Gold and Economic Freedom (by ALAN GREENSPAN)

An almost hysterical antagonism toward the gold standard is one issue which unites statists of all persuasions. They seem to sense-perhaps more clearly and subtly than many consistent defenders of laissez-faire-that gold and economic freedom are inseparable, that the gold standard is an instrument of laissez-faire and that each implies and requires the other.

In order to understand the source of their antagonism, it is necessary first to understand the specific role of gold in a free society.

Money is the common denominator of all economic transactions. It is that commodity which serves as a medium of exchange, is universally acceptable to all participants in an exchange economy as payment for their goods or services, and can, therefore, be used as a standard of market value and as a store of value, i.e., as a means of saving.

The existence of such a commodity is a precondition of a division of labor economy. If men did not have some commodity of objective value which was generally acceptable as money, they would have to resort to primitive barter or be forced to live on self-sufficient farms and forgo the inestimable advantages of specialization. If men had no means to store value, i.e., to save, neither long-range planning nor exchange would be possible.

What medium of exchange will be acceptable to all participants in an economy is not determined arbitrarily. First, the medium of exchange should be durable. In a primitive society of meager wealth, wheat might be sufficiently durable to serve as a medium, since all exchanges would occur only during and immediately after the harvest, leaving no value-surplus to store. But where store-of-value considerations are important, as they are in richer, more civilized societies, the medium of exchange must be a durable commodity, usually a metal. A metal is generally chosen because it is homogeneous and divisible: every unit is the same as every other and it can be blended or formed in any quantity. Precious jewels, for example, are neither homogeneous nor divisible.

More important, the commodity chosen as a medium must be a luxury. Human desires for luxuries are unlimited and, therefore, luxury goods are always in demand and will always be acceptable. Wheat is a luxury in underfed civilizations, but not in a prosperous society. Cigarettes ordinarily would not serve as money, but they did in post-World War II Europe where they were considered a luxury. The term "luxury good" implies scarcity and high unit value. Having a high unit value, such a good is easily portable; for instance, an ounce of gold is worth a half-ton of pig iron.

In the early stages of a developing money economy, several media of exchange might be used, since a wide variety of commodities would fulfill the foregoing conditions. However, one of the commodities will gradually displace all others, by being more widely acceptable. Preferences on what to hold as a store of value, will shift to the most widely acceptable commodity, which, in turn, will make it still more acceptable. The shift is progressive until that commodity becomes the sole medium of exchange. The use of a single medium is highly advantageous for the same reasons that a money economy is superior to a barter economy: it makes exchanges possible on an incalculably wider scale.

Whether the single medium is gold, silver, sea shells, cattle, or tobacco is optional, depending on the context and development of a given economy. In fact, all have been employed, at various times, as media of exchange. Even in the present century, two major commodities, gold and silver, have been used as international media of exchange, with gold becoming the predominant one. Gold, having both artistic and functional uses and being relatively scarce, has always been considered a luxury good. It is durable, portable, homogeneous, divisible, and, therefore, has significant advantages over all other media of exchange. Since the beginning of Would War I, it has been virtually the sole international standard of exchange.

If all goods and services were to be paid for in gold, large payments would be difficult to execute, and this would tend to limit the extent of a society's division of labor and specialization. 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.

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, 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 for 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.

When banks loan money to finance productive and profitable endeavors, the loans are paid off rapidly and bank credit continues to be generally available. But when the business ventures financed by bank credit are less profitable and slow to pay off, bankers soon find that their loans outstanding are excessive relative to their gold reserves, and they begin to curtail new lending, usually by charging higher interest rates. This tends to restrict the financing of new ventures and requires the existing borrowers to improve their profitability before they can obtain credit for further expansion. Thus, under the gold standard, a free banking system stands as the protector of an economy's stability and balanced growth.

When gold is accepted as the medium of exchange by most or all nations, an unhampered free international gold standard serves to foster a world-wide division of labor and the broadest international trade. Even though the units of exchange (the dollar, the pound, the franc, etc.) differ from country to country, when all are defined in terms of gold the economies of the different countries act as one--so long as there are no restraints on trade or on the movement of capital. Credit, interest rates, and prices tend to follow similar patterns in all countries. For example, if banks in one country extend credit too liberally, interest rates in that country will tend to fall, inducing depositors to shift their gold to higher-interest paying banks in other countries. This will immediately cause a shortage of bank reserves in the "easy money" country, inducing tighter credit standards and a return to competitively higher interest rates again.

