Gold: The Sovereign Power of the Veto

The price of gold has recently been making another of its upward moves. These upward moves have been beaten back so consistently over the last 22 years that there is not much interest by the financial press or investors. But there will come a day when the threat of central banks to sell gold — which they sell mainly to each other — will no longer scare gold buyers. They will start taking delivery of their futures contracts. That will change everything.

If officials in the central bank of China ever decide to use the bank’s enormous supply of dollar reserves to start buying gold, they will make their bank the dominant central bank on earth. At some point, they will do this. They will finally understand how vulnerable the G-8 nations are to a determined central bank that wishes to get its corporate hands on the West’s gold.

If Chinese central bank officials should also demand physical delivery of their gold bars from the vault in the New York Federal Reserve Bank, they will announce to the West, “Your days of wine and roses have ended. Call this revenge for the opium wars.” They will have achieved a symbolic victory over the West in general and the United States in particular.

The Chinese could do this tomorrow. I think they are likely to do it sometime in this decade. When they do, they will become the dominant central bank. I think this is what they want: symbolic affirmation of their new-found international economic might. They are fast becoming the 800-pound gorilla in the world’s export markets. By 2010, they will be that gorilla, if you count Hong Kong, which they control, Taiwan, which has sent $180 billion in private investment into China since 1991, and 40 million overseas Chinese, who serve as the middlemen in the expansion of Chinese foreign trade.

The West’s best chance of avoiding this transfer of international power is to continue to educate younger Chinese economists in one or another of the West’s gold-hating graduate schools in economics. The professors must teach the Chinese that gold is just another commodity, except that it’s a barbarous relic.

The year that China takes delivery of 1,000 tons of barbarous relic is the year that China will replace Japan as the dominant nation in what might be called the Greater East Asia Co-Prosperity Sphere.


Why has the price of gold trended lower since January, 1980? Part of this drop was a reaction to the large price rise in 1978-80, which had been driven by the inflationary policies of the Federal Reserve System under the long-forgotten and unlamented Chairman of the Board of Governors, G. William Miller. He was not an economist. He was a corporate executive without any known understanding of monetary theory. His tenure of office was brief: March, 1978 to August, 1979, but public confidence had been lost. He was replaced by Paul Volcker, who adopted tight money policies in October, after being persuaded by other members of the Board.

Meanwhile, OPEC had driven up the price of oil for the second time in the decade, this time under Jimmy Carter. By 1979, there was deep pessimism regarding Carter’s political leadership and the economy. This elected Ronald Reagan in 1980.

In late 1979, Iranians kidnapped the staff of the American embassy.

Throughout 1979, there was also Bunker Hunt’s squeeze on silver, which drove up the price to $50/oz from under $5 a year earlier. He had been taking delivery of silver contracts all year, terrifying the shorts. Poor Hunt. He was about to lose his second fortune. The first had taken place in 1971, when Qadaffi had nationalized Hunt’s oil holdings. As soon as the Gulf sheikhs saw that Qadaffi had gotten away with this massive theft, they decided to squeeze the West. That fabulously successful oil squeeze began in 1973, the same year that Hunt began buying silver futures at $1.95/oz. What stopped Hunt in 1980 was two-fold: Volcker’s tight money policies and the COMEX, which changed the rules. No further purchases of silver future contracts were accepted by the exchange except for shorts who were covering their positions. By March, 1980, the price of silver was at $11. Hunt lost a billion dollars. He had to borrow from the FED to cover his position. He then uttered those memorable words, “A billion dollars just doesn’t go as far as it used to.” Silver never has recovered.

The last two decades have seen a fall of the price of all raw commodities. The nominal price of oil has stayed up, but price increases of finished goods and services have dramatically lowered the purchasing power of the dollar since 1980. It costs $2,150 to buy what $1,000 bought in 1980, according to the inflation calculator at the Bureau of Labor Statistics. The percentage of American family incomes that is spent on food, for example, has gone down year by year. So, all the metals have dropped in price and have stayed down except for brief upward moves.

Is this a permanent feature of the West’s economy? Those who think that we are running out of raw materials say no. They are generally not economists. Most economists say yes. They argue that improved extraction techniques and resource-discovery techniques and technological substitutes will continue to place a premium on the knowledge-service economy in relation to commodities. Throughout the twentieth century, the economists have been correct about this except during wartime.

