Interest Rates in a Gold Coin Standard
by Gary North: Christopher
Hitchens: Death of a Wasted Wordsmith
Americans are living in a world of central bank profligacy. This
has been true ever since 1914, when the Federal Reserve System opened
for business. But the most recent bank-created economic crisis,
which began in December 2007, has received more attention than ever
before. This is mainly the result of Ron Paul's 2007 candidacy for
the Republican nomination for President. He warned that this crisis
would happen. He also spelled out the reasons: Federal Reserve policy.
Then the crisis hit.
Reserve lost its immunity from criticism in 2008-9. It will never
get it back. It also lost its invisibility. The general public now
has some limited awareness of the FED. The FED gets a lot of negative
publicity. This to a positive development.
This has also
created a problem. Some of the critics of the Federal Reserve System
propose a solution worse than the FED itself: the creation of a
fiat-money based central bank that creates money out of nothing
to pay for government-funded projects. These critics argue that
this government-run bank will be able to offer interest-free loans
to the public, which will keep the economy running at full capacity.
This is what
John Maynard Keynes taught in "The General Theory of Employment,
Interest, and Money" (1936). Keynes praised several economically
unsophisticated predecessors who proposed schemes for government-created
zero-interest money, including the founder of Social Credit, Major
C. H. Douglas, and the farmer and former economist for the week-long
Bavarian Soviet Republic of 1919, Silvio Gesell. He referred to
them as part of the economic underground, as indeed they were. I
have given a lecture on this. You
can hear it here.
In the United
States, the largest and oldest component of the economic underground
promoting government-issued fiat money has been the Greenback movement,
named in honor of the Union's Civil War currency, unbacked by gold
and printed with green ink. The Greenbackers have been a separate
ideological movement ever since the 1870s. They are influential
on the extreme fringes of both Left-wing and Right-wing circles
a unique achievement.
I have been
writing about these people for over 45 years. I am the only person
in the Austrian School who has published critiques of their position.
The first one I wrote in 1965 as a privately circulated essay. I
published it in my book, "An Introduction to Christian Economics"
(1973). I revised it to bring it up to date as a mini-book published
by the Mises Institute: Gertrude
Coogan's Bluff. You
can download a PDF for free here.
was the main theoretician of the Greenback movement in the 1930s.
Her books are still in print. More recently, she has been replaced
by a lawyer, Ellen Brown. I have dissected her book, The
Web of Debt (2007) here.
hate the idea of the gold standard, just as Keynes did. They claim
that fiat money will keep depressions from happening, just as Keynes
did. They claim that capital the tools of production
can be obtained free of charge at a rate of zero percent per annum,
just as Keynes did.
The odd thing
is this: most of the adherents of the Greenback position think of
themselves as conservatives. They think of themselves as defenders
of the free market. Yet they see all privately owned banking as
an economic evil. They trust Congress to set up a government-owned
bank with the legal right to print however much fiat money that
the government-protected, monopolistic bankers decide.
WRONG WITH THEIR POSITION?
They do not
understand the reason why there are interest rates in every society.
They see interest payments as an undeserved payment to bankers.
The bankers, because they control lending, are exploiting the public.
They are able to get something (interest) for nothing (fiat money).
to the heart of the matter. I ask this question the question
that every free market economist asks whenever he finds someone
arguing that anyone can get something for nothing.
If a seller
is charging something for nothing, why doesn't a competing seller
charge slightly less?
If bank A
is charging 6%, why doesn't bank B charge 5%? If bank B can make
a profit charging 5%, why can't bank C charge 4%. And so we go,
right down to such a low rate that nobody would complain
not even Greenbackers. You get the idea. Let me put it a different
is really worth nothing, how is it that anyone can charge anything
isn't it? Yet I have never seen any Greenbacker admit in print the
existence of this conceptual threat to his/her theory of banking.
