Gold Bugs: Swivel-eyed, Mad-eyed, Lunatic Fringe?

Many of the authors and Cobden Centre advisory board members (including some distinguished academics) would like to see money eventually re-rooted back into some kind of commodity backing. Why? Simply put: the record of government control of the peoples’ money has been catastrophic! I have said here before:

One ounce of gold today is worth $1,093.40 and 1/20 oz therefore $54.67 but the dollar pre World War I was just a name in the USA for 1/20 of an ounce of gold: what would have cost $1 before World War I would cost $54.67 today. The dollar has lost its purchasing power. In fact it has lost 98.17% of its purchasing power in 100 years. One dollar today should buy something like a single person’s weekly food shop, not a single daily newspaper. The fate of the pound sterling has been even worse than that of the dollar. One ounce of gold today is £692.26. So if a pound sterling pre World War I was just a name in the UK for 1/4 of an ounce of gold, it would imply that the pre World War I purchasing price was 1/4 of £692.26 or £173.06. In fact the pound sterling has lost 99.42% of its purchasing power in 100 years. One pound should buy something like a good week’s food shop for a family of four and not just one daily newspaper like it would today.

This was written at the start of this year, so the figures are actually even worse now! Governments do not like the gold standard as it forces them to be honest with our money. Thus, if they have created the conditions for a credit induced boom, they hope a bust can be worked out of the system, for example, by the currency depreciating against other currencies. Under a gold standard, gold (money) would exit the country and cause a deflationary correction by forcing prices down to their real market clearing levels. Politicians do not get re-elected telling voters the unfortunate truth that they have been living beyond their means and that there is no magic fix to the prior problems created by excessive credit expansion. The basic needs of human society are often mediated via the price mechanism. By this, I mean virtually all our essential goods and services that sustain our needs are transacted via the medium of money. This allows entrepreneurs to allocate resources where they are most urgently needed. Artificial bubbles in the price mechanism prevent this smooth allocation from happening. The Greenspan bubble in the USA and the Brown bubble here are testament to the power of governments to be popular while sowing the seeds for the actual destruction of our wealth. With the retail price index at nearly 5%, we are having a sizeable potion of our wealth confiscated each year, silently and by stealth, as the biggest single indebted entity being the State itself, engineers, lower real repayments of capital and interest. Never in our lifetime have we seen such distortion and such uncertainty. Why did we leave honest money behind? How often are you told you are swivel-eyed, mad-eyed or a loony tune when you ask “what about linking money back to gold?” Indeed, Robert Zoellick dared to ask that when he suggested that gold may well form a small part of a new world-wide money system, and was roundly and rudely sounded down. The pundits remind us that during the 1930s the recession was deepened massively by the gold standard, and some even argue it caused the recession! Revisionist history is fashionable, as we know, but I would encourage a look at the facts.

Churchill, posturing and the overvaluing of GBP when returning to the gold standard

Churchill as Chancellor of the Exchequer had his moment when sadly for us, he contributed massively to the Great Depression. During World War I, the expenditure on the military was facilitated when the payment of promissory notes (redeemed in gold) was suspended, leaving bank-created credit unconstrained. If you borrowed at a rate that was $4.87 and could pay your government debt back at a rate of $4.87 even though the real worth had now fallen to $3.40, you are paying back much less. Under some odd posturing suggesting there was a need to establish pre war parity with our great trading partner and lender, seeming to hang onto the notion that we might still be their equal, Churchill, in his worst economic act, sought to mis-price money at an overvalued rate.

