by Gary North: Gold
vs. Badges and Guns
On March 12,
David Stockman gave a lecture at the Mises Institute in Alabama.
I was in attendance. It was a rousing speech, filled with funny
one-liners. It reminded me of Patch Adams' listing of euphemisms
for death in the hospital room of the guy with terminal cancer.
It got us all laughing.
had four important points. First, the Treasury-Federal Reserve bailout
in October 2008 was not necessary to save the financial markets.
It was necessary to save three or four finance companies that had
cooked their books and were facing exposure, meaning write-downs.
crisis took place because of Nixon's decision on August 15, 1971,
to cease honoring the good-as-gold guarantee of the 1944 Bretton
Woods agreement. He "closed the gold window." While Stockman did
not mention what prompted this, we gold standard dinosaurs remember:
Nixon refused to insist that the Federal Reserve System cease inflating,
which it was doing in order to stimulate the economy and get it
out of a two-year recession. He admitted publicly that he was now
a Keynesian, and the FED's Arthur Burns funded this transition.
idea behind this decision to close the gold window was what Stockman
called Milton Friedman's contraption: a two-part reform to float
the dollar and abolish the last traces of the gold standard.
Asians are running mercantilist economies. They are inflating their
domestic monetary bases in order to buy Treasury debt in a plan
to keep their currencies from rising, which would otherwise reduce
exports. They will not be able to follow this program much longer,
he said. Labor costs are rising.
text of his speech is here.
FRIEDMAN'S MONEY MACHINE
believed in the free market most of the time. The trouble was, whenever
he approached the coercive monopoly known as civil government, he
came up with logical solutions based on the idea that civil government
can be made more efficient by adopting pseudo-market arrangements.
He came up with ideas justifying the imposition of the Federal withholding
tax in 1943. That was going to be a temporary wartime tax, the public
was assured. He believed the government could collect far more revenue
through withholding. He was correct. This made government far more
efficient than ever before at extracting wealth.
the idea of educational vouchers issued by local governments and
based on taxes extracted from the public. He did not consider the
obvious fact that the courts would make this the wedge by which
the state would take over private education. He
and I debated this in 1993.
Most of all,
he promoted the idea that storing gold in government vaults to back
the currency is wasteful. It wastes gold. It wastes storage space.
It wastes armed guards. So, to make monetary policy more efficient,
the Federal Reserve should increase money he never said which
M by 2% to 5% per annum. He wanted central-bank-controlled
The only critics
from the fringes of academia were the Austrian School economists.
We knew that an efficient government is a dangerous government.
We also knew that a central bank that does not face an outflow of
gold in response to its policies of monetary inflation will inflate
far more than would be allowed in any gold-related economy.
responded to this argument, which had been picked up by The
Wall Street Journal, back in 1969.
responded on many occasions. So did Murray Rothbard. But we were
not taken seriously. We were not part of the mainstream. Academic
economists had long since abandoned any support of a gold coin standard.
They did not all support Friedman's idea of a restrained Federal
Reserve. In fact, very few of them supported it. They wanted flexibility.
They still do.
closed the gold window, there was no turning back. The monetary
base grew, all of the various Ms grew, prices rose, bubbles grew
and blew, and the Federal debt rose to today's gigantic, unsustainable
level unsustainable apart from mass inflation followed by
of a currency convertible on demand into gold was only one part
of Dr. Friedman's contraption. The other part was his suggestion
of floating exchange rates. This deserves special consideration.
A is redeemable on demand at 35 A's for one ounce of gold, and currency
B is redeemable at 70 B's per ounce of gold, they will trade at
a fixed rate of two B's for one A. No one establishes a price control
that mandates this. No one needs to. Here's why.
If the central
bank of nation A starts cranking up the money machine, currency
A will decline in price. Gold will start creeping up to 36 A's.
At that point or before speculators will start buying
currency A and cashing the units in for gold at 35 units. Then they
will take the gold and buy 36 A's. Then they take 35 A's to nation
A's treasury and demand an ounce of gold. They pocket the extra
A. Over time, they will have 35 A's. They will then cash them in
for another ounce of gold.
by transaction, the gold will flow out of nation A's treasury. Either
the treasury will run out of gold, or else it will stop redeeming
gold at 35 A's per ounce. It may even cease all gold redemptions.
will fall in relation to currency B. After all, you can buy an ounce
of gold for 70 B's. Anyone who thinks he can buy 35 A's and then
sell them for 70 B's, so as to make a run on B's treasury, will
find that all of his competitors have figured out the same move.