They either do not understand this most elementary principle of
economic theory, or else they do not connect general economic theory
If you ever
come across a defender of Greenbackism, ask the person to explain
this. Why does it take a government-created monopolistic bank to
offer zero-interest loans? Why doesn't the free market provide this?
there is no answer that is coherent with the theory of supply and
demand. When the person starts to mumble, you will know he is stymied.
You therefore do not need to pay any attention to him or her.
If you get
the response, "Well, you have to answer my question first," just
reply: "You brought this up. It's therefore your responsibility
to explain how something that is worth nothing can command a price
in a free market. Why doesn't competition among sellers lower the
says: "Because there are government restrictions on entry into the
field," the person is close to the truth. The correct response is
this: "Then we citizens should demand that Congress get the federal
government out of the field of money and banking. You should stop
calling for a government bank."
See what the
person replies. Does the mumbling become sputtering?
LUNCHES AND NO FREE TIME
The free market
economist usually begins with the fact of scarcity. That was where
Adam Smith began in 1776. He observes that some things command a
price. The fresh air we breathe is free, but almost everything else
has a price tag. Why? Because, in the words of free market economics:
at zero price, there is greater demand than supply. In the giant
auction that every market is, there are more bids to buy at zero
price than offers to sell.
it? But is this a universal law? The economist says that it is.
This is why Keynes was not an economist. He said that capital can
ultimately be free. He wrote this: "But whildst there may be intrinsic
reasons for the scarcity of land, there are no intrinsic reasons
for the scarcity of capital." (General Theory, p. 376.) I
regard this as the most preposterous sentence in the history of
economic theory. I don't think anything else comes close.
What is wrong
with his statement? This. Capital is the product of land plus labor
over time. If land has an intrinsic reason for being scarce, then
capital must, too. But Keynes in The General Theory did not
think straight, which is another way of saying that he either lost
his mind when he wrote it or else he was in the delightful
phrase of the South putting the shuck on the rubes. Most
of the economics profession is an assembly of rubes on whom the
shuck has been put.
In this sense,
I have respect for Greenbackers. They are no more misled than Keynesians
in their theory of capital, but they did not pay a dime to go to
college to be taught this obviously nutty idea.
land must be paid for. There are competing bids to own it. When
we buy land, we buy a hoped-for stream of future services. Or we
can rent land. We call the payment "rent." We can buy these future
services by purchasing land or raw materials.
must be paid for. There are competing bids to own it. In today's
world, we rent labor services. Back when slavery was legal in the
West, men could buy these lifetime services at a slave auction.
But what about
time? Is it free?
Of all resources
that are not free, time is at the top of the list. Time is the only
irreplaceable resource. This has been understood in every culture
in every era. I
think Ralph Stanley at age 73 said it best for my generation. (At
age 84, he is still on the road saying it.)
In any economy,
raw materials command a price. We call these prices "prices." In
every economy, labor services command a price. We call these services
of capital? It is produced by combining land and labor over time.
It therefore commands a price. But here, there is a widespread and
fundamental conceptual error. People call the price of capital "interest."
Why is this incorrect? Because the price of capital is the result
of land (prices), labor (wages) and time (interest). The word "interest"
should be applied only to what we pay for time. It should not be
used to identify what we pay for capital.
discussion of this that I have seen appears in Murray Rothbard's
book, Man, Economy,
and State (1962), Chapter 7, Section 4. He discusses what
we must pay for factors of production. He begins with a discussion
of a theoretical construct that does not exist in history: a perfectly
competitive economy in which there are no profits or losses, because
everyone knows the future. In such a world, "there is no net income
to the owners of capital goods, since their prices contain the prices
of the various factors that co-operate in their production. Essentially,
then, net income accrues only to owners of land and labor factors
and to capitalists for their 'time' services."
Basic to Austrian
economics is the idea that there can be no perfectly competitive
economy., Nevertheless, as economists, we must initially factor
out profit and loss (uncertainty) in order to get to the core economic
concepts associated with pricing the factors of production. When
we buy a capital good or a piece of land, we buy a stream of future
services (we hope). We always discount the expected future value
of these services. Let me offer an example. If I promise to pay
you an ounce of gold each year for 30 years, you will not offer
me 30 ounces in exchange for this written promise. Think about this.
