A formerly wiser man once warned of “an almost hysterical antagonism toward the gold standard” as a force which unites all statists. I wanted to wrap my mind around that particular statement because I’ve grown up in an era entirely dominated by fiat money, easy credit, booms and busts, and a great deal of inflation; and because I wanted to know why it would be beneficial to a statist, or someone interested in affecting a “positive” change in the economy, to seek to abolish the gold standard, I had to explore popular thinking on the matter.
What would a gold standard accomplish in terms of wealth and debt, and what would a system based entirely on fiat, or paper, secure without the backing of a commodity as a store of actual wealth?
In 1966, Alan Greenspan wrote that, “in order to understand the source of their [statist’s] antagonism, it is necessary first to understand the specific role of gold in a free society.” 1 We must first assume that money, as a commodity, is the means by which economic transactions take place, whether it be for goods or services, in a given society, “and can, therefore, be used as a standard of market value and as a store of value, i.e., as a means of saving.” 1 Without it we cannot build wealth, discharge debts, exchange goods and services, or plan for the long term in any meaningful fashion. Exchange of any asset would become quite difficult. 1
In the development of international economic systems, precious metals, particularly gold, became the means by which goods and services could be exchanged; gold became a preferred choice because by “having both artistic and functional uses and being relatively scarce, [it had] significant advantages over all other media of exchange.” 1 Gold is a limiting resource in this fashion simply because of its scarcity; if all transactions were paid in gold, it would become difficult to handle larger payments and economic development would be sharply limited. “Thus a logical extension of the creation of a medium of exchange is the development of a banking system and credit instruments (bank notes and deposits) which act as a substitute for, but are convertible into, gold.” 1
Greenspan dives into what this development means in terms of free banking:
A free banking system based on gold is able to extend credit and thus to create bank notes (currency) and deposits, according to the production requirements of the economy. Individual owners of gold are induced, by payments of interest, to deposit their gold in a bank (against which they can draw checks). But since it is rarely the case that all depositors want to withdraw all their gold at the same time, the banker need keep only a fraction of his total deposits in gold as reserves. This enables the banker to loan out more than the amount of his gold deposits (which means that he holds claims to gold rather than gold as security of his deposits). But the amount of loans which he can afford to make is not arbitrary: he has to gauge it in relation to his reserves and to the status of his investments.
Unbalanced expansions of business activity (the booms we often see in modern times) are held in check because credit cannot be extended too far beyond limited gold reserves; however, in some cases banks would extend credit too far, and “as a result of [this] overly rapid credit expansion, banks became loaned up to the limit of their gold reserves, interest rates rose sharply, new credit was cut off, and the economy went into a sharp, but short‐lived recession.” 1 Most often these recessions were seen as mild in comparison to more modern experiences.
In order to solve this economic puzzle, it was determined that if shortages were what caused declines in business activity it would be best to ensure that no shortages ever existed.
If banks can continue to loan money indefinitely‐it was claimed‐there need never be any slumps in business. And so the Federal Reserve System was organized in 1913. It consisted of twelve regional Federal Reserve banks nominally owned by private bankers, but in fact government sponsored, controlled, and supported. Credit extended by these banks is in practice (though not legally) backed by the taxing power of the federal government. Technically, we remained on the gold standard; individuals were still free to own gold, and gold continued to be used as bank reserves. But now, in addition to gold, credit extended by the Federal Reserve banks (paper reserves) could serve as legal tender to pay depositors. 1
In 1927, business in the United States experienced a mild contraction, and in order to shore up the possibility of a shortage, the Federal reserve printed more paper reserves; more disastrously, “however, was the Federal Reserve’s attempt to assist Great Britain who had been losing gold to us because the Bank of England refused to allow interest rates to rise when market forces dictated (it was politically unpalatable).” 1
The basic idea was to pump excessive paper reserves into the US system in order to create interest rates that would be comparable to England’s, thus stopping the outflow of gold. Unfortunately the success of this plan in stopping the outflow of gold added additional credit to the market that created a speculative boom in the markets. To stop this boom, Reserve officials decided to destroy the excess paper reserves; unfortunately it was too late because “by 1929 the speculative imbalances had become so overwhelming that the attempt precipitated a sharp retrenching and a consequent demoralizing of business confidence.” 1
The American economy collapsed. “Great Britain fared even worse, and rather than absorb the full consequences of her previous folly, she abandoned the gold standard completely in 1931, tearing asunder what remained of the fabric of confidence and inducing a world‐wide series of bank failures. World economies plunged into the Great Depression of the 1930’s.” 1 In short, the machinations of central banking created a mess that was largely blamed on the gold standard, because, it was reasoned, “if the gold standard had not existed…Britain’s abandonment of gold payments in 1931 would not have caused the failure of banks all over the world.” 1 Irony in this case is not lost on Greenspan, as he notes that we had not in fact been on a de facto gold standard since 1913, but instead a sort of mixed system.
Under a gold standard, the amount of credit that an economy can support is determined by the economy’s tangible assets, since every credit instrument is ultimately a claim on some tangible asset. But government bonds are not backed by tangible wealth, only by the government’s promise to pay out of future tax revenues, and cannot easily be absorbed by the financial markets. A large volume of new government bonds can be sold to the public only at progressively higher interest rates. Thus, government deficit spending under a gold standard is severely limited. 1
Abandoning this standard made it possible for welfare statists to expand credit in an unlimited fashion; paper reserves are treated as a commodity, as assets, as if they were a gold deposit. “The holder of a government bond or of a bank deposit created by paper reserves believes that he has a valid claim on a real asset. But the fact is that there are now more claims outstanding than real assets.” 1 Thus because as the supply of money increases relative to assets, prices are forced to rise in order to balance the books. Money is devalued, thus any savings–and relative wealth in terms of money–is diminished in value. “When the economy’s books are finally balanced, one finds that this loss in value represents the goods purchased by the government for welfare or other purposes with the money proceeds of the government bonds financed by bank credit expansion.” 1
In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value. If there were, the government would have to make its holding illegal, as was done in the case of gold. If everyone decided, for example, to convert all his bank deposits to silver or copper or any other good, and thereafter declined to accept checks as payment for goods, bank deposits would lose their purchasing power and government‐created bank credit would be worthless as a claim on goods. The financial policy of the welfare state requires that there be no way for the owners of wealth to protect themselves.
Thus, one could conclude a government that is dedicated to welfare state policies, dedicated to spending on a deficit, and dedicated to the confiscation of wealth in order to suit their plans and maintenance of power, will make a return to the gold standard increasingly less likely as time passes–if not impossible.
I can also conclude that a gold standard is the only real way to maintain wealth. In our current arrangement we are forced to invest for the future in order to outpace inflation, but no market can guarantee a secure investment and it is often subject to booms and busts as a result of the Federal Reserve’s management of the ‘money’ supply; but in order for the government to continue to operate it’s entitlement programs, as well as finance itself, we are forced to maintain this system not of wealth but of constant debt. And we do this by borrowing our own tax payments; ironically those payments are pretty worthless if you consider that we’re simply returning what was originally borrowed, at interest, in order to discharge the debt of the government. We are in perpetual debt to a perpetual debtor.
In light of this, how could one advocate for a system based entirely on paper reserves and tax obligations?
- Greenspan, Alan. Gold and Economic Freedom. Originally published in the Objectivist in 1966. Accessed at: http://www.ritholtz.com/blog/2008/11/gold-and-economic-freedom-by-alan-greenspan/. 7/8/2009.