of the Great Depression and one of the reasons why it was so protracted. []

No Shortage of Gold
By Hans F. Sennholz • September 1973 • Volume: 23 • Issue: 9 Related • Filed Under • ShareThis• Print This Post • Email This Post Dr. Sennholz heads the Department of Economics at Grove City College and is a noted writer and lecturer on monetary and economic affairs.
Many economists seem to agree on the virtues of the gold standard. It limits the power of governments or banks to create excessive amounts of paper currency and bank deposits, that is, to cause inflation. And it affords an international standard with stable patterns of exchange rates that encourage international trade and investments. But the same economists usually reject it without much hesitation because of its assumed disadvantages. The gold standard, they say, does not allow sufficient flexibility in the supply of money. The quantity of newly mined gold is not closely related to the growing needs of the world economy. If it had not been for the use of paper money, a serious shortage of money would have developed and economic progress would have been impeded. The gold standard, they say, also makes it difficult for a single country to isolate its economy from depression or inflation in the rest of the world. It does not permit exchange rate changes and resists government controls over international trade and payments. It is true, the gold standard makes it difficult to isolate one country from another. After all, the common currency that is gold would invite exchanges of goods and services and thus thwart an isolationist policy. For this reason, completely regimented economies cannot possibly tolerate the gold standard that springs from economic freedom and inherently resists regimentation. It is true, the gold standard also exposes all countries that adhere to it to imported inflations and depressions. But as the chances of any gold inflation—and depression that would follow such an inflation — are extremely small, the danger of contagion is equally small. It is smaller by far than with the floating fiat standard that suffers frequent disruptions and uncertainties, or with the dollar-exchange standard that actually has inundated the world with inflation and credit expansion. It must also be admitted that the gold standard is inconsistent with government controls over international trade and payment. But we should like to question the objection that the newly mined gold is not closely related to the growing needs of business and that a serious shortage of money would have developed without the issue of paper money. In fact, this popular objection to the gold standard is rooted in several ancient errors that live on in spite of the refutations by economists. Gold in History There is no shortage of gold today and there has been no such shortage in the past. Indeed, it is inconceivable that the needs of business will ever require more gold than is presently available. Gold has been an item of wealth and a medium of exchange in all of the great civilizations. Throughout history men have toiled for this enduring metal and used it in economic exchanges. It has been estimated that most of the gold won from the earth during the last 10,000 years, perhaps from the beginning of man, can still be accounted for in man’s vaults today, and in ornaments, jewelry, and other artifacts throughout the world. No

other possession of man has been so jealously guarded as gold. And yet, we are to believe that today we are suffering from a serious shortage of gold and therefore must be content with fiat money. Economic policies are the product of economic ideas. This is true also in the sphere of monetary policies and the organization of the monetary system. The advocates of government paper and foes of gold are motivated by the age-old notion that the monetary system in scope and elasticity has to be tailored to the monetary needs of business. They believe that these needs exceed the available supply of gold, which deprives it of any monetary usefulness and thus makes it a relic of the distant past.

The Monetary Needs of Business
With most contemporary economists, the notion of the monetary requirements of business implies the need for an institution, organization, or authority that will determine and provide the requirements. It ultimately implies that the government must either establish such an institution or provide the required money itself. These writers, in fact, accept without further thought government control over the people’s money. Today, all but a few economists readily accept the apparent axiom that it is the function of the government to issue money and regulate its value. Like the great classical economists, they blindly trust in the monetary integrity and trustworthiness of government and the body politic. But while we can understand the faith of Hume, Thornton, and Ricardo, we are at a loss to explain the confidence of our contemporaries. We understand Ricardo when he proclaimed that "In a free society, with an enlightened legislature, the power of issuing paper money, under the requisite checks of convertibility at the will of the holder, might be safely lodged in the hands of commissioners…"1 The English economists had reason to be proud of their political and economic achievements and confident in the world’s future in liberty. However, it is more difficult to understand any such naive confidence today. After half a century of monetary depreciation and economic instability, still to accept the dogma that it is the proper function of government to issue money and regulate its value, reflects a high degree of insensibility to our monetary plight.

A Persistent Fallacy
And yet, the world of contemporary American economics blindly accepts the dogma. It is true, we may witness heated debates between the Monetarists and Keynesians about the proper rate of currency expansion by government, or the proper monetary/fiscal mix of Federal policy. But when their squabbles occasionally subside they all agree on "the disadvantages" of the gold standard and the desirability of fiat currency. They vehemently deny the only alternative: monetary freedom and a genuine free market. The money supply needs no regulation; it can be left to the free market in which individuals determine the demand for and supply of money. A person wants to keep a certain store of purchasing power, a margin of wealth in the form of money. It does not matter to him whether this wealth is represented by a few large units of money or by numerous smaller units with the same total purchasing power. And he is not interested in an increase in the number of units if such an increase constitutes no addition to his wealth. This is not to deny that people frequently complain about their "lack of money" or their "need for more money." What they mean, of course, is additional wealth, not merely more monetary units with smaller purchasing power. But this popular mode of expression probably has contributed to the spread of erroneous notions according to which monetary expansion is

identical with additional wealth. Our present policies of inflation seem to draw public support from this primitive confusion. More than 200 years ago John Law was victim of this confusion when he stated that "a larger quantity (of money) employs more people than a smaller one. And a limited quantity can employ only a proportionate number." It also made Benjamin Franklin denounce the "want of money in a country" as "discouraging laboring and handicraft from coming to settle in it." And it made Alexander Hamilton advocate currency expansion for the development of the "vast tracts of waste land." But only additional real capital in the shape of plants and equipment can employ additional people at unchanged wage rates, or develop new tracts of land. It is true, even without additional capital, a market economy readily adjusts to additions in the labor supply until every worker who seeks employment is fully employed. But in this process of adjustment wage rates must decline on account of the declining marginal productivity of labor. Monetary expansion tends to hide this wage reduction as it tends to support nominal wages, or even may raise them, while real wages decline. The "full-employment" economists, such as Lord Keynes and his followers, recommend monetary expansion because of this very wage reduction. They correctly realize that institutional maladjustments may prevent a necessary readjustment and thus cause chronic unemployment. The labor unions may enforce wage rates that are higher than the market rates, which inevitably leads to unemployment. Or political expedience may call for the enactment of minimum wage legislation that causes mass unemployment. Under such conditions the full-employment economists recommend monetary expansion as a facesaving device for both the labor government and labor unions. But while it alleviates the unemployment, it causes a new set of ominous effects. It originates the economic boom that will be followed by an other recession. It benefits the debtors at the expense of the creditors. And while it depreciates the currency, it causes maladjustment and capital consumption and destroys individual thrift and self-reliance.

Consequences of Depreciation
In fact, the effects of currency depreciation, no matter how expedient such a policy may be, are worse than the restrictive effects of labor legislation and union policies. Furthermore, monetary expansion as a face-saving device sooner or later must come to an end. If not soon abandoned by a courageous administration, it will destroy the currency. If it is abandoned in time, the maladjustments and restrictive effects of labor legislation and union policies will then be fully visible. No matter how ominous and ultimately disastrous this array of consequences of currency expansion may be, it is immensely popular with short-sighted and poorly-informed people. After all, currency expansion at first generates an economic boom; it benefits the large class of debtors; it causes a sensation of ease and affluence; it is a face-saving device for popular but harmful labor policies; and last but not least, it affords government and its army of politicians and bureaucrats more revenue and power than they would enjoy without inflation. But all these effects that may explain the popularity of currency expansion do not prove the necessity of expanding the stock of money for any objective reason. In fact, an increase in the money supply confers no social benefits whatsoever. It merely redistributes income and wealth, disrupts and misguides economic production and, as such, constitutes a powerful weapon of conflict within society. In a free market economy, it is utterly irrelevant what the total stock of money should be. Any given quantity renders the full services and yields the maximum utility of a medium of exchange. No additional utility can be derived from additions to the quantity of money.

When the stock is relatively large, the purchasing power of the individual units of money will be relatively small. And when the stock is small, the purchasing power of the individual units will be relatively large. No wealth can be created and no economic growth can be achieved by changing the quantity of the medium of exchange. It is so obvious, and yet so obscured by the specious reasoning of special interest spokesmen, that the printing of another ton of paper money does not create new wealth. It merely wastes valuable paper resources and generates the redistributive effects mentioned above. Money is only a medium of exchange. To add additional media merely tends to reduce their exchange value, their purchasing power. Only the production of additional consumer goods and capital goods enhances the wealth and income of society. For this reason, some economists consider the mining of gold a sheer waste of capital and labor. Man is burrowing the ground in search of gold, they say, merely to hide it again in a vault underground. And since gold is a very expensive medium of exchange, why should it not be replaced with a cheaper medium, such as paper money? If gold were to serve merely as medium of exchange, new mining would indeed be superfluous. But it is also a commodity that is used in countless different ways. Its mining, therefore, does enrich society in the form of ornaments, dental uses, industrial products, and the like. Gold mining is as useful as any other mining that serves to satisfy human wants.

The Law of Costs Applies to Money
Actually, the great expense of gold mining and processing assures the limitation of its quantity and therefore its value. Both gold and paper money are subject to the "law of costs," which explains why gold has remained so valuable over the millennia and why the value of paper money always falls to the level of costs of the paper. This law, which is so well-established in economic literature, states that in the long run the market price of freely reproducible goods tends to equal the costs of production. For if the market price should rise considerably above cost, production of the goods becomes profitable, which invites additional production. When more goods are produced and offered on the market, their price begins to fall in accordance with the law of demand and supply. Conversely, if the market price should fall below cost and inflict losses on manufacturers, production is restricted or abandoned. Thus, the supply in the market is decreased, which tends to raise the price again in conformity with the law of supply and demand. Of course, the law of costs does not conflict with the basic principle of value and price. Their determination originates in the consumers’ subjective valuations of finished products. The law of costs obviously is applicable to gold. When its exchange value rises, mining becomes more profitable, which will encourage the search for gold and invite mining of ore that heretofore was unprofitable because of low gold content or other high mining costs. When additional quantities of gold are offered on the market, its exchange value or purchasing power tends to decline in accordance with the law of supply and demand. Conversely, when its exchange value falls, the opposite effects tend to ensue, thus discouraging further mining.

A Delayed Reaction
That paper money is subject to the law of costs is vehemently denied by all who favor such money. After all, they retort, the profit motive does not apply to its production and

management. Its exchange value may be kept far above its cost of manufacture through wise restraint and management by monetary authorities. It must be admitted that the law of costs works slowly on money, more slowly indeed than on other goods. It may take several decades before the paper money exchange value falls to the level of manufacturing costs. After all, the fall is rather considerable, from the value of gold — for which the paper money first substitutes — to that of the printing paper. Few other commodities ever experience such a large discrepancy between market value and manufacturing costs when the law of costs begins to work. But this original discrepancy does not refute the applicability of the law; it merely offers an explanation for the length of time needed for the price-cost adjustment. It must also be admitted that a certain measure of restraint prevents an immediate fall of the paper money value to the level of manufacturing costs. Popular opposition prevents the monetary authorities from multiplying the quantity of paper issue too rapidly, which would depreciate its value at intolerable rates and lead to an early disintegration of the exchange economy. In a democratic society these monetary authorities and their political employers would soon be removed from office and be replaced by others promising more restraint. But no matter who manages the fiat money, the law of costs is working quietly and continuously. After all, the manufacturers do profit from a gradual expansion of the money supply. The profit motive is as applicable to money as it is to all other goods. The only difference between the manufacturer of fiat money and that of other goods is the monopolistic position of the former and the normally competitive limitations of the latter. Who would contend that the incomes and fortunes of central bankers and the jobs of many thousands of their employees do not provide a powerful motive for currency expansion? To stabilize the stock of money is to deny them position and power and thus income and wealth. Political Motivation The profit motive for fiat money expansion is even stronger with the administration in power and thousands of politicians seeking the votes of their electorates. Election to high political office usually assures great personal fortune, prestige, and power, and successful politicians quickly rise from rags to riches. But in order to be elected in a redistributive conflict society, commonly called the welfare society, the candidate for political office is tempted to promise his electorate any conceivable benefit. It is true, he may at first propose to tax the rich members of his society whose few votes may be ignored. But when their incomes and fortunes no longer yield the additional revenue needed for costly handouts, called social benefits, the welfare politician resorts to deficit spending. That is to say, he calls for currency expansion that facilitates the government expenditures that hopefully win the vote and support of his electorate and thus assure his election. When seen in this light, the profit motive is surely applicable to the manufacture of paper money. Or, the politicians in power conduct full-employment policies through easy money and credit expansion. In search of the popular boom that would assure their re-election, they spend and inflate and thus set into operation the law of costs. Who would believe that such policies are not motivated by the personal gains that accrue to the politicians in power? But this profit motive must be sharply distinguished from that in the competitive exchange economy. When encompassed by competition, the motive is a powerful driving force for the best possible service to the ultimate bosses, the consumers. It raises output and income and leads to capital formation and high standards of living. But in the case of the

monopolistic manufacture of paper money by government authorities, the profit motive finds expression in currency expansion, which is inflation. In the end, when the law of costs has completely prevailed and the exchange value of money equals the cost of paper manufacture, not only the fiat money is destroyed but also the individual-enterprise privateproperty order. For inflation not only bears bitter economic fruits but also has evil social, political, and moral consequences.

How to Return to Gold
By Henry Hazlitt • September 1980 • Volume: 30 • Issue: 9 Related • Filed Under • ShareThis• Print This Post • Email This Post
Henry Hazlitt, noted economist, author, editor, reviewer and columnist, is well known to readers of the New York Times, Newsweek, The Freeman, Barton‘s, Human Events and many others. For more on inflation, see his recent book, The Inflation Crisis, and How to Resolve It. The economic letter of the Texas Commerce Bank, dated April 18, discussed the problems of returning to the gold standard, and decided that such a return should not be attempted. The bank‘s discussion reveals a number of misconceptions of how a gold standard functions. As these misconceptions are probably widespread, they are worth analysis. The bank takes for granted, without explicitly saying so, that the only form of gold standard now being recommended is a full, 100 percent gold backing for outstanding money and credit. This is not the system that prevailed in the nineteenth century, or at any time since. What the world then had —and now calls the ―classical‖ gold standard—was a fractional gold reserve system—that is, one in which each nation‘s gold stock represented only a fraction of its outstanding money and credit. My own preference happens to be for a full gold standard. But as most advocates of a return to the gold standard have in mind the previous fractional reserve system, that should be discussed first. The basic objection to it is that until the reserve falls to the legal minimum fraction permitted, there is continuous pressure from banks to continue expanding their loans. But when the minimum reserve is reached, political pressure is likely to develop to reduce the required gold reserve still further to permit the volume of credit to be further increased. The historic tendency, therefore, is for the required gold reserve to be constantly attenuated. Dwindling Reserves When the United States officially ceased gold payments in 1971, for example, its outstanding quantity of money and credit (M-2, including both demand and time bank deposits) had expanded to $454.5 billion. Against this, the U.S. gold stock was only about $12.3 billion (291.60 million fine troy ounces at $42.22 an ounce), or only 2.7 percent. In other words, there was only one dollar in gold to redeem every thirty-seven dollars of paper credit. The situation was even worse than this, because under the then existing ―gold- exchange‖ standard, the currencies of all other countries—more than 100 of them—in the International Monetary Fund were convertible merely into dollars, while only the dollars were directly convertible into gold. This made our American gold reserve equal to only some small fraction of 1 percent of the total outstanding money and credit which was supposed to be directly or indirectly convertible into it. When the Texas Commerce Bank‘s letter contends that a return to the gold standard would ―tie changes in the money supply to changes in the quantity of gold in Ft. Knox,‖ and on a dollar -for dollar basis, it is assuming, as I have already pointed out, that the return would be to a 100 percent gold reserve system. It falls into a number of other misconceptions. It assumes, for example, that to return to a gold standard the government would once more have to establish a fixed relationship between the dollar and an ounce of gold —a new official ―price‖ for gold—and it mentions $450 as a possibility. But under today‘s conditions, when every nation on earth has abandoned the gold standard, and nearly all of them have followed recklessly inflationary policies for the last ten or twenty years, it would be practically impossible for the monetary managers of any one country to establish a fixed relationship between its present currency unit and gold that they could count on not to prove either dangerously inflationary or dangerously deflationary.