Why would you give up 30 ounces of gold today in order to receive
30 ounces over 30 years? Those future ounces are not worth as much
to you as your present ounces. So, you offer to buy my promise for
much less than 30 ounces up front. This discount is the rate of
interest. It affects every promise to pay. Its effects are not confined
By the way,
if you do not believe me here, I will make you this deal. I or my
estate will pay you one ounce of gold at the end of each year for
the next 30 years at the bargain price of 29 ounces of gold up-front.
What a deal!
You say don't think it's a good deal for you? Why not? Because you
have accepted the Austrian School's theory of interest. Again here
is the theory. The rate of interest is the discount that is applied
by all rational economic actors to every expected future income
is rent? Rent is the stream of income. This stream of income can
sometimes be purchased by offering cash up front. A buyer pays for
these future rents, but always discounted. Again the discount is
the rate of interest.
are no free lunches in life. There is also no free land. There is
no free labor. Above all, there is no free time. Time is running
GREENBACKER'S FAVORITE QUESTION
I have said
that Greenbackers have no answer to this question: "If interest
is a payment of something for nothing, why doesn't competition drive
the interest rate to zero?" My discussion of interest as a discount
for the use of scarce resources over time shows why interest is
not a payment of something for nothing.
have a favorite pair of questions to ask those who say that bankers
get paid for valuable services rendered. It goes like this.
How do bankers
get paid back more than they have lent? Where does the extra money
is that bankers are paid something for nothing. But this question
applies more fundamentally than mere exploitation. How can economic
theory explain this extra payment?
was at the heart of Karl Marx's theory of capitalism. He argued
that the extra payment to capitalists from the exploitation of labor
was surplus value. It is value received from workers above value
paid in wages. The Austrian economist Eugen Bohm-Bawek answered
this 130 years ago. He said that the payment to capitalists is for
scarce services rendered. All capitalists are forced by the auction
for labor services to bid up the price of labor (wages) to the point
at which labor services receive full payment.
It is not
possible to retain an extra payment not by workers, land
owners, employers, or bankers. Why not? Because of the unbreakable
rule of the free market's auction: "high bid wins." (If a would-be
seller refuses to sell, he offers the highest bid.) I will now answer
the Greenbacker's favorite question.
Let us start
simply. Let us say we live in a gold coin standard. There are no
fractional reserves. Every bank-issued warehouse receipt for an
ounce of gold has an ounce of gold in the vault.
Let us say
that the banking system has a total of 100 million ounces of gold
on deposit. Let us also say that depositors have lent the money
to bankers for one year at 2%. So, the bankers go looking for borrowers
who are willing to pay about 5%. (I choose these numbers for the
sake of easier computation.) Let's say that they find them.
look at the financial accounts of the borrowers. Will these borrowers
have sufficient income over the year to repay the loans? Will the
borrowers receive enough gold in the future in order to pay off
the loans? The may be able to sell their labor. They may be able
to sell some land. Maybe an inheritance check will arrive. But the
bankers will not make the loans if they do not think they will be
repaid with interest.
depositors cannot legally get their money back until the end of
the deposit term. There are no fractional reserves. If they want
a positive rate of return, they must let the banker lend their deposit
money during the time specified in the deposit agreement. Otherwise,
they would have to pay money to the bank for safe storage: warehouse
buy a future 105 million ounces of gold over the year by lending
100 million ounces today. They buy those future 105 million ounces
at a discount.
Case by case,
loan by loan, the borrowers collectively offer to pay back 105 million
ounces of gold over the next 12 months. The bankers require monthly
payments. The borrowers agree.
So, the bankers
lend the money. They money goes into the borrowers' bank accounts.
Then the borrowers spend this money on whatever they want to buy.