This scenario applies to commodities that are used in production. But one commodity is not generally used in production: gold. From about 2,000 B.C. until today, gold has been used mainly as money. The issue is: Used by whom?


To facilitate exchange, a medium of exchange is crucial. Barter is too inefficient. If you don’t have what I want to obtain, or I don’t have what you want to obtain, there will not be an exchange unless a third party steps in. He will get a high commission for his specialized knowledge of markets.

Money reduces these commissions by making exchange between producers easier, i.e., converting exchangers from producers into consumers. The best definition of money was provided by Ludwig von Mises in 1912: the most marketable commodity.” Historically, the most widely acceptable money commodities have been gold and silver. We read of the patriarch Abram, “And Abram was very rich in cattle, in silver, and in gold” (Genesis 13:2).

Sometime between 700 B.C. and 635 B.C., the king of Lydia, in Asia Minor, began producing the first coins. They were round, uniform, and stamped with a lion’s head, the symbol of the Lydian dynasty. This invention was soon imitated by the Greeks. Originally, the coins were electrum: silver and gold. Under King Croesis (“Creesis”), all of the Lydian coins were gold. He was the famous king discussed by Herodotus, who made war on the Persians and lost his empire. But his economic innovation reigned until 1933. I think it will reign again, but that’s another story. For the story of Lydia’s coinage, read Chapter 2 of Peter L. Bernstein’s book, The Power of Gold.

The world was re-shaped by that invention: the extension of trade and the division of labor. Wealth increased. But there was another consideration, one which became the basis of the visible destruction of the gold standard in the 20th century. Lydia’s invention carried with it an assertion, an implication, and a symbol: the sovereignty of the State over coinage. The stamp of the dynasty marked the coins as the monopoly of the State. Civil governments have claimed this sovereignty over money ever since. The stamp not only announced the coin’s authenticity; it announced a monopoly. He who counterfeited a coin by adding base (cheap) metals was a violator of the State’s exclusive right. The State had to authority to bring negative sanctions against the violator — not on the basis of his having committed a fraud, but on the basis of violating the exclusive authority of the State to produce the coinage.

The practice of debasement had been condemned by the prophet Isaiah two generations before the invention of coinage. “Thy silver is become dross, thy wine mixed with water” (Isaiah 1:22). His condemnation was an extension of the law against false weighs and measures.

Ye shall do no unrighteousness in judgment, in meteyard, in weight, or in measure (Leviticus 19:35).

But thou shalt have a perfect and just weight, a perfect and just measure shalt thou have: that thy days may be lengthened in the land which the LORD thy God giveth thee. For all that do such things, and all that do unrighteously, are an abomination unto the LORD thy God (Deuteronomy 25:15-16).

The presence of an authoritative stamp made a coin more acceptable in trade. It reduced the product-seller’s risk of not weighing or testing the coins. The fact that the stamp was imposed by the authority of the king did not, in and of itself, make the coin a monopoly instrument of trade. What made it a monopoly was the decision of the king to monopolize the production of coins. He did not authorize others to use his stamp even when their coins matched the weight and purity of his coins. He could have charged them a stamping fee for use on their coins — a trademark fee, in other words. He refused. From that time on, civil governments resisted the production of coins by private parties. Coins were deemed an aspect of State sovereignty.

So, three separate analytical issues were involved: (1) the reduction of transaction costs associated with small coins compared to large ingots; (2) the reduction of transaction costs associated with officially stamped metal; (3) the assertion of State sovereignty over coinage. The third was not necessary to the first two.


The judicial issue of sovereignty in the pre-modern world (say, pre-1660) was the issue of divine right. The assertion of divine right was the judicial-theological issue of the final earthly court of appeal. He who possesses legal sovereignty cannot be sued, apart from his permission, for he is judged by no human court. Sovereignty is why the U.S. government cannot be sued without its permission, according the long-established doctrine of “legal immunity.” This is why there is so much political pressure on the U.S. government to allow American or foreign citizens to appeal to the World Court and other international jurisdictions above the U.S. Supreme Court. To be the King of the Hill, a court must be the final court of appeal. Without a world supreme court, there cannot be world government.

The final judicial court of appeal for money is a nation’s supreme court. But the final economic court of appeal is the free market. A court can determine what is lawful money. The free market determines what is actual money. A civil government can legislate the price of money: exchange rates between two forms of money; price controls on goods. The free market will determine what the rates of exchange are in actual exchanges: the black market rate of exchange.