None was more open to the thought of these past glories than the then Chancellor of the Exchequer, Winston Churchill, for whom the past was part of life itself and also a rich source of family prestige and personal income. His address to Parliament on 28 April 1925 announcing the return to gold was a Churchillian occasion. The self-governing dominions, he observed, had moved or were moving to re-establish the gold standard, so over the whole of the British Empire there would be ‘complete unity of action’. The success of the step was being ensured by American support – $200 million from the Federal Reserve Bank of New York, $100 million from J. P. Morgan. The consequence would be a great revival in international and intra-imperial trade. Hence-forth nations united by the gold standard would ‘vary together, like ships in harbour whose gangways are joined and who rise and fall together with the tide’. As a minor defect, gold could be had only for export. There would be no more gold coins. The New York Times reported next day that, according to opinion expressed in the lobby’, the Chancellor’s speech was one of the ‘finest in a long line’ and ‘fully up to his own high reputation as a parliamentary orator’. Its headline said that Churchill’s proposals had carried ‘PARLIAMENT AND NATION TO HEIGHTS OF ENTHUSIASM’.( New York Times, 29 April 1925) Sixteen years later Churchill would be well cast; no man was so well equipped to make the lion roar. In 1925, both he and oratory were, without doubt, a misfortune…… The error they defended was in restoring the pound to its pre-war gold content of 123.27 grains of fine gold, its old exchange rate of $4.87. In 1920, the pound had fallen to as low as $3.40 in gold-based dollars. Though it had since gained and was still gaining, the pre-war gold content and dollar exchange rates were far too high. That was because, for these rates, British prices were far too high. Because of this high British prices anyone possessed of gold or dollars could do better by exchanging them for the money of one of Britain’s competitors and buying there. And Englishmen likewise could do better by exchanging pounds for dollars, gold or other currencies at the favourable Churchillian rate and buying abroad. In 1925, the price advantage in doing so was about 10 per cent. Exports, as always, were essential for Britain. So, other things equal, British coal, textiles and other manufactured tools could only become competitive at the new exchange rates if their prices were to come down by approximately 10 per cent. A very uncomfortable process” (Background and consequences of Winston Churchill’s House of Commons “Gold Standard budget Speech”, from “Money: Whence it came, where it went” by John Kenneth Galbraith (First Published 1975), Page 174 to 178)

when Britannia ruled the waves and the pound was regarded with respect and awe in all the world’s money markets. They assumed that the restoration of the pound’s parity with the American dollar would re-establish Britain’s pre-war prosperity. None seemed to realize that England had squandered its wealth between Sarajevo and Versailles, or that the country’s shrunken export  trade could no longer provide the surplus needed to re-establish London’s fiscal ascendancy over the rest of the world (The Last Lion: Winston Spencer Churchill Visions of Glory 1874-1932″ by William Manchester, Copyright William Manchester 1983, Sphere Books Ltd, 1984. pp 568-570. , Pages 645 to 649)

What we can learn from this is that just like the despotic Nero or Henry VIII who debased their currency to enrich their Treasury, Churchill through vainglory and a puffed-up belief in the importance of the role of our nation in the world, sought to overvalue money, leading to a massive outflow of money as people would move their gold to where it was sold for more purchasing power, as Gresham’s law dictates. Also, with all our exports being greatly overvalued, large sections of industry became uncompetitive. Much as I acknowledge Churchill’s greatness in his leadership during the War, his conduct during the Great Depression made it deeper and longer than it should have been via his misuse of the people’s money. Governments have a truly appalling record at pricing money, this is but one example. Glory the gold bugs and we will celebrate the day when hapless politicians have nothing to do with our money. The one thing for sure is that government itself if not responsible enough to have this unique control of our money.

Rockwell: The Gold Standard Never Dies

great article by Lew Rockwell:

