There is no reason, technically or economically, why
the world today, even with its countless wide-ranging and complex
commercial transactions, could not return to the gold standard and
operate with gold money. The major obstacle is ideological.
Many people believe that it would be impossible to
return to the gold standard - ever! There are just too many people in
the world, they say, and the economy is too complex. Many others look on
a return to the gold standard as an almost magical solution to today's
major problems-big government, the welfare state, and inflation. What is
the truth of the matter?
Certainly if the United States went on a gold standard,
it would have to carry out many reforms. The federal government would
really have to stop inflating, balance its budget, and abandon welfare
state programs. Most voters are not ready for such reforms. And
politicians, pressured by voters and special interest groups for favors,
hesitate to pass them. Thus the major stumbling block to monetary reform
is ideological. If this basic obstacle could be overcome, however, a
return to gold money would become a realistic possibility.
Let's consider possible ways for transforming our
present paper and credit monetary system, based on fractional reserve
banking, into a gold standard. There may be better ways and worse ways.
Unfortunately the science of economics cannot prescribe a correct,
scientific or "right" way. It can only help us choose among alternatives
by analyzing their various consequences. A review of monetary history
will also be helpful.
Several methods have been suggested for returning to a
gold standard. All gold standard advocates agree that the goal must be
to re-introduce gold as money, while making it possible to continue
honoring outstanding contracts. The principal point on which they differ
is with respect to the price that should be set for gold and how any
existing paper currency should be defined.
The question of re-adopting gold as money always arises
because inflation has persisted for some time, prices of almost
everything, including gold, have risen, and the savings of the people
have been eroded. Some gold standard proponents want to return to the
pre-inflation gold/money ratio. Others want to raise the gold price to
some arbitrary figure and allow the monetary expansion to play
"catch-up." Still others say that the least disruptive way would be to
discover the current market gold/money ratio and redefine the dollar on
that basis.
Returning to Gold at an Artificially High Rate
Great Britain suspended specie payments in 1797 and
inflated during the Napoleonic Wars. She finally returned to the gold
standard in 1821, 24 years later. On the theory that it was only
honorable to recognize debts made in British gold pounds at the old
ratio, she re-established the 1797 gold/pound ratio. However, not all
the debts outstanding in 1821 dated from before 1797. Many loans had
been made in the interim. Persons who had borrowed relatively cheap
inflated British pounds, then had to pay back their loans in
higher-valued gold pounds. This worked a special hardship on tenants,
farmers, merchants and others. Britain abandoned the gold standard again
in World War I. Before 1914, London had been the world's financial
center. When the war started in August, shipments to England of gold,
silver, and goods from all over the world were immediately disrupted.
The shortage of funds put London's banks and stock exchange in crisis
and they closed down for a few days. When they reopened, a debt
moratorium was declared and the Bank Charter Act of 1844, fixing the
gold/ pound ratio and tying the quantity of paper pounds issued to the
gold bullion reserves, was suspended. As the war continued and the
government's costs increased, the government inflated more and more. By
1920, after the war was over, inflation had proceeded to such an extent
that prices had tripled and the gold value of the British pound had
fallen 10 percent on world markets, from US$4.86 to US$4.40.
Faced with a devalued pound that was worth less on the
market than it had been, the British again chose, as they had after the
Napoleonic wars, to try to return to gold at the pre-war, pre-inflation
rate. On April 28, 1925, England went back on the gold standard at the
artificially high rate for the pound of US$4.86. The immediate effect
was to price British goods out of the world market. For instance, U.S.
importers who had been paying US$4.40 to buy a British pound's worth of
British wool or coal, now had to pay about 10 percent more. England was
heavily dependent on exports, especially of coal, to pay for imported
food and raw materials for her factories. As the cost of her goods to
foreign buyers went up, they could buy less and British exports
declined. Her factories and mines were hard hit. To keep the factories
and mines open and men working, money wages would have had to be
adjusted downward. This drop in money wages would not necessarily have
affected real wages for, with the return to gold, the pound was worth
more. But the unionized workers resisted and refused to work for less.
