Two Kinds of Gold Standards

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The British
economist, John Maynard Keynes, is famous for one aphorism, "In
the long run, we are all dead," which he applied to the operations
of the price system, and one phrase: "barbarous relic,"
which he applied to the gold standard. He believed that the free
market needed to be policed by bureaucrats to be made efficient.
He also believed that the gold standard’s restriction of State
power is a great evil.

Keynes’ hostility
to the traditional gold standard is shared by all inflationists
and statists. It places temporary limits on the government’s ability
to create fiat money and thereby spend without taxing directly.
I say "temporary," because the traditional gold standard
is a promise made by a government. It is made to be broken later,
during an emergency that is declared by the government. It is
ultimately paper gold. It is a misuse of the people’s trust.

The gold
standard made possible much of the civilization of the ancient
world, until gold was abandoned in the third-century by the government
of Rome. Then classical civilization disappeared in the West.
But in the Eastern Roman Empire (Byzantium), a reliable gold coinage
lasted for over a thousand years.

Even in the
Alexandrian and Roman empires, the government needed gold to pay
its troops. When the costs of maintaining Rome’s war machine and
its bread and circuses at home grew too great for direct taxation
to fund them, the government began to debase its coins. This debasement
paralleled the decay of the Roman Empire.

Is the traditional
gold standard really a relic? Yes. It becomes a relic in every
empire, as surely as there was gold at the beginning of that empire.
No nation honors the requirements of a State-run gold standard:
the free convertibility of the State’s money into gold.


The first
view is that of the free market. The gold standard is seen as
the product of voluntary exchange. The State’s enforcement of
the laws of contract leads to the development of a commodity money.
The commodity usually is gold or silver. Whatever commodity is
portable, widely recognized, divisible, and has a high value in
terms of weight and volume can function as money. But gold and
silver are the common winners in the competition for money. Money
is therefore initially not the product of State action. It is
the product of voluntary exchange. This is the view of Austrian
School economists: Mises, Rothbard, Hayek. See my eBook, "Mises
on Money

The other
view of gold argues that money is the product of State declaration,
i.e., fiat announcement. Money is anything that the State says
it is. This has been the view of all governments from the beginning
of coinage in the sixth century B.C. The State’s gold standard
can be extended as a result of military conquest. The victorious
nation steals the gold hoard of the defeated nation. While the
empire is expanding, the gold standard is possible. When the empire
shrinks, gold is abandoned. The costs of empire lead to the debasement
of the currency.

Keynes’ statement
on gold came in the early 1920’s, which was when the British Empire
had begun to fade. World War I had nearly bankrupted the British
government. World War II would end the British empire.

Lenin’s famous
quote on gold was that gold would someday be used for public urinals.
But that would be later. Under Communism, torture was common to
get men to surrender their gold to the state.

began in the twentieth century when World War I broke out in 1914.
Within weeks, the commercial banks suspended redeemability in
gold. The governments authorized this, and then had their central
banks confiscate the confiscated gold from the commercial banks.
The degree of barbarism that the war produced could not have been
accomplished had a gold standard been in force. The public would
have stripped the banks of the public’s gold. The governments
would have had to come to terms with the enemy.

It was the
abandonment of the gold standard that made modern barbarism affordable.


Gold initially
becomes the favored money metal because of the decisions of individuals.
The division of labor is not the product of State sovereignty
over money. It is the product of the rule of law.

Under contract
law, if a gold coin’s producer debases his coins, he can be sued
in court by his victims or by his competitors. Debasement is fraud:
a violation of contract. The State need only enforce contracts
in order for a gold standard to be extended by market participants.

officials then see that gold coins circulate. They intervene,
mandating that all coins be stamped with the State’s seal. The
State comes in the name of its own sovereignty to bask in the
light of a free market institution: the gold standard. It is like
a species of bird that lays its eggs in another species’ nests.
It has to fool the other birds. So does the State have to fool
the public. "Money is an attribute of the state’s sovereignty!"
Not initially, it isn’t.

The State
then offers to store coins for free and issues receipts: IOU’s.
A free service! How wonderful! Something for nothing! But the
offer is bogus. The State’s goal is to get the public to start
using IOU’s for gold coins rather than actual coins. The State
can then more easily confiscate these coins: nothing for something!