John Maynard Keynes thought he had pretty well killed gold as a monetary standard back in the 1930s. Governments of the world did their best to help him. It took longer than they thought. Gold in the money survived all the way to Nixon, and it was he who finally drove the stake in once and for all. That was supposed to be the end of it, and the beginning of the glorious new age of paper prosperity. It didn’t work out as they thought. The 1970s was a time of monetary chaos. What was worth a buck in 1973 is worth only 20 cents today. Stated another way: a dime is worth 2 cents, a nickel is worth a penny, and a penny is worth…nothing at all. It is an accounting fiction that takes up physical space for no reason. Welcome to the age of paper money, where governments and central banks can manufacture as much money as they want without limit. Gold was the last limit. Its banishment as a standard unleashed the inflation monster and leviathan itself, which has swelled beyond comprehension. But guess what? Gold actually hasn’t gone anywhere. It is still the hedge of choice, the thing that every investor embraces in time of trouble. It remains the most liquid, most stable, most fungible, most marketable, and most reliable store of wealth on the planet. It has a more dependable buy-sell spread than any other commodity in existence, given its value per unit of weight. But is it dead as a monetary tool? Maybe not. Whenever the failures of paper become more-than-obvious, someone mentions gold and then look out for the hysteria. This is precisely what happened the other day when Robert Zoellick, head of the World Bank, made some vague noises in the direction of gold. He merely suggested that its price might be used as a metric for evaluating the quality of monetary policy. What happened? The roof fell in. Brad DeLong of Keynesian fame called Zoellick “the stupidest man alive” and the New York Times trotted out a legion of experts to assure us that the gold standard would not fix things, would hamstring monetary policy, would bring more instability rather than less, would bring back the great depression, and lead to mass human suffering of all sorts. One thing this little explosion proved: newspapers, governments, and their favored academic economists all hate the gold standard. I can understand this. The absence of the gold standard has made possible the paper world they all love, one ruled by the state and its managers, a world of huge debt and endless opportunities for mischief to be made from the top down. One of the funniest explosions came from Nouriel Roubini, who listed a series of merits of gold without recognizing them as such: gold limits the flexibility and range of actions of central banks (check!); under gold, a central bank can’t “stimulate growth and manage price stability” (check!); under gold, central banks can’t provide lender of last resort support (check!); under gold, banks go belly-up rather than get bailed out (check!). His only truly negative point was that under gold, we get more business cycles, but here he is completely wrong, as a quick look at the data demonstrates. And how can anyone say such a thing in the immediate wake of one of history’s biggest bubbles and its explosion, which brought the world to the brink of calamity (and it still isn’t over)? Newsflash: it wasn’t the gold standard that gave us this disaster. As Murray Rothbard emphasized, the essence of the gold standard is that it puts power in the hands of the people. They are no longer dependent on the whims of central bankers, treasury officials, and high rollers in money centers. Money becomes not merely an accounting device but a real form of property like any other. It is secure, portable, universally valued, and rather than falling in value, it maintains or rises in value over time. Under a real gold standard, there is no need for a central bank, and banks themselves become like any other business, not some gigantic socialistic operation sustained by trillions in public money. Imagine holding money and watching it grow rather than shrink in its purchasing power in terms of goods and services. That’s what life is like under gold. Savers are rewarded rather than punished. No one uses the monetary system to rob anyone else. The government can only spend what it has and no more. Trade across borders is not thrown into constant upheaval because of a change in currency valuations. Of course the World Bank head was not actually talking about a real gold standard. At most he was talking about some kind of rule to rein in central banks that attempt what the Fed is attempting now: inflating the money supply to drive down the exchange-rate value of the currency to subsidize exports. Still, it’s good that he raised the topic. The Mises Institute has been pushing scholarship and writing about gold since its founding. To be sure, the issue of the gold standard is largely historical, but no less important for that reason. The people who hate the gold standard of the past have no desire for serious monetary reform today. We should be thrilled should the day ever come when monetary authorities really make paper money directly convertible into gold (or silver or something else). I doubt we can look forward to that day anytime soon. But one thing they could let happen right away: free the market to create its own gold standard by permitting true innovation and choice in currency. It’s a fair guess that opponents of the gold standard would oppose that too, because, as Alan Greenspan himself once admitted, the people who oppose gold are ultimately opposed to human freedom. This debate isn’t really about monetary policy, much less the technical aspects of the transition. It is about political philosophy: what kind of society do we want to live in? One ruled by an ever-growing, all-controlling state or one in which people have freedom guaranteed and protected?

Cameron's Misguided Warning To China

In this article about our Prime Minister’s recent trip to China, the journalist warns us as follows

The Prime Minister said China needed to understand what was at stake and he urged its leaders to open its markets. In a speech in Beijing Mr Cameron explained that for the world economy to be able to grow strongly again – in particular the struggling Western economies – China had to start spending more and open its markets. In a reference to the low valuation of the yuan, which has helped China’s exports and allowed it to build up massive reserves of foreign currency, he said: “The truth is that some countries with current account surpluses have been saving too much while others like mine with deficits have been saving too little.” Then “And the result has been a dangerous tidal wave of money going from one side of the globe to the other. We need a more balanced pattern of global demand and supply, a more balanced pattern of global saving and investment.” Addressing students at Peking University, Mr Cameron admitted that China was already moving towards increased domestic consumption and looking at introducing greater “market flexibility into its exchange rate.” But he added: “This cannot be completed overnight, but it must happen. Let’s be clear about the risks if it does not, about what is at stake for China and for the UK – countries that depend on an open global economy.”

Mr Cameron describes the effects of a loose money policy in his nation and other nations of the Western World. No mention is made that our central banks have produced the money in the first place that has created this money “tidal wave.” So he is describing a situation and policy prescription for a horse that has already bolted. Perhaps the best policy would be to stop doing this loose money policy!? There is a core intellectual error associated with this line of thinking, which I wrote about here. I would encourage a re-read of it for anyone who holds the same views as our PM on these matters. I hope he is better advised before he makes such statements in the future.