Many went on the dole. And many went out on strike. Prices and
production were seriously disrupted. Finally, on September 20, 1931,
England announced that she would again suspend gold payments and go off
the gold standard. The consequences were disastrous. The British
monetary experiment played an important role in bringing about and
prolonging the world depression of the 1930s.
Returning to Gold at an Artificially Low Rate
To consider returning to the gold standard in the
United States at the long-since outgrown ratios of $20.67, $35.00, or
even $42.42 per ounce of gold is obviously completely unrealistic. The
U.S. dollar is now selling (mid-1995) at about $385 so that the value of
the dollar has declined to approximately 1/385th of an ounce of gold. To
re-value it at 1/20th, 1/35th or even 1/42nd of an ounce of gold would
constitute an artificially high revaluation of the dollar and would
undoubtedly lead to even more disastrous consequences than those
resulting from the return to gold in Britain in 1925.
Realizing the problems England encountered in trying to
establish an artificially high dollar/gold ratio, some gold standard
advocates go to the opposite extreme and suggest an artificially low
ratio. We are free, they maintain, to select any definition of the
dollar we want. They then suggest dividing the quantity of gold
mathematically by the total number of dollars in circulation, in
commercial bank deposits, in checking accounts, and even in cashable
savings accounts. By this method they arrive at several possible prices
for the dollar, respectively $1,217/ounce, $2,000/ounce, $3,350/ounce,
or even $7,500/ounce. Given the fact that an ounce of gold has been
trading on the world market at about US$385, offering to pay any of
these higher prices for a single ounce of gold would have an extremely
inflationary influence. Prices would start to climb until they reflected
the new dollar/gold ratio. For instance, anything that cost the
equivalent of one gold ounce in today's market would soon rise to
$1,217, $2,000 or whatever.
An announcement that the U.S. planned to start paying
something between $1,217 and $7,500 for an ounce of gold would
immediately lead to the import of gold into this country at an
unprecedented rate. It would spark a tremendous increase in gold mining,
gold processing, and all related activities, to the detriment of all
other production. To attempt to return to a gold standard at any such
rate would be extremely disruptive of all prices and production. It
would also destroy completely the value of all dollar savings and all
outstanding contracts or commitments expressed in U.S. dollars. As
practically all international production and trade depend on the dollar,
this would bring business transactions to a halt worldwide.
Returning to Gold at the Market Rate
The goal of returning to a gold standard must be (1) to
reintroduce gold and gold coins as money, without producing deflation
and without causing the economy to go into shock, while permitting the
fulfillment of outstanding contracts, including those of the U.S.
government to its bondholders, and (2) to arrange for the transfer of
gold from the government's holdings into private hands, so that gold
coins would be in circulation daily. As pointed out above, before this
can happen, there must be a major ideological shift in the climate of
opinion. The voters must be willing to be more self-reliant and accept
personal responsibility for their actions. And the politicians must
refrain from asking for more government spending at every turn. If this
ideological stumbling block to establishing a gold standard could be
overcome, if the people were willing to forgo welfare state spending and
were determined to reform their monetary standard and introduce gold
money once more in the United States, and if politicians would
cooperate, then a shift from our paper and credit monetary system could
be accomplished without radically disrupting the market, prices, and
production.
Advocates of the gold standard should not be deterred
by the three reasons given by critics who believe a gold standard could
not work: that there isn't enough gold to serve the needs of the world,
with its increasing population and its expanding production and trade;
that gold would be an unstable money; and that a gold standard would be
expensive.
In the first place, there is no shortage of gold. The
size of the world's population, and the extent of production and trade
are immaterial; any amount of money will always serve all society's
needs.1 Actually, people don't care about the number of
dollars, francs, marks, pesos, or yen, they have in their wallets or
bank accounts; what is important to them is purchasing power. And if
prices are free and flexible, the available quantity of money, whatever
that may be, will be spread around among would-be buyers and sellers who
bid and compete with one another until all the goods and services being
offered at any one time find buyers. In this way, the available quantity
of money would adjust to provide the purchasing power needed to purchase
all available goods and services at the prevailing competitive market
prices.
