Gold and Economic Freedom
It seems that lotsa' folks are ignoring what A.G. wrote not too long ago regarding why gold has to be 'fixed' or done away with in order to get the welfare state going.
gold-eagle.com
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.
* * * * * * *
As reprinted from the book "Capitalism, the Unknown Ideal"
by Ayn Rand with additional articles by Alan Greenspan - 1967. |