The Silver Lining in the Fed’s $600 Billion Decision

A good article from Ryan Streeter

The Federal Reserve’s recent decision to buy $600 billion in bonds—another example of the mysteriously named “quantitative easing”—may have the unintended effect of solidifying GOP policy makers behind an economic growth agenda. House GOP Conference Chairman Mike Pence immediately issued a release, as did Republican Study Committee Chairman Tom Price, claiming that the decision was the wrong thing for America. It would devalue the dollar, retard growth, and make us less competitive overall. In an unanticipated development, Sarah Palin burst onto the scene decrying the decision, earning the praise of the Wall Street Journal’s editorial board this morning for her articulate encapsulation of the problem. Palin pointed out that American households will pay more for basics such as food and oil as a result of the Fed’s decision, which—to paraphrase her—will end up working against any recognizable set of economic growth policies.

Read more.

A Third Way: Instant Access By Exception

Come the Revolution, in a free banking world, where there is at least no lender of last resort, commodity backed money with no possibility of over issuing above that commodity in reserve and no deposit insurance, it would be possible for safe deposit accounts and savings accounts where money is lent to borrowers to exist. Both 100% Reserve Free Bankers and Fractional Reserve Free Bankers would be happy thus far. If an instant access demand deposit is offered that is fractional in nature, we get heated debate within the free banking community; the arguments will be familiar to readers of this site. So I am going to throw in a left field ball and see what comes out in debate about what I see as a potential solution to this. I will remain silent on the thread until all comments are in. The Third Type of Account (not named yet, will not use 100% or Fractional in the title due to fear of the verbal abuse that will come forth!) Consider this, a depositor goes into his bank, he is offered a safe deposit account that is safe, but gives no interest, his time preference is such that he wants to earn some interest. The bank worker shows him to his colleague who offers him a savings account. Our depositor loves the rate of interest offered, but notes that he has to put his money away for at least a month, 3,6,9, 18 months, X number of years to get a proceedingly better rate of interest. This does not satisfy our depositor as he wants to have instant access and interest. He wants to have his cake and eat it. He gets taken to see the Third Type of Account manager. This manager says this account is a timed deposit account in nature i.e. your money is locked away for at least a month, 3,6,9 18 months X number of years, but the bank will allow instant access, by exception for the liquidity that it keeps in reserve all the time. However, should there be too much call on liquidity, the bank reserves the right to point out that you the depositor are actually a de jure timed depositor / creditor to the bank for at least a month, 3,6,9 18 months X number of years and are going to he held to the time period you freely signed up to. This third type of account always allows the bank to be reliant on no legal privilege and no accounting standard that is different to other commercial organisation to keep its current and long term creditors whole at all points in time as the creditor in question is in fact a timed depositor who has instant liquidity by exception and not by demand. The reality is this liquidity would be almost at all times there bar the period of bank runs. In fact, dare I say it (I can feel the avalanche of invective building up already) that this is a robust 100% reserve type account form an accounting an legal point of view, with all the benefits of a fractional reserve account of instant access, with none of the inflationary business cycle inducing consequences hotly alleged by the 100% Reserve Bankers.

Hayek vs Keynes @ Buttonwood

Readers, if you saw the first video of Hayek v Keynes and the explanation of their key contributions in the rap format, then watch this Part Two, you will love it. If you haven’t seen the original, I urge you to watch Part One. Enjoy! [youtube height=”600″ width=”620″][/youtube]  

Video of Huerta de Soto's Hayek Lecture

We have previously posted the text of Huerta de Soto’s speech, and an audio recording via Cobden Centre Radio. It was a fantastic event, and I’m pleased that we can now provide a video recording as well: [vimeo height=”400″ width=”620″][/vimeo] LSE Hayek Lecture 2010: Professor Jesús Huerta de Soto from Cobden Centre on Vimeo.  

Huerta de Soto Pays Tribute To Hayek

We were pleased to see this thoughtful and enthusiastic write-up of Huerta de Soto’s Hayek lecture by Andreas Kuersten for the LSE student paper, The Beaver. We reproduce it here by kind permission of the editor.