When the United States, after its greenback adventure in the Civil War, decided in 1875 to return the dollar to the previous gold parity, beginning in 1879, and when Britain decided in early 1925 to work its way back to the old parity of $4.86 for the pound, both countries experienced several years of severe deflation and unemployment. Today it would not only be difficult and dangerous, but unnecessary, for any country to try to tie the purchasing power of its existing paper money to any fixed ratio with a new gold-standard currency. All that would be necessary would be the minting of a new gold coin (and perhaps the issuance of gold certificates), stamped not in dollars, pounds, marks, or any other national unit, but simply with its weight —an ounce, a gram, ten grams, or whatever. (If coined in a metric unit of weight, such as a ten-gram piece, it would circulate as an international medium of exchange no matter by what leading country issued.) Countries issuing such coins should make neither them nor their previous irredeemable paper currencies compulsory legal tender. The market rate between their paper currencies and gold would be left free to fluctuate daily. Private citizens would be free to make con tracts with each other for repayment of new long-term debts in either paper or gold, and such contracts should be enforceable. Private citizens, corporations or banks should also be free to mint gold coins and issue gold-certificates against them, subject to suit for fraud, short weight or non-performance. Within such a legal framework, an alternative and dependable currency system would always be available for increased use whenever a paper currency began depreciating so fast that nobody wanted to continue doing business in it. Two Possibilities Let me sum up. There are two possible kinds of gold standard, one requiring only a fractional gold reserve against outstanding currency and credit, the other requiring a 100 percent gold reserve against it. The first was the kind the Western world actually operated on from about the middle of the nineteenth century to 1914 (and to some extent in later periods until 1971). The problem with it is that either the required fraction of gold reserve keeps being reduced as the legal minimum reserve is approached, thus permitting a great deal of inflation even under the gold standard; or credit that has been expanding must be suddenly tightened to prevent the gold reserve from falling below the set legal limit. In the second case, which frequently occurred, individual countries, seeking to safeguard their gold reserves, suffered the familiar cycles of credit expansion and contraction, boom and depression. A 100 percent gold reserve system prevents this consequence. But under it, prices do depend upon the existing gold supply; the volume of money and credit cannot be expanded at will. There can be no inflation. And that is precisely why so many people oppose the system. That is why the author of the Texas Commerce Bank letter opposes it. In his words, it ―cannot support the increased needs for liquidity arising from greater world tra de . . . . The gold standard does not provide sufficient flexibility to deal with today‘s complex domestic and international conditions.‖ By ―flexibility‖ the bank means credit expansion. And credit expansion, when left to the whim of government authorities, means inflation. The great merit of the gold standard is precisely that it takes the decision regarding the quantity of money out of the hands of the politicians. The quantity of gold can only be determined by the physical amount that is discovered, extracted and refined, whereas the quantity of paper money can be determined by political caprice. Misplaced Fears Opponents of the gold standard sometimes express the fear that new annual supplies of gold will finally prove insufficient to ―carry on the growing volume of world trade.‖ Such fears are misplaced. The existing amount of money is always sufficient to carry on the existing volume of trade; it is merely the overall price average that is affected. There is, of course, a theoretic possibility that the annual increase in gold supplies might finally prove insufficient to keep commodity prices from falling dangerously and disruptively. Such a shrinkage in new gold production has never actually occurred. The opposite has. There have been ―gold inflations,‖ like that following the gold rush to

California in 1849 and later discoveries. But the worst that could happen, if new gold supplies started to dry up, would be a return to a fractional instead of a 100 percent gold standard. ―The myriad problems of adopting the gold standard,‖ reads the last sentence of the bank‘s letter, ―suggest that its adoption is not the optimal way to control inflation.‖ It is significant that the bank letter does not tell us what this optimal way would be. The experience over the last decades of 140 members of the International Monetary Fund proves that it could not be continuance of irredeemable currencies under government regulation. Return to the gold standard is not only the ―optimal‖ way to control inflation; it is the onl y way.

The Solution
By Murray N. Rothbard • November 1995 • Volume: 45 • Issue: 11 Related • Filed Under • ShareThis• Print This Post • Email This Post
To save our economy from destruction and from the eventual holocaust of run away inflation, we the people must take the money-supply function back from the government. Money is far too important to be left in the hands of bankers and of Establishment economists and financiers. To accomplish this goal, money must be returned to the market economy, with all monetary functions performed within the structure of the rights of private property and of the free-market economy. It might be thought that the mix of government and money is too far gone, too pervasive in the economic system, too inextricably bound up in the economy, to be eliminated without economic destruction. Conservatives are accustomed to denouncing the "terrible simplifiers" who wreck everything by imposing simplistic and unworkable schemes. Our major problem, however, is precisely the opposite: mystification by the ruling elite of technocrats and intellectuals, who, whenever some public spokesman arises to call for large-scale tax cuts or deregulation, intone sarcastically about the dimwit masses who "seek simple solutions for complex problems." Well, in most cases, the solutions are indeed clear-cut and simple, but are deliberately obfuscated by people whom we might call "terrible complicators." In truth, taking back our money would be relatively simple and straightforward, much less difficult than the daunting task of denationalizing and decommunizing the Communist countries of Eastern Europe and the former Soviet Union. Our goal may be summed up simply as the privatization of our monetary system, the separation of government from money and banking. The central means to accomplish this task is also straightforward: the abolition, the liquidation of the Federal Reserve System–the abolition of central banking. How could the Federal Reserve System possibly be abolished? Elementary: simply repeal its federal charter, the Federal Reserve Act of 1913. Moreover, Federal Reserve obligations (its notes and deposits) were originally redeemable in gold on demand. Since Franklin Roosevelt‘s monstrous actions in 1933, "dollars" issued by the Federal Reserve, and deposits by the Fed and its member banks, have no longer been redeemable in gold. Bank deposits are redeemable in Federal Reserve Notes, while Federal Reserve Notes are redeemable in nothing, or alternatively in other Federal Reserve Notes. Yet, these Notes are our money, our monetary "standard," and all creditors are obliged to accept payment in these fiat notes, no matter how depreciated they might be. In addition to cancelling the redemption of dollars into gold, Roosevelt in 1933 committed another criminal act: literally confiscating all gold and bullion held by Americans, exchanging them for arbitrarily valued "dollars." It is curious that, even though the Fed and the government establishment continually proclaim the obsolescence and worthlessness of gold as a monetary metal, the Fed (as well as all other central banks) clings to its gold for dear life. Our confiscated gold is still owned by the Federal Reserve, which keeps it on deposit with the Treasury at Fort Knox and other gold depositaries. Indeed, from 1933 until the 1970s, it continued to be illegal for any Americans to own monetary gold of any kind, whether coin or bullion or even in safe deposit boxes at home or abroad. All these measures, supposedly drafted for the Depression emergency, have continued as part of the great heritage of the New Deal ever since. For four decades, any gold flowing into private American hands had to be deposited in the banks, which in turn had to deposit it at the Fed. Gold for "legitimate" non-monetary purposes, such as dental fillings, industrial drills, or jewelry, was carefully rationed for such purposes by the Treasury Department. Fortunately, due to the heroic efforts of Congressman Ron Paul it is now legal for Americans to own gold, whether coin or bullion. But the ill-gotten gold confiscated and sequestered by the Fed remains in Federal Reserve hands. How to get the gold out from the Fed? How privatize the Fed‘s stock of gold? Privatizing Federal Gold

The answer is revealed by the fact that the Fed, which had promised to redeem its liabilities in gold, has been in default of that promise since Roosevelt‘s repudiation of the gold standard in 1933. The Federal Reserve System, being in default, should be liquidated, and the way to liquidate it is the way any insolvent business firm is liquidated: its assets are parceled out, pro rata, to its creditors. The Federal Reserve‘s gold assets are listed, as of October 30, 1991, at $11.1 billion. The Federal Reserve‘s liabilities as of that date consist of $295.5 billion in Federal Reserve Notes in circulation, and $24.4 billion in deposits owed to member banks of the Federal Reserve System, for a total of $319.9 billion. Of the assets of the Fed, other than gold, the bulk are securities of the U.S. government, which amounted to $262.5 billion. These should be written off posthaste, since they are worse than an accounting fiction: the taxpayers are forced to pay interest and principle on debt which the Federal Government owes to its own creature, the Federal Reserve. The largest remaining asset is Treasury Currency, $21.0 billion, which should also be written off, plus $10 billion in SDRs, which are mere paper creatures of international central banks, and which should be abolished as well. We are left (apart from various buildings and fixtures and other assets owned by the Fed, and amounting to some $35 billion) with $11.1 billion of assets needed to pay off liabilities totalling $319.9 billion. Fortunately, the situation is not as dire as it seems, for the $11.1 billion of Fed gold is a purely phoney evaluation; indeed it is one of the most bizarre aspects of our fraudulent monetary system. The Fed‘s gold stock consists of 262.9 million ounces of gold; the dollar valuation of $11.1 billion is the result of the government‘s artificially evaluating its own stock of gold at $42.22 an ounce. Since the market price of gold is now about $350 an ounce, this already presents a glaring anomaly in the system. Definitions and Debasement Where did the $42.22 come from? The essence of a gold standard is that the monetary unit (the "dollar," "franc," "mark," etc.) is defined as a certain weight of gold. Under the gold standard, the dollar or franc is not a thing-in-itself, a mere name or the name of a paper ticket issued by the State or a central bank; it is the name of a unit of weight of gold. It is every bit as much a unit of weight as the more general "ounce," "grain," or "gram." For a century before 1933, the "dollar" was defined as being equal to 23.22 grains of gold; since there are 480 grains to the ounce, this meant that the dollar was also defined as .048 gold ounce. Put another way, the gold ounce was defined as equal to $20.67. In addition to taking us off the gold standard domestically, Franklin Roosevelt‘s New Deal "debased" the dollar by redefining it, or "lightening its weight," as equal to 13.714 grains of gold, which also defined the gold ounce as equal to $35. The dollar was still redeemable in gold to foreign central banks and governments at the lighter $35 weight; so that the United States stayed on a hybrid form of international gold standard until August 1971, when President Nixon completed the job of scuttling the gold standard altogether. Since 1971, the United States has been on a totally fiat paper standard; not coincidentally, it has suffered an unprecedented degree of peace-time inflation since that date. Since 1971, the dollar has no longer been tied to gold at a fixed weight, and so it has become a commodity separate from gold, free to fluctuate on world markets. When the dollar and gold were set loose from each other, we saw the closest thing to a laboratory experiment we can get in human affairs. All Establishment economists–from Keynesians to Chicagoite monetarists–insisted that gold had long lost its value as a money, that gold had only reached its exalted value of $35 an ounce because its value was "fixed" at that amount by the government. The dollar allegedly conferred value upon gold rather than the other way round, and if gold and the dollar were ever cut loose, we would see the price of gold sink rapidly to its estimated non-monetary value (for jewelry, dental fillings, etc.) of approximately $6 an ounce. In contrast to this unanimous Establishment prediction, the followers of Ludwig von Mises and other "gold bugs" insisted that gold was undervalued at 35 debased dollars, and claimed that the price of gold would rise far higher, perhaps as high as $70. Suffice it to say that the gold price never fell below $35, and in fact vaulted upward, at one point reaching $850 an ounce, in recent years settling at somewhere around $350 an ounce. And yet since 1973, the Treasury and Fed have persistently evaluated their gold stock, not at the old and obsolete $35, to be sure, but only slightly higher, at $42.22

an ounce. In other words, if the U.S. government only made the simple adjustment that accounting requires of everyone–evaluating one‘s assets at their market price–the value of the Fed‘s gold stock would immediately rise from $11.1 to $92.0 billion. From 1933 to 1971, the once very large but later dwindling number of economists championing a return to the gold standard mainly urged a return to $35 an ounce. Mises and his followers advocated a higher gold "price," inasmuch as the $35 rate no longer applied to Americans. But the majority did have a point: that any measure or definition, once adopted, should be adhered to from then on. But since 1971, with the death of the once-sacred $35 an ounce, all bets are off. While definitions once adopted should be maintained permanently, there is nothing sacred about any initial definition, which should be selected at its most useful point. If we wish to restore the gold standard, we are free to select whatever definition of the dollar is most useful; there are no longer any obligations to the obsolete definitions of $20.67 or $35 an ounce. Abolishing the Fed In particular, if we wish to liquidate the Federal Reserve System, we can select a new definition of the "dollar" sufficient to pay off all Federal Reserve liabilities at 100 cents to the dollar. In the case of our example above, we can now redefine "the dollar" as equivalent to 0.394 grains of gold, or as 1 ounce of gold equalling $1,217. With such redefinition, the entire Federal Reserve stock of gold could be minted by the Treasury into gold coins that would replace the Federal Reserve Notes in circulation, and also constitute gold coin reserves of $24.4 billion at the various commercial banks. The Federal Reserve System would be abolished, gold coins would now be in circulation replacing Federal Reserve Notes, gold would be the circulating medium, and gold dollars the unit of account and reckoning, at the new rate of $1,217 per ounce. Two great desiderata –the return of the gold standard, and the abolition of the Federal Reserve–would both be accomplished at one stroke. A corollary step, of course, would be the abolition of the already bankrupt Federal Deposit Insurance Corporation. The very concept of "deposit insurance" is fraudulent; how can you "insure" an entire industry that is inherently insolvent? It would be like insuring the Titanic after it hit the iceberg. Some free-market economists advocate "privatizing" deposit insurance by encouraging private firms, or the banks themselves, to "insure" each others‘ deposits. But that would return us to the unsavory days of Florentine bank cartels, in which every bank tried to shore up each other‘s liabilities. It won‘t work; let us not forget that the first S&Ls to collapse in the 1980s were those in Ohio and in Maryland, which enjoyed the dubious benefits of "private" deposit insurance. This issue points up an important error often made by libertarians and free-market economists who believe that all government activities should be privatized; or as a corollary, hold that any actions, so long as they are private, are legitimate. But, on the contrary, activities such as fraud, embezzlement, or counterfeiting should not be "privatized"; they should be abolished. This would leave the commercial banks still in a state of fractional reserve, and, in the past, I have advocated going straight to 100 percent, nonfraudulent banking by raising the gold price enough to constitute 100 percent of bank demand liabilities. After that, of course, 100 percent banking would be legally required. At current estimates, establishing 100 percent to all commercial bank demand deposit accounts would require going back to gold at $2,000 an ounce; to include all checkable deposits would require establishing gold at $3,350 an ounce, and to establish 100 percent banking for all checking and savings deposits (which are treated by everyone as redeemable on demand) would require a gold standard at $7,500 an ounce. But there are problems with such a solution. A minor problem is that the higher the newly established gold value over the current market price, the greater the consequent increase in gold production. This increase would cause an admittedly modest and one-shot price inflation. A more important problem is the moral one: do banks deserve what amounts to a free gift, in which the Fed, before liquidating, would bring e very bank‘s gold assets high enough to be 100 percent of its liabilities? Clearly, the banks scarcely deserve such benign treatment, even in the name of smoothing the transition to sound money; bankers should consider themselves lucky they are not tried for embezzlement. Furthermore, it would be difficult to enforce and police 100 percent banking on an administrative basis. It would be easier, and more libertarian, to go through the courts. Before the Civil War, the notes of unsound

