The Gold standard, and its several equivalents, remains a
testy and emotional topic and everyone seems to have some reason to strongly
urge or patently discourage the reinstatement of such a standard. Most of the
objections to such a standard relate back to the Depression Era when the gold
standard reputedly prevented the Federal Reserve from ‘stimulating’ the economy
and exiting the Great Depression, a classic piece of negative evidence.[1] Such a standard
has desirable attributes so we need to examine some of the fiscal events that
let up to numerous nations exiting and then reinterring the gold standard and
how those antics led to fiscal problems such as inflation.
The need for money:
There must be some medium of exchange in commerce and gold
or its equivalent has been the choice for some 60 centuries. Gold, thus, is
money. Gold has been used as a currency and a currency reserve for centuries.
In 550 BCE, gold coins were introduced by king Croesus of Lydia.[2] The attempt here
was to standardize the coin weight although the metal was a complex mixture of
gold and silver [63% gold and 27% silver]. This worked well as such a standard
was necessary to avoid exchange rate squabbles and stalling markets. Earlier,
the Egyptians and others used bulk gold as a transfer medium. The Romans used silver coins initially but an
influx of silver from their provinces forced them to switch to gold coins. The
Roman system [about 1000 year depending on when you select start and end dates was
excellent as there was no credit system and debts were collected by the
military and if the debtor failed to pay
up, then the cosigners were assessed so that on Roman government contracts they
never lost money. Inflation was low. The historical data seem to suggest that
some standard such as gold is needed and
although this is not perfect and other options are worse in the long run.
Gold as a reserve:
This history of gold as a currency or a currency reserve can
be observed in two distinct fiscal outcomes in each century or even each decade
in the last 500 years. Either the gold standard worked out rationally well or
some event forced that standard to be changed in some manner and paper currency
and its creation was always the reason the for instability. Government credit
problems and urgent need to finance wars generally led to a provisional
suspension of the standard and the rapid and simplistic printing of money. In
most of the historical cases a precious metal standard was an asset to commerce
until governments created episodes of credit expansion for wars and such.
Problems with keeping reserves constant:
As the Industrial Revolution progressed, trade with China became
possible and profitable but the Chinese wanted only silver as payment for their
goods. Thus reserves of European silver were almost depleted and this caused
major problems with English currency based on silver. The British then smuggled
opium into the Chinese ports of trade because that new medium of exchange was
readily accepted but caused major social problems. This led to the Opium Wars
in the periods 1839–42 and 1856–60 and the forced signing of the Treaty of
Tianjin and later the Treaty of Nanking. An historical rendering of the specification
in the first treaty translates as:
5. China was to pay an indemnity to Britain and France in 2
million taels of silver respectively, and compensation to British merchants in
2 million taels [1.33 ounces per tael] of silver. [3]
That is about 5 million ounces and at today’s price amounts
to $140 million dollars not adjusted to 1839 values.[4]
Notice that this war effort resulted in the government silver reserves being
essentially reinstated because the Western economies were suffering from the
outflow of this metal. The Chinese economy was being crushed[5] as their trade balance
in 1810 was 350 million Mexican silver dollars and by 1837 opium purchases equaled
57% of all Chinese imports. The British economy was in trouble from losing
silver reserves and the Chinese economy was forced to return much of that
silver. War accomplished this feat. We can presume [with caution] that if the
silver reserves were stable then the effect on British trade would have been
minimal in this case.
Effects of War:
An event that typically wrecks any reasonable silver or gold
based currency is war and that was the case for the US Revolutionary War. Here
government debt was high and silver coins were being exchanged for paper money as
the standard specified so President Jefferson suspended the minting of silver
coins in 1806. The Independent Treasury Act of 1848 forced the Treasury to deal with only silver
or gold and some unsuccessfully and poorly chosen selected exchange rates
between the two metals forced gold to exit the US from market forces. Due to
the US Civil War the government suspended such metal payments.[6] In summary: Debt
and war forced major changes in gold and silver standards. The reserve supply problem
is always speculation where there is a market established using the currency
and the reserve metals. An imbalance here forces an oversupply or shortage of
either of these two items.
