Alan Greenexpand A "Goldbug?"
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, seashells, 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 World 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 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 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 re-established 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 Great Britain; this would act to stop Britain's
gold loss avoid the political embarrassment of having to raise interest
rates.
"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 bad 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 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.
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.
The Objectivist, July 1966. |