fractional reserve banks in the United States, if geographically far from home base, were bought up at a discount by professional "money brokers," who would then travel to the banks‘ home base and demand massive redemption of these notes in gold. The same could be done today, and more efficiently, using advanced electronic technology, as professional money brokers try to make profits by detecting unsound banks and bringing them to heel. A particular favorite of mine is the concept of ideological Anti-Bank Vigilante Leagues, who would keep tabs on banks, spot the errant ones, and go on television to proclaim that banks are unsound, and urge note and deposit holders to call upon them for redemption without delay. If the Vigilante Leagues could whip up hysteria and consequent bank runs, in which noteholders and depositors scramble to get their money out before the bank goes under, then so much the better: for then, the people themselves, and not simply the government, would ride herd on fractional reserve banks. The important point, it must be emphasized, is that at the very first sign of a bank‘s failing to redeem its notes or deposits on demand, the police and courts must put them out of business. Instant justice, period, with no mercy and no bailouts. Under such a regime, it should not take long for the banks to go under, or else to contract their notes and deposits until they are down to 100 percent banking. Such monetary deflation, while leading to various adjustments, would be clearly one-shot, and would obviously have to stop permanently when the total of bank liabilities contracted down to 100 percent of gold assets. One crucial difference between inflation and deflation, is that inflation can escalate up to an infinity of money supply and prices, whereas the money supply can only deflate as far as the total amount of standard money, under the gold standard the supply of gold money. Gold constitutes an absolute floor against further deflation. If this proposal seems harsh on the banks, we have to realize that the banking system is headed for a mighty crash in any case. As a result of the S&L collapse, the terribly shaky nature of our banking system is at last being realized. People are openly talking of the FDIC being insolvent, and of the entire banking structure crashing to the ground. And if the people ever get to realize this in their bones, they will precipitate a mighty "bank run" by trying to get their money out of the banks and into their own pockets. And the banks would then come tumbling down, because the people‘s money isn‘t there. The only thing that could save the banks in such a mighty bank run is if the Federal Reserve prints the $1.6 trillion in cash and gives it to the banks –igniting an immediate and devastating runaway inflation and destruction of the dollar. Liberals are fond of blaming our economic crisis on the "greed of the 1980s." And yet "greed" was no more intense in the 1980s than it was in the 1970s or previous decades or than it will be in the future. What happened in the 1980s was a virulent episode of government deficits and of Federal Reserve-inspired credit expansion by the banks. As the Fed purchased assets and pumped in reserves to the banking system, the banks happily multiplied bank credit and created new money on top of those reserves. There has been a lot of focus on poor quality bank loans: on loans to bankrupt Third World countries or to bloated and, in retrospect, unsound real estate schemes and shopping malls in the middle of nowhere. But poor quality loans and investments are always the consequence of central bank and bank-credit expansion. The all-too-familiar cycle of boom and bust, euphoria and crash, prosperity and depression, did not begin in the 1980s. Nor is it a creature of civilization or the market economy. The boom-bust cycle began in the eighteenth century with the beginnings of central banking, and has spread and intensified ever since, as central banking spread and took control of the economic systems of the Western world. Only the abolition of the Federal Reserve System and a return to the gold standard can put an end to cyclical booms and busts, and finally eliminate chronic and accelerating inflation. Inflation, credit expansion, business cycles, heavy government debt, and high taxes are not, as Establishment historians claim, inevitable attributes of capitalism or of "modernization." On the contrary, these are profoundly anti-capitalist and parasitic excrescences grafted onto the system by the interventionist State, which rewards its banker and insider clients with hidden special privileges at the expense of everyone else. Crucial to free enterprise and capitalism is a system of firm rights of private property, with everyone secure in the property that he earns. Also crucial to capitalism is an ethic that encourages and rewards savings, thrift, hard work,

and productive enterprise, and that discourages profligacy and cracks down sternly on any invasion of property rights. And yet, as we have seen, cheap money and credit expansion gnaw away at those rights and at those virtues. Inflation overturns and transvalues values by rewarding the spendthrift and the inside fixer and by making a mockery of the older "Victorian" virtues. Restoring the Old Republic The restoration of American liberty and of the Old Republic is a multi-faceted task. It requires excising the cancer of the Leviathan State from our midst. It requires removing Washington, D.C., as the power center of the country. It requires restoring the ethics and virtues of the nineteenth century, the taking back of our culture from nihilism and victimology, and restoring that culture to health and sanity. In the long run, politics, culture, and the economy are indivisible. The restoration of the Old Republic requires an economic system built solidly on the inviolable rights of private property, on the right of every person to keep what he earns, and to exchange the products of his labor. To accomplish that task, we must once again have money that is produced on the market, that is gold rather than paper, with the monetary unit a weight of gold rather than the name of a paper ticket issued ad lib by the government. We must have investment determined by voluntary savings on the market, and not by counterfeit money and credit issued by a knavish and State-privileged banking system. In short, we must abolish central banking, and force the banks to meet their obligations as promptly as anyone else. Money and banking have been made to appear as mysterious and arcane processes that must be guided and operated by a technocratic elite. They are nothing of the sort. In money, even more than the rest of our affairs, we have been tricked by a malignant Wizard of Oz. In money, as in other areas of our lives, restoring common sense and the Old Republic go hand in hand.

A Golden Comeback, Part I
By Mark Skousen • September 1998 • Volume: 48 • Issue: 9 Related • Filed Under • ShareThis• Print This Post • Email This Post Dr. Skousen ([email protected]) is an economist at Rollins College, Department of Economics, Winter Park, Florida 32789, a Forbes columnist, and editor of Forecasts & Strategies. He is also the author of Economics on Trial (Irwin, 1993), a review of the top ten textbooks in economics. Visit his new Web page: www.mskousen.com “A more timeless measure is needed; gold fits the bill perfectly.” —Mark Mobius When speaking of the Midas metal, I‘m reminded of Mark Twain‘s refrain, ―The reports of my death are greatly exaggerated.‖ After years of central-bank selling and a bear market in precious metals, the Financial Times recently declared the ―Death of Gold.‖ But is it dead? Following the Asian financial crisis last year, Mark Mobius, the famed Templeton manager of emerging markets, advocated the creation of a new regional currency, the asian, convertible to gold, including the issuance of Asian gold coins. ―All their M1 money supply and foreign reserves would be converted into asians at the current price of gold. Henceforth asians would be issued only upon deposits of gold or foreign-currency equivalents of gold.‖[1] Mobius castigated the central banks of Southeast Asia for recklessly depreciating their currencies. As a result, ―many businesses and banks throughout the region have become bankrupt, billions of dollars have been lost, and economic development has been threatened.‖ Why gold? ―Because gold has always been a store of value in Asia and is respected as the last resort in times of crisis. Asia‘s history is strewn with fallen currencies. . . . The beauty of gold is that it limits a country‘s ability to spend to the amount it can earn in addition to its gold holdings.‖ Not Just Another Commodity Recent studies give support to Mobius‘s new monetary proposal. According to these studies, gold has three unique features: First, gold provides a stable numeraire for the world‘s monetary system, one that closely matches the ―monetarist rule.‖ Second, gold has had an amazing capacity to maintain its purchasing power throughout history, what the late Roy Jastram called ―The Golden Constant.‖ And, third, the yellow metal has a curious ability to predict future inflation and interest rates. Let‘s start with gold as a stable monetary system. With most commodities, such as wheat or oil, the ―carryover‖ stocks vary significantly with annual production. Not so with gold. Historical data confirm that the aggregate gold stockpile held by individuals and central banks always increases and never declines.[2] Moreover, the annual increase in the world gold stock typically varies between 1.5 and 3 percent, and seldom exceeds 3 percent. In short, the gradual increase in the stock of gold closely resembles the ―monetary rule‖ cherished by Milton Friedman and the monetarists, where the money stock rises at a steady rate (see Chart I).

The World Stock of Gold and the Share Held by Central Banks, 1913-96 Compare the stability of the gold supply with the annual changes in the paper money supply held by central banks. As Chart II indicates, the G-7 money-supply index rose as much as 17 percent in the early 1970s and as little as 3 percent in the 1990s. (Why has monetary growth slowed, even under a fiat money standard? The financial markets, especially the bondholders, have demanded fiscal restraint of their governments.) Moreover, the central banks‘ monetary policies were far more volatile than the gold supply. On a worldwide basis, gold proved to be more stable and less inflationary than a fiat money system. Critics agree that gold is inherently a ―hard‖ currency, but complain that new gold production can‘t keep up with economic growth. In other words, gold is too much of a hard currency. As noted, the world gold stock rises at a miserly annual growth rate of less than 3 percent and oftentimes under 2 percent, while GDP growth usually exceeds 3 or 4 percent and sometimes 7 or 8 percent in developing nations. The result? Price deflation is inevitable under a pure gold standard. My response: Critics are right that gold-supply growth is not likely to keep up with real GDP growth. Only during major gold discoveries, such as in California and Australia in the 1850s or South Africa in the 1890s, did world gold supplies grow faster than 4 percent a year.[3] Prices Must Be Flexible Consequently, an economy working under a pure gold standard will suffer gradual deflation; the price level will probably decline 1 to 3 percent a year, depending on gold production and economic growth. But price deflation isn‘t such a bad thing as long as it is gradual and not excessive. There have been periods of strong economic growth accompanying a general price deflation, such as the 1890s, 1920s, and 1950s. But price and wage flexibility is essential to make it work. Next month: Update on Jastram‘s study The Golden Constant, and gold‘s amazing ability to maintain its purchasing power over the past 400 years.

A Golden Comeback, Part II
By Mark Skousen • October 1998 • Volume: 48 • Issue: 10 Related • Filed Under • ShareThis• Print This Post • Email This Post Dr. Skousen (http://www.mskousen.com; [email protected]) is an economist at Rollins College, Department of Economics, Winter Park, Florida 32789, a Forbes columnist, and editor of Forecasts & Strategies. He is also the author of Economics of a Pure Gold Standard, 3rd edition (Foundation for Economic Education, 1996). He is currently working on his own textbook, Economic Logic.

―Gold maintains its purchasing power over long periods of time, for example, half-century intervals.‖

—Roy Jastram, The Golden Constant[1] In last month‘s column, I focused on gold‘s inherent stability as a monetary numeraire. Historically, the monetary base under gold has neither declined nor increased too rapidly. In short, it has operated very closely to a monetarist rule. What about gold as an inflation hedge? In this column, I discuss the work of Roy Jastram and others who have demonstrated the relative stability of gold in terms of its purchasing power—its ability to maintain value and purchasing power over goods and services over the long run. But the emphasis must be placed on the ―long run.‖ In the short run, gold‘s value depends a great deal on the rate of inflation and therefore often fails to live up to its reputation as an inflation hedge. The classic study on the purchasing power of gold is The Golden Constant: The English and American Experience, 1560–1976, by Roy W. Jastram, late professor of business at the University of California, Berkeley. The book, now out of print, examines gold as an inflation and deflation hedge over a span of 400 years. Two Amazing Graphs The accompanying two charts are from Jastram‘s book and updated through 1997 by the American Institute for Economic Research in Great Barrington, Massachusetts. They tell a powerful story: First, gold always returns to its full purchasing power, although it may take a long time to do so; and

Second, the price of gold became more volatile as the world moved to a fiat money standard beginning in the 1930s. Note how gold has moved up and down sharply as the pound and the dollar have lost purchasing power since going off the gold standard. In my economics classes and at investment conferences, I demonstrate the long-term value of gold by holding up a $20 St. Gaudens double-eagle gold coin. Prior to 1933, Americans carried this coin in their pockets as money. Back then, they could buy a tailor-made suit for one double eagle, or $20. Today this same coin—which is worth between $400 and $600, depending on its rarity and condition—could buy the same tailor-made suit. Of course, the double-eagle coin has numismatic, or rarity, value. A one-ounce gold-bullion coin, without numismatic value, is worth only around $300 today. Gold has risen substantially in dollar terms but has not done as well as numismatic U.S. coins. Gold as an Inflation Hedge The price of gold bullion was over $800 an ounce in 1980 and has steadily declined in value for nearly two decades. Does that mean it‘s not a good inflation hedge? Indeed, the record shows that when the inflation rate is steady or declining, gold has been a poor hedge. The yellow metal (and mining shares) typically responds best to accelerating inflation. Over the long run, the Midas metal has held its own, but should not be deemed an ideal or perfect hedge. In fact, U.S. stocks have proven to be much profitable than gold as an investment. The work of Jeremy Siegel, professor of finance at the Wharton School of the University of Pennsylvania, has demonstrated that U.S. stocks have far outperformed gold over the past two centuries. Like Jastram, Siegel confirms gold‘s long-term stability. Yet gold can‘t hold a candle to the stock market‘s performance. As the chart, taken from his book, Stocks for the Long Term, shows, stocks have far outperformed bonds, T-bills, and gold. Why? Because stocks represent higher economic growth and productivity over the long run. Stocks have risen sharply in the twentieth century because of a dramatic rise in the standard of living and America‘s freeenterprise system. One final note: Stocks tend to do poorly and gold shines when price inflation accelerates. As Siegel states, ―Stocks turn out to be great long-term hedges against inflation even though they are often poor short-term hedges.‖[2] Price inflation is the key indicator: When the rate of inflation moves back up, watch out. Stocks could flounder and gold will come back to life. In my next column, I‘ll discuss the ability of gold to predict inflation and interest rates.

A Golden Comeback, Part III
By Mark Skousen • November 1998 • Volume: 48 • Issue: 11 Related • Filed Under • ShareThis• Print This Post • Email This Post Dr. Skousen (http://www.mskousen.com; [email protected]) is an economist at Rollins College, Department of Economics, Winter Park, Florida 32789, a Forbes columnist, and editor of Forecasts & Strategies. He is also the author of Economics of a Pure Gold Standard, 3rd Edition (Foundation for Economic Education, 1996). He is currently working on his own textbook, Economic Logic. “A free gold market . . . reflects and measures the extent of the lack of confidence in the domestic currency.” —Ludwig von Mises In the past two columns, I‘ve highlighted the uses and misuses of gold. Despite occasional calls for a return to a gold standard, the Midas metal has largely lost out to hard currencies as a preferred monetary unit and monetary reserve. Most central banks are selling gold. Gold has also done poorly as a crisis hedge lately. It has not rallied much during recent wars and international incidents. U.S. Treasury securities and hard currencies such as the German mark and Swiss franc have become the investments of choice in a flight to safety. Nor has gold functioned well as an inflation hedge over the past two decades. The cost of living continues to increase around the world, yet the price of gold has fallen from $800 an ounce in 1980 to under $300 today. What‘s left for the yellow metal? I see two essential functions for gold: first, a profitable investment when general prices accelerate and, second, an important barometer of future price inflation and interest rates. Gold as a Profitable Investment Since the United States went off the gold standard in 1971, gold bullion and gold mining shares have become well-known cyclical investments. The first graph demonstrates the volatile nature of gold and mining stocks, with mining shares tending to fluctuate more than gold itself. The gold industry can provide superior profits during an uptrend, and heavy losses during a downtrend. One of the reasons for the high volatility of mining shares is their distance from final consumption. Mining represents the earliest stage of production and is extremely capital intensive and responsive to changes in interest rates.[1] Gold as a Forecaster

Gold also has the amazingly accurate ability to forecast the direction of the general price level and interest rates. In an earlier Freeman column (February 1997), I referred to an econometric model I ran with the assistance of John List, economist at the University of Central Florida. We tested three commodity indexes (Dow Jones Commodity Spot Index, crude oil, and gold) to determine which one best anticipated changes in the Consumer Price Index (CPI) since 1970. It turned out that gold proved to be the best indicator of future inflation as measured by the CPI. The lag period is about one year. That is, gold does a good job of predicting the direction of the CPI a year in advance. (All three indexes did a poor job of predicting changes in the CPI on a monthly basis.) Richard M. Salsman, economist at H. C. Wainwright & Co. in Boston, has also done some important work linking the price of gold with interest rates. As the second graph demonstrates, the price of gold often anticipates changes in interest rates in the United States. As Salsman states, ―A rising gold price presages higher bond yields; a falling price signals lower yields. . . . Gold predicts yields well precisely because it‘s a top-down measure. It is bought and sold based purely on inflation-deflation expectations; thus it‘s the purest barometer of changes in the value of the dollar generally.‖[2] In sum, if you want to know the future of inflation and interest rates, watch the gold traders at the New York Merc. If gold enters a sustained rise, watch out: higher inflation and interest rates may be on the way.

