Gold Isn't Money, Yet

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The recent
move up in the price of gold has strengthened the hand of the
camp of gold bugs. But this is a tiny camp. Among professional
economists, support of a gold coin standard is limited mainly
to members of the Austrian School, which has been a tiny minority
in the profession. There are a few supply-side economists who
call for a government-run monetary system comprised mostly of
credit money, which in turn is created by a government-licensed
monopoly, the commercial banking system. Behind this monopoly
stands another government-licensed monopoly, the central bank.
The number of academic economists who believe that there should
be laws against fractional reserve banking — that banks should
not be allowed to loan out money long term that has been deposited
short term, with a guarantee that the depositor can withdraw his
money at any time — is probably under fifty, and may be under
a dozen.

What economists
think is a marginal issue. The crucial issue to the operation
of any monetary system is what participants in the market decide
to use as money. Here, the issue today is clear: the public does
not use gold coins as money. Gold coins in the United States were
removed from circulation by executive order in 1933. In Europe,
the banks’ suspension of redeemability in gold coins took place
within weeks of the outbreak of World War I in the summer of 1914.
England restored redeemability in 1925, but a public run on the
Bank of England’s gold forced the Bank to suspend payment in 1931.

With the
universal suspension of gold coin redeemability by citizens by
1933, the public was forced to accept the theft of their deposits.
They were taught by every media outlet including the universities
that gold was a barbarous relic, in the words of that self-taught
economist, the mathematician (B.A. degree), John Maynard Keynes.
The world’s bankers applauded. So did the world’s political leaders.
Without the threat of a run on the banks’ gold, politicians and
bankers could create money at will. They could print up all the
money they wanted because the public could not demand gold coins
in exchange for their bank deposits and their paper money. The
golden handcuffs were thrown away, and they remain discarded.

School economists are in favor of a gold coin standard because
they are in favor of market-created money. They are convinced
that gold and silver coins will function as money whenever laws
establishing bank monopolies are abolished, when contract law
is enforced by the civil government, and when no agency is allowed
to issue receipts for precious metals (or anything else) that
are not backed 100% by the assets necessary to redeem them. Austrian
School economists present the case for gold in terms of real-world
decisions by acting individuals on an unhampered free market.
They deny that gold has intrinsic value, i.e., value independent
of the decisions of acting individuals. They insist that gold
has had historic value because of its industrial uses, its applications
in jewelry and art, and demand for gold as money — mainly the
last factor.


The case
for a gold coin standard is the case for individual economic sovereignty.
It is a case for a monetary standard that arises without government
interference for or against gold as money. This is the case for
voluntary contracts.

The modern
economy is not a voluntaristic system. The laws reflect the political
power of special-interest voting blocs. Commercial banks are among
the most powerful of these special interests. The modern monetary
system is therefore a rigged system. It always has been, but from
the end of the Napoleonic wars in 1815 until the outbreak of World
War I in 1914, the international monetary system was the least
rigged system since the days of the gold coin standard in the
Byzantine Empire, which enjoyed eight centuries of stable money.

The public
in the West today is completely unfamiliar with gold as money.
Everyone uses paper money or bank credit money: checks and credit
cards. Contracts are written in terms of bank credit money. Everyone’s
economic plans are based on men’s faith in the long-term sovereignty
of governments over money, which means bank credit money. The
mark of this faith is the capital markets’ responses to decisions
of the Federal Reserve System, which is seen as an appendage of
Alan Greenspan. He has the power to move markets up or down merely
by controlling the degree of clarity in his public pronouncements.

If we are
going to defend intellectually the legitimacy of free market economics
and free market institutions, then we must adopt the principle
of consumer sovereignty. The primary justification of the free
market is that it extends the greatest authority to the individual
over his own affairs. It makes individuals responsible for the
allocation of whatever they own. It is a system based on the judicial
and moral principle of individual legal responsibility.