There is
no long-run limit on the State when the State controls the coinage.
The traditional gold standard is a paper standard, revocable at
will by politicians.

banks can also issue IOU’s for depositors’ gold. The banks make
the same offer: redeemable on demand. The tip-off that there is
fraud in the arrangement is when storage fees are not charged
for the service. There are no free lunches. You must ask: How
can the institution afford to offer a free service? Who pays now?
Who will pay later? Someone must pay for storage.

There is
a limit on the ability of a bank to issue credit, but only when
the government enforces gold contracts. The government can and
will change the gold contract law during an emergency.

I suggest
this relationship: a government-guaranteed gold standard is to
money what government-guaranteed health inspection is to prostitution.
Both guarantees are subsidies to the providers. Both guarantees
create the illusion of decreased risk. Finally, the operations
of both systems are best described by the same verb.

When money
fails, legitimacy is lost, too. Gold’s price is a test of political
legitimacy: the value of a national currency. A rising gold price
is a vote of reduced confidence in the State’s money. This is
why governments since World War I have done everything they could
to remove gold coins from circulation. Politicians want no public
referendum on the legitimacy of the State. They allow political
voting. Political voting can be controlled. Gold coins cannot
be controlled. So, they are abolished by law.

This is why
governments sell off gold. It de-legitimizes gold and legitimizes
government currency. But this can go only for as long as central
banks sell their confiscated gold.


Most of the
problems are obvious. Coins are bulky. They must be carried with
you, which increases the risk of robbery and loss. There are problems
with making small change.

The solution
is an IOU redeemable in gold. The IOU must be signed over by the
existing owner to a new owner. The IOU, if trusted, results in
wide acceptance. It is "as good as gold." It may even
be better than gold: less risky.

But then
comes default on the IOU contract. If the agency that stores the
gold and issues the IOU is protected by the government, as banks
are, or if the issuer is an arm of the government, then the risk
of default in wartime is high.

We see an
extension of trust: by the public to the banks, by the banks to
the central bank; by the central banks to the State. The transfer
of trust moves from economics to political sovereignty. But a
system based on political sovereignty is not trustworthy. It has
the ability to cheat, and no agency can bring charges. No agency
of appeal exists.

During World
War II, the Bank for International Settlements (Basle) was created
so that agents of the various central banks of warring nations
could clear their accounts. It was a neutral third-party agency
that enforced the rules. This made a gold exchange standard possible
among central bankers. What they did not allow to the masses whose
gold had been stolen by the commercial banks they demanded from
each other: settlement in gold. This allowed the national war
machines to continue their bloody efforts.


In the republican
phase of government, the State monetizes gold. It places its stamp
of approval on gold coins. It asserts sovereignty over money in
the name of preserving the value of money by guaranteeing the
fineness and weight of the coins.

Then, in
the empire phase, debasement begins. The State de-monetizes gold.
It substitutes base metals and calls the new coins equally valuable.
The free market assesses the truth of this claim, exchange by

The result
of the de-monetization of gold is the de-capitalization of the
State. The de-monetized IOU’s become IOU nothings. The State finds
it more difficult to get the masses to accept its money.

In the twentieth
century, the State persuaded the masses to accept its IOU nothings.
The result has been a vast expansion of state power and state
debt, coupled with a vast depreciation of money’s purchasing power.
This will not be reversed until the debt system overwhelms the
monetary system (deflation), or the state’s official money is
abandoned by the public (inflation).


The State’s
gold standard is a preliminary to eventual confiscation or debasement.
The State’s promise of redemption on demand should not be trusted.

A gold coin
standard by profit-seeking storage organizations can be trusted
with less risk, but not if the storage is offered for free. There
are no free lunches. Someone will eventually pay for free services.
When it comes to fractional reserve banking, that someone is always
the late-coming depositors.

This is why
any call by conservatives for the State to adopt a gold standard
is futile. No one will listen. Even if voters understood the case
for a limited State, they would not be able to limit the State
by a State-run gold standard. A State-run monetary system, with
the exception only of Byzantium, becomes a debased standard.

This is why
the free market is the only reliable source for the re-establishment
of a gold standard. Honest money begins with these steps: (1)
the revocation of legal tender laws that require people to accept
the State’s money; (2) the enforcement of contracts; (3) laws
against fraud, which fractional reserve banking is. The free market
can do the rest.

a free copy of my book, "Honest Money," click here.

26, 2003

North is the author of Mises
on Money
. Visit
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