The Value of Money
By Hans F. Sennholz • November 1969 • Volume: 19 • Issue: 11 Related • Filed Under • ShareThis• Print This Post • Email This Post
Dr. Sennholz heads the Department of Economics at Grove City College in Pennsylvania. Most economists are in agreement that the inflation in the United States during the past three years has been the worst since the early 1940’s, taking account of both severity and duration. But they cannot agree on the nature of the inflation that is engulfing the American economy. To some, inflation denotes a spectacular rise in consumer prices; to others, an excessive aggregate demand; and to at least one economist, it is the creation of new money by our monetary authorities. This disagreement among economists is more than an academic difference on the meaning of a popular term. It reflects professional confusion as to the cause of the inflation problem and the policies that might help to correct it. A review of some basic principles of economics that are applicable to money may shed light on the problem. Two basic questions need to be answered: (1) What are the factors that originally afforded value to money, and (2) What are the factors that effect changes in the "objective exchange value of money" or its purchasing power? Money is a medium of exchange that facilitates trade in goods and services. Wherever people progressed beyond simple barter, they began to use their most marketable goods as media of exchange. In primitive societies they used cattle, or measures of grain, salt, or fish. In early civilizations where the division of labor extended to larger areas, gold or silver emerged as the most marketable good and finally as the only medium of exchange, called money. It is obvious that the chieftains, kings, and heads of state did not invent the use of money. But they frequently usurped control over it whenever they suffered budget deficits and could gain revenue from currency debasement. When an economic good is sought and wanted, not only for its use in consumption or production but also for purposes of exchange, to be held in reserve for later exchanges, the demand for it obviously increases. We may then speak of two partial demands which combine to raise its value in exchange—its purchasing power. The Origin of Money Value People seek money because it has purchasing power; and part of this purchasing power is generated by the people’s demand for money. But is this not reasoning in a vicious circle? It is not! According to Ludwig von Mises’ "regression theory," we must be mindful of the time factor. Our quest for cash holdings is conditioned by money purchasing power in the immediate past, which in turn was affected by earlier purchasing power, and so on until we arrive at the very inception of the monetary demand. At that particular moment, the purchasing power of a certain quantity of gold or silver was determined by its nonmonetary uses only. This leads to the interesting conclusion that the universal use of paper monies today would be inconceivable without their prior use as "substitutes" for real money, such as gold and silver, for which there was a nonmonetary demand. Only when man grew accustomed to

these substitutes, and governments deprived him of his freedom to employ gold and silver as media of exchange, did government tender paper emerge as the legal or "fiat money." It has value and purchasing power, although it lacks any nonmonetary demand, because the people now direct their monetary demand toward government tender paper. If for any reason this public demand should cease or be redirected toward real goods as media of exchange, the fiat money would lose its entire value. The Continental Dollar and various foreign currencies over the years illustrate the point. On Demand and Supply The purchasing power of money is determined by the demand for and supply of money, like the prices of all other economic goods and services. The particular relation between this demand and supply determines its particular purchasing power. So, let us first look at those factors that exert an influence on individual demand for money. As money is a medium of exchange, our demand for it may be influenced by considerations of facts and circumstances either on the goods side of the exchange or on the money side. Therefore, we may speak of goods-induced factors and money-induced factors. Variation on the Side of Goods A simple example may illustrate the former. Let us assume we live in a medieval town that is cut off from all fresh supplies by an enemy army. There is great want and starvation. Although the quantity of money did not change—no gold or silver has left our beleaguered town—its purchasing power must decline. For everyone seeks to reduce his cash holdings in exchange for some scarce food in order to assure survival. The situation is similar in all cases where the supply of available goods is decreased although the quantity of money in the people’s cash holdings remains unchanged. In a war, when the channels of supply are cut off by the enemy or economic output is reduced for lack of labor power, the value of money tends to decline and goods prices rise even though the quantity of money may remain unchanged. A bad harvest in an agricultural economy may visibly weaken the currency. Similarly, a general strike that paralyzes an economy and greatly reduces the supply of goods and services raises goods prices and simultaneously lowers the purchasing power of money. In fact, every strike or sabotage of economic production tends to affect prices and money value even though this may not be visible to many observers. Some economists also cite the level of taxation as an important factor in the determination of the exchange value of money. According to Colin Clark, whenever governments consume more than 25 per cent of national product, the reduction in productive capacity as a result of such an oppressive tax burden causes goods prices to rise and the purchasing power of money to fall. According to that view, with which one may disagree, high rates of taxation are the main cause of "inflation." At any rate, there can be no doubt that the American dollar has suffered severely from the burdens of Federal, state, and local government spending and taxing that exceed 35 per cent of American national product. Yet, this purchasing power loss of the dollar would have been greater by far if a remarkable rise in industrial productivity had not worked in the opposite direction. In spite of the evergrowing burden of government and despite the phenomenal increase in the supply of money (to be further discussed below), both of which would reduce the value of the dollar, American commerce and industry managed to increase the supply of marketable goods, thus bolstering the dollar’s purchasing power. Under most difficult circumstances,

businessmen managed to form more capital and improve production technology, and thus made available more and better economic goods which in turn helped to stabilize the dollar. Without this remarkable achievement by American entrepreneurs and capitalists, the U.S. dollar surely would have followed the way of many other national currencies to radical depreciation and devaluation. Factors on the Side of Money There also are a number of factors that affect the demand for money on the money side of an exchange. A growing population, for instance, with millions of maturing individuals eager to establish cash holdings, generates new demand, which in turn tends to raise the purchasing power of money and to reduce goods prices. On the other hand, a declining population would generate the opposite effect. Changes in the division of labor bring about changes in the exchange value of money. Increased specialization and trade raises the demand and exchange value of money. The nineteenth century frontier farmer who tamed the West with plow and gun was largely selfsufficient. His demand for money was small when compared with that of his great grandson who raises only corn and buys all his foodstuff in the supermarket. Under a modern and a highly advanced division of labor, one needs money for the satisfaction of all his wants through exchange. It is obvious that such demand tends to raise the exchange value of money. On the other hand, deterioration of this division of labor and return to self-sufficient production, which we can observe in many parts of Asia, Africa, and South America, generates the opposite effect. Development and improvement of a monetary clearing system also exert an influence toward lower money value. Clearing means offsetting payments by banks or brokers. It reduces the demand for money, as only net balances are settled by cash payments. The American clearing system which gradually developed over more than 130 years from local to regional and national clearing, slowly reduced the need and demand for cash and thus its purchasing power. Of course, this reduction of the dollar’s exchange value was negligible when compared with that caused by other factors, especially the huge increase in money supply. Business practices, too, may influence the demand for money and therefore its value. It is customary for business to settle its obligations on the first of the month. Tax payments are due on certain dates. The growing popularity of credit cards reduces the need for money holdings throughout the month, but concentrates it at the beginning of the month when payments fall due. All such variations in demand affect the objective exchange value of money. The Desires of Individuals for Larger or Smaller Holdings The most important determinant of purchasing power of money under this heading of "money-induced factors" is the very attitude of the people toward money and their possession of certain cash holdings. They may decide for one reason or another to increase or reduce their holdings. An increase of cash holdings by many individuals tends to raise the exchange value of money, reduction of cash holdings tends to lower it. This is so well understood that even the mathematical economists emphasize the money "velocity" in their equations and calculations of money value. Velocity of circulation is

defined as the average number of times in a year which a dollar serves as income (the income velocity) or as an expenditure (the transaction’s velocity). Of course, this economic use of a term borrowed from physics ignores acting man who increases or reduces his cash holdings. Even when it is in transport, money is under the control of its owners who choose to spend it or hold it, make or delay payment, lend or borrow. The mathematical economist who weighs and measures, and thereby ignores the choices and preferences of acting individuals, is tempted to control and manipulate this "velocity" in order to influence the value of money. He may even blame individuals (who refuse to act in accordance with his model) for monetary depreciation or appreciation. And governments are only too eager to echo this blame; while they are creating ever new quantities of printing press money, they will restrain individuals in order to control money velocity. It is true, the propensity to increase or reduce cash holdings by many people exerts an important influence on the purchasing power of money. But in order to radically change their holdings, individuals must have cogent reasons. They endeavor to raise their holdings whenever they foresee depressions ahead. And they usually lower their holdings whenever they anticipate more inflation and declining money value. In short, they tend to react rationally and naturally to certain trends and policies. Government cannot change or prevent this reaction; it can merely change its own policies that brought forth the reaction. The Supply of Money No determinant of demand, whether it affects the goods side of an exchange or the money side, is subject to such wide variations as is the supply of money. During the age of the gold coin standard when gold coins were circulating freely, the supply of money was narrowly circumscribed by the supply of gold. But today when governments have complete control over money and banking, when central banks can create or withdraw money at will, the quantity of money changes significantly from year to year, even from week to week. The student of money and banking now must carefully watch the official statistics of money supply in order to understand current economic trends. Of course, the ever-changing supply of money must not be viewed as a factor that evenly and uniformly changes the level of goods prices. The total supply of money in a given economy does not confront the total supply of goods. Changes in money supply always act through the cash holdings of individuals, who react to changes in their personal incomes and to changing interest rates in the loan market. It is through acting individuals that supply changes exert their influences on various goods prices. In the United States, we have two monetary authorities that continually change the money supply: the U.S. Treasury and the Federal Reserve System. As of February 28, 1969, the U.S. Treasury had issued some $6.7 billion of money, of which $5.1 billion were fractional coins. The Federal Reserve System had issued $46.3 billion in notes and, in addition, was holding some $22 billion of bank reserves. Commercial banks were holding approximately $150 billion in demand deposits and some $201 billion in time deposits, all of which are payable on demand in "legal money," which is Federal Reserve and Treasury money. The vast power of money creation held by the Federal Reserve System, which is our central bank and monetary arm of the U.S. Government, becomes visible only when we compare today’s supply of money with that in the past. Let us, therefore, look at the vol ume of Federal Reserve Bank credit on various dates since 1929: Date 1929 Jun. Total in Billions 1.5

1939 1949 1959

Dec. Dec. Dec.

2.6 22.5 29.4

1969 Aug. 20 58.2 Source: Federal Reserve Bulletins These figures clearly reveal the nature and extent of the inflation that has engulfed us since the early 1930’s. The 1940’s and again the 1960’s stand out as the periods of most rapid inflation and credit expansion. How Government Creates Money Why and how do our "monetary authorities" create such massive quantities of money that inevitably lead to lower money value? During the 1940’s, the emergency argument was cited to justify the printing of any quantity the government wanted for the war effort. During the 1960’s, the Federal government through its Federal Reserve System was printing feverishly in order to achieve full employment and a more desirable rate of economic growth. Furthermore, the ever-growing public demand for economic redistribution inflicted budgetary deficits, the financing of which was facilitated by money creation. How was it done? The Federal Reserve has at its disposal three different instruments of control which can be used singly or jointly to change the money supply. It may conduct "open-market purchases," i.e., it buys U.S. Treasury obligations in the capital market and pays for them with newly-created cash or credit. Nearly all the money issued since 1929 was created by this method. Or, the Federal Reserve may lower its discount rate, which is the rate it charges commercial banks for accommodation. If it lowers its rate below that of the market, demand will exceed supply, which the Federal Reserve then stands ready to provide. Or finally, the Federal Reserve may reduce the reserve requirements of commercial banks. Such a reduction will set Federal Reserve money free for loans or investments by commercial banks. It does not matter how the new money supply is created. The essential fact is the creation by the monetary authorities. You and I cannot print money, for this would be counterfeiting and punishable by law. But our monetary authorities are creating new quantities every day of the week at the discretion of our government leaders. This fact alone explains why ours is an age of inflation and monetary destruction. Variable Responses The Quantity Theory, which offers one of the oldest explanations in economic literature, demonstrates the connection between variations in the value of money and the supply of money. Of course, it is erroneous to assume, as some earlier economists have done, that changes in the value of money must be proportionate to changes in the quantity of money, so that doubling the money supply would double goods prices and reduce by one-half the value of money. As was pointed out above, changes in supply always work through the cash holdings of the people. When the government resorts to a policy of inflation, some people may react by delaying their purchases of certain goods and services in the hope that prices will soon

decline again. In other words, they may increase their cash holdings and thereby counteract the price-raising effect of the government policy. From the inflators’ point of view, this reaction is ideal, for they may continue to inflate while these people through their reaction may prevent the worst effects of inflation. This is probably the reason why the U.S. Government, through post office posters, billboards, and other propaganda, endeavors to persuade the American people to save more money whenever the government itself resorts to inflation. When more and more individuals begin to realize that the inflation is a willful policy and that it will not end very soon, they may react by reducing their cash holdings. Why should they hold cash that depreciates, and why should they not purchase more goods and services right now before prices rise again? This reaction intensifies the price-raising effects of the inflation. While government inflates and people reduce their money demand, goods prices will rise rapidly and the purchasing power of money decline accordingly. Passing the Buck It may happen that the government may temporarily halt its inflation, and yet the people continue to reduce their cash demand. The central bank inflators may then point to the stability of the money supply, and blame the people for "irrational" behavior and reaction. The government thus exculpates itself and condemns the spending habits of the people for the inflation. But in reality, the people merely react to past experiences and therefore anticipate an early return of inflationary policies. The monetary development during most of 1969 reflected this situation. Finally, the people may totally and irrevocably distrust the official fiat money. When in desperation they finally conclude that the inflation will not end before their money is essentially destroyed, they may rush to liquidate their remaining cash holdings. When any purchase of goods and services is more advantageous than holding rapidly depreciating cash, the value of money approaches zero. The money then ceases to be money, the sole medium of exchange. When government takes control over money, it not only takes possession of an important command post over the economic lives of the people but also acquires a lucrative source of revenue. Under the ever-growing pressures for government services and functions, this source of revenue—which can be made to flow quietly without much notice by the public — constitutes a great temptation for weak administrators who like to spend money without raising it through unpopular taxation. The supply of money not only is the best indicator as to the value of money, but reflects the state of the nation and the thinking of the people.

*** Debauch the Currency Lenin is said to have declared that the best way to destroy the Capitalist System was to debauch the currency. 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 confiscate arbitrarily; and while the process impoverishes many, it actually enriches some…. As the inflation proceeds and the real value of the currency fluctuates wildly from month to month, all permanent relations between debtors and creditors, which form the ultimate foundation of capitalism, become so utterly

disordered as to be almost meaningless; and the process of wealth-getting degenerates into a gamble and a lottery.