So, the intellectual
defenders of the pure gold coin standard are caught in a bind.
They believe that government manipulation of the monetary system
is inefficient. This interference with consumer sovereignty over
money through contract law must produce a misallocation of money,
meaning capital. The present system will produce booms and busts
in the capital markets and the consumer markets. Austrian economists
stand on the sidelines and yell "stop" every time the
central bank interferes with interest rates by increasing or decreasing
the supply of "high-powered money" — mainly its holdings
of government debt certificates.

The public
understands none of this. Neither do most economists and politicians.
All they know is that, once adopted, the central bank’s control
over money is like holding a tiger by the tail. The central bank
can’t let loose safely. Neither can the rest of us. This is why,
three decades ago, economist F. A. Hayek wrote a book on monetary
policy titled, A
Tiger by the Tail: The Keynesian Legacy of Inflation
Two years later, he received the Nobel Prize in economics, but
not for this book.

The fact
that the public doesn’t understand monetary theory isn’t the bedrock
assumption of my theory that the public isn’t interested in gold
as money. The public has never understood monetary theory, even
in the gold standard era. They knew this much: crooks can counterfeit
money. They knew that it is difficult to counterfeit gold and
silver coins. So, people voluntarily used gold coins in exchange.
They demanded gold coins for large transactions, with silver coins
for smaller transactions. What mattered most for monetary policy
was the individual’s legal authority to walk into a bank and exchange
his banknotes or his deposit certificates issued by the bank and
get gold coins. The banks could also do the same thing to the
United States Treasury.

Today, the
public doesn’t regard gold as money. If we are to make the case
for gold as money, we must acknowledge the reality that gold is
money today only for central banks. They tag their bars of gold
stored mainly in the Federal Reserve Bank of New York. Employees
in the vault move these bars back and forth into appropriate piles.
This is how central banks clear their accounts with each other.
Some central bankers still believe that gold is money, but only
for central bankers. They regard gold as money for their closed,
monopolistic little world. After all, they stole it fair and square
from commercial banks, who stole it fair and square from their
depositors. The victims did not complain much in 1914, 1931, and
1933. Possession is nine-tenths of the law, especially when governments
not only go along with the existing arrangement, they created


The mountain
of debt piles up because creditors are convinced that the central
banks will not inflate their currency units "too much,"
and debtors are convinced that central banks will not allow price
deflation. They believe that the existing pile of debt will never
be repaid. It cannot be repaid without shrinking the money supply,
because the monetary system is based on the monetization of debt,
especially government debt, by the central banks. If the government
ever paid off their debts, forcing the central banks to sell their
debt, the central banks would have to monetize something else
as a replacement asset in the monetary base. If the banks don’t
monetize debt, then they must monetize equity: stocks, real estate,
or (if necessary to prevent monetary deflation) desk chairs.

The world’s
existing debt level is assumed to be a floor. It is assumed to
be like a ratchet. It moves only in one direction: up. This means
that monetary reform is never discussed by economists and reformers
except in terms of preserving the existing debt floor. To speak
of the repayment of debt in general is to speak of either monetary
deflation, price deflation, bankruptcy, and depression (the shrinking
of the monetary base back to the level of gold coins) or else
the transfer of ownership to central banks (the monetization of
equity). We have a tiger by the tail.

This morality
of this system was described by David about 3,000 years ago: "The
wicked borroweth and payeth not again" (Psalms 36:21a). The
results of this monetary policy were described by the prophet
Isaiah 250 years later: "Thy silver has become dross, thy
wine mixed with water" (Isaiah 1:22).

There is
only one a way back to (1) a full gold coin standard without (2)
fractional reserve banking that would not be massively deflationary,
thereby destroying men’s confidence in the free market. That non-deflationary
transition would involve the central banks’ raising the price
of gold while simultaneously selling off its debt. The currency-denominated
value of the nation’s monetary base would remain the same.

Then, to
get the gold into the hands of the public, the central banks would
either have to auction off their gold in the form of coins (not
bullion) or else simply mail the same number and quantity of gold
coins to individual voters or taxpayers. I think the latter strategy
would be the most politically acceptable. I just don’t think there
is any constituency for it. If one appeared, governments would
fight it, and academic economists would back the government.

