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.