A Closer Look at Gold
By Charles E. Weber • September 1972 • Volume: 22 • Issue: 9 Related • Filed Under • ShareThis• Print This Post • Email This Post
Dr. Charles E. Weber received his Ph.D. from the University of Cincinnati in ¹954 on the basis of a dissertation on the incunabula (books printed prior to ¹5º1 A.D.) in the German language. After military service in World War II, at times as a member of intelligence units, he resumed his education and started his teaching career at the University of Missouri and the University of Tulsa, where he has been teaching since ¹956 except for four years at Louisiana State University (¹962-¹966). Dr. Weber is the author of numerous articles on literature, history and monetary questions. When we contemplate the gold coins from previous centuries we are painfully reminded to what extent modern man has lost his monetary freedom and hence an important aspect of his economic freedom. For thousands of years, with only relatively few and brief exceptions prior to 1915 (or 1934 in the case of the United States) nearly all nations in the main stream of human progress have enjoyed the advantages of the use of gold coinage as a monetary medium. Cowrie shells, stone wheels, rolls of bright bird feathers, salt, bronze ingots and the like were generally the monetary media of only the least advanced peoples. Restraints on the use of gold as a monetary medium were rare in previous centuries, so rare, in fact, that we are tempted to speculate that many of the social and economic problems besetting the world in recent decades might not simply be concomitant phenomena of the decline of the public monetary use of gold, but even the results of this decline. In our own case, it is probably not a mere coincidence that since 1934, when the monetary use of gold was prohibited to U.S. citizens, the public debt has climbed to levels that could scarcely have been imagined forty years ago, the purchasing power of the national monetary unit has deteriorated so badly that this decline has become a major national problem, export trade has declined, the centers of large cities have been rotting at an accelerated pace and the problem of overpopulation has begun to threaten the very quality of life to which we had become accustomed. Prior to 1934 the use of gold as a monetary medium had been deeply rooted in our economic and legal traditions. Undoubtedly as a reaction to the chaos caused by excessive issues of paper money¹ before and during the Revolution, the Constitution provided in Article I, Section 10, that "No state shall… make any Thing but gold and silver Coin a Tender in Payment of Debts."2 A handsome U.S. gold coinage was commenced in 1795 to supplement the foreign gold in circulation, which continued to have the status of legal tender until 1857 on the basis of laws of 1793, 1816, 1834 and 1843. It was this sort of legal precedent that was the basis for the monetary stability of the country (and probably its economic progress) down to recent years. Fiat Money in France There is an interesting parallel in French monetary history. When the revolutionary government of France at the end of the 18th century tried to substitute paper money (assignats) supposedly based on the value of confiscated church properties, economic chaos resulted.3 Later on, Napoleon I saw the need of a reform to overcome the paralysis and reinstated the use of the precious metals. His introduction of the twenty franc piece (the "napoleon") in 1803 was an act of far-reaching consequences, as we shall see below. Russia had also tried paper money, likewise designated by a similar word, assignashii.4

Although a number of governments make every desperate attempt to suppress the monetary use of gold, faith in the sun metal as a store of value is deeply ingrained in the economic common sense of human beings all over the world. When I was in Russia in the summer of 1970, a young man explained to me that the old five rouble pieces struck on the standard used beginning with 1897 are now fetching about 90 paper roubles, nearly a typical month’s wages in the present Soviet State. The grimly strict monetary laws and energetic propaganda of the Soviet State5 had not been able to eradicate a desire for and a trust in gold. During and immediately after World War II many a family was able to avoid starvation by gradually giving up one gold piece after the other to purchase food that could otherwise not be obtained in economies paralyzed by war and postwar controls. A Coin at Work Let us contemplate a half eagle struck by the young United States in 1800. As in the case of the vast majority of gold coins struck in the world before 1800, there is also no designation of value or weight on this piece. Gold coins need no designation of value or legal tender status to function well. The piece we are contemplating is worn, so badly worn that its designs are only slightly above the level of the fields, but its weight is 8.50 grams, only about 3 per cent below its legal weight of 135 grains (8.748 grams). Now let us reconstruct the tremendous economic task that this gold piece performed so well and so long. The wear on this piece would suggest that it was in circulation at least until the weight reduction of 1834 and perhaps quite a bit longer. If it changed hands on the average of just once a week over a period of 50 years, it changed hands more than 2,500 times and was thus involved in an exchange of more than $12,500. However, the really remarkable aspect of this performance lies in the fact that every time it changed its owner, the new owner was guaranteed a stable value as long as he wished to keep the piece. What were the costs of this remarkable performance? About 15 cents’ worth of gold lost through wear and the very modest cost of striking the piece. To have printed paper money for this period of circulation would have approached or exceeded the minting and gold loss costs. Far more important, however, is the fact that the costs of the gold loss and minting were a very trivial consideration in relation to the social and economic benefits of the gold piece. Modern paper money, without a connection with the precious metals, simply cannot fulfill the traditional capacity of gold coinage to function both as a medium of exchange and a store of value. Not only does gold coinage go back to the early days of the American Republic, but it covers some twenty-seven centuries of Western Civilization. It was, in turn, antedated by an even earlier, specifically monetary use of gold, a use that can be readily documented. Thus, a mural painting from Thebes, Egypt, assigned to the reign of Thutmosis III, 15011447 B.C., shows the weighing of gold rings and holed disks." Details of this painting reveal the status that gold had attained as a monetary medium. The weights on the balance pan are in the form of bovine heads and sheep! This illustrates the fact that a transition had been made from an economy in which cattle were used as exchange to one in which the precious metals had taken their place, but the tradition of the cattle exchange is preserved in the very shape of the weights. To mention a later parallel, the earlier Latin word for money, petunia, developed from pecus, meaning "cattle." In the case of the Teutonic languages, the German word for cattle, Vieh, is a cognate of English fee. American Indian civilizations never developed a gold coinage as did the Europeans, but gold was used as a medium of exchange in the form of quills filled with gold dust. Undoubtedly, too, the many pre-Columbian gold ornaments, often of considerable artistic merit, played some sort of monetary role.

Coinage in Ancient Greece The very beginnings of Greek gold (or more specifically, electrum) coinage are nebulous. One type with two confronted lions’ heads is actually inscribed "Alyas," a variant form of the name of King Alyattes, fourth of the Mermnad kings of Lydia, who reigned 610-561 B.C. Far more abundantly preserved, however, are the electrum pieces of various weights (1/12, 1/6 and 1/3 staters) bearing the head of a lion with a radiate knob on the forehead. The weights of these pieces are astonishingly consistent. Six specimens of the 1/3 stater preserved in the Boston Museum of Fine Arts have the narrow range of 4.66 grams to 4.71 grams, with fractional pieces in a close proportion.7 Other very important early series of electrum coins were those of Kyzikos in Mysia (started before 550 B.C.), Mytilene on the island of Lesbos (ca. 500 B.C. ff.) and Phokaia in Ionia (started before 500 B.C.). These early gold series consisted of electrum, a more or less natural mixture of gold and silver, such as was mined in what is now western Turkey. Later on, more sophisticated refining methods were used to prepare the planchets. The huge gold coinages of the kings of Macedonia, Philip II (359-336 B.C.) and Alexander the Great (336-323 B.C.), are notable for the fact that they consisted of nearly pure gold, with specific gravities ranging around 19 (pure gold: 19.3 times the weight of water). By the time the autonomy of the Greek states had been extinguished by the expanding Roman Empire, no less than fifty of them had struck gold coins. The Roman Republic and subsequently the Roman Empire had as a gold unit the aureus, which was first struck in quantity around 46 B.C. At that time it had a weight of 1/40 of a Roman pound (8.19 g). Its high purity persisted but its weight gradually sank over a period of nearly four centuries. The Solidus The next great gold series, the solidus, got its start in the early fourth century under Constantine the Great (reigned 306-337 A.D.). The solidus was one of the most remarkable and enduring of all gold coins. Its weight and fineness were maintained with only occasional variations for over seven centuries, in spite of all the military, economic and political vicissitudes of the late Roman Empire and its continuation in the east (the "Byzantine" Empire). During this very long period the solidus had little competition in the world except for the gold of the Islamic dynasties which originally started as imitations of the Byzantine solidus during the seventh century. The Ostrogoths in Italy also imitated the solidus in great quantities during the fifth and sixth centuries, but unlike the Islamic imitations, the Ostrogothic solidi bore the name and portraits of the Byzantine emperor and can be distinguished from the Byzantine pieces only by subtle stylistic differences. So familiar was the world with the solidus that we seldom find specimens with cuts to test the authenticity of the pieces; forgeries of them were evidently rare. Hoards of them have been found as far away as Scandinavia. Although we have no exact mint records from the Byzantine Empire, the mintage of the solidus was certainly enormous. As late as about 1950, common, worn solidi could be had for as little as about $12., not much more than twice their bullion value. 8 After the decline of the solidus in the later medieval period it was supplanted by several important Italian, Hungarian and German series. Florence struck the fiorino d’oro (gold florin) beginning with the year 1252. It was imitated in a land with big gold mines, Hungary, in the 14th century and later. In Germany and the Netherlands, in turn, large quantities of florins were struck in the 15th and early 16th centuries, but they declined in weight and fineness when the German gold mines began to be so badly depleted that the gold became too dear in relation to the huge supplies of silver flowing from Saxony and Bohemia. (The first large-scale coinage of the predecessor of the silver dollar was done in Saxony, 1500 ff.) The Rhenish gold florin was struck in enormous quantities in such towns as Frankfurt,

Cologne, Nuremberg and Utrecht. A quarter million of them were struck in 1418 in Frankfurt alone and Basel struck 126,020 during the years 1434-5. The Gold Ducat On 31 October, 1284, the Maggior Consiglio of Venice decided to mint the gold ducat, one of the most important gold coins of all times. It is still being struck from dies dated 1915 in the Vienna Mint nearly 700 years later. In Venice itself, the ducat was struck with the same design (St. Mark and Doge) down to the end of the 18th century. The ducat weight and fineness became a favorite in Germany, the Netherlands, Poland, Scandinavia and Russia. It was even crudely imitated as far away as India, where the Venetian originals were also in use. England, France, Spain and Portugal had many gold coinages in the later middle ages, but they were of great variety. An outstandingly successful English coin of the late medieval period was the noble, which was imitated to some extent in the Netherlands, but the English and French kings changed their standards too often to establish gold coins of the great success and influence of the solidus and the ducat. The Spanish exploitation of the large deposits in Mexico, Bolivia and Peru resulted in the huge escudo coinage of the 16th to 19th centuries. Its multiple of eight is familiar to us as the doubloon. As noted above, the gold coinage of the United States was started in 1795, with a modest weight decrease in 1834, after which U.S. gold coinage was continued for almost exactly a century on the same standard. About 3/4 of the enormous U.S. gold coinage was in the form of double eagles (1850 ff.). The Latin Monetary Union In France a new gold coinage was introduced in 1803 that continued to be of great importance until 1914. Denominations of 5, 10, 20, 40, 50 and 100 franc pieces were struck at various times but the most important was the 20 franc piece. The French standard was copied in Italy, Switzerland, Belgium, Spain, Greece, Serbia, Bulgaria, Romania and other lands, in some cases with different names. Some gold coinage on the franc standard continued even after World War I, especially in Switzerland. In recent years the French government has struck considerable quantities of gold using dies with older dates. The prosperous German Empire struck large quantities of gold on the mark standard (18711915), while the huge English sovereign coinage (1816 ff.) still dominates the trade in coined gold. India had a long tradition of monetary gold use before the establishment of the present Republic of India with its socialistic orientation and hence hostility to private ownership of gold. Gold coinage of the European type was introduced to India no later than the time when the Bactrian Empire struck gold in a quite Greek form and with Greek inscriptions (ca. 250 B.C. ff.). Later on there were other very important Indian gold series. The Kushan gold coins were fairly close imitations of the Roman aureus, many hoards of which have also been found in India. The very abundant Kushan gold coinage was at first of high purity, like the Roman aureus, and it is even assumed that the planchets for it were prepared from remelted Roman gold. During the first and second centuries the Roman Empire had a severe balance of trade problem with India because of the commerce in spices, gems and other Indian goods desired by the luxury-loving Romans. Debasement in India

With the decline of the Kushan Empire its gold coinage became severely debased, especially after about 200 A.D. After about 320 A.D. the Gupta kings also continued gold coinage in important quantities. After the decline of the Gupta realm, i.e., after about 450 A.D., a number of Hindu dynasties continued gold coinage. The famous uninscribed and enigmatic elephant pagodas of perhaps about 1300 and later are now believed to be the private products of Indian goldsmiths. In the north the Islamic rulers (the Sultans of Delhi and subsequently the Mughal Emperors) struck gold in large quantities. In the south, the Hindu Vijayanagar Empire struck large amounts of a very neat gold coinage between 1377 A.D. and the disastrous Battle of Tallikota in 1565. Beginning with the 16th century, various European powers struck gold series for their territories in India; the Portuguese, the Dutch, the French, the Danes and especially the British, who first imitated the trusted gold coinage of the moribund Mughal Empire before striking gold in the European style. In Japan, which has gold mines that have been worked since medieval times, gold was used in the form of oval plates punched with various devices. During the 19th century base gold rectangles were produced in considerable quantities. Just as the Meiji Era brought so many other changes to Japan, its earliest years saw the introduction of a very beautiful gold coinage of occidental style based on the U.S. gold denominations. So highly prized are 20 yen pieces of 1870 (46,139 struck) that they fetch over one million yen today. With the exception of a few gold issues in this century, China has virtually no tradition of the coining of gold, although it has been prized for artistic uses for many centuries in China. 3000 Years of Gold I have surveyed the history of gold coinage in some detail here in order to show what a great economic role it has played in nearly every civilization (with the notable exception of the Chinese) European traditions of the monetary use of gold can be traced back for nearly three millenia in the form of gold coins alone. The decline of gold coinage we have witnessed during the last three to five decades 9 thus represents a radical departure in monetary affairs. The coining of gold had hitherto been interrupted only sporadically by attempts to substitute other media for the precious metals. It is undeniably true that many modern economists harbor a strong bias against the monetary use of gold. This bias is by no means difficult to explain, since these economists are the ones who see the most important role for themselves in governments which intervene strongly in the economy. Gold strongly restricts governmental intervention in the economy and the redistribution of wealth from the productive to the non-productive components of the population. Perhaps to some extent, too, the bias against the monetary use of gold is simply based on ignorance about the present and past monetary roles of gold. After all, a new generation has come onto the scene since 1934. We appreciate the role of gold as an honest, constructive monetary medium when we consider the nature of its enemies. Keynes, whom Lenin lauded before the Second Congress of the Communist International, considered gold a barbarous relic. Typically, the people who are shouting most loudly that gold is a barbarous relic are the very ones who are most adamant in their demands to suppress the monetary use of gold by force. (Who, really, are the barbarians?) These "experts" must know full well just how powerful gold is in spite of their public denials that it should play a role in the monetary system and in spite of their claims that it is worthless except for filling teeth and the like. Private Coinage

When governments have refused or have been unable to strike gold coins in sufficient quantities for commerce, private persons have provided gold coins in many instances. We need only think of the many private gold coinages in the United States alone: the Bechtler gold pieces struck in North Carolina in the 1830s and later, in addition to the massive amounts of gold struck privately in California in the 1850s and later. There have also been many private gold series in India and Germany, for example. A large private striking of gold on the ducat standard has taken place in Germany during the last two decades. In addition, many forgeries of well-known gold types with full or nearly full weight and fineness have been made in large quantities in recent decades. The American double eagle, the British sovereign and the 20 franc piece have been favorite forms of the counterfeiters, whose activities have flourished on a vast scale in recent years because of the need for gold coinage and the failure of public mints to perform their traditional duties of providing gold in convenient form. Because of the strong biases of many economists against the monetary use of gold, a number of myths and erroneous conceptions have grown up about gold coinage. Even some libertarian economists are lacking in sufficient knowledge about the history of gold coinage to refute the nonsense that is often deliberately propagated. It is an error to assume that all gold coinages were constantly being eroded in value by debasement and weight reductions. Indeed, the really important gold series were struck over long periods of time, in some instances for many centuries, without substantial reductions. One need only think of the solidus, the ducat, the escudo and the vast gold coinages of the nineteenth century; the sovereign, the double eagle and the napoleon. It is also an error to assume that the frauds committed in connection with gold coins were of very great importance. Sometimes coins were filed or sweated (friction in bags in which the gold dust was collected) and sometimes test cuts were made by which a small amount of gold was removed. However, such frauds could readily be detected by gold scales. Forgeries existed and there were printed descriptions of them as early as the 15th century. Still, such frauds are quite insignificant compared to the vast frauds carried out in connection with paper money, which is cheaper to counterfeit than gold coins. Of vastly greater importance, of course, is the fraud carried out against productive citizens by governments themselves which refuse to coin precious metals and keep issuing ever greater quantities of paper money. It is still another error to assume that gold is the ally only of the wealthy. In this age of complicated tax laws and deceptive monetary policies it is the wealthy who can afford the best advice on taxes and investments. For the saver of modest means, a little hoard of gold and silver has often proved to be the best protection against confiscation of his savings by devaluations of currency. There’s Plenty of Gold The argument that there is "no longer enough gold for monetary purposes" is one of the more absurd arguments that has been made against the return to the monetary use of gold. The United States could start minting gold again within the very short time required to prepare the dies. Plenty of gold could be delivered to the mints from the mines now kept idle by governmental restrictions. Any seigniorage charged should not exceed the actual minting costs. As to the relation of the new gold coins to the huge heaps of paper money now in circulation, the problem could be easily circumvented simply by omitting any designation of value on the coins and employing the familiar weights and fineness of the quarter eagles, half eagles, eagles and double eagles. The double eagles, for example, might bear the inscription "516 GRAINS, 900 FINE" instead of the erstwhile "TWENTY