Gresham’s mid-16th century law says, “Bad money drives out good money.” This form of Sir Thomas’s law is imprecisely stated. Here is the correct version: “The monetary unit that is artificially overvalued by law will drive out of circulation the monetary unit that is artificially undervalued by law.” This means that there will be a shortage of any artificially undervalued currency. The best recent example was the U.S. dollar in relation to Argentina’s currency unit in December, 2001. The dollar was artificially undervalued by Argentina’s law. Almost no one could buy dollars at the government’s fixed exchange rate. There was a shortage of dollars at the phony low price.

As always, government-enforced price ceilings create shortages (too much demand). Government-enforced price floors create gluts (too much supply).

The government can pass all the price controls it wants. The free market will respond: shortages and gluts. Whenever you hear of a shortage or a glut, think: “At what price?” Whenever a price is established by law, the shortage or glut will remain until this legislated price randomly matches the free market price, at which time, there is no further need for the legislated price.

Politicians do not understand that the final court of appeal is the free market. The economy trumps the State. Governments, by imposing added risk for the detection of an illegal transaction — a voluntary exchange at free market prices — do raise transaction costs, but governments cannot establish the price at which exchanges will take place. There is no appeal beyond the free market. The market, not civil governments, is sovereign.

Politicians rarely believe this. So, they play power games with prices. By establishing by law which currency unit is acceptable for paying taxes, politicians can determine which currency unit functions as money in tax-related transactions. But politicians cannot determine at what prices this tax/currency unit will function as money. The free market — buyers and sellers of money — establish the money prices of goods and services. Consumers, not governments, are sovereign over the value of money.


Gold has served as money in free markets for over four millennia. Paper money was an invention of the Mongols less than a millennium ago. Within a century, they had destroyed their currency. Commercial bank-created money is less than six hundred years old. Central bank-created money began in 1694, with the Bank of England.

Here is a nearly unbreakable rule: politicians serve their own self-interest by paying off their constituents with money collected from their opponents’ constituents. When the taxation of their opponents’ constituents threatens to create a tax revolt, or the defeat of the incumbents at the next election, or both, incumbent politicians seek ways to keep the money flowing to their special-interest voting blocs without visibly taxing their opponents’ special-interest voting blocs.

The key word here is “visibly.”

Monetary inflation is the preferred solution of politicians. The real cause of the public’s increased cost of living can be hidden from most voters, who are economically ignorant, naive, and trusting. Price increases can be blamed on profit-seeking speculators and capitalistic price-gougers.

If the currency system were exclusively private, then there could be no element of sovereignty for counterfeiters. Counterfeiters could be brought into a court of law and prosecuted for fraud: false weights and measures. They could not claim that they are beyond the law, above the law, and immune from law suits.

Governments can and do make these claims of immunity. They transfer by law to central banks this same political sovereignty. This is why the mixing of judicial sovereignty over money and economic sovereignty over money eventually leads to fraud on the part of governments: monetary debasement, either openly (“thy silver has become dross”), or through the printing of more paper IOU’s for gold or silver than there is metal on reserve, or through the adding of digits in bank computers.

When a national government has established a State-run gold standard by persuading the public to exchange their gold for the government’s IOU’s of gold at a fixed price, then the public can retaliate against future monetary inflation. Prices rise due to the increase in the money supply. This would raise the money-price of gold, except that the government or its central bank has promised to sell gold at an official price to anyone who brings in an IOU. The demand for gold therefore rises at the government’s artificially legislated price. This is a rational response of the IOU-holders. The government is subsidizing the price of gold.

Two groups want access to the promised gold: (A) people who think the government will soon change the rules and (1) stop paying gold for IOU’s (default), or (2) reduce the amount of gold that has been promised (devalue the currency); (B) industrial or ornamental users of gold who want to take advantage of the subsidy.

If the government wants to maintain full value of its IOU’s for gold, then it must stop inflating the currency. This will cause a recession: the reversal of the prior policy of monetary inflation, and the restoration or prices, especially of capital goods.

Politicians lose elections during recessions. “It’s the economy, stupid.” So, they want the good times to continue to roll, which means the printing presses must continue to roll. But then the gold reserves of the government will be depleted.

