The Gold Standard: Gateway to Freedom
In our modern, state-controlled economy, there are primarily three methods by which government may finance its budgets. The first is through direct taxation. The second is through the sale of government debt in the form of treasury bonds and T-bills, etc., the interest and principle of which must ultimately be paid back through an increase in direct taxation. However, because direct taxes tend to be very unpopular to most voters, thus imposing a political handicap upon elected officials, the government has employed a third method of funding its growth: indirect taxes through the issuance of new paper money created by a government - controlled centralized banking cartel. Before exploring the disastrous economic effects of this third method of government financing, it is helpful to understand an alternative system which prohibits it: the gold standard.
GOLD: BARRIER TO GOVERNMENT POWER
Historically, precious metals were determined to be the most effective and efficient media of exchange (money). Market participants came to this conclusion acting freely and voluntarily within the free market, absent any form of government compulsion. Gold in particular became the most valuable form of money utilized in all indirect exchange transactions (exchanges other than barter). Consequently, gold became the most widely accepted form of money circulating throughout the economy.
The monetary and banking systems operating under a gold standard are relatively simple to understand. Because gold (and other precious metals) is (are) rather cumbersome to transport in mass quantities, it is more expedient to deposit the gold itself into banking vaults, and instead make indirect exchanges with the use of paper notes representing these gold deposits. The paper notes are issued by different banks holding different levels of gold deposits, and represent a promise to pay a certain amount of gold to the bearer upon demand. These promissory notes can be issued in various denominations according to the number of units of gold each denomination represents. For example, a paper note issued by bank X and bearing the number five would represent five gold pounds held in deposit by bank X. Hence, the paper note would be directly redeemable for five pounds of gold at bank X, and would be acceptable as a monetary unit by market participants who felt they could trust bank X to make good on its outstanding promise.
Further, in order to maintain a trustworthy image, banks would not lend out or issue paper notes representing a greater level of gold deposits than what were actually held in their vaults. Were this to happen, and were holders of paper notes unable to redeem them for gold deposits on demand, the issuing bank would be inviting a run on and a depletion of its entire holdings, thus soiling its reputation as a financial institution and ruining the confidence placed in it by market participants. Consequently, the level of paper notes issued by various banks competing for depositors and borrowers would rarely exceed the level of gold held by these same banks, thus providing a stable currency upon which market participants could make sound economic calculations.
Under a gold standard, there are a multitude of various types of paper notes issued by a wide array of banks, all holding different levels of gold deposits and all competing for depositors and borrowers by offering sound banking at the most competitive interest rates. Merchants and individual market participants would determine which paper currency to accept or reject based upon decisions about which issuing banks were most competitive, most trustworthy, and most sound (similar to the way in which decisions are currently made about which credit cards to accept or reject). Consequently, the gold standard monetary system is immune to international currency exchange rate confusions. There is only one root currency, one root form of money: gold.
Hence, the paper notes issued by banks in foreign countries would be no different than the paper notes issued by domestic banks, provided they were all backed by gold deposits. It would matter little if one held a five pound paper note issued by the Greater Bank of Chicago or the same five pound paper note issued by the Greater Bank of London, because the amount of gold deposits represented by each bank would remain exactly the same. As a result of this simple system of indirect exchange, international transactions could be made with much greater ease, thus providing for a greater interaction among the international division of labor, a greater level of competition, and, consequently, an increase in the international standard of living.
The stability and efficiency of the gold standard notwithstanding, perhaps the most important aspect of such a system is the fact that it prohibits government from meddling with our currency for the purposes of expanding state power. It forces government to tax its citizens directly in order to finance its endless variety of state-sponsored programs and spending schemes, thus making revenue raising a much more difficult task. The gold standard makes it impossible for government to create new "funny money" precisely because government, under a gold standard, has nothing to do with the issuance of money, period! Private banks hold gold deposits. Private banks issue paper notes representing these gold deposits. And, the private banks which prosper are those which best serve the interests of their depositors and borrowers, determined solely by the subjective evaluations of individual market participants.
Government has absolutely nothing to do with any aspect of the gold standard monetary system other than upholding the right to private property. This is precisely why all those who oppose economic freedom and the liberty of free markets detest the gold standard. As Alan Greenspan, current chairman of the Federal Reserve Board, stated in 1966, "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. . . ." Hence, in order to expand state power government has intervened into monetary markets, shifted the economy away from the free banking of the gold standard, established a centralized banking monopoly, and outlawed the use or exchange of any currency other than the currency issued by this central bank. The results have been disastrous.