The price of B's in relation to A's will rise. That ends the fixed
exchange. The fixed exchange ends because nation A quits redeeming
its currency at 35 A's per ounce of gold.
There was a
fixed exchange rate before A's central bank began buying debt with
fiat money. This rate was not set by law. It was set by the free
market. The legal convertibility of A into gold at 35 A's per ounce,
plus the legal convertibility of B's at 70 B's per ounce, set the
rate of exchange.
This was not
a price control of currency A vs. currency B. It was a pair of price
controls: currency and gold at 35 A's per ounce (fixed by domestic
law), and currency B and gold at 70 B's per ounce (fixed by domestic
law). The second relationship was by definition-law. The rate of
exchange was set by each nation's central bank.
from that fixed definition would cause feedback. If the price of
gold was set too high, the central bank would be flooded with gold:
"glut." If the price were set too low, the central bank would experience
a run: "shortage." Either condition would force the bank to make
changes: either changes in monetary policy or changes in the official
definition of the currency-currency exchange rate.
The fixed rate
of exchange, currency A vs. currency B, was a market rate of exchange.
It did not change, because each nation honored its respective contract
regarding convertibility into gold at a fixed price.
INTERNATIONAL MONETARY FUND
The 1944 Bretton
Woods agreement was a contraption. It was a "new, improved" contraption
whose original design was the gold-exchange standard, which came
into existence in 1922 at the Genoa Conference. At that conference,
governments agreed to establish a "new, improved" gold standard.
Rather than re-establishing full gold coin convertibility domestically,
which would transfer authority over monetary policy to the people,
they came to an agreement. They would hold interest-bearing debt
certificates issued by the United States or Great Britain instead
of holding gold.
back onto the gold standard in 1925, but at the pre-War rate of
exchange, as if mass inflation had not taken place. This was Churchill's
decision as Chancellor of the Exchequer. This would soon force Britain
either to sell gold or shrink the money supply. The government wanted
to do neither. So, Montagu Norman, the head of the Bank of England,
persuaded his very, very close friend Benjamin Strong, the head
of the New York Federal Reserve, to persuade the Federal Reserve
to pump up the U.S. money supply, so as to avoid a run on the Bank
of England's gold. This Strong did until he died in 1928. Then the
FED reversed course late 1928. It ceased inflating. That popped
the stock market bubble.
The IMF created
a system of fixed exchange rates. These were not based on gold convertibility.
These were price controls. The IMF enforced these fixed rates, though
not very well. From time to time, some nation devalued, i.e., refused
to supply foreign exchange at the fixed rate. The IMF had no sanctions
to impose. So, the system lurched along from devaluation to devaluation.
Only the United
States sold gold at $35 per ounce to governments and central banks.
But this could not go on. Gold flowed out. After 1964, France kept
demanding payment in gold. The Federal Reserve kept inflating.
took apart the idea of fixed exchange rates. Fixed exchange rates
are a form of price control. Friedman was a good enough economist
to know that price controls produce shortages. The artificially
undervalued currency goes out of circulation. The overvalued currency
produces gluts. There will be runs on central banks.
of foreign goods say to the central bank: "Sell us the artificially
undervalued foreign currency at the official price." The central
bank runs out of foreign currencies. Trade collapses. There is then
a devaluation. The official prices of the foreign currencies are
raised to new fixed exchange rates.
It was easy
for Friedman to expose this as ridiculous. "Just float the currencies,"
he said. "Let the free market set their prices." This was good advice.
Price controls do not work as promoted. They always produce gluts
But then Friedman
recommended his old favorite: pure fiat currencies. He said that
these can be managed rationally by means of a fixed rule governing
a predictable expansion of money. "Turn it over to the Federal Reserve.
All will be well if the Federal Reserve does not tamper with the
rate of growth." As John Wayne said in The
Searchers: "That'll be the day."
Friedman's contraption. First, there would be no more convertibility
of gold for foreign official government agencies.
For a little
less than two years, there were universal price controls on American
goods. These controls led to shortages and a disruption of international
trade. The dollar was not officially floated until December 1973.
When the price
controls came off, prices rose. In 1975, Gerald Ford launched the
WIN plan: Whip Inflation Now. The recession of 1975 did exactly
that. Then came the worst monetary inflation in American peacetime
history: 1976-80. Gold and silver soared.
contraption clearly was not working. Floating exchange rates were
not the problem. The abolition of the gold exchange standard was
contraption has engulfed the whole world in monetary inflation,
bubbles, and busts.