In the second place, gold would be a much more stable
money than most paper currencies. The purchasing power of government -
or bank-issued paper currency may fluctuate wildly, as the quantity is
expanded or contracted in response to the "needs" of business and/or
political pressures, causing prices to rise or fall sharply. Under a
gold standard, there would be some slight cash-induced price increases
when the quantity of gold used as money rose, as more gold was mined,
refined, and processed; and there would be some slight cash-induced
price declines as the quantity of gold used as money fell, when gold was
withdrawn from the market to be devoted to industry, dentistry, or
jewelry. However, under a gold standard, price changes due to such
shifts in the quantity of money would be relatively minor and easy to
anticipate, and the purchasing power per unit of gold would be more
stable than under an unpredictable paper currency standard.
In the third place, although it would cost more to
introduce gold into circulation than a paper currency that requires no
backing, in the long run a gold standard is not at all expensive as
compared to paper. Again and again throughout history, paper moneys have
proven to be extremely wasteful and expensive; they have distorted
economic calculation, destroyed people's savings, and wiped out their
investments. Yale economist William Graham Sumner (1840-1910), writing
long before the world had experienced the disastrous inflations of this
century, estimated that "our attempts to win [cheap money] 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." 2
Once it is agreed that the introduction of a market
gold money standard is the goal, here are the steps to take:
First: All inflation must be stopped as of a
certain date. That means calling a halt also to all expansion of credit
through the Federal Reserve and the commercial banks.
Second: Permit gold to be actively bought, sold,
traded, imported, exported. To prevent the U.S. government from exerting
undue influence, it should stay out of the market for the time being.
Third: Oscillations in the price of gold would
diminish in time and the "price" would tend to stabilize. At that point
a new dollar-to-gold ratio could be established and a new legal parity
decreed. No one can know what the new dollar-to--gold ratio would be.
However, it is likely that it would stabilize a little above the
then-current world price of gold, whatever that might be.3
Fourth: Once a new legal ratio is established
and the dollar is newly defined in terms of gold, the U.S. government
and the U.S. Mints may enter the market, buying and selling gold and
dollars at the new parity, and minting and selling gold coins of
specified weights and fineness. Gold might well circulate side by side
with other moneys, as it did during the fiat money inflation time of the
French Revolution, so that parallel moneys would develop, easing the
transition to gold. 4
Fifth: The U.S. Mint should mint gold coins of
certain agreed-upon fineness and of various weights-say one-tenth of an
ounce, one--quarter, one-half, and one ounce, etc. and stand ready to
sell these gold coins for dollars at the established parity and to buy
any gold offered for minting.5 As old legal tender dollars
were turned in for gold, they should be retired, so that gold coins
would gradually begin to appear in circulation.
Sixth: The financing of the U.S. government must
be divorced completely from the monetary system. Government must be
prevented from spending any more than it collects in taxes or borrows
from private lenders. Under no condition may the government sell any
more bonds to the Federal Reserve to be turned into money and credit;
monetization of the U.S. government's debt must cease! A 100 percent
reserve must be held in the banks for all future deposits, i.e., for all
deposits not already in existence on the first day of the reform.
Seventh: Outstanding U.S. government bonds held
by non-U.S. government entities, must be fulfilled as promised.
6
Eighth: To avoid deflation, there should not be
any contraction of the quantity of money currently in existence. Thus
prices and outstanding debts would not be adversely affected. U.S.
government bonds held by the Federal Reserve as "backing" for Federal
Reserve notes may be retained, but should not be used as the basis for
further issues of notes and/or credit. No bank may be permitted to
expand the total amount of its deposits subject to check or the balance
of such deposits of any individual customers, whether private citizen or
the U.S. Treasury, otherwise than by receiving cash deposits in gold,
legal tender banknotes from the public or by receiving a check payable
by another bank subject to the same limitations.7
Ninth: The funds collected over the years from
employees and employers, ostensibly for Social Security, were spent as
collected for the government's general purposes. Thus the U.S.
government bonds held as a bookkeeping ploy in the so-called Social
Security Trust Fund are mere window-dressing. These U.S. bonds may be
canceled. To keep its "promises" to those who have been led to expect
"Social Security" benefits in their old age, arrangements could be made
to phase out the program by a number of devices, including payments from
the general tax fund to current retirees, to the soon-to-be-retired and,
on a gradually declining basis, to others in the system down to, say,
ages 40-45 years. The program could then be closed down. No more Social
Security "benefits" would be paid out and no more taxes would be
collected for "Social Security." People would have to become personally
responsible for planning for their own old age and retirement. Without
"Social Security" taxes to pay, they would be better able to save.