A fully free banking system and fully consistent gold standard have not as yet been achieved. But prior to World War I, the banking system in the United States (and in most of the world) was based on gold, and even though governments intervened occasionally, banking was more free than controlled. Periodically, as a result of 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. (Compared with the depressions of 1920 and 1932, the pre-World War I business declines were mild indeed.) It was limited gold reserves that stopped the unbalanced expansions of business activity, before they could develop into the post- World War I type of disaster. The readjustment periods were short and the economies quickly reestablished a sound basis to resume expansion.

But the process of cure was misdiagnosed as the disease: if shortage of bank reserves was causing a business decline- argued economic interventionists-why not find a way of supplying increased reserves to the banks so they never need be short! 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.

When business in the United States underwent a mild contraction in 1927, the Federal Reserve created more paper reserves in the hope of forestalling any possible bank reserve shortage. More disastrous, 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). The reasoning of the authorities involved was as follows: if the Federal Reserve pumped excessive paper reserves into American banks, interest rates in the United States would fall to a level comparable with those in Great Britain; this would act to stop Britain's gold loss and avoid the political embarrassment of having to raise interest rates.

The "Fed" succeeded: it stopped the gold loss, but it nearly destroyed the economies of the world, in the process. The excess credit which the Fed pumped into the economy spilled over into the stock market-triggering a fantastic speculative boom. Belatedly, Federal Reserve officials attempted to sop up the excess reserves and finally succeeded in braking the boom. But it was too late: by 1929 the speculative imbalances had become so overwhelming that the attempt precipitated a sharp retrenching and a consequent demoralizing of business confidence. As a result, 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. The world economies plunged into the Great Depression of the 1930's.

With a logic reminiscent of a generation earlier, statists argued that the gold standard was largely to blame for the credit debacle which led to the Great Depression. If the gold standard had not existed, they argued, Britain's abandonment of gold payments in 1931 would not have caused the failure of banks all over the world. (The irony was that since 1913, we had been, not on a gold standard, but on what may be termed "a mixed gold standard"; yet it is gold that took the blame.)

But the opposition to the gold standard in any form-from a growing number of welfare-state advocates-was prompted by a much subtler insight: the realization that the gold standard is incompatible with chronic deficit spending (the hallmark of the welfare state). Stripped of its academic jargon, the welfare state is nothing more than a mechanism by which governments confiscate the wealth of the productive members of a society to support a wide variety of welfare schemes. A substantial part of the confiscation is effected by taxation. But the welfare statists were quick to recognize that if they wished to retain political power, the amount of taxation had to be limited and they had to resort to programs of massive deficit spending, i.e., they had to borrow money, by issuing government bonds, to finance welfare expenditures on a large scale.

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.

The abandonment of the gold standard made it possible for the welfare statists to use the banking system as a means to an unlimited expansion of credit. They have created paper reserves in the form of government bonds which-through a complex series of steps-the banks accept in place of tangible assets and treat as if they were an actual deposit, i.e., as the equivalent of what was formerly a deposit of gold. 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.

The law of supply and demand is not to be conned. As the supply of money (of claims) increases relative to the supply of tangible assets in the economy, prices must eventually rise. Thus the earnings saved by the productive members of the society lose value in terms of goods. When the economy's books are finally balanced, one finds that 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.

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.

This is the shabby secret of the welfare statists' tirades against gold. Deficit spending is simply a scheme for the "hidden" confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights. If one grasps this, one has no difficulty in understanding the statists' antagonism toward the gold standard.