What’s a government to do?

Franklin Roosevelt’s answer was two-fold: (1) confiscate the gold of American citizens in 1933, and, once the gold had come in and had been turned over to the privately owned Federal Reserve System, (2) raise the price by 75% in 1934, thereby transferring to the FED a huge windfall profit. The FED’s monetary base rose because of the higher monetary value of its newly received gold, so commercial banks created new credit money to take advantage of these increased central banking reserves. The result was the economic recovery of 1934-36. But when the FED raised bank reserve requirements in 1936, thereby reducing the increase of bank credit, this produced the recession — a whopper — of 1937.

Because the government also raised taxes in 1936, this added to the economy’s woes: a double-whammy.

After 1932, Americans were no longer able to pressure the government to change its monetary policies. They lost the right of redemption. This abolition of the public’s right of redemption had been the decision of European governments, 1914-1925, in response to the war: a suspension of gold payments. Whenever a major war broke out in Europe, governments suspended gold redemption. Why? Because they planned to inflate the money supply to pay for the war. It happened during the Napoleonic wars. It happened in 1914. In between, 1815-1914, Europe enjoyed a century of price stability.

The public’s right of redemption of gold serves as a veto on the government’s expansion of fiat money, or the central bank’s expansion of credit money. Until the right of redemption is suspended by the government, the public holds the strong hand.

Every government-run monetary system is a compromise with the free market. Every government-run gold standard is based on promises: IOU’s issued for gold at a fixed price. Such a promise is no better than the promise of politicians. The government can always invoke its sovereign right to change the rules. It can legally renege on its promises. It is judicially sovereign.

The war against gold is part of the larger war of political sovereignty — the State’s self-imposed immunity from law suits — against free market sovereignty. In this case, it is a war by the politicians against the public’s right to select whatever they as individuals want to use as their currency unit, and their right to bring counterfeiters to justice in the State’s courts. Private, profit-seeking counterfeiters have no immunity from law suits, unlike legalized private counterfeiters (central bankers).

In the case of the law suits brought by Americans against the Roosevelt Administration in 1933, the Supreme Court refused to hear the cases. (The most detailed account of this subterfuge should be available in March: a 1,600-page book on the Constitutional history of the dollar, written by Ed Viera, author of a shorter, earlier edition of this book, Pieces of Eight. Viera is a Harvard-trained lawyer who has devoted his career to the money question. He is also an Austrian School economist.)

Every gold standard that is established by a civil government is a pseudo-gold standard. It is no better than a government promise, a government that claims sovereignty over money, i.e., legal immunity from prosecution for breaking its promise to redeem gold for its earlier IOU’s.

When it comes to gold standards, only one is real: a gold standard that has developed through voluntary exchange on a free market, in which counterfeiting is exclusively private and illegal under the statutes governing fraud. Under such a legal order, no one may lawfully issue more receipts for gold or silver than he has metal in reserve to deliver. Every warehouse receipt for the monetary commodity must be backed 100% by the amount of metal specified in the receipt, which is a legal contract. Any issuing of more receipts to the metal than there is metal in reserve is counterfeiting: dishonest weights.

Any form of gold standard in which the civil government is the issuer of warehouse receipts for metal is inherently a temporary measure. The promise of “full redemption on demand” is no more reliable that the promises of politicians. The guarantee is just one more government con job to separate the public from its wealth — in this case, gold. It is a sucker’s play. And do the suckers love to play! Paper receipts for gold. How convenient: no more heavy lifting. And it’s 100% guaranteed, free of charge, by the government. What a deal! It’s something for nothing!

With the government as the fiduciary agent, the deal has always been nothing for something. This is why, in the 20th century, the central banks wound up with most of the world’s gold.

When someone tells you that he is for “the gold standard,” think one word: sovereignty. If, in the proposed version of the gold standard that someone is pitching, any agency of civil government is the sovereign guarantor of warehouse receipts to gold, redeemable on demand, I strongly suggest that you keep your hand upon your wallet and your back against the wall.


