MANY ECONOMISTS seem to agree on the virtues of the
gold standard. It limits the power of governments or banks to create
excessive amounts of paper currency and bank deposits, that is, to cause
inflation. And it affords an international standard with stable patterns
of exchange rates that encourage international trade and investments.
But the same economists usually reject it without much hesitation
because of its assumed disadvantages.
The gold standard, they say, does not allow
sufficient flexibility in the supply of money. The quantity of newly
mined gold is not closely related to the growing needs of the world
economy. If it had not been for the use of paper money, a serious
shortage of money would have developed and economic progress would have
been impeded. The gold standard, they say, also makes it difficult f or
a single country to isolate its economy from depression or inflation in
the rest of the world. It does not permit exchange rate changes and
resists government controls over international trade and payments.
It is true, the gold standard makes it difficult to
isolate one country from another. After all, the common currency that is
gold would invite exchanges of goods and services and thus thwart an
isolationist policy. For this reason, completely regimented economies
cannot possibly tolerate the gold standard that springs from economic
freedom and inherently resists regimentation. It is true, the gold
standard also exposes all countries that adhere to it to imported
inflations and depressions.
But as the chances of any gold inflation-and
depression that would follow such an inflation - are extremely small,
the danger of contagion is equally small. It is smaller by far than with
the floating flat standard that suffers frequent disruptions and
uncertainties, or with the dollar-exchange standard that actually has
inundated the world with inflation and credit expansion.
It must also be admitted that the gold standard is
inconsistent with government controls over international trade and
payment. But we should like to question the objection that the newly
mined gold is not closely related to the growing needs of business and
that a serious shortage of money would have developed without the issue
of paper money. In fact, this popular objection to the gold standard is
rooted in several ancient errors that live on in spite of the
refutations by economists.
Gold in History
There is no shortage of gold today and there has been
no such shortage in the past. Indeed, it is inconceivable that the needs
of business will ever require more gold than is presently available.
Gold has been an item of wealth and a medium of exchange in all of the
great civilizations. Throughout history men have toiled for this
enduring metal and used it in economic exchanges. It has been estimated
that most of the gold won from the earth during the last 10,000 years,
perhaps from the beginning of man, can still be accounted for in man's
vaults today, and in ornaments, jewelry, and other artifacts throughout
the world. No other possession of man has been so jealously guarded as
gold. And yet, we are to believe that today we are suffering from a
serious shortage of gold and therefore must be content with fiat money.
Economic policies are the product of economic ideas.
This is true also in the sphere of monetary policies and the
organization of the monetary system. The advocates of government paper
and foes of gold are motivated by the age-old notion that the monetary
system in scope and elasticity has to be tailored to the monetary needs
of business. They believe that these needs exceed the available supply
of gold, which deprives it of any monetary usefulness and thus makes it
a relic of the distant past.
The Monetary Needs of Business
With most contemporary economists, the notion of the
monetary requirements of business implies the need for an institution,
organization, or authority that will determine and provide the
requirements. It ultimately implies that the government must either
establish such an institution or provide the required money itself.
These writers, in fact, accept without further thought government
control over the people's money. Today, all but a few economists readily
accept the apparent axiom that it is the function of the government to
issue money and regulate its value. Like the great classical economists,
they blindly trust in the monetary integrity and trustworthiness of
government and the body politic. But while we can understand the faith
of Hume, Thornton, and Ricardo, we are at a loss to explain the
confidence of our contemporaries. We understand Ricardo when he
proclaimed that "In a free society, with an enlightened legislature, the
power of issuing paper money, under the requisite checks of
convertibility at the will of the holder, might be safely lodged in the
hands of commissioners . . ."1The English economists had
reason to be proud of their political and economic achievements and
confident in the world's future in liberty. However, it is more
difficult to understand any such naive confidence today. After half a
century of monetary depreciation and economic instability, still to
accept the dogma that it is the proper function of government to issue
money and regulate its value, reflects a high degree of insensibility to
our monetary plight.
A Persistent Fallacy
And yet, the world of contemporary American economics
blindly accepts the dogma. It is true, we may witness heated debates
between the Monetarists and Keynesians about the proper rate of currency
expansion by government, or the proper monetary/fiscal mix of Federal
policy. But when their squabbles occasionally subside they all agree on
"the disadvantages" of the gold standard and the desirability of fiat
currency. They vehemently deny the only alternative: monetary freedom
and a genuine free market.
The money supply needs no regulation; it can be left
to the free market in which individuals determine the demand for and
supply of money. A person wants to keep a certain store of purchasing
power, a margin of wealth in the form of money. It does not matter to
him whether this wealth is represented by a few large units of money or
by numerous smaller units with the same total purchasing power. And he
is not interested in an increase in the number of units if such an
increase constitutes no addition to his wealth. This is not to deny that
people frequently complain about their "lack of money" or their "need
for more money." What they mean, of course, is additional wealth, not
merely more monetary units with smaller purchasing power. But this
popular mode of expression probably has contributed to the spread of
erroneous notions according to which monetary expansion is identical
with additional wealth. Our present policies of inflation seem to draw
public support from this primitive confusion.