ON THE CONTRAPTION
floating exchange rates and the abolition of the gold standard.
demise of the gold standard should have been as destructive of
fiscal discipline as it was of monetary probity can hardly be
gainsaid. Under the ancient regime of fixed exchange rates and
currency convertibility, fiscal deficits without tears were simply
not sustainable no matter what errant economic doctrines
lawmakers got into their heads.
the machinery of honest money could be relied upon to trump bad
policy. Thus, if budget deficits were monetized by the central
bank, this weakened the currency and caused a damaging external
drain on monetary reserves; and if deficits were financed out
of savings, interest rates were pushed up thereby crowding
out private domestic investment.
This is an
accurate assessment of what happened. But the anchor to this was
not the fixed exchange rate system, because the IMF had no real
authority to enforce them. The anchor was the promise of the United
States to sell gold at $35 an ounce. When the chain was cut, and
the U.S. kept its gold, the international currency system was cut
adrift. The anchor resides in the vault of the New York Federal
In the good
old days, there was pain, Stockman observed. "Politicians did not
have to be deeply schooled in Bastiat's parable of the seen and
the unseen. The bitter fruits of chronic deficit finance were all
too visible and immediate." This ended in 1971.
the four decades since the gold window was closed, the rules of
the fiscal game have been profoundly altered. Specifically, under
Professor Friedman's contraption of floating paper money, foreigners
may accumulate dollar claims or exchange them for other paper monies.
But there can
never be a drain on U.S. monetary reserves because dollar claims
are not convertible. This infernal engine of fiat dollars, therefore,
has had numerous lamentable consequences but among the worst is
that it has facilitated open-ended monetization of the U.S. government
is running a $1.6 trillion deficit. Nothing can be done politically
to stop this. We are on a runaway train. The main brakes were removed
in 1971. The only brake now is that of the bond vigilantes, but
the Federal Reserve is the buyer of bonds today, along with Asian
central banks. Stockman observed that "the Fed's QE2 bond purchases
have been so massive that it is literally buying Treasury paper
in the secondary market almost as fast as new bonds are being issued."
Is all this
Friedman's fault? Stockman lets him off the hook, to some extent.
contrast, under the contraption that Professor Friedman inspired,
trade account imbalances are never settled. They just grow and grow
and grow until one day they become the object of fruitless
jabbering at a photo-op society called G-20.
In all fairness,
Professor Friedman did not envision a world of rampant dirty floating.
Indeed, it would have taken a powerful imagination to foresee
four decades ago that China would accumulate $3 trillion of foreign
currency claims or more than 50% of GDP, and then insist over
a period of years and decades that it did not manipulate its exchange
it was all Friedman's fault, intellectually speaking. When an economist
recommends a policy, he also recommends its effects. Friedman failed
to see what Austrian School economists had predicted: the unleashing
of fiat money, and manipulated rates dirty floating. Dirty
floating is all there is in a world run by government-licensed central
banks without gold coin convertibility. But for our saying this,
decade after decade, the economics profession has marginalized us.
was always too clever by half. He advised governments to get more
efficient, and they did so. They used his advice to expand their
power and expand their reach into our wallets.
We told him
so. He did not listen. His followers did not listen. Today, they
all sit mute at the side of the road, mumbling about potentially
excessive deficits and potentially excessive price inflation, but
generally approving of the Federal Reserve.
is the original contraption: (1) government's monopolistic control
over money and (2) central banking as such. Here, Friedman was supportive
was not floating exchange rates or the breakdown of Bretton Woods
in 1971. Those were the inevitable results of Bretton Woods, as
Henry Hazlitt warned in the late 1940s, and was fired by the New
York Times for saying so. You
can read what he predicted.
was not even the Genoa Conference of 1922, the contraption designed
to solve the inflation that came as a result of the suspension of
redemption in the second half of 1914, when World War I broke out.
was the mass confiscation of the people's gold in 1914: first by
commercial banks, then by the central banks.
contraption was just one more ill-fated attempt to deal with the
results of the original confiscation. It was one more case of his
outlook: "The government was right to confiscate the gold and end
the gold standard. That was an efficient way to fight a war, just
as withholding taxes are efficient, and vouchers are efficient."
Friedman spent his career defending the efficiency of the free market.
But, on the really big issues, he sold his peers on the efficiency
and good will of government politicians and bureaucrats. "Trust
them to be efficient."
said the same thing, but added, following Forrest Gump's mother,
"Efficiency is as efficiency does." The state gets more efficient
only in order to tyrannize people on a cost-effective basis.
contraption was the unchecked welfare-warfare state: unchecked by
annual taxation without withholding and unchecked by the gold standard.
If that's efficiency,
include me out.
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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