The main
problem with a central-bank hike in the price of gold is this:
it would create massive windfall profits for gold investors. This
is politically unacceptable. If you think getting a flat tax substituted
for the graduated income tax is a hard sell politically, think
of what a pro-gold coin standard political movement would face,
and how few people would understand the issues.

There is
no conceivable way to establish a full gold coin standard that
doesn’t involve either massive deflation or else a huge hike in
the price of gold as the price of de-monetizing debt. A rise in
the price of gold that did not also mandate the return to the
public of all of the stolen gold would validate the central banks’
ownership of most of the world’s gold, which is the opposite of
the traditional free market economist’s case for gold: individual
consumer sovereignty.

My conclusions:
(1) the level of debt will increase, (2) the central banks’ monetization
of debt will increase, and (3) monetary inflation will increase.

If monetary
inflation increases, gold will eventually rise in price. This
is my case for gold as a commodity investment. Entrepreneurial
("windfall") profits to gold owners will take place
indirectly, through the price effects of monetary inflation, but
not directly, i.e., through a coordinated, international decision
of the major central banks to de-monetize debt and re-monetize
gold by (1) hiking its price and (2) substituting gold coins for
debt as the monetary base, nation by nation.

We really
do have a tiger by the tail, just as Hayek wrote three decades
ago. As investors, we must think through the implications of remaining
behind the tiger. A few people may be able to escape safely, but
most people cannot do so without confronting the tiger face to
face. Everyone can’t sell currency-denominated assets at the top
and buy gold or other inflation hedges at the bottom.

I believe
this process has already begun.


It is conceivable
that individuals will someday return to a full gold coin standard,
but only in response to a breakdown in the monetary units of international
trade. The cost of such a transition would be horrendous. Hardly
anyone knows where to buy gold coins. There are not enough coin
stores to handle demand for two or three billion adults to sell
debt or equity (to whom?) and buy gold.

There are
technical ways to make the transition from credit money to gold
money. It is possible to create digital bank accounts in gold,
with 100% reserves. It could be computerized. Actually, this has
already been done:
But making the technology available is very different from persuading
billions of individuals, most of whom do not have bank accounts,
to make the transition a little at a time.

For as long
as the existing monetary system muddles through, most people will
stick with it. I cannot imagine a smooth transition to a full
gold coin standard, or even a 100% reserve gold digital standard.
This doesn’t mean that it cannot be done. It means that I cannot
imagine how, and that I have not seen any written case for how
this smooth transition could be accomplished. It took World War
I and the Great Depression to get voters to accept the legality
of the theft of their gold by commercial banks and then by central
banks. What will it take to reverse the theft and return gold
to the general public as a way to jump-start a gold standard and
a banking system without fractional reserves?

If this transition
comes, it is more likely to come in Asia, where the legacy of
precious metals coins is stronger, and where the division of labor
has not advanced to Western levels — although it is advancing
very fast. The problem is, Asian monetary systems are also credit-based,
central bank-operated. They are all rigged currencies. As 2.5
billion people in India and China jog into middle-class living
over the next two decades, the coin of the two realms will be
mostly digital, credit-based, and therefore debt-based. Only if
there are secondary markets among the masses that remain based
on precious metals will the transition be easier.


The recent
upward move of gold’s dollar-denominated price has to do with
gold’s status as a well-known inflation hedge and war hedge. We
are experiencing nothing like "a return to gold." The
public remains unfamiliar with gold coins, and this is not likely
to change, short of an international economic catastrophe.

We who are
defenders of the free market must do what we can to educate people,
especially ourselves, to understand the case for freedom and individual
responsibility. This involves understanding the case for voluntary
contracts. As part of this educational effort, we should make
the case for honest money, which is the case against fractional
reserve banking. But this task has barely begun, and the rise
in debt is now becoming exponential. There will be a series of
debt crises long before voters force the politicians to return
to a full gold coin standard. That return would involve a return
to freedom. For this, there is a small constituency, even among
self-identified gold bugs.

30, 2002

North is the author of Mises
on Money
. Visit
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