I suppose that I wasn’t entirely aware of how hard-core Henry Hazlitt was on the gold question until re-reading The Inflation Crisis and How to Resolve it:
This brings us to gold. It is the outstanding merit of gold as the monetary standard that it makes the supply and the purchasing power of the monetary unit independent of government, of office holders, of political parties, and of pressure groups. The great merit of gold is precisely that it is scarce; that its quantity is limited by nature; that it is costly to discover, to mine, and to process; and that it cannot be created by political fiat or caprice. It is precisely the merit of the gold standard, finally, that it puts a limit on credit expansion.
But there are two major kinds of gold standards. One is the fractional reserve system, and the other the pure gold, or 100 percent reserve, system.
The fractional-reserve system is the one that developed and prevailed in the Western world in the century from 1815 to 1914. It is what we now call the classical gold standard. It had the so—called advantage of elasticity. And it made possible—we might justly say it was responsible for—the business cycle, the recurrent round of prosperity and recession, of boom and bust.With the fractional-reserve system what typically happened was that in a given country—let us say Ruritania—borrowers would be given credit by the banks, in the form of demand deposits, and they would launch upon various enterprises. The new money so created, perhaps after taking up a slack in business and employment, would increase Ruritanian prices. Ruritania would become a better place to sell to, and a poorer place-to buy from. The balance of trade or payments would begin to turn against it. This would be reflected in a fall in the exchange rate of the Ruritanian-currency until the “gold export point” was reached. Gold would then flow out to other countries. in order to stop it, interest rates in Ruritania would have to be raised. With a higher interest rate or a smaller gold base, the volume of currency would be contracted. This would mean a deflation or a crisis followed by a slump.
In brief, the gold standard with a fractional—reserve system tended almost systematically to bring about the cycle of boom and slump…. (p. 172-73)
AGAIN:
“Governments should be deprived of their monopoly of the currency-issuing power. The private citizens of every country should be allowed, by mutual agreement, to do business with each other in the currency of any other country. In addition, they should be allowed to mint privately gold or silver coins and to do business with each other in such coins… The issuers should be required to hold at all times the full amount in metal of the notes they have issued, as a warehouse owner is required to hold at all times everythign against which he has issued an outstanding warehouse receipt, on penalty of being prosecuted for fraud…. As the use of the private currencies expanded, a private gold standard would develop. And because of the restrictions placed on it, it would be a pure, a 100 percent, gold standard. The government fractional-reserve gold standard—which was the classical gold standard—was finally stretched and abused to the point where, in my opinion, it can never be restored by any single national… But this, when one comes to think of it, will be ultimately a tremendous boon. Though people will probably again never trust a fractional-reserve gold standard, they will trust a full gold standard….” (p. 187-88)
{ 23 comments }
I’m glad this was posted. It’s been a while since I’ve studied currency and need to brush up on it.
What little gold and silver I have has already gone up about 10% in a few weeks (yes, weeks). One can only hope that sooner or later we’ll see the period of fiat money as a blunder in history. One can only hope.
Hazlitt was a great popularizer of Austrian economics, but one needn’t be an anarchist to see here that he ceded way too much power to government.
“Governments should be deprived of their monopoly of the currency-issuing power.”
Huh? Why should governments be able to issue any currency at all? If there’s a market demand for currency (which there obviously is), profit-seeking entrepreneurs will provide for it (as indeed was the case through great swaths of European history).
This is like a libertarian saying that government should be deprived of its monopoly on schools, when the salient point should be that government should never have gotten into schooling in the first place.
This isn’t merely a quibble. Government is unlikely to fairly compete in the market, relying as it does on tax support and lawmaking that favors the government sector and its cronies by handicapping the independent competition. And taxpayers shouldn’t have to subsidize such superfluous at best government operations.
“The issuers should be required to hold at all times the full amount in metal of the notes they have issued, as a warehouse owner is required to hold at all times everythign [sic] against which he has issued an outstanding warehouse receipt, on penalty of being prosecuted for fraud….”
Again, a libertarian needn’t be an anarchist to see that it’s unnecessary and an invitation to mischief for the government to regulate the backing of private currencies. Customers can determine for themselves which vendors offer stable, redeemable currencies to fit their needs.
Such regulations as Hazlitt proposes here limit customer flexibility, are apt to be twisted to suit favored cronies, and subsidize incompetent buyers at taxpayer expense.
The word “dollar” derives from the German word *thaler*, the name of an early Renaissance company that reliably issued sound one-ounce silver coins. That company attracted business far and wide because customers could really count on getting an ounce of silver for the thaler coin.