Last Friday Professor Jesús Huerta de Soto, of the King Juan Carlos University of Madrid, delivered a lecture at the LSE on the recent financial crisis and economic recession.  The event, hosted by Professor Tim Besley of the LSE Economics Department,  was held in honor of the work of former LSE Professor and 1974 Nobel laureate Friedrich von Hayek. Professor de Soto holds doctorates in both Economics and Law from the Complutense University of Madrid and an MBA from Stanford University.  He is considered by many to be one of the principal exponents of the Austrian School of Economics, which is largely influenced by Hayek’s ideas, and some of his notable publications include the books Money, Bank Credit, and Economic Cycles and Socialism, Economic Calculation, and Entrepreneurship. Professor de Soto began his analysis by attributing a great deal of responsibility for modern financial problems to the Bank Charter Act passed on July 19th, 1844 in the United Kingdom.  This was a landmark act that sought to eliminate the boom and bust cycle of markets caused by artificial credit expansions induced by private banks which were financed not by savings but by fiduciary media issued in large amounts.  In essence, credit granted without reserve backing.  The Bank Charter Act required 100 per cent reserve backing for banknotes issued.  Yet it did not address demand deposits, which is money created just on the books of banks but which are still part of the money supply.  Banks therefore diverted their business from issuing banknotes to demand deposits and thus circumvented the act’s requirement for total reserve backing. This sort of financial business has continued, unaddressed, since then and resulted in a six-step process which led to the recent financial crisis. Firstly, consumers are not encouraged to save because banks can issue credit without significant reserve backing. De Soto commented that the lack of savings means that demand for consumer products remains high which causes producers of these products to compete with one another for the means of production. This, according to de Soto, causes a rise in prices of these means. The second step results from an increase in the price of consumer goods at a faster rate than that of the means of production due to consumer producers having to compete so vastly for them. De Soto identified the third step as accounting profits rise in the companies closest to final consumption of products by consumers due to the rising prices. The fourth step occurs as the Ricardo Effect takes hold, an effect meant to occur in an environment of savings and reserve backing to allow production to shift from consumer to capital goods to keep jobs and wages and consumer goods production becomes more expensive.  Instead real wages decrease so companies hire cheap labour rather than investing in capital to replace labour.  Price of capital decreases and further decreases profits of firms further from consumption. The fifth step is an increase in the interest rate as growth stagnates.  Step six then comes as companies farther from consumption incur mounting accounting losses and investment projects are liquidated. After identifying these six critical steps, de Soto commented that their growth ceases and the receivers of banks loans are seen to not be able to pay them back in which case the banks are discovered not to have the reserve backing to absorb and handle the losses.  The banks are shown to be bankrupt and the central bank must step in to stop the collapse of the financial system. In response to this situation Professor de Soto suggests austerity measures to decrease government need for money and then a reduction of taxes on firms which need to concentrate on paying down debt.  All levels of the market also need to be liberalised in order to facilitate easier transition by companies between different sectors depending on profitability. De Soto also outlined a three step process for recovery and prevention.  To begin with, the demands of the Bank Charter Act must be put into law but this time applying to demand deposits and all transactions.  100 per cent reserve backing must be required in all banks dealings.  The next step is to get rid of the inherent socialism of our current financial system by getting rid of central banks.  They succumb to all of the inherent problems of a socialist system noted by Austrian School of Economics scholars. De Soto acknowledged that they are too large and unable to keep track of myriad dealings and types of dealings done by financial actors, follow changes in supply and demand, and are based on an enormous amount of privilege being given to private bankers who engage in fractional reserve dealings.  They cannot coordinate the system. The final step involves privatizing the source of money and replacing modern paper money with the classical gold standard which would ensure 100 per cent reserve backing. One of the more interesting questions put forth by the audience was a challenge to the reversion of the financial system to once again being based on the gold standard despite its links with the Great Depression.  Professor de Soto responded that it was not the gold standard which led to this crisis but the actions of private bankers in seeking to subvert this system by ignoring it and undertaking fractional reserve transactions.  The gold standard system was simply blamed when it failed due to these actions by bankers because it was the system officially recognized, even though it was not being followed. Through his lecture Professor de Soto offered some very radical changes as solutions to the current financial crisis which were quite well received, the audience applauded them loudly.  This was exemplified by spontaneous applause for the suggestion of returning to the classical gold standard.  De Soto presented his arguments very passionately and, overall, they were received very positively by the audience.

Could The World Go Back To The Gold Standard?

Martin Wolf asks “Could the world go back to the gold standard?

During any period of monetary disorder — the 1970s, for example, or today — a host of people calls for a return to the gold standard. This is not the only free-market response to the current system of fiat (or government-made) money. Other proposals are for privatising the creation of money altogether. (See, on this, Leland Yeager, professor emeritus at the University of Virginia and Auburn University, in the latest issue of the Cato Journal.) But the gold standard is the classic alternative to fiat money. It is not hard to understand the attractions of a gold standard. Money is a social convention. The advantage of a link to gold (or some other commodity) is that the value of money would apparently be free from manipulation by the government. The aim, then, would be to “de-politicise” money. The argument in favour of doing so is that in the long-run governments will always abuse the right to create money at will. Historical experience suggests that this is indeed the case.

Wolf’s answer is predictable, but the whole article is worth reading.