Paper currencies:
Greenbacks or demand notes were issued by the US government
in 1861 at the start of the Civil War by buying goods and materials for the war
and for payment to soldiers. There was no backing for these paper entities but there
were options to get silver or gold ‘on demand’ on this paper. A stipulation was
that such notes could not be used to pay import duties [tariffs], a process of merely
returning the paper back to the government, forced a flurry of demand
requests and that led to a suspension of
such redemptions in early 1862. The next month the government was forced to
offer 5% interest on notes since gold was starting to vanish after rising about
2% over the paper price.[7] February of that
year the United States Note was invented with the works “on demand” on the
paper.[8] Hoarding of commodities and gold prices rose.
There were several more frantic manipulations of paper currency to the end of
the war. The greenbacks eventually metamorphosed into the United States Note. The
problems here were related directly to paper currency printing and an expansion
of credit on the part of the US government. The Confederacy experienced the
same problems and more as each succeeding state issued their own currency. All
their currencies collapsed after they lost the war. Clearly, for reserve stability
the market price of the metal and of the currency must be about equal or the
reserve will either rise or fall on demand. This means that printing money that
tends to debase the currency will always force redemptions of the reserve if
one exists. Other options include buying other currencies.
Setting relative exchange rates:
From the time of the US Civil War and other wars, many
countries attempted to independently set exchange rates based upon US or
British gold standards. This was a period of chaos. There were various pegging
schemes, all mostly temporary, and many of these failed. Today some countries
like Belize use US dollars and, as such, have to follow the fortunes of that
currency.
Wars:
For the next war [World War I] the need was to fund armies
and navies of all belligerents and, not unexpectedly, many nations abandoned
their gold standards and started to print money and that forced differential
inflation among the participants. This wrecked exchange rates and chaos ensued.
The world’s international financial system collapsed in the summer of 1914[9] and the US stock
market was forced to close in September of that year for about 6 months. Credit
was essentially nonexistent for a while. Later, attempts by various nations to
regenerate the gold standard resulted in mixed prices for various assets and commodities
and chaos reigned again. Alternatives were needed: A bond sale was organized
along the political scheme of the War Chest and Liberty Bonds were offered for
sale with window notes that contributors could openly display to show they were
loyal. The media published threats in the form of cartoons that queried:
Will you invest your money with Uncle Sam Now? Or, Let
Germany take it away from you later?
Woodrow Wilson chimed in on the scheme by issuing a
letter Sept 30, 1918 that read, in
part:
The money that is held back now will be of little use or
value if this war is not won and the selfish masters of Germany are permitted
to dictate what Americans may and may not do. [10]
This is a process called cleptocracy and is tightly entwined
with emotion and demagoguery where governments steal the wealth of their
citizens with propaganda or fright campaigns. It is a long stretch to suggest
that the US had any business in either of Europe’s wars. The two World Wars saw
81 million dead bodies scattered across Europe and parts of Asia not counting
Russia. Their losses were much higher.
These bond drives by all belligerents continued but the fear
that gold reserves would be depleted by demand forced the British Government to
pass the 1914 Currency and Bank Notes Act[11]
with a convenient three day bank holiday so Britain left the gold standard and
issued paper banknotes.[12] In that war
period from 1914 to 1919, the Allies borrowed $10.35 billion dollars from the
US Treasury. And, as noted above the US government borrowed from its own
citizens. Foreign debtors were granted a three year relief period on interest
payments. The US government tried to
obtain principal replacement in a period of 25 years. Much of this was paid off
in inflated dollars. There is a theory advanced by Pierre Renouvin in his book,
mentioned above, that the British pleaded with the Americans to loan them money
at the expense of the Germans because the Brits owed them much more money and
if the lost the war the US would experience defaults on those loans. As such
loans and currency debasements can be used as weapons of war.
The [not so] Great Depression:
By 1931 the US’s former WW1 allies were off the gold
standard. The latent debt loads for all participants in the Great War were too
high to handle. Austria’s biggest bank failed. The uncertainties in post-war
Europe forced runs on the Bank of England depleting much of their reserves. [13] The Depression
in 1932 occurred because of a debt-driven deflationary spiral initiated by
falling equity prices.
Gold became a major player in the depression game as the US
Federal Reserve was mandated to back their paper with a 40% gold backing. This
feature allows the left to criticize the government’s gold reserve program as
they were not permitted to just print more money as most governments tend to do
in a panic over debt or during some economic crisis such as a depression or in
time of war. This forced the money supply M2 to a maximum level in March 1937
and a minimum in May 1938.[14]
The inability
to print money was thus offered as a defect in the gold reserve system by many
economists. The trouble with this view is that printing money or works programs
by Hoover for 3 years and FDR for another 3 or so failed. So far, there is
little known value, other than political, when governments print money for
infrastructure and other projects as we see in the US, UK and most of the EU.