With any pseudo-gold standard, the government retains the right to veto any attempt by the public to veto the government’s monetary policies. When holders of government IOU’s for gold begin to present their IOU’s and take home their gold, the government can intervene and refuse to pay. Remember, it is not the government’s gold; it is the IOU-holders’ gold. Anyway, that was what was originally promised. But agents of governments lie. This is their primary function operationally in every democracy: to deceive the citizenry. A pseudo-gold standard allows undeceived citizens to call the deceivers’ bluff until the government publicly reneges. This is why any gold standard is hated by all modern political liberals and most conservatives: it places a veto in the hands of citizens. The overwhelming majority of the intellectual defenders of State power dismiss the gold standard as a barbarous legal institution based on a barbarous relic. Why barbarous? Because it places a veto in the hands of the barbarians: citizens and non-citizens who can legally buy up the IOU’s with depreciating paper money and then launch a gold run on the government’s treasury or the government-licensed counterfeiters: central banks and their clients, commercial banks.

The monetary skeptics announce, “There’s gold in them thar vaults!” When the gold flows out, the day of reckoning draws closer for the purveyors of counterfeit IOU’s for gold. The counterfeiters grow desperate. “Their” gold is now being demanded by barbarians — arrogant citizens who think that a government promise is worth its weight in gold. Finally, the counterfeiters end the illusion of their pseudo-gold standard. They had persuaded the public to sell the government their gold in exchange for IOU’s. Then the government defaults. “Tough luck, suckers!”

This has been going on for three hundred years. The suckers — IOU-holding citizens — never learn. We are more trusting of known crooks (legally immune politicians) than money center bankers are who lend money to Latin American dictators.


The public trusts the government, which claims judicial sovereignty: immunity from law suits. The public also trusts Alan Greenspan. The American public has not had legal government-issued or bank-issued IOU’s to gold in their collective hands since 1933. They have voluntarily renounced the power of the veto. It has been even longer for most Europeans.

The economic veto over monetary policy has been transferred by the market to bond speculators. There are fewer of them than citizens who used to hold gold coins. But they do have a lot of power. They are hated by the government. The’s Daniel Gross reminded us in November, 2001:

In 13 years at the helm of the Fed, Greenspan has built up an enormous amount of credibility and clout — in Washington and New York. His actions in controlling the movement of interest rates have been credited with making or breaking the past two presidencies. George Bush — the elder — explicitly blamed Greenspan for dooming his one-term presidency by not cutting rates quickly enough in 1991. “I reappointed him, and he disappointed me,” Bush said.

Greenspan, on the other hand, made Clinton’s presidency. The Fed Chairman strongly suggested, early on, that the president focus on deficit reduction because that would please him and, in turn, the bond market. Clinton exploded: “You mean to tell me that the success of the program and my reelection hinges on the Federal Reserve and a bunch of [bleeping] bond traders?” But with the market-savvy Robert Rubin whispering in his ear, Clinton chose the path of budgetary restraint. Greenspan ratified his 1993 budget plan, and the rest is economic history.

In today’s political/investing culture, it is difficult for policymakers to make much progress without the cooperation of the bond market. And because the bond market regards Greenspan as an oracle par excellence, the 74-year-old former devotee of Ayn Rand now occupies the catbird seat.

The bleeping bond traders today are called “bond vigilantes.” This name fits. Vigilantes in the old West used to string up suspected malefactors when the government refused to prosecute, or when, in some cases, the people at the end of the ropes were the local government.

For politicians, the free market’s speculators who publicly expose the government’s monetary policies as detrimental to the public are regarded by the government as barbarians or vigilantes. Politicians hate any veto power held by the public. Bond market speculators are exercising a veto on behalf of the public. The government will do what it can to bankrupt them, hamper them, or in some way remove their veto power. But, in the long run, there is no escape. The free market will veto bad economic policies. The free market, not the State, is economically sovereign. Economic sovereignty trumps judicial sovereignty in the long run.

Keynes dismissed the long run. “In the long run, we are all dead.” Well, Keynes is dead, and his theoretical legacy is dying. But, for the moment, the rival sovereignties are about equally matched: market vs. State.

But if the Chinese central bank ever starts exchanging Western currencies for gold, and then demands physical delivery, the West’s central banks will face something more ominous than a handful of private gold bugs. It will face a rival that has the money to drive up the price of gold to 1980-levels. If Western central banks try to thwart this price rise by selling gold, the Chinese will smile. “Almond eyes wish to subsidize our purchase of gold? We accept!” The West would then be between a rock and a 24-carat hard place.

If you want to know what the “yellow peril” is in central banking circles these days, this is it.

January 15, 2002

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