THE SAD LEGACY OF GOVERNMENT CURRENCY DEBASEMENT
The Federal Reserve System, the American variant of centralized banking, was established in 1913 by President Woodrow Wilson. The FRS was ostensibly designed to "control the economy," thereby preventing economic downturns and recessions. Despite the fact, however, that the Federal Reserve System is itself directly responsible for the wildest, woolliest, most violent period of boom and bust business cycles ever experienced by the American economy (i.e., the entire twentieth century since 1913), the Federal Reserve System continues to run the money presses, spewing infinite reams of paper currency, all the while claiming to be a "vital part" of our economic well-being. The reason for this is quite simple. In truth, the FRS was not created as a tool to control economic fluctuations.
Oh yes, simple-minded Keynesians have always sought to exploit centralized banking as a means of "tinkering" with economic outcomes. However, the FRS was established solely as a means of shifting the economy away from the solid foundations of the gold currency system, and toward the shaky, unpredictable, forever unstable system of unbacked paper money. Why? So that government, through control of the money presses and thus the currency, could more easily finance its expenditures without increasing the level of direct taxation exacted upon its citizens. In order for this to be done, it was necessary to eliminate the gold standard.
It was not long before the FRS had flushed enough new Federal Reserve notes into the American and European economies to stimulate an artificial rise in spending and borrowing. The new government money began to distort interest rates, thereby sending distorted market signals to consumers, entrepreneurs, and investors. Such a distortion lead to an artificial boom in the economy (the 1920s), and, as was inevitable, a consequent downturn (the Great Depression) resulting from overproduction and government-induced malinvestment.
However, in 1933, President Franklin D. Roosevelt took this shift one step further. The President, blatantly ignoring the constitutional right to private property embodied within the Fifth Amendment takings clause, made illegal the redemption of gold bank deposits for government-created Federal Reserve notes. In other words, Roosevelt issued an executive order which forcibly removed the citizens' right to redeem government-issued paper notes for their own gold deposits. This order placed the entire economy on a system of "funny money," backed by no hard currency whatsoever, and enabled Roosevelt (and every president or Congress since) to create an infinite supply of new money without being checked by a limited supply of gold deposits. As a result, the government could easily finance its ravenous appetite for every conceivable type of welfare program simply by printing fiat (false) currency, and forcing its citizens to accept only this currency. Thus, Roosevelt's spending frenzy throughout the 1930s worked to perpetuate the Great Depression, prohibiting market forces from correcting for the previous government mistakes which had created it.
THE ECONOMIC DISASTER OF FIAT MONEY
Business cycles and economic depressions are not the only harmful effects of government-controlled, fiat- paper money systems. Currency devaluation and the distortion and maldistribution of income caused thereby are equally disastrous. As central banks continue inflating the supply of money in the economy, the first recipients of this new money suddenly find their purchasing power enhanced in relation to the current level of prices. These citizens increase their spending 1), as a result of increased borrowing (brought on by artificially depressed interest rates), or 2), because they belong to a particular special interest group directly subsidized by the creation of this new money (i.e., welfare recipients, government employees, etc.). The reason for such spending increases lies in the fact that the addition of each new dollar into the economy results in a marginal diminution in its value. In other words, the greater the quantity of any commodity (including money) held by market participants, the less it is valued by these same market participants. This process is known as currency debasement.
As a result of artificially increased spending, producers of goods and services notice increased consumer demand. Hence, these producers, seeking a possible increase in revenues, will naturally attempt to increase prices to the point where supply reaches a relative equilibrium with the newly-increased demand. In other words, to a price just below the level where consumers will begin to decrease marginal consumption. And, because of currency devaluation, the first recipients of the new government "funny money" will be willing to pay the higher prices asked by producers. This aggregate price increase is commonly referred to as "inflation," although the proper definition of inflation is the introduction of new money into the economy. Aggregate price increases are merely a result of such money creation, and could not possibly exist without it.
Once prices have risen throughout the entire economy, it is quickly discovered that the newly created money, far from increasing wealth, has actually diluted the purchasing power of the currency. The destructive effects of inflation are explained very well by Austrian economist Murray Rothbard:
As the new money spreads, it bids prices up--as we have seen, new money can only dilute the effectiveness of each dollar. But this dilution takes time and is therefore uneven; in the meantime, some people gain and other people lose. In short, [the first recipients] have found their incomes increased before any rise in the prices of the things they buy. But . . . people in remote areas of the economy, who have not yet received the new money, find their buying prices rising before their incomes. . . . The first receivers of the new money gain most, and at the expense of the latest receivers.
In other words, government-induced inflation is a form of indirect taxation, and is nothing less than pure theft!
SOLUTION: THE GOLD STANDARD AND FREE BANKING
If the process of government currency debasement, government counterfeiting, hyperinflation, and volatile business cycles is ever to be halted, the American people must seek to reestablish a private- based, hard currency monetary system. The first step toward this goal would be to eliminate the Federal Reserve Board and to scrap all notions of government- controlled, centralized banking. This would immediately open the door for market participants to establish a system of free banking based upon sound currency; a system which would prohibit government from expanding its power by debasing the currency and defrauding its citizens, thus providing a gateway to economic freedom.
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