DOLLARS." As in previous generations, the deliverers of gold to be minted would be charged a small fee for minting costs and the gold pieces would be theirs to keep or put into commerce. Striking gold coins without any designations of value on them is a procedure that was not only used in previous centuries, but also in recent decades. Consider the following examples: Beginning in 1921, Mexico had struck gold pieces somewhat larger than the U.S. double eagle. The Mexican pieces are known as the "centenario" because they originally commemorated the centennial of the Republic. For years these pieces were struck in large quantities with the designation of 50 Pesos. By 1943, however, the designation had become meaningless because of the considerable depreciation of the value of the Mexican paper and silver currency. In 1943 the centenario appeared without the usual inscription of 50 Pesos but with an inscription describing the weight and fineness, the really important factors. There are many variations on the procedure. Great Britain, for example, struck over 30 million sovereigns between 1957 and 1966 for overseas trade. These continued to bear no designation of value, just as all modern sovereigns (since 1816) had borne none. Market Sets the Value If the government were to resume the striking of gold pieces, as it should without delay, it would be easy to determine what designation of value, if any, were to be put on them after supply and demand had established a price in terms of other media. For purely monetary purposes, however, no designation of value would really be necessary, since gold coins need no legal tender status to work well, both as a medium of exchange and as a store of value. The lessons of monetary history are clear. Without the resumption of gold coinage or at least a free commerce in all of the precious metals, including especially gold, inflation will go on and on and on. Even just the tolerance of a free gold market would inhibit inflation by providing a constant gauge of the value of other monetary media. Those being hurt by inflation should bear the following in mind: The reason that governments with a redistributive economic philosophy frown on gold coins is because of the fact that inflation is a big aid if not, indeed, an essential factor in the redistributive process. If those persons in government circles who are talking about "fighting inflation" were at all sincere, they would immediately remove all restrictions on the mining and monetary use of gold and resume a governmental function which had been taken for granted for literally thousands of years in western thought, the striking of gold coins with an established weight and fineness. Those being hurt by inflation have a powerful weapon at their disposal if they would only realize it and act accordingly. They could refuse to buy all bonds, public or private, that did not contain gold clauses. While it is true that gold obligations have been repudiated in the past,’" the constant demand for gold obligations would undoubtedly have an influence on national monetary policies. Restoration of the right to own gold and make contracts in terms of gold would be a major step toward restoration of the basic principle of economic freedom, a freedom no less sacred than other freedoms. The restoration of our traditional rights with regard to gold should be vigorously supported by all those who prize economic freedom and abhor the emptiness, stagnation, decay and oppression of the omnipotent socialistic state.

Hazlitt on Gold
By Jude Blanchette • November 2004 • Volume: 54 • Issue: 11 Related • Filed Under • ShareThis• Print This Post • Email This Post Jude Blanchette is a research fellow at FEE. Henry Hazlitt concentrated much of his thinking and writing on the topic of money, producing two books and dozens of articles and columns on the subject. His writings during the dark years following World War II, published on the editorial page of the New York Times and in Newsweek, offered intelligent readers ammunition against the feverish calls for monetary socialism. His anti-Keynesian columns and articles of the 1960s and ‘70s provided uncommon knowledge for those who sided against inflation, budget deficits, and the belief that ―we owe it to ourselves.‖1 Hazlitt was well known for his views on monetary theory and specifically his advocacy of a gold standard. In its final, polished form, his case for the gold standard was profound and persuasive. What‘s more, the clarity and precision of his work made the subject accessible to the intelligent public. Following in the footsteps of the Austrian economist Carl Menger (1840–1921), Hazlitt begins with the origin of money as a commodity. In times of barter, men traded goods directly—two eggs for six apples, for example. It soon became apparent to the more observant traders that there were goods preferred by almost all individuals who traded, and what‘s more, these highly demanded goods could be used to acquire other goods through indirect exchange. As Hazlitt explained it, ―people tried to exchange their goods first for some article that nearly everybody wanted, so that they could exchange this article in turn for the exact things they happened to want.‖2Menger describes this near universal demand for a certain good as its ―saleableness‖ (Absatzfähigkeit). Because of their numerous advantages over rival commodities, precious metals evolved through the marketplace to become money.3 No doubt part of gold‘s historical appeal as money was its allure. For some who disparage its monetary role, this is indicative of its hold over the imaginations of traders and merchants. Keynes disparagingly called it ―auri sacra fames‖ (―the accursed hunger for gold‖).4 Hazlitt, however, thought this was one of the attributes that made gold superior to paper money. To be universally desired (and hence to have a high degree of ―saleableness‖), gold (or whatever commodity came to be used as money) must be held in high esteem; that is, it must be desired by almost all consumers at almost all times. Besides its aesthetic value, gold never spoils and is extremely scarce. As Hazlitt wrote, it could be ―hammered or stamped into almost any shape or precisely divided into any desired size or unit of weight.‖5 As transactions in gold became omnipresent, traders looked for more efficient ways to exchange goods for gold. The advent of banks was for Hazlitt another example of the market‘s supplying society with a newer and better way of doing business. Yet Hazlitt also believed that with the appearance of banks, economic booms and busts were born. Banks began simply as depositories for gold. An

individual would carry or keep at home enough gold to facilitate daily or small transactions, and would store the rest in a bank vault. When a larger purchase was to be made or when gold for daily purchases was running low, he would return to the bank for more. As Hazlitt wrote, ―Then came a development that probably no one had originally foreseen. The people who had left their gold in a [bank] vault found, when they wanted to make a purchase or pay a debt that they did not have to go to the vaults themselves for their gold. They could simply issue an order to the [banker] to pay over the gold to the person from whom they had purchased something.‖ He continued, ―If the receipts were made out by the [bank], for round sums payable to bearer, they were bank notes. If they were orders to pay made out by the legal owners of the gold themselves, for varying specified amounts to be paid to particular persons, they were checks.‖6 The Roots of Fractional-Reserve Banking It is from this system, however, that fractional-reserve banking evolved, Hazlitt writes. And from this came the devastating economic fluctuations known as the business cycle. Bankers soon began to realize that the amount of gold demanded in its physical form was far less than the amount of gold held in reserve. For the entrepreneurial banker here was a profit opportunity. If loans were made from the present gold stock and this gold stock was rarely touched, why not increase the amount of outstanding credit beyond the bank‘s reserve capability? Hazlitt notes that ―honest‖ banks would not expand credit beyond what they had in total assets, that is, the amount of gold in reserve plus the amount of assets held as collateral for other existing loans. However, because gold deposits must be paid out on demand and assets held as collateral are to be returned at some fixed point in the future, a ―bank might be ‗solvent‘ (in the sense that the value of its assets equaled the value of its liabilities) but it would be at least partly ‗illiquid.‘ If all its depositors demanded their gold at once, it could not possibly pay them all.‖ Thus according to Hazlitt, banks continued to lend funds above the amount of gold held in their vaults. It is here that the ―boom‖ begins. Hazlitt outlines a hypothetical scenario in which banks lower their reserve ratio to 50 percent. With twice the lendable funds, banks are ―now suddenly free to extend more credit. They can, in fact, extend twice as much credit as before. Previously, assuming they were lent up, they had to wait until one loan was paid off before they could extend another loan of similar size. Now they can keep extending more loans until the total is twice as great. The new credit plus competition causes them to lower their interest rates. The lower interest rates tempt more firms to borrow, because the lower costs of borrowing make more projects seem profitable than seemed profitable before.‖7 Hazlitt thus found in such credit expansion a cause of the business cycle, which he thought could occur even with ―free banking,‖ because banks would be pressured by competition constantly to lower their reserve ratios. While inflation under free banking would be substantially less than under government-managed credit expansion, it would persist nonetheless. Because of his profound dislike of inflation, regardless of the source, Hazlitt favored a ―pure‖ gold standard, or a 100 percent reserve requirement. To secure this, Hazlitt advocated strict government regulation of required reserves. Any expansion of credit above the amount of gold held in reserve was fraudulent, and as such, should be prosecuted by government authorities, he wrote in The Inflation Crisis, and How to Resolve It.8

Here Hazlitt‘s position differs from that of his friend Ludwig von Mises, who saw the boom/bust phenomenon as exclusively government-created. While Hazlitt viewed interbank competition as a driving force behind the creation of fiduciary money, for Mises it was exactly because banks compete with one another that solvency is assured. Mises conceded that while a slow creation of bank credit would potentially occur under free banking, competitive forces would limit a bank‘s ability to inflate: ―Since the over-issuance of fiduciary media on the part of one bank . . . increases the amount to be paid by the expanding bank‘s clients to other people, it increases concomitantly the demand for the redemption of its money-substitutes. It thus forces the expanding bank back to a restraint.‖9 Subjective Valuation Value in currency is not something that can be declared, decreed, or ordered by a government or any private institution, Hazlitt wrote. It is, like the value of all other economic goods, a matter of subjective valuation by market participants. While there is an objective purchasing power for money, it ―is derived from the composite of . . . subjective valuations.‖10Economists and government planners who use crude mathematical formulas and rigid exchange relationships between money and prices miss the subjective and thus unquantifiable nature of money‘s value. Hazlitt considered all monetary reform specious if it lacked gold redeemability. A monetary system either was sound or it was not. There was no middle ground. He also believed private citizens should be free to mint and circulate private coins for business transactions. Private paper currency would be allowed insofar as it was ―redeemable on demand in the respective quantities of the metals specified.‖11 For Hazlitt a gold standard was preferable to any form of government-managed currency because no one controls it. ―The supply of gold is governed by nature; it is not, like the supply of paper money, subject merely to the schemes of demagogues or the whims of politicians. Nobody ever thinks he has quite enough money. Once the idea is accepted that money is something whose supply is determined simply by the printing press, it becomes impossible for the politicians in power to resist the constant demands for further inflation.‖12 Thus for Hazlitt the gold standard‘s inflexibility is its great strength.

How Much Money
By Percy L. Greaves Jr. • May 1965 • Volume: 15 • Issue: 5 Related • Filed Under • ShareThis• Print This Post • Email This Post
Mr. Greaves is a free-lance economist and lecturer. Most people want more money. So do I. But I wouldn’t keep it long. I would soon spend it for the things I need or want. So would most people. In other words, for most of us, more money is merely a means for buying what we really want. Only misers want more money for the sake of holding onto it permanently. However, if more money is to be given out, most of us would like to get some of it. If we can’t get any for ourselves, the next best thing, from our viewpoint, would be for it to be given to those who might buy our goods or services. For then it is likely their increased spending would make us richer. From such reasoning, many have come to believe that spreading more money around is a good thing—not only for their personal needs, but also for solving most all of the nation’s problems. For them, more money becomes the source of prosperity. So they approve all sorts of government programs for pumping more money into the economy. If such programs are helpful, why not have more money for everyone? Why not have the government create and give everyone $100 or $200 or, better yet, $1,000? Why not have the government do it every year or every month or, better yet, every week? Of course, such a system would not work. But why not? When we understand why not, we will know why every attempt to create prosperity by creating more money will not work. When we have learned the answer, we shall have taken a long step toward eliminating the greatest cause of both human misery and the decay of great clvilizations. One way to find the answer is to analyze the logic which seemingly supports the idea that more money in a nation’s economy means more prosperity for all. If we can spot an error in the chain of reasoning, we should be able to make it clear to others. Once such an error is generally recognized, the popularity of government money-creation programs will soon disappear. Neither moral leaders nor voting majorities will long endorse ideas they know to be false. Stable Price Argument Perhaps the basic thought that supports an ever-increasing money supply is the popular idea that more business requires more money: if we produce more goods and services, customers must have more money with which to buy the additional goods and services. From this, it is assumed that the need for prosperity and "economic growth" makes it the government’s duty to pump out more purchasing power to the politically worthy in the form of more money or subsidies paid for by the creation of more money. Support for such reasoning is found in an idea that goes back at least to medieval days. In the thirteenth and fourteenth centuries some of the world’s best minds believed there was a

"just price" for everything. The "just price" was then thought to be determined by a fixed cost of production. Actual prices might fluctuate slightly from day to day or season to season, but they were always expected to return to the basic "just price," reflecting the supposedly never-changing number of man-hours required for production. From such thinking, it naturally follows that increased production can only be sold when consumers have more money. More goods might be needed for any of several reasons, let us say for an increased population. However, no matter how much they were needed, they would remain unsold and unused unless buyers were supplied additional funds with which to buy them at, or near, the "just price." What is the situation in real life? What do businessmen do when they have more goods to sell than customers will buy at their asking price? They reduce prices. They advertise sales at mark-down prices. If that doesn’t work, they reduce their prices again and again until all their surplus goods are sold. Any economic good can always be sold, if the price is right. The way to move increased production into consumption is to adjust prices downward. Businessmen, who have made mistakes in judging consumer wants, will suffer losses. Those who provide what consumers prefer will earn profits. Lower prices will benefit all consumers and mean lower costs for future business operations. Under such a flexible price system, there is no need for more money. Businessmen soon learn to convert available supplies of labor and raw materials into those goods for which consumers will willingly pay the highest prices. What Are Prices? Prices are quantities of money. They reflect a complex of interrelated market conditions and individual value judgments at any one time and place. Each price reflects not only the available supply of that good in relation to the supply of all other available goods and services, but also the demand of individuals for that good in relation to their demand for all other available goods and services. But even this is only one side of price-determining factors. The money side must also be taken into consideration. Every price also reflects not only the supply of money held by each market participant, but also—since very few people ever spend their last cent—how much money each participant decides to keep for his future needs and unknown contingencies. Prices thus depend on many things besides the cost of production. They depend primarily on the relative values that consumers place on the satisfactions they expect to get from owning the particular mixture of goods and services that they select. However, prices also depend on the amount of money available both to each individual and to all individuals. In a free market economy, unhampered prices easily adjust to reflect consumer demand no matter what the total supply of money or who owns how much of it. What Is This Thing Called Money? Money is a commodity that is used for facilitating indirect exchange. Money first appeared when individuals recognized the advantages of the division of labor and saw that indirect exchange was easier and more efficient than the clumsy, time-consuming direct exchange of barter.