There are no direct and verifiable cases where Keynesianism has allowed
bankrupt nations to print their way out of debt. There are numerous cases where
printing money only made this worse as in Hungary in 1948 and Germany in the
1920s and Argentina more recently.
This notion that there must be freedom to print money has
some merit if, and only if, such printing might solve some problems in the
economy and not just raise the debt as is happening in the US and Europe today.
The Austrian School maintains that depressions are the result of too much cheap
credit and that seems to apply to most places where depressions occurred as one
did in the US in 2006 with falling house prices due to a glut of housing and
from the CRA[15] [Community
Reinvestment Act] that forced lenders to offer mortgages to people who could
not afford to service the loans. All this was pushed into debt with Fannie Mae
now holding some 80% of all US mortgages and probably in debt in the $3-5 trillion
dollar range. We are still suffering the effects of the housing bubble and
deflation and depression from 2006.
John Maynard Keynes was against the gold reserve but also
cautioned governments from printing too much money. He suggested that the power
to print money should reside only at the Bank of England, a private company. [16] Cleptocracy is
thus facilitated by this mechanism as explained by Keynes:
"By a continuous 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".
Warren Buffet also echoes this same theme decades later:[17]
“The United States economy is now out of the emergency room
and appears to be on a slow path to recovery. But enormous dosages of monetary
medicine continue to be administered and, before long, we will need to deal
with their side effects. For now, most of those effects are invisible and could
indeed remain latent for a long time. Still, their threat may be as ominous as
that posed by the financial crisis itself.”[18]--
Greenback Effect By Warren E. Buffett
“Every country that has denominated its debt in its own
currency and has found itself with uncomfortable amounts of debt relative to
the rest of the world, in the end they inflate,”-- Greenback Effect
Options to the Gold Standard:
The Bretton Woods agreement of 1944[19]
was originally conjured up by frantic bankers. In this system, gold was fixed
at $35 per Troy ounce and US dollars could be redeemed in gold. 44 Allied
nations could participate if they tied their currencies to the US dollar. Countries
like France thus exchanged dollars for gold [as expected] and gold reserves in
the US shrank. President Nixon nixed this agreement unilaterally in 1971. The price of gold quickly soared to $ 65 and
then to $160 in the next year or so. The backing of the US dollar is now based
on nothing.
The lack of any standard forced the creation of a currency
market known as FOREX. This is a market where there is no intrinsic value to
any currency only a relative value compared to other single currencies or based
on a bag of such currencies as in the Dollar Index. So, the whole thing floats
and currencies sink and fall. Some nations refuse to trade in FOREX such as
China who has certain mechanisms that long allowed them to peg their currency
artificially low against the dollar. The proof for such a mechanism becomes
obvious when a plot of the exchange rates of the Dollar and Renminbi fall on a
straight line for years.
Debt and government spending:
Since the gold standard is effectively gone with the
exception that the gold market is driven by inflation of the dollar, the
problem of deficits and debt are now the hot topics of the current presidential
race in the US. The gold standard is effectively in place at this time because
there is a huge market in currency and gold speculation and gold rises, as it
should, when any currency starts to inflate.
The US GDP is sick and government spending is too high but
many argue for more taxation.[20] Social unrest
among the leftist radicals and other activists call for Wall Street to be
‘occupied’ and assets from that quarter stripped and distributed to the masses.[21] The stale Rousseauian concept of the ‘social
contract’ is constantly used as a pretext for more spending or taxation or
both. [22]
Governments are too large in the US and EU. The efficiency[23]
of government runs by the inverse ratio of G/GDP
where G is government spending and GDP
= C +I+G where C is consumption and I is investment. Any time G/GDP exceeds
0.15 the government is too big and spending too much because G also includes
deficits and is debt. Number essays lead to impossible scenarios like this
prattle:
“Meanwhile, the CBO estimates potential real GDP in 2021 at
about $18 trillion in 2005 dollars, or around $19 trillion in 2011 dollars.”[24]—Paul Krugman
Put these together, and they say that an extra trillion in
borrowing adds something like a mere
pittance of 0.07% of GDP in future debt service costs. Yes, that zero belongs
there. The $4 trillion S&P said it needed to see clocks in at less than
0.3% of GDP.”[25]-- The
Arithmetic of Near-term Deficits[26]
My Conclusion:
Although the notion that currencies must be based on
something like gold is problematical at best it must be noted that one
desirable effect is limiting government’s ability to print money. Every country
that went off the gold standard inflated their currencies and cheated their
citizens out of their savings.