Most folks are not into economic logic, because it is intangible, complex and time consuming. Even economists have short attention spans for economic theories of others. The "mind cliques" here on FR regularly issue "talibanesque" responses to most anything that causes them to read economic logic that hurts their mind. It is ironic that conservative economic theory is so widely trashed on a conservative forum. But, the same thing happened when some people tried to call attention to the stock market bubble. Conservative social, conservative moral, conservative political, conservative patriotic and conservative economic thinking may not always be best, but it has worked well. There is absolutely nothing wrong with your article - except the "mind cliques" want you to ignore classical economic theory and accept their liberal logic.

This whole argument of fiat verses tangible "money" reminds me of the childhood story, Three Little Pigs." Except in real life, the wolf is trying to explain to Practical Pig why he should build his house out of straw like his lazy party loving consumption oriented brothers.

The "mind cliques" here on FR regularly issue "talibanesque" responses to most anything that causes them to read economic logic that hurts their mind.

I agree. Most of them think, "Well, Thomas Jefferson was and IDIOT. What did he know about money and banking? Keynes was the architect of today's economic prosperity."

When all is said and don, Thomas Jefferson will be hailed as a GREAT ECONOMIST finally when elitist bankers from COUNCIL ON FOREIGN RELATIONS and TRILATERAL COMMISSION have finally achieved their aim of distroying our economy by running their FED RESERVE printing presses at MACH-10 speeds.

"It is a [disputed] question, whether the circulation of paper, rather than of specie, is a good or an evil... I believe it to be one of those cases where mercantile clamor will bear down reason, until it is corrected by ruin." --Thomas Jefferson to John W. Eppes, 1813. ME 13:409

Thomas Jefferson on Politics & Government

Thomas Jefferson on Money and Finance

Although many years ago I was schooled in economics and finance, I am certainly no expert. However, I learned enough to know that a good economist can dream up many pleasant sounding theories, and a good salesman can sell most of them. So, the world is full half baked, over sold economic theories and burned out, illiterate suckers who who "bought" into them. When some economic view is pushed so hard by so many salesmen in the political and media establishments, it is usually wrong for the masses and right for the few.

I have listened to many slick arguments concerning tangible assets verses intangible "money." Certainly, the faith and credit standing behind an intangible can give the illusion of a tangible. However, all the salesmen in the world can do no better than create an illusion. On the bottom line and in the end, something is either tangible or it is not. Gold is tangible and enduring. Government IOU's are intangibles spun by the salesmen to be tangible, and they are definitely not enduring. Eventually, the US Dollar will go the way of all government backed IOU's. It's best hope for long term survival is in a museum. When that time comes, the argument will be as it always has been - Gold verses the next dream scheme presented by the politicians and bankers. The more dollars and dollar credits created, the more difficult it will become to spin the illusion of intangibility. When the illusion begins to fade the masses will be left holding the intangible dollar and the few will be holding the value.

If a central bank acts responsible there is no need for any gold standard or whatever.

That two letter word, "If" throws everything into the world of liberal purist theory. Jimmy Carter was also a liberal purist. He said that if people treat one another with respect, there is no need for wars! He found that to be a basis for disarming so that peace would take hold of the world. Liberal purist theory works good in the movies, in school books and for political yarns. We all know that the world is not the liberal utopia envisioned by so many of our "intellectuals," but rather a place of devilish cut throat competition and treachery. "If a politician (or banker)" will bust a liberal dream every time.

That two letter word, "If" throws everything into the world of liberal purist theory.

The man's comment had to do with a gold standard. Your reply takes a figure of deserved ridicule, Jimmy Carter, who has nothing to do with this discussion, and holds up his idealistic views on war as an example of what's wrong with saying that if central bankers act responsibly, there is no need for a gold standard.

As a form of argumentation, that really sucks. It is not just unpersuasive, it is "slick argument from a salesman" of the sort you were decrying yourself only 3 notes ago.

Try again.

look, two out of three big central banks managed to keep their currencies value stable, one didn't. does that mean that the whole system doesn't work or that some people at the Federal Reserve didn't exactly know what they are doing (I'm not even sure what they have done wrong, during the last stock bubble they hardly had any choice, but to increase the amount of dollars in circulation, there were just too many people who wanted them.)?

Other than that, i hear a lot of people here complain about China pegging its currency to the dollar. if we would still have the gold standard like in the time after ww2, every currency would be.