Moreover, given a sound gold standard, they would be confident that
their savings would not be wiped out by inflation.
After the Reform
For U.S. monetary reform to be carried out it is
essential that the U.S. government balance its budget and refrain from
spending more than it collects from taxes and borrows from willing
lenders. The prerequisite for this, as noted above, is a change in
ideology. Once the public and the politicians were determined to cut
government spending, reform would become a realistic possibility.
When the United States is again on a gold standard, the
old legal-tender paper money could continue to circulate until worn out
when it would be returned and replaced by gold coins. New issues of
paper notes would not be designated "legal tender." But they should be
strictly limited, always fully convertible into gold, and issued only
against 100 percent gold. Gold coins would also be in daily circulation;
should they start to disappear from the market, this would serve as a
warning that the government was violating its strictures and starting
once more to inflate.
Those who think that a gold standard would place such
rigid limits on the market that money lending would no longer be
possible should be reminded that what fully convertible money precludes
is not money lending per se. Individuals and banks would, of course,
still be able to lend, but no more than the sums savers had accumulated
and were willing to make available. What the gold standard prevents is
the involuntary lending by savers, who are deprived in the process of
some of the value of their savings, without having any choice in the
matter. Fully convertible money under the gold standard prevents more
than one claim to the same money from being created; while the borrower
spends the money borrowed, the savers forgo spending until the borrower
pays it back.
Under the gold standard, banks would have to return to
their original two functions: serving as money warehouses and as money
lenders, or intermediaries between savers and would-be borrowers. These
two functions - money--warehousing and money-lending - should be kept
entirely separate. But that will not preclude a great deal of
flexibility in the field of banking. With today's modern developments,
computerized record-keeping, electronic money transfers, creative ideas
about arranging credit transactions, credit cards, ATM machines, and so
forth, lending and borrowing, the transfer of funds and money clearings
could continue to take place rapidly and smoothly under the gold
standard and free banking, even as they do now. However, under a market
gold standard people need no longer fear the ever-impending threat of
inflation, price distortions, economic miscalculations, and serious
malinvestments.
At the time of the original publication, Mrs. Greaves,
FEE's resident scholar, based this proposal on the understanding and
recommendations presented in the writings of of Hans F. Sennholz,
Henry Hazlitt, Percy L. Greaves, Jr., and Ludwig von Mises.
1. "No Shortage of Gold," Hans F. Sennholz, The
Freeman, September 1973, pp. 516-522; "How Much Money," Bettina Bien
Greaves, The Freeman, March 1994, pp. 131-134.
2. "History of Banking in the U.S.," The Journal of
Commerce and Commercial Bulletin, 1896, p. 472.
3. The present, mid-1995, price is in the neighborhood
of US$385.
4. Louis Adolphe Thiers, History of the French
Revolution, 7th ed. Brussels, 1838, Vol. V, p. 171; Henry Hazlitt, The
Inflation Crisis, and How to Resolve It, Arlington House, 1978, pp.
176-178, 187-188.
5. In 1986, the U.S. government began to mint one-ounce
91.67 percent pure gold Eagles, which were labeled "Fifty Dollars but
were sold at a mark-up over the then-current world gold price. If it
continued to mint such one ounce coins, however, it would seem
preferable to label them in ounces rather than dollars.
6. Daniel J. Pilla, "Should We Cancel the National
Debt?" in The Freeman, November 1995, pp. 684-688.
7. Ludwig von Mises, The Theory of Money and Credit,
Yale, 1953, pp. 448-452; Liberty Fund, 1981, pp. 490-495.
Reprinted with permission from The
Freeman, a publication of the Foundation for Economic Education, Inc.,
November 1995, Vol. 45, No. 11.
Yourname@libertyhaven.com