In the earliest days of specialized production, those who made shoes or caught fish soon found that if they wanted to buy a house, it was easier to buy it with a quantity of a universally desired commodity than with quantities of shoes or fresh fish. So, they first exchanged their shoes or fish for a quantity of that commodity which they knew was most in demand. Such a commodity would keep and not spoil. It could be divided without loss. And most important, all people would value it no matter what the size of their feet or their desire for fish. The commodity which best meets these qualifications soon becomes a community’s medium of exchange, or money. Many things have been used as money. In this country we once used the wampum beads of Indians and the shells found on our shores. As time pased, reason and experience indicated that the commodities best suited for use as money were the precious metals, silver and gold. By the beginning of this century, the prime money of the world had become gold. And so it is today. Gold is the commodity most in demand in world markets. Money is always that commodity which all sellers are most happy to accept for their goods or services, if the quantity or price offered is considered sufficient. Money is thus the most marketable commodity of a market society. It is also the most important single commodity of a market society. This is so because it forms a part of every market transaction and whatever affects its value affects every transaction and every contemplated transaction. Kinds of Goods There are three types of economic goods:

<!--[if !supportLists]-->1. Consumers’ goods.<!--[endif]--> <!--[if !supportLists]-->2. Producers’ goods.<!--[endif]--> <!--[if !supportLists]-->3. Money.<!--[endif]-->
Consumers’ goods are those goods which are valued because they supply satisfaction to those who use or consume them. Producers’ goods are goods which are valued because they can be used to make or produce consumers’ goods. They include raw materials, tools, machines, factories, railroads, and the like. Money is that good which is valued because it can be used as a medium of exchange. It is the only type of economic good that is not consumed by its normal usage. In the case of consumers’ goods and producers’ goods, every ad ditional unit that is produced and offered for sale increases the wealth not only of the owner but of everyone else. Every additional automobile that is produced not only makes the manufacturer richer but it also makes every member of the market society richer. How? The more useful things there are in this world, the larger the numbers of human needs or wants that can be satisfied. The market system is a process for distributing a part of every increase in production to every participant in that market economy. When there is no increase in the money supply, the more goods that are offered for sale, the lower prices will be—and, consequently, the more each person can buy with the limited amount of money he

has to spend. So every increase in production for a market economy normally means more for every member of that economy. On the other hand, when any consumers’ goods or producers’ goods are lost or destroyed, not only the owner but all members of the market community suffer losses. With fewer goods available in the market place, and assuming no increase in the money supply, prices must tend to rise. Everybody’s limited supply of money will thus buy less. Recently, a Montreal apartment house was destroyed by an explosion. The loss to the occupants and the owners or insurance companies is obvious. The loss to all of us may be less obvious, but nevertheless it is a fact. The market society has lost forever the services and contributions of all those who were killed. It has also lost for a time the contributions of all those whose injuries temporarily incapacitated them. There is also a loss for all of us in the fact that human services and producers’ goods must be used to clear away the wreckage and rebuild what was destroyed. This diversion of labor and producers’ goods means the market will never be able to offer the things that such labor and producers’ goods could otherwise have been used to produce. With fewer things available in the market, prices will tend to be higher. Such higher prices will force each one of us to get along with a little less than would have been the case if there had been no explosion. Thus, we are all sufferers from every catastrophe. Be it an airplane crash, a tornado, or a fire in some distant community, we all lose a little bit. And all these little bits often add up to a significant sum. This is particularly true of war losses. Every American killed in Vietnam hurts every one of us not only in the heart but also in the pocketbook. Our government must supply some monetary compensation to his family and an income, however little, to his dependents. In such cases, the loss may continue for years. The killed man’s services are lost for his normal life span and his dependents become a long-term burden on the nation’s taxpayers and consumers. Such losses can never be measured or calculated, but they are real nonetheless. So, in a market society every increase in consumers’ goods or producers’ goods permits us to buy more with whatever money we have, and every decrease in con sumers’ goods or producers’ goods means ultimately higher prices and less for our money. Increased supplies of such economic goods help both the producers and everyone else who owns one or more units of money. Limited Goods Available With money, the situation is quite different. Any increase in the supply of money helps those who receive some of the new supply, but it hurts all those who do not. Those who receive some of the new supply can rush out and buy a larger share of the goods and services in the market place. Those who receive none of the new money supply will then find less available for them to buy. Prices will rise and they will get less for their money. Pumping more money into a nation’s economy merely helps some people at the expense of others. It must, by its very nature, send prices up higher than they would have been, if the money supply had not been increased. Those with no part of the new money supply must be satisfied with less. It does not and cannot increase the quantity of goods and services available.

There are some who claim that increasing the money supply puts more men to work. This can only be so when there is unemployment resulting from pushing wage rates above those of a free market by such political measures as minimum wage laws and legally sanctioned labor union pressures. Under such conditions, increasing the money supply reduces the value of each monetary unit and thus reduces the real value of all wages. By doing this, it brings the higher-than-free-market wage rates nearer to what they would be in a free market. This in turn brings employment nearer to what it would be in a free market, where there is a job for all who want to work.¹ Those who create and slip new supplies of money into the economy are silently transferring wealth which rightfully belongs to savers and producers to those who, without contributing to society, are the first to spend the new money in the market place. When this is done by private persons, they are called counterfeiters. Their attempts to help themselves at the expense of others are easily recognized. When caught, they are soon placed where they can add no more to the money supply. Governments Inflate In recent generations our major problem has not been private counterfeiters. It has been governments. Over the years, governments have found ways to increase the money supply that not more than one or two persons in a million can detect. This is particularly true when production is increasing and when more and more of the monetary units are held off the market. Nonetheless, whether prices go up or not, every time a government increases the money supply, it is taking wealth from some and giving it to others. This semi-hidden increase in the money supply occurs in two ways: One, by the creation and issuance of money against government securities. This is a favorite way to finance government deficits. Government securities that private investors will not buy, because they pay lower-than-free-market interest rates, are sold to commercial banks. The banks pay for such securities by merely adding the price of the securities to government bank accounts. The government can then draw checks to pay suppliers, employees, and subsidy recipients. (This process is encouraged and increased by technical actions and direct purchases of the nation’s central bank. In the United State s, these powers reside in the Federal Reserve Board, which has not been hesitant about using them.) The government thus receives purchasing power without contributing anything to the goods and services offered in the market place. It thus gets something for nothing. As a result, there is less available for those spending and investing dollars they have received for their contributions to society. The consequence of such government spending is that prices are higher than they would otherwise have been. Two, the other major semi-hidden means of increasing the money supply is for banks to lend money to private individuals or organizations by merely creating or adding a credit to the borrowers’ checking accounts. In such cases, they are not lending the savings of depositors. They are merely creating dollars, in the form of bank accounts, by simple bookkeeping entries. The borrowers are thereby enabled to draw checks or ask for newly created money with which to buy a part of the goods and services available in the market place. This means that those responsible for the production of these goods and services must be satisfied with less than the share they would have received if the money supply had not been so increased.

By such systems of money creation, our government and our government-controlled banking system have, from the end of 1945, increased the nation’s money sup ply from $132.5 billion to an estimated $289.9 billion by the end of 1964. This is an increase of $157.4 billion. During the same period, the gold stock, held as a reserve against this money and valued at $35 an ounce, fell from $20.1 billion to $15.4 billion. The increase in the money supply for 1964 amounted to $21.0 billion. All these new dollars provided the first recipients with wealth which, had there been no artificial additions to the money supply, would have gone to those spenders Figures for the money supply include those for currency outside of banks, demand deposits, and time deposits of commercial banks which in practice may be withdrawn on demand, and investors who received their dollars in return for contributions to society. Last year alone, political favorites were helped to the tune of $21 billion, at the expense of all the nation’s producers and savers of real wealth. These money-increasing policies remain hidden from most people, particularly when prices do not rise rapidly. It is now popular to say there is no inflation unless official price indexes rise appreciably. This popular corruption of the term inflation, originally defined as an increase in the money supply, makes it seem safe for the government to increase the money supply so long as the government’s own price indexes do not rise no ticeably. So, if these price indexes can somehow be kept down, the government can continue buying or allocating wealth which has been created by private individuals who must be satisfied with less than the free market value of their contributions. Price Rise Kept Down Since World War II, there have been two continuing situations which have helped to keep official price indexes from reflecting the full effect of this huge increase in the money supply. The first such situation is that throughout this period American production of wealth has continued to increase. The second is that during these years foreigners and their banks and governments have taken and held off the market increasing supplies of dollars. If there had been no upward manipulation of the money supply, the increased production of wealth would have resulted in lower prices. This would have provided more for everyone who earned or saved a dollar. It would also have reduced costs and increased the amount of goods and services that would have been sold at home and abroad. As it was, with prices rising slowly over the 1945-64 period, the Federal government and our government-controlled banking system have been able to allocate the benefits of increased production, and a little bit more, to favored bank borrowers who pay lower than free market interest rates and those who received Federal funds over and above the sums collected in taxes or borrowed from private individuals or corporations. Untold billions of dollars have also gone into the hands or bank accounts of international organizations, foreigners, their banks, and governments. Many of these dollar holders consider $35 to be worth more than an ounce of gold. Such dollar holders have felt they could always get the gold and, meanwhile, they can get interest by leaving their dollars on deposit with American banks. Foreign governments could even count such deposits as part of their reserves against their own currencies. For example, the more dollars held by the Bank of France, the more it can expand the supply of French francs. So the inflations of

many European governments are built on top of the great increase in their holdings of dollars. Short term liabilities of American banks to foreigners at the end of 1945 were only $6.9 billion.3 By the end of last year, they had risen to an estimated $28.8 billion, an increase of $20.9 billion.’ How many more dollars rest in foreign billfolds or under foreign mattress es cannot even be guessed. Should such foreign dollar holders lose confidence in the ability of their central banks to get an ounce of gold for every $35 presented to our government, more and more of these dollars will return to our shores where their presence will bid up American prices. This whole process of increasing the money supply by semi-hidden manipulations is not only highly questionable from the viewpoint of morality and economic incentives, but it also has a highly disorganizing effect on the production pattern of our economy. Over the years, as these newly created dollars have found their way into the market, they have forced profitseeking enterprises to allocate a growing part of production to the spenders of the newly created dollars, leaving less production available for the spenders of dollars which represent contributions to society. Once this artificial creation of dollars comes to an end, as it must eventually, those businesses whose sales have become dependent upon the spending of the newly created dollars will lose their customers. This will call for a reorganization of the nation’s production facilities. Such reorganizations of business have become known as depressions. The depression can be short, with a minimum of human misery, if prices, wage rates, and interest rates are left free to reflect a true picture of the ever-changing demands of consumers and supplies of labor, raw materials, and savings. Private business will then move promptly and efficiently to employ what is available to produce the highest valued mixture of goods and services. Any interference with the free market indicators will not only slow down recovery but also misdirect some efforts and reduce the ability of business to satisfy as much human need as a completely free economy would. The day of reckoning can only be put off so long. Once the na tion’s workers and savers realize that such semi-hidden increases in the money supply are appropriating a part of their purchasing power, they may take their dollars out of government bonds, savings banks, life insurance policies, and the like in order to buy goods or invest in real estate or common stocks, and even borrow at the banks to do so. If this trend should develop, the government would soon be forced to adopt sound fiscal and monetary policies. The same effect might be produced by a rush of foreign dollar holders to spend the dollars they now consider as good as one thirty-fifth of an ounce of gold. In any case, an everincreasing supply of dollars and ever-increasing prices will eventually bring on a "runaway inflation," unless the government stops its present practices before the situation gets completely out of hand. The important thing to remember is that increases in the nation’s money supply can never benefit the nation’s economy. Such increases in the money supply do not and cannot increase the supply of goods and services that a free economy would produce. Such inflations of the money supply can only help some at the expense of others. Even such help for the politically favored is at best only temporary. As prices rise, it takes ever bigger doses of new money to have the same effect, and this in turn means still higher prices. The fact is that no matter what the volume of business may be, any given supply of money is sufficient to perform all the services money can perform for an economy. All that is

needed for continued prosperity is for the government to let prices, wage rates, and interest rates fluctuate so that they reveal rather than hide the true state of market conditions. Under the paper money standard, politicians are easily tempted to keep voting for just a little more spending than last year, and just a little less taxing than last year. The gap can be covered by a semi-hidden increase in the money supply—just a little more than last year. Then, too, the illusions of prosperity are often helped along by an easy money policy— holding interest rates below those of a free market. This tends to increase the demand for loans above the amount of real savings available for lending. The banks then meet the demand for more credit by the bookkeeping device of increasing the bank accounts of borrowers. Clever financial officials must then find ways to put off the day of reckoning. If gold continues to flow out, private travel, imports, and investments can be blamed and controls instituted. When the first controls do not succeed, more and more controls can be added. When these fail, public attention can always be diverted by a war. War is now generally considered a sufficient excuse for more inflation and a completely controlled economy of the type Hitler established in Germany. No man or government should ever be trusted with the legal power to increase a nation’s money supply at will. The great advantage of the gold standard is that gold cannot be created by printing presses or by bookkeeping entries. When a country is on the gold standard, politicians who want to vote for spending measures must also vote for increased taxes or sanction the issuance of government securities paying free market interest rates that will attract the funds of private savers and investors. Under a true gold standard, men remain free, the quantity of money is determined by market forces, and both the manipulated inflations and the resulting depressions are eliminated, along with all the poverty and human misery that they cause.

The Future of the Dollar
By Henry Hazlitt • January 1974 • Volume: 24 • Issue: 1 Related • Filed Under • ShareThis• Print This Post • Email This Post
Mr. Hazlitt is the well-known economist, columnist, editor, lecturer and author of numerous books, including What You Should Know About Inflation which is available in paperback from the Foundation for Economic Education. Before we consider the future of the American dollar it may be wise to cast a glance at the glories of its past and examine the main causes that have brought it to its present humiliating state. The logical starting point in this examination is Bretton Woods. When the representatives of some forty nations met there in 1944, heretical monetary notions were floating in the air. Lord Keynes, who was there, was their chief spokesman. The most definite of these notions was that the gold standard was a barbarous relic, and neither could nor should be restored. It put every national economy in a strait jacket. It prevented full employment; it strangled economic growth; it tied the hands of national monetary managers. And all for no good reason except an outworn mystique. Besides, there wasn’t enough gold in the world to sustain convertibility. But because some American Congressmen and some parliaments were thought to have a lingering prejudice in favor of gold, it seemed prudent to compromise, and to set up something that looked almost like a gold standard — a thinly gold-plated standard. So, through an International Monetary Fund (IMF), a sort of world central bank, every other currency was to be pegged at a fixed rate to the Almighty Dollar. Each nation, after fixing an official parity for its currency unit, pledged itself to maintain that parity by buying or selling dollars. The dollar alone was to be convertible into gold, at the fixed rate of $35 an ounce. But unlike as in the past, not everybody who held dollars was to be allowed to convert them on demand into gold; that privilege was reserved to national central banks or other official institutions. Thus, everything seemed to be neatly taken care of. When every other currency was tied to the dollar at a fixed rate, they were all necessarily tied to each other at fixed rates. Only one currency was tied to the dreadful discipline of gold, and even that in a very limited way. Gold was "economized" as never before. It was now the servant, no longer the master. Automatic Credit In addition, the Bretton Woods agreements provided that if any nation or central bank got into trouble, it was entitled to automatic credit from the Fund, no questions asked. Thus, not only released from a strict gold standard, but tempted to imprudence, individual nations felt free to expand their paper money and credit supply to meet their own so-called domestic "needs." The politicians and the monetary managers in practically every country were infected with a Keynesian or inflationary ideology. They rationalized budget deficits and continuous monetary and credit expansion as necessary to maintain "full employment" and "economic growth." As a consequence, there were soon wholesale devaluations. The IMF has published hundreds of thousands of statistics; but the single figure of how many

devaluations there were between the opening of the Fund and August 15, 1971, when the dollar itself became officially inconvertible into gold, the IMF has never published. There were certainly hundreds of devaluations. To my knowledge, practically every currency in the Fund, with the exception of the dollar, was devalued at least once. The record of the British pound was much better than that, say, of the French franc, but the pound itself, which had already been devalued from $4.86 to $4.03 when it entered the IMF, was devalued again from $4.03 to $2.80 in September 1949 (an action that touched off 25 more devaluations of other currencies within a single week), and devalued still again from $2.80 to $2.40 in November, 1967. Devaluation, let us remember, is an act of national bankruptcy. It is a partial repudiation, a government welching on part of its domestic and foreign obligations. Yet, by repetition by all the best countries, devaluation acquired a sort of respectability. It became not a swindle, but a "monetary technique." Until the dollar went off gold in August 1971 and was devalued in December, we heard incessantly how "successful" the Bretton Woods system had proved. During the early part of this period, however, the world suffered from what everybody called a "shortage of dollars." The London Economist, among others, even solemnly argued that there was now a permanent "shortage of dollars." Americans thought so too. Our monetary managers seemed completely unaware of the tremendous responsibility we had assumed when we allowed the dollar to become the standard and the anchor for all the other currencies of the world. Our money managers never dreamed that it was possible to create an excess of dollars. They issued and poured out dollars and sent them abroad in foreign aid. Total disbursements to foreign nations, in the fiscal years 1946 through 1971, came to $138 billion. The total net interest paid on what the United States borrowed to give away these funds amounted in the same period to $74 billion, bringing the grand total through the 26-year period to $213 billion. This amount was sufficient in itself to account for the total of our Federal deficits in the 1946-1972 period. The $213 billion foreign aid total exceeds by $73 billion even the $140 billion increase in our gross national debt during the same years. Foreign aid was also sufficient in itself to account for all our balance-of-payments deficits up to 1970. Internal Inflation We created a good deal of this money through internal inflation. From January 1946 to August 8, 1973, the money supply, as measured by currency in the hands of the public plus demand bank deposits, increased from $102 billion to $264 billion, an increase of $162 billion, or of 159 per cent. In the same period the money supply as measured by currency plus both demand and time deposits increased from $132 billion to $549 billion, an increase of $417 billion, or 316 per cent. Because of what our monetary authorities believed was the necessity of keeping this enormous inflation going, they adopted one expedient after another. In 1963, blaming the deficit in our balance of payments on private American investment abroad, they put a penalty tax on purchases of foreign securities. In 1965 they removed the legal requirement to keep a gold reserve of 25 per cent against Federal Reserve notes. They resorted to a "two-tier" gold system. Next they invented Special Drawing Rights, or "paper gold." But all to no avail. On August 15, 1971, they officially abandoned gold convertibility. They devalued the dollar by about 8 per cent in December, 1971. They devalued it again, by 10 per cent more, on February 15, 1973.

