RECENT ECONOMIC Developments reflect and portend the
painful convulsions of our flat money system. The federal government is
projecting a budget deficit of $34.7 billion for fiscal 1975 and a
deficit of $51.9 billion for fiscal 1976. The U.S. Congress can be
expected to boost federal spending even further which, together with the
growing deficits of such "off-budget" agencies as the Postal Service and
the Environmental Protection Agency, may raise the total federal deficit
to more than $100 billion. State and local government deficits are
making additional demands for economic resources. To finance such
deficits out of the savings of the American people is well-nigh
impossible. Therefore, the federal government may be expected to rely
increasingly upon its monetary arm, the Federal Reserve System. Only
hyper-inflation can finance super deficits.
A budgetary deficit is not just a temporary shortage of
money that is readily covered by a loan. It is not primarily a monetary
phenomenon that is efficiently handled by monetary authorities and
bankers. Instead, a federal deficit means consumption of economic
resources - real goods and services - beyond those taken directly from
taxpayers. It consumes the real wealth and substance of savers who
directly or indirectly buy the new Treasury obligations. The coming $100
billion deficit, in fact, greatly exceeds the annual savings of the
American people, which were estimated to be $74.4 billion in 1973 and
$76.7 billion in 1974. (Federal Reserve Bulletin, February, 1975, P.
57).
Redistributing Wealth
Whenever our savings are consumed by government, they
obviously can no longer be used by individuals who would build or buy
homes, household appliances, or make some other improvements. More
facilities of production are used to serve government demand, fewer are
left to cater to private demand. As the U.S. Treasury enters the capital
market to sell its bills, notes and bonds, it absorbs and consumes the
very substance of economic productivity. Its capital demand is felt as a
chronic lack of capital for industry and commerce, for public utilities,
for development of more energy, modernization and renovation and new
production facilities. It is felt as a universal "shortage of funds"
which, in reality, is a shortage of real savings and economic resources.
Plagued by such shortages and enmeshed in serious economic difficulties
and crises, the federal government then calls on the Federal Reserve
System to alleviate the shortages through credit expansion and money
creation. Tons of new paper money are thus to take the place of real
goods that are consumed by our political organizations.
The inevitable rise in prices of goods, commonly called
inflation, then serves to withdraw the resources from certain
individuals and redirects them to the spender with the newly created
purchasing power, the federal government. Inflation acts as a federal
tax on all holders of money and claims to money. It silently and
efficiently transfers real income and wealth from millions of
individuals to the inflating government. Nor do most of the victims
understand the nature of this taxing process. After all, rising prices
can be blamed on merchants and industrialists, thus exculpating the
government that is withdrawing and consuming the economic resources. The
very administration that is conducting such policies may even blame
businessmen for the inflation and proceed to impose price and wage
controls on its victims.
A Tool of Politics
In the coming years of galloping inflation the American
people may come to understand the true nature of the fiat system that
makes government the creator and guardian of money. They may learn what
the defenders of gold as money knew all along, that fiat money is
political money - an effective tool for the financial aspirations of
political parties and administrations. Fiat money serves as an important
implement, not only for such policies as "full employment" and "economic
growth," but also for massive redistribution of economic wealth from
creditors to debtors. Fiat money is the political device ideally suited
to achieve the transfer of income and wealth on a gigantic scale.
Inflation that gradually erodes the capital substance
of the middle class can be effective in the fog of political confusion
and economic ignorance. In a few years of double-digit inflation, the
savings bonds, pension funds, life insurance policies and even corporate
stock holdings which constitute the very substance of the middle class,
are consumed by government or transferred into the possession of
debtors. Massive deficits financed by double-digit inflation thus
sustain the redistributive society that heretofore depended mainly on
confiscatory taxation of its richer members,
The proceeds of inflation as a tax on monetary assets
accrue not only to the government that is actively inflating the
currency but also to all other debtors, including corporations and
individuals. When the dollar depreciates, all creditors lose while all
debtors gain, whether they are political organizations or corporations.
Economic property is redistributed universally f rom a large class of
victims, commonly the middle class, to the political institutions and a
new class of nouveaux riches, which is enjoying the fall-out effects of
inflation. We need not emphasize here that such policies create new
sources of economic conflict and social strife.
Yearning for Stability
The yearning of the people of America for "stable
money" is a natural reaction to the painful experience of unprecedented
instability. The task of philosophers, jurists, historians, and
economists is to explain the alternative to the fiat system, to teach
the virtues and advantages of natural money which is also honest money.
If people who work and trade are free to choose between political fiat
and gold or silver, they naturally turn to the precious metals. They
choose the gold standard as a monetary system in which gold is proper
money and all paper moneys are merely substitutes that are payable in
gold. This makes the U.S. dollar a piece of gold of a certain weight and
fineness.
But it is a popular mistake that is shared by many
historians and economists alike that the gold standard affords monetary
stability and that gold coins are endowed with unchanging purchasing
power. In a changing world of human action, no money can be neutral or
stable. Even a 100 per cent hard-money gold standard, in which the
currency of each country would consist exclusively of gold, cannot
afford stability of purchasing power to its gold coins. Just as the
price of an economic good is ultimately determined by the subjective
valuation of buyers and sellers, so is the purchasing power of money.
Individual valuation of money is subject to the same considerations of
demand and supply as that of all other goods and services. People expend
labor or forgo the enjoyment of other economic goods in order to acquire
money. At times they bid for money, at other times they offer money, and
all this bidding and offering ultimately determines the purchasing power
of money in the same way as it determines the mutual exchange ratios of
other goods.