And even if the current system doesn't work perfectly, would you rather have inflation / deflation purely at random without any possibility to control the amount of money in circulation?

You have restricted your field of vision to the gold issue, but I think the gold issue is simply a sub-part of a much bigger issue of liberal thinking verses traditional thinking. The university "intellectuals" (85% liberal), who dream up this stuff, don't teach only gold issues, they teach a thought process which encourages the acceptance of liberal thinking. Jimmy Carter is the perfect example of liberal thinking in contrast to the traditional. The thought mechanism is the same whether it be the desire for a liberal utopia with respect to war or with respect to economics. If one thinks of the underlying mechanism as the cause, and the sub issues as the symptoms, then it is perfectly logical to expand the discussion to include other related sub issues. If you do not agree, then it is reasonable for you to state your opinion and/or ask me clarifying questions. As far as a form of argumentation that sucks, how about firing shots before asking questions?

That reply amounts to saying that you reserve the right to arbitrarily label any opinion that you don't like as "liberal," and therefore deficient. It's a glorious form of namecalling, but namecalling nevertheless.

There are many ways that one might arrive at the opinion that gold is obsolete as the governor on the creation of money. One such way would be to have lived through a deflationary period caused by gold-induced brake-slamming during a time that should have seen exceptional growth because of new technology adoption.

In particular one need not get there by proceeding toward utopia from the head of a pin. That may be the only way that you can deduce, but there are others, such as the one I described.

Having reached a conclusion that gold is obsolete for the purpose of governing a money supply, the question then becomes, "What takes its place as the thing which prevents kings and politicians from burying us in funny-money?"

There are innumerable answers to that question, but certainly one of them is some collection of Wise Men(tm) who just plain guess as to how much money there ought to be, with their guesses predicated on various price signals like interest rates and so on.

This process is really no different than the one that the board of wise men who run gold mining companies use to decide when to mine at a higher rate, or when to invest in a new mine, or a bigger mine.

No matter how it gets arranged, there will be humans in there making mistakes all along the way. I know of no reason to believe that the sort of humans who run gold mining companies are any smarter than the humans we have on the Federal Reserve Board of Governors.

The only differences I see are that (1) gold operates like a ratchet, in the sense that once mined, gold can't be unmined; and (2) the Federal Reserve can increase credit a lot more quickly than the Homestake Mining Company can find a new deposit and bring it into production, and that time span difference can be critical if the economy is trying to grow rapidly.

I don't think that "liberalism" has much to do with the choice. It's pretty much a practical thing of how we go about providing a convenient medium of exchange so that we can conduct economic activity expeditiously.

Money is sort of like electricity in the sense that 99% of us want to go about our business without worrying about how the electricity is made, whether by coal or nuclear. There are people who want to turn that decision into an ideological crusade, but most of us don't care and dismiss such people as cranks. "But it's nuclear! It will surely blow up! Radiation! Booga! Booga!"

To which, I think the right answer is, "Oh, shut up." That's my opinion.

fine, then make laws. make it the 'prime directive' for the central bank to keep the inflation rate low and make sure that as long as it isn't they don't even try to boost economical growth with their monetary policy. We did that with the ECB, for me thats enough to trust in our currency.

and look around, so far Greenspan has acted in the interest of your country. you do have relatively strong economical growth, low interest rates and a low inflation, what more do you want?
(i do realize that there probably is a bubble somewhere in between all that, but there hardly is anything a central bank can do about it.)

now look what you would have with a gold standard: with the fixed exchange rates like in the old gold standard the world couldn't handle all the flows of international investments. it would simply not be possible without some flexibility in the exchange rates.

so now you will say 'then lets just fix the dollar to gold, who cares about the rest of the world anyway?'. in that case look back to the late 90s, when everyone was buying dollars like crazy, the dollar would have become even stronger, meaning that even more jobs would have been outsourced to Asia.

i even doubt that a strong economical growth is possible with a gold standard. look at this: you have economical growth, meaning there are more goods available. you have the same amount of money in circulation but more goods, that means falling prices. if prices fall in an economy, why should i invest? its not worth it. i probably would even stop buying goods for consumption, because i would probably get them cheaper if only i wait a little.

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