Exported Inflation Before we bring this dismal history any further down to date, let us pause to examine some of the chief fallacies prevailing among the world’s journalists, politicians, and monetary managers that have brought us to our present crisis. Because we were sending so many of our dollars abroad, the real seriousness of our own inflation was hidden both from our officials and from the American public. We contended that foreign inflations were greater than our own, because their official price indexes were going up more than ours were. What we overlooked —what most Americans still overlook — is that we were exporting part of our inflation and that foreign countries were importing it. This happened in two ways. One was through our foreign aid. We were shipping billions of dollars abroad. Part of these were being spent in the countries that received them, raising their price level but not ours. The other way in which we exported inflation was through the IMF system. Under that system, foreign central banks bought our dollars to use them as part of their reserves. But in addition, under the rules of the IMF system, central banks were obliged to buy dollars, whether they wanted them or not, to keep their own currencies from going above parity in the foreign exchange market. The result is that foreign central banks and official institutions today hold some 71 billion of our dollars. These dollars will eventually come home to buy our goods or make investments here. When they do, their return will have an inflationary effect in the United States. Our domestic money supply will be increased even if our Federal Reserve authorities do nothing to increase it. Balance of Payments The meaning of the "deficit" in our balance of payments has been grossly misunderstood. It has not been in itself the real disease, but a symptom of that disease. The real question Americans should have asked themselves is not what consequences the deficits in the balance of payments caused, but what caused the deficits. I have just given part of the answer — our huge foreign aid over the last 27 years, and the obligation of foreign central banks under the Bretton Woods agreements to buy dollars. But the foreign central banks had to buy dollars because dollars had become overvalued at their official rate. They became overvalued because the U.S. was inflating faster than some other countries. After the United States formally suspended gold payments, and after the dollar was twice devalued, foreign banks no longer felt an obligation to buy dollars. The dollar fell to its market rate, and as one consequence we again have a monthly excess of exports. The economists who had all along been demanding the restoration of free-market exchange rates were right. Now that the dollar is no longer even nominally convertible into gold there is no longer any excuse for governments to try to peg their paper currency units to each other at arbitrarily fixed rates. The IMF system ought to be abandoned. The International Monetary Fund itself ought to be liquidated. Paper currencies should be allowed to "float" — that is, people should be allowed to exchange them at their market rates. But it is profoundly wrong to assume, as many economists and laymen unfortunately now do, that daily and hourly fluctuating market rates for currencies will be alone sufficient to solve the multitudinous problems of foreign commerce. On the contrary, these wildly fluctuating rates create a serious impediment to international trade, travel and investment. They force importers, exporters, travelers, bankers, and investors either to become

unwilling speculators or to resort to bothersome and costly hedging operations. With 125 national currencies represented in the IMF, there are some 7,750 changing cross-rates to keep track of, and twice as many if you state each cross-rate both ways. With a gold standard gone, with the dollar standard gone, there is no longer a single accepted unit in which all of these rates can be stated. Some Gain — Some Loss It is a great gain when currencies can be exchanged at their true market rates. Since this has happened the American trade balance has improved. In the second quarter of 1973, for example, there was again a surplus of exports. In July, 1973, American exports in dollar terms were the highest for any single month on record. But it is one thing to allow trade to improve by abandoning arbitrary pegs on foreign-exchange rates; it is quite another thing for a country to seek to increase its exports at the expense of its neighbors by deliberate devaluation. Yet this is what the United States government has very foolishly done. In early August, 1973, Frederick B. Dent, the U. S. Secretary of Commerce, assured the American public that the devaluations of the dollar had provided the nation with a "bright opportunity." "Without question," he added, "the most important factor in the improving trade trend is the combination of the two devaluations." In fact, the U. S. Department of Commerce placed an advertisement in the issue of Time of July 2, and in other magazines, declaring that to the U. S. exporter the devalued dollar means "vastly improved prospects," that it would help him to capture "a bigger share of over-sea markets," and that it was up to him to "start putting the devalued dollar to work." The basic fallacy in this euphoric picture is that it looks only at the short run consequences of devaluation and even at these only as they affect a small segment of the population. It is true that the first effect of a devaluation, if it is confined to a single country, is to stimulate that country’s exports. Foreigners can buy that country’s products cheaper in terms of their own money. Thus, as the Department of Commerce’s ad correctly pointed out: "For instance, an American product for which a West German importer paid 1000 deutsche mark only 18 months ago would now cost him as little as 770 marks. Or about 23 per cent less than before." So the American exporter stands to sell more goods abroad at the same price in dollars, or the same volume of goods in higher prices in dollars, or something in between, depending on whether his product is competitive or a quasimonopoly. So far, so good. But U. S. exports amount to only 4¹/2 per cent of the gross national product. Now let us enlarge our view. If the dollar is devalued, say, by a weighted average of 25 per cent in terms of other currencies, something else happens even on the first day after devaluation. The prices of all American imports go up by that percentage (or more precisely, by its converse). Every American consumer has to pay more, directly or indirectly, for meat, coffee, cocoa, sugar, metals, newsprint, petroleum, foreign cars, or whatever. Even the American exporter, as a consumer, has to pay more, and also more for his imported raw materials. So the immediate effect of a devaluation is to force the consumers of the devaluing nation to work harder to obtain a smaller consumption than otherwise of imported goods and services. Is it really a national gain for the American people to sell their own goods for less and buy foreign goods for more? The belief that devaluation is a blessing, because it temporarily enables us to sell more and forces us to buy less, stems’ from the old mercantilist fallacy that looked at international

trade only from the standpoint of sellers. It was one of the primary achievements of the classical economists to explode this fallacy. As John Stuart Mill said: The only direct advantage of foreign commerce consists in the imports. A

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o:allowoverlap="f"> o:title=""/> <!--[if !vml]--><!--[endif]-->country obtains things which it either could not have
produced at all, or which it must have produced at a greater expense of capital and labor than the cost of the thing which it exports to pay for them… The vulgar theory disregards this benefit, and deems the advantage of commerce to reside in the exports: as if not what a country obtains, but what it parts with, by its foreign trade, was supposed to constitute the gain to it. Long- Run Effects So far I have considered only the immediate effects of a devaluation. Now let us look at the longer effects. The devaluation or depreciation of a currency soon leads to a rise of the internal price level. The prices of imported goods, as I have just pointed out, have a corresponding rise immediately. The demand for exports rises, and therefore the prices of export goods rise. This rise of prices leads to increased borrowing by manufacturers and others to stock the same volume of raw materials and other inventories. This leads to an expansion of money and credit which soon makes other prices rise. (Often, of course, the causation is the other way round: an expansion of a country’s currency and a consequent rise of its intern al price level will soon be reflected in a fall of its currency quotation in the foreign exchange market.) In brief, internal prices soon adjust to the foreign-exchange quotation of the currency, or vice versa. We can see more clearly how this must take place if we look at a freely transportable international commodity like wheat, copper, or silver. Let us say, for example, that copper is 50 cents a pound in New York when the deutsche mark in the foreign exchange market is 25 cents. Then purchases, sales, and arbitrage transactions will have brought it about that the price of copper in Munich is four times as high in marks as in dollars plus

costs of transportation. Suppose the dollar is devalued or depreciated so that the mark now exchanges for 40 cents. Then, assuming that the price of copper in terms of marks does not change (and though I have been specifically mentioning marks, dollars, and copper I intend this as a hypothetical and not a realistic illustration), purchases, sales, and arbitrage transactions will now bring it about that the price of copper in New York will have to rise 60 per cent in terms of dollars. To bring this new adjustment about, more copper will flow from the U. S. to Germany. But after this temporary stimulus to American export, the new price adjustment will bring it about that, other things being equal, the relative amount of copper exported may be no different than before the devaluation. A Brief Period of Transition I have been speaking of international commodities, traded on the speculative exchanges, and easily and quickly transportable. In these commodities the international price adjustments will take place in a few days or weeks. The price adjustments of most other goods will, of course, take place more slowly. The main point to keep in mind is that there is a constant tendency for the internal purchasing power of a currency to adjust to its foreignexchange value —and vice versa. In other words, there is a constant tendency for the internal prices in a country to adjust to the changing foreign-exchange value of its currency —and vice versa. Though our modern monetary managers and secretaries of commerce seem to know nothing about this, the purchasing power theory of the exchanges was first explained a century and a half ago by Ricardo. In other words, the alleged foreign trade "advantages" of a devaluation last for merely a brief transitional period. Depending on specific conditions, that period may stretch over more than a year or less than twenty-four hours. It tends to become shorter and shorter for any given country as depreciation of its currency continues or devaluations are repeated. Internal currency depreciation usually lags behind external depreciation, but the lag tends to diminish. Statistical studies have been made of the relationships of the internal and external purchasing power of a currency under extreme conditions — for instance, the German mark during the 1919-1923 inflation. (See The Economics of Inflation, by Constantino BrescianiTurroni, 1937.) It would not be too hard for any competent statistician, with the help of a copy of International Financial Statistics, published monthly by the IMF, to put together revealing comparisons of foreign-exchange rates and internal prices for any country that publishes reasonably honest wholesale or consumers price indexes. It is instructive to recall, incidentally, that at the height of the German hyperinflation, which eventually brought the mark to one-trillionth of its former value, monthly exports, measured in tonnages, fell to less than half of what they had previously been, while the tonnage of imports doubled or tripled. In brief, the pursuit of a more "favorable" balance of payments, or a trade "advantage," through depreciation or devaluation of one’s own currency, is the pursuit of a will -o-thewisp. Any gain of exports it brings to the devaluating nation is temporary and transient, and is paid for at an excessive cost — an internal price rise and all the economic distortions and social discontent and unrest this brings about.

The usual criticism of currency devaluation is that it will provoke reprisals; that other countries will try the same thing, and the world may be plunged into competitive devaluations and trade wars. This objection is, of course, both a valid and a major one. But what I have been trying to emphasize here is a point that few of our monetary managers have grasped — that even if there is no retaliation, devaluation as a deliberate policy pursued for the sake of a foreign trade gain is self-defeating and stupid. The two American devaluations, for example, were monumental blunders. If the world’s monetary managers can be brought to learn this one lesson, the economic and political gain will be immense. Remedial Measures What steps should be taken to halt the present world inflation and return the world to sound money? The immediate steps are simple and can be briefly stated. The United States — and for that matter every country — should forthwith allow its citizens to buy, sell, and make contracts in gold. This would be immediately followed by free gold markets, which would daily measure the real depreciation in each paper currency. Gold would immediately become a de facto world currency, whether "monetized" or not. The metal itself would not necessarily change hands with each transaction, but gold would become the unit of account in which prices would be stated. Exporters would be insured against the depreciation of the currencies in which they were being paid. The second (and preferably simultaneous) step can be stated more briefly still. Every nation should refrain from further increase in its paper money and bank credit supply. For the United States a special measure would also be needed. A hundred billion dollars or more are held by foreign central banks and foreign citizens. Most of these are no longer wanted. They dangerously overhang the market, and constantly threaten to bring sudden and sharp declines in the dollar. The U. S. government must do two things. It must follow monetary policies that will assure foreign dollar holders that they are not holding an asset that is likely to depreciate still further but, on the contrary, one that is likely to keep its value or even to appreciate a little. Secondly, the U. S. government should volunteer to fund the dollar overhang. It could do this by offering foreign central banks interest-bearing long-term obligations for their liquid dollar holdings — say, bonds that would be repayable and retirable, principal and interest, in equal installments over a period of twenty-five or thirty years. It should preferably negotiate with each country separately, and should guarantee its bonds by making principal and interest repayable, at the option of the central bank holding them, in either the face value of the dollars or in the currency of the country holding them, at the same ratio to the dollar as of the market rate on the day the agreement was reached. Thus, the Bank of Japan would be paid off, at its option on any payment date, either in dollars or in yen; the Bundesbank either in dollars or in marks; and so on. Ricardo’s Recommendations of a Full Gold Standard Of course, the world should eventually return to a full gold standard. A gold standard is needed now for the same reason that David Ricardo gave for it in 1817: Though it (paper money) has no intrinsic value, yet, by limiting its quantity, its value in exchange is as great as an equal denomination of coin, or of bullion in that coin…. Experience, however, shows that neither a State nor a bank ever have had the

unrestricted power of issuing paper money without abusing that power; in all States, therefore, the issue of paper money ought to be under some check and control; and none seems so proper for that purpose as that of subjecting the issuers of paper money to the obligation of paying their notes either in gold coin or bullion. A return to gold will involve some difficult but not insuperable problems, which we shall not attempt to discuss in detail here. The main immediate requirement is that individual countries stop increasing their paper money supplies. But my topic here is the future of the dollar — not what it ought to be, but what it is likely to be. And I am obliged to say that the outlook for the dollar — or, for that matter, of national currencies anywhere — is hardly bright. The world’s currencies will be what the world’s politicians and bureaucrats make them. And the world’s politcians and bureaucrats are still dominated everywhere by an inflationary ideology. Whatever they say publicly, whatever fair assurances they give, they still have a mania for inflation, domestic and international. They are convinced that inflation is necessary to maintain "full employment" and to continue "economic growth." They will probably continue to "fight" inflation only with false remedies, like "income policies" and price controls. The International Monetary Fund is the central world factory of inflation. Nearly all the national bureaucrats in charge of it are determined to continue it. Having destroyed the remnants of the gold standard by printing too much paper money, they now propose to substitute Special Drawing Rights, or SDR’s, for gold — in other words, they propose to print more international paper money to serve as the "reserves" behind still more issues of national paper monies. The first international step toward sound money, to repeat, would be to abolish the IMF entirely. In August, 1973, the present American Secretary of the Treasury, George P. Schultz, named fourteen men as members of a new advisory committee on reform of the international monetary system. These included three former Treasury secretaries, all of whom pursued the very monetary policies that brought the United States and the world to its present crisis. The whole list of men in this committee included only two professional economists. I don’t want to attack individuals, but to my knowledge not a single man appointed to the new panel believes in the gold standard, has ever advocated its restoration, or has ever spoken out in clear and unequivocal terms even against the chronic increase in paper money issues. But the climate of opinion is now such in the United States that I must confess I would find myself hard put to it to name as many as fourteen qualified Americans who could be counted on to recommend a sound international monetary reform. The truth is that everybody is afraid of a return to sound money. Nobody in power wants to give up inflation altogether because he fears its abandonment would be followed by a recession. It’s true that if we stopped inflation forthwith we might have a recession, for much the same reasons as a heroin addict, deprived of his drug, might suffer agonizing withdrawal symptoms. But such a recession, even if it came, would be a very minor and transient evil compared with the catastrophe toward which the world is now plunging.