Since going off the
gold standard the currencies in the West have inflated greatly and since the
1990s governments have printed money with abandon and the debts are now
unbearable. Following Buffett those governments will attempt to inflate thus
robbing, again, their citizens of their wealth. This process is fashionably denoted
as ‘ quantitative easing’ or QE. The purpose is to debase the currency to minimize
the debt service problem.
This debasement effort at first appears to be sound for
leftist governments to employ but the bond markets then force interest rates up
to cover risk and profits and use derivatives to insure their investment. National
debt service then rises and this is usually put into deficits or more borrowing
to cover the expense. All this time the price of gold soars. What this means is
that a de facto gold standard is in effect and is market based. Thus, the
attempt to evade a rigid standard is futile and those who hold gold in ETFs or
in coin will see their holdings rise faster than the inflation rate.
All the problems above seem to be based on governments that
print too much money or encourage too much credit and that printing or
borrowing causes all sorts of fiscal problems and wars. It is clear that the
science of government and the conduct of its members is in its crudest state at
this time and is not likely to improve unless another crisis appears like a
depression, war or inflation. The quest for some gold standard or some equivalent is thus misplaced and we
should be looking at ways to curtain government growth and spending and
maintaining a fixed money supply that grows no faster than the real growth and
to use other measures to initiate growth in the private sector.
Comments: ryckki@gmail.com
[1] That didn’t happen so
we don’t know if it would have worked. Current stimulus is not working.
[3] Tianjin history - The
Treaty of Tianjin
[4] Using an inflation
calculator: What cost $28 in 1838 would cost $565.98 in 2010. The current 140
million would have been almost $7 million in 1838. This tempts us to make the
crude assumption that the inflation multiplier back to 1838 is about 20 setting
the silver value at about $2.8 billion dollars. There are several assumptions
inherent in this calculation. http://www.westegg.com/inflation/infl.cgi
[5] “Equally disturbing for
the imperial government was the imbalance of trade with the West: whereas prior
to 1810 Western nations had been spending 350 million Mexican silver dollars on
porcelain, cotton, silks, brocades, and various grades of tea, by 1837 opium
represented 57 per cent of Chinese imports, and for fiscal 1835-36 alone China
exported 4.5 million silver dollars. http://www.victorianweb.org/history/empire/opiumwars/opiumwars1.html
[6]http://en.wikipedia.org/wiki/Gold_standard#The_crisis_of_silver_currency_and_bank_notes_.281750.E2.80.931870.29
[7] People are willing to
speculate on a 2% margin.
[9] A careful reading of the 1957
book: War and Aftermath 1914-1929 by Pierre Renouvin enlightens us on
the curious but celebrated practice of ‘diplomacy,’ it’s manifold failures,
questionable utility, and the unavoidable events that led to World War 1, the
forceful and fatal structuring of World
War 2 and the many more wars of the 1920s. War and
Aftermath 1914-1929 by Pierre Renouvin Harper & Row, 1968.
Hardcover. First edition.
[13] http://en.wikipedia.org/wiki/Gold_standard#The_crisis_of_silver_currency_and_bank_notes_.281750.E2.80.931870.29
[14] A Monetary History of
the US 1867-1960 Friedman and Schwartz page 544
[15] Meet the Real Villains of the Financial Crisis—the CRA [Community Reinvestment Act], “Affordable Housing”
and the US Government
[17]
Gangrening the Greenback as Explained by Warren Buffett. Liberalism Has New
Excuses for Spending and Printing Money.
[18] The Greenback Effect By
Warren E. Buffett Op-Ed Contributor Published: August 18, 2009 http://www.nytimes.com/2009/08/19/opinion/19buffett.html?_r=1&hp
[20] The Eternal Whine for More Taxes from Krugman
[21] Krugman of the
NYT is Immune to the Facts about Occupy Wall
Street Protesters
[22] Tax Mongering at
its Pinnacle: Krugman invokes the Social Contract
[23]
Inefficiency in California, Greece and Other Places and the Socialist Disease
of Parasitism: They will NOT stop spending and WILL default.
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