The money goes out either in the form of coins or checks or credit
of this money moves from high bidder to high bidder. Borrowers earn
money streams of income from these other spending
customers. The borrowers then begin to repay the banks.
In a free
market economy where there are no laws favoring fractional reserve
banking, and where bank runs are allowed by law, there is money
in circulation outside of banks. There surely is today: "currency
held outside of banks." This is part of the money supply today.
How can everyone
pay off these loans? Where do they get the extra 5%? By selling
more goods and services to other people who use gold coins to buy
items. Some of these gold coins may be held outside the banking
But what happens
if the borrowers find that they can no longer afford to do this?
They cannot earn the extra money from outside the bank-money system.
They will not borrow at 5%. They will agree only to less.
will find fewer takers for the loans at 5%. They will have to lend
at lower rates. They will have to pay less to depositors.
may pull money out of the banks. The money held outside of banks
then increases. The money in banks decreases. The recipients of
the depositors' withdrawn money then spend this money. This makes
it possible for borrowers to pay extra money to bankers.
On the other
hand, some depositors may agree to be paid less interest. They may
agree all the way to zero or very close to it.
they hand over their gold coins to the banks at zero percent? Because,
in a free market economy, the production of goods and services constantly
increases. This has been the normal situation ever since 1800. The
greatest unanswered question of modern history is how this compound
economic growth started when it did and where it did: Great Britain
and the United States. But it did, and the world changed. Sellers'
competition drives down money prices. The real price of goods falls
even when the money price of goods stays the same. People get richer
even though the have no extra money.
So, in a free
market economy, the money (gold coins) paid by borrowers to lenders
may not be more than the money borrowed zero percent
but the real income of the lenders rises. Interest is still being
paid to lenders, but it is concealed. The interest rate is the same
as the decline in gold-denominated prices.
no one pays income taxes on this increased wealth. Why not? Because
the income in gold coins is the same as the outflow.
Say that a
gold coins owner goes to a banker. "I will pay you to store my coins."
The banker says, "Fine. That will cost you 2% a year." The coin
owner says: "That's way too high." The banker says: "I'll tell you
what. Let me lend out your coins, and I'll put coins of the same
weight and fineness back in the vault in a year. It will cost you
nothing." The coin man says: "But I won't make any money." The banker
says: "True, but you also won't pay any income tax. The gold in
a year will probably be worth 3% more in purchasing power. And you
will worry less about burglars."
are deceived by the above-zero money rate of interest received by
fractionally reserved banks in a price inflationary economy. This
distracts their attention from the fundamental aspect of the free
market economy, namely, the constantly declining real price of goods
sees the price inflation that is caused by fractional reserve banking:
monetary inflation. What are fractional reserves? More warehouse
receipts for gold than there is gold in the vault. He wisely opposes
fractional reserves. But he does not make the crucial conceptual
leap: imagining what a price system would look like, including interest
rates, in a full gold coin standard economy without fractional reserves.
In a capitalist
world in which there is no increase in the money supply, there would
be low rates of interest in an expanding economy. Banks might offer
probably would offer loans at zero percent or slightly
above to borrowers, and also offer negative rates of interest
charges for depositing gold to depositors. They would sell
gold storage and check-writing services.
Really? Have you looked at what your bank is paying you to get you
to deposit your money? Look at what the U.S. Treasury is paying:
one one-hundredth of one percent per annum on 90-day T-bills. If
this can happen in this economy, it can surely happen in a full
gold coin standard economy with falling prices.
is not how the banks lend out money at interest and get repaid more
money. "Where did the extra money come from?" The question rather
is what the future purchasing power of money will be when it gets
paid back. If prices are falling, banks will be repaid in money
terms exactly what they lent and prosper.
do not understand this. I hope you do.
North [send him mail]
is the author of Mises
on Money. Visit http://www.garynorth.com.
He is also the author of a free 20-volume series, An
Economic Commentary on the Bible.
2011 Gary North
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