More than 200 years ago John Law was victim of this
confusion when he stated that "a larger quantity (of money) employs more
people than a smaller one. And a limited quantity can employ only a
proportionate number." It also made Benjamin Franklin denounce the "want
of money in a country" as "discouraging laboring and handicraft from
coming to settle in it." And it made Alexander Hamilton advocate
currency expansion for the development of the "vast tracts of waste
land." But only additional real capital in the shape of plants and
equipment can employ additional people at unchanged wage rates, or
develop new tracts of land. It is true, even without additional capital,
a market economy readily adjusts to additions in the labor supply until
every worker who seeks employment is fully employed. But in this process
of adjustment wage rates must decline on account of the declining
marginal productivity of labor. Monetary expansion tends to hide this
wage reduction as it tends to support nominal wages, or even may raise
them, while real wages decline.
The "full-employment" economists, such as Lord Keynes
and his followers, recommend monetary expansion because of this very
wage reduction. They correctly realize that institutional maladjustments
may prevent a necessary readjustment and thus cause chronic
unemployment. The labor unions may enforce wage rates that are higher
than the market rates, which inevitably leads to unemployment. Or
political expedience may call for the enactment of minimum wage
legislation that causes mass unemployment. Under such conditions the
full-employment economists recommend monetary expansion as a face-saving
device for both the labor government and labor unions. But while it
alleviates the unemployment, it causes a new set of ominous effects. It
originates the economic boom that will be followed by an other
recession. It benefits the debtors at the expense of the creditors. And
while it depreciates the currency, it causes maladjustment and capital
consumption and destroys individual thrift and self-reliance.
Consequences of Depreciation
In fact, the effects of currency depreciation, no
matter how expedient such a policy may be, are worse than the
restrictive effects of labor legislation and union policies.
Furthermore, monetary expansion as a face-saving device sooner or later
must come to an end. If not soon abandoned by a courageous
administration, it will destroy the currency. If it is abandoned in
time, the maladjustments and restrictive effects of labor legislation
and union policies will then be fully visible.
No matter how ominous and ultimately disastrous this
array of consequences of currency expansion may be, it is immensely
popular with short-sighted and poorly informed people. After all,
currency expansion at first generates an economic boom; it benefits the
large class of debtors; it causes a sensation of ease and affluence; it
is a face-saving device for popular but harmful labor policies; and last
but not least, it affords government and its army of politicians and
bureaucrats more revenue and power than they would enjoy without
inflation. But all these effects that may explain the popularity of
currency expansion do not prove the necessity of expanding the stock of
money for any objective reason. In f act, an increase in the money
supply confers no social benefits whatsoever. It merely redistributes
income and wealth, disrupts and misguides economic production and, as
such, constitutes a powerful weapon of conflict within society.
In a free market economy, it is utterly irrelevant
what the total stock of money should be. Any given quantity renders the
full services and yields the maximum utility of a medium of exchange. No
additional utility can be derived from additions to the quantity of
money. When the stock is relatively large, the purchasing power of the
individual units of money will be relatively small. And when the stock
is small, the purchasing power of the individual units will be
relatively large. No wealth can be created and no economic growth can be
achieved by changing the quantity of the medium of exchange. It is so
obvious, and yet so obscured by the specious reasoning of special
interest spokesmen, that the printing of another ton of paper money does
not create new wealth. It merely wastes valuable paper resources and
generates the redistributive effects mentioned above.
Money is only a medium of exchange. To add additional
media merely tends to reduce their exchange value, their purchasing
power. Only the production of additional consumer goods and capital
goods enhances the wealth and income of society. For this reason, some
economists consider the mining of gold a sheer waste of capital and
labor. Man is burrowing the ground in search of gold, they say, merely
to hide it again in a vault underground. And since gold is a very
expensive medium of exchange, why should it not be replaced with a
cheaper medium, such as paper money?
If gold were to serve merely as medium of exchange,
new mining would indeed be superfluous. But it is also a commodity that
is used in countless different ways. Its mining, therefore, does enrich
society in the form of ornaments, dental uses, industrial products, and
the like. Gold mining is as useful as any other mining that serves to
satisfy human wants.