All plans to make money stable are contradictory to
human nature and dangerous to individual freedom, as they would call on
government to enforce the impossible. The yearning for "stable money,"
therefore, is forever futile unless it means to want honest money that
is free from the political processes of public treasuries and central
banks. The best we can hope for is monetary freedom that embodies the
freedom of contract and choice of money. In freedom, the American people
once again could express their preference for gold and silver coins over
depreciating political fiat.
A Crucial Choice
Our choice of a monetary system is of crucial
importance. Do we want a system in which government creates and manages
money through the political process? Or do we prefer to leave that
choice to acting people who are exchanging goods and services on the
market? If we rely on government we must be prepared to live with
government fiat, which is ideally suited to serve political ends. Fiat
money can be expanded or contracted at will, always accommodating the
national policy of the moment. Above all, it can be inflated at will to
supplement government revenue.
On the other hand, if buyers and sellers are free to
make the selection they may choose a great variety of marketable goods
as their media of exchange. In the past, in a selective process
extending over several thousand years, they chose the precious metals,
gold and silver, as their money. Are they no longer to be trusted with
such freedom of choice?
Government need not establish the gold standard by any
conscious or deliberate act. In fact, the gold standard needs neither
rules nor regulations, no legislation or government control, merely the
individual freedom to own gold. Of course, this freedom of gold
ownership embodies the freedom not only to buy and sell gold for use in
industrial production, but also to employ it in exchange.
The gold-coin standard means sound money. It is true,
it cannot achieve the unattainable ideal of an absolutely stable
currency. But it protects the monetary system from the influence of
governments. The quantity of gold in existence is utterly independent of
the wishes and manipulations of government officials and politicians,
parties and pressure groups. There are no arbitrary "rules of the game,"
which people must learn to observe. The gold standard is a social
institution that is controlled by inexorable economic law.
Fully Redeemable
The issuers of money substitutes keep their currencies
at par with gold through unconditional redemption. The issuing bank can
buy any amount of gold offered to it at the parity rate, and agrees to
sell indiscriminately and on demand any amount of gold against its notes
or deposits. It thereby renders no national service in the sense of
"defending" or "Protecting" its currency. It merely fulfills the
contract it made when it issued the money substitutes.
Under the gold-coin standard, inflationary policies are
not rendered impossible, but they are made difficult. Redemption
requirements and the threat of drains of their gold reserves would
restrain the issuers of money substitutes from inflationary expansion.
For any such expansion would alarm the owners of substitutes and cause
them to demand redemption in gold coin, which would spell ruin to the
issuer. As the gold standard makes inflationary policies difficult, it
avoids the wide fluctuations of economic activity, known as the business
cycle. This binds the issuers of money substitutes within very narrow
limits, and thus efficiently checks the sort of credit expansion that
creates great instability and generates the economic boom and bust
cycle.1
Professor William Graham Sumner, the great Yale
economist of the pre-Federal Reserve era, described the instability of
irredeemable paper currency as follows: "Scheme after scheme has been
proposed and tried for realizing the gain which it was believed that
cheap money could produce for the public; that is, for those who buy and
use currency. This gain has been pursued as the alchemists pursued the
philosopher's stone, by trial and failure. Whether there be any such
gain or not, our attempts to win it have all failed, and they have cost
us, in each generation, more than a purely specie currency would have
cost, if each generation had had to buy it anew. . . . The revulsion-,
to which the system was subject overwhelmed us in every decade. The
notions on which the system was based are proved to have been delusion,
disastrous to everybody concerned, including those who tried to profit
by them,"2
A World Market
The international gold standard evolved without
intergovernmental treaties and institutions. No one had to make the gold
standard work as an international system. When the leading nations of
the world had adopted gold as their currency, the world had an
international money. It is true, the coins bore different names and had
different weights. But this hardly mattered as long as they consisted of
gold and could be exchanged freely. After all, an ounce of gold is an
ounce of gold whether it consists of eagles or sovereigns.
The gold standard united the world as it overcame the
problem of international payments. It facilitated international trade
and finance, and thereby promoted a world-wide division of labor.
Countries specialized in producing those internationally traded
commodities which afforded them the greatest comparative advantage. But
above all, the gold standard encouraged exportation of capital from the
industrial countries to the backward areas. Without fear of devaluation
losses or transfer restrictions, European capital eagerly sought
profitable employment opportunities on all continents. It developed
commerce and industry and thus improved working and living conditions
all over the globe.
The history of the gold standard heralds the principles
and achievements of free and honest money, The history of fiat money is
little more than a register of monetary follies and inflations. Current
affairs afford but another entry in this dismal register. We may hope
for an early return of monetary freedom and sound money, but realization
is hidden in the dark clouds of the future, Sound money is the most
prominent concomitant of economic freedom and morality; fiat money is an
inevitable symptom of their absence.
The duty of each of us is to understand and explain as
best he can the principles of economic freedom and honest money. Our
future depends on it.
At the time of the original publication, Dr. Sennholz
headed the Department of Economics at Grove City College and is a
noted writer and lecturer on monetary and economic affairs.
This
article is published by permission from a paper before a meeting of
the Committee for Monetary Research and Education, March 22, 1975.
1 Ludwig von Mises, Human Action, Yale University
Press, 1949, p. 535 et seq.
2 William Craham Sumner, History of Banking in the
U.S., New York: The Journal of Commerce and Commercial Bulletin, 1896,
p. 472.
Reprinted with permission from The
Freeman, a publication of The Foundation for Economic Education, Inc.,
June, 1975, Vol. 25, No. 6.
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