The Law of Costs Applies to Money
Actually, the great expense of gold mining and
processing assures the limitation of its quantity and therefore its
value. Both gold and paper money are subject to the "law of costs,"
which explains why gold has remained so valuable over the millennia and
why the value of paper money always falls to the level of costs of the
paper. This law, which is so well-established in economic literature,
states that in the long run the market price of freely reproducible
goods tends to equal the costs of production. For if the market price
should rise considerably above cost, production of the goods becomes
profitable, which invites additional production. When more goods are
produced and offered on the market, their price begins to fall in
accordance with the law of demand and supply. Conversely, if the market
price should fall below cost and inflict losses on manufacturers,
production is restricted or abandoned. Thus, the supply in the market is
decreased, which tends to raise the price again in conformity with the
law of supply and demand. Of course, the law of costs does not conflict
with the basic principle of value and price. Their determination
originates in the consumers' subjective valuations of finished products.
The law of costs obviously is applicable to gold.
When its exchange value rises, mining becomes more profitable, which
will encourage the search for gold and invite mining of ore that
heretofore was unprofitable because of low gold content or other high
mining costs. When additional quantities of gold are offered on the
market, its exchange value or purchasing power tends to decline in
accordance with the law of supply and demand. Conversely, when its
exchange value falls, the opposite effects tend to ensue, thus
discouraging further mining.
A Delayed Reaction
That paper money is subject to the law of costs is
vehemently denied by all who favor such money. After all, they retort,
the profit motive does not apply to its production and management. Its
exchange value may be kept far above its cost of manufacture through
wise restraint and management by monetary authorities.
It must be admitted that the law of costs works
slowly on money, more slowly indeed than on other goods. It may take
several decades before the paper money exchange value falls to the level
of manufacturing costs. After all, the fall is rather considerable, from
the value of gold - for which the paper money first substitutes - to
that of the printing paper. Few other commodities ever experience such a
large discrepancy between market value and manufacturing costs when the
law of costs begins to work. But this original discrepancy does -not
refute the applicability of the law; it merely offers an explanation for
the length of time needed for the price-cost adjustment.
It must also be admitted that a certain measure of
restraint prevents an immediate fall of the paper money value to the
level of manufacturing costs. Popular opposition prevents the monetary
authorities from multiplying the quantity of paper issue too rapidly,
which would depreciate its value at intolerable rates and lead to an
early disintegration of the exchange economy. In a democratic society
these monetary authorities and their political employers would soon be
removed from office and be replaced by others promising more restraint.
But no matter who manages the fiat money, the law of
costs is working quietly and continuously. After all, the manufacturers
do profit from a gradual expansion of the money supply. The profit
motive is as applicable to money as it is to all other goods. The only
difference between the manufacturer of fiat money and that of other
goods is the monopolistic position of the former and the normally
competitive limitations of the latter. Who would contend that the
incomes and fortunes of central bankers and the jobs of many thousands
of their employees do not provide a powerful motive for currency
expansion? To stabilize the stock of money is to deny them position and
power and thus income and wealth.
Political Motivation
The profit motive for fiat money expansion is even
stronger with the administration in power and thousands of politicians
seeking the votes of their electorates. Election to high political
office usually assures great personal fortune, prestige, arid power, and
successful politicians quickly rise from rags to riches. But in order to
be elected in a redistributive conflict society, commonly called the
welfare society, the candidate for political office is tempted to
promise his electorate any conceivable benefit. It is true, he may at
first propose to tax the rich members of his society whose few votes may
be ignored. But when their incomes and fortunes no longer yield the
additional revenue needed for costly handouts, called social benefits,
the welfare politician resorts to deficit spending. That is to say, he
calls for currency expansion that facilitates the government
expenditures that hopefully win the vote and support of his electorate
and thus assure his election. When seen in this light, the profit motive
is surely applicable to the manufacture of paper money.
Or, the politicians in power conduct full-employment
policies through easy money and credit expansion. In search of the
popular boom that would assure their re-election, they spend and inflate
and thus set into operation the law of costs. Who would believe that
such policies are not motivated by the personal gains that accrue to the
politicians in power?
But this profit motive must be sharply distinguished
from that in the competitive exchange economy. When encompassed by
competition, the motive is a powerful driving force for the best
possible service to the ultimate bosses, the consumers. It raises output
and income and leads to capital formation and high standards of living.
But in the case of the monopolistic manufacture of paper money by
government authorities, the profit motive finds expression in currency
expansion, which is inflation. In the end, when the law of costs has
completely prevailed and the exchange value of money equals the cost of
paper manufacture, not only the fiat money is destroyed but also the
individual-enterprise private-property order. For inflation not only
bears bitter economic fruits but also has evil social, political, and
moral consequences.
At the time of the original publication, Dr. Sennholz
headed the Department of Economics at Grove City College and was a
noted writer and lecturer on monetary and economic affairs.
1 Ricardo, David. Principles of Political Economy and
Taxation in "The Works and Correspondence of David Ricardo," ed. by
Piero Sraffa, Vol. 1, Cambridge, 1951, p. 362.
Reprinted with permission from The
Freeman, a publication of The Foundation for Economic Education, Inc.,
September, 1973, Vol. 23, No. 9.
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