Now that’s the order of the marketplace in action! What Hazlitt implicitly endorses is the partial dismantling of such a system, where taxpayer-underwritten regulators and enforcers are supposed to make the order better but will only succeed in making it worse.
I’m very sceptical about prospects of reintroduction of gold-based currency.
The gold is way too easy to confiscate. And it is too costly to lug around, which would immediately create gold-backed paper and electronic currencies.
And there’s only one very short step from gold-backed to fractional reserve banking – how does anyone know the papers are really 100% gold-backed? The incentives for lying are huge, and so will be the cries of those left holding the bag – calling for the governments to step back in again.
I do not pretend to know the answers, but the fundamentals didn’t change, so the end results will also be similar.
“Huh? Why should governments be able to issue any currency at all? If there’s a market demand for currency (which there obviously is), profit-seeking entrepreneurs will provide for it (as indeed was the case through great swaths of European history).”
Well sure. But whose to say he doesn’t agree with that. If I’m pontificating on how the Fed should get rid of fractional reserve fiat and go to 100% fiat it doesn’t mean I don’t want them also to move towards their own demise and the eventual takeover of purely private monies.
Dude. You just digitise it. Its no problem at all to ‘lug around’.
How rich are you? Not being able to carry all my Gold around is something I’m not anticipating anytime soon.
In transition yes there would be some temptations to cheat. But think of the ongoing situation with prices falling all the time and low nominal yet high real interest rates. There isn’t all THAT much incentive to cheat. But its got to be against the law to do so and they have to be punished if they break the law.
The other thing is that we would keep much more of this stuff at home. The banks would charge us to look after it. And they would have to work hard to get it off us for term loans.
So you have to imagine an entirely different set of assumptions. It would not be like the current situation. They would not be sitting on all our cash and entirely unable to resist the temptation to lend it out.
Any bank that holds gold would have to publish financials, right? Has anyone ever heard of Standard and Poors or Moodys? It is not that bad if private banks lend out gold deposits, as long as everyone (at least depositors) know about it. It could affect their credit rating.
But we don’t want them to lend out money pledged for on-call committments. If they do that then the monetary system is not viable. We can then get recessions and bubbles.
It doesn’t matter what their credit rating is. If they have made committments that they cannot honour then this is fraudulent under that system.
Its not viable under our system either. And the only reason that elephant keeps balancing on its trunk is all the government assistance on hand to keep the banking system from toppling.
I don’t see the problem with “lugging around” precious medals. A few small gold coins in my wallet could meet my entire month’s spending needs, and a few small platinum coins could suffice for most larger transactions. For really big stuff, do the transfer on paper or digitally.
Exactly. And lets not forget the silver.
Hey don’t you think that savings rates would take off with all these Gold, Silver, Platinum and Palladium coins around. I mean it would be so cool you just would be reluctant to part with any of the little critters.
averros and banker,
First off, of course there would be paper gold receipts, and I don’t see the problem of fractional-reserve banking in the absence of gov’t interference.
I do not fear FRB on a free market because the market would set reserve requirements. The most likely scenario is that reserves would be very high, somewhere near 100%. Banks that tried to cheat the market and have low reserves would run the risk of a run and would see their bank ruined.
In a modern, unregualted fractional reserve system, most consumers would inquire about their bank’s Reserve requirement, much like they inquire about an interest rate.
Roger M:
Bastiat was right to distinguish between money and wealth, but he also knew that gold is money precisely because it is a good that, for millennia, has best served as a medium of exchange.
That said, ALL, money is an “illusion” in that it is purely a function of people’s faith in it. Take away the faith, and you take away the money. Yet since civilization as we know it is impossible without money, when people lose faith in whatever currency they are presently using, where do they turn? No less than Alan Greenspan had the answer when he testified before Congress in 1999 as follows: “Gold still represents the ultimate form of payment in the world. Fiat money, in extremis, is accepted by nobody. Gold is always accepted.”
In other words, when push comes to shove, if you don’t have wealth, you’d better have gold, as it’s ultimately the next best thing: real money.
As for the World Gold Council, it is to gold what the World Bank is to banking: a fraud of the first order. And if you think that “the US has the largest stash of gold of any country in the world,” think again. According to the Gold Anti-Trust Action Committee — http://www.gata.org/gold_reserves.html — “Hard as it is to fathom, it appears that much of America’s gold is essentially gone or in severe jeopardy.”
Perhaps you’re just naive, but I rather think you have an undeclared interest in the status (as in statist) quo.
David,
I think you meant to post on the other thread about trade deficits, but I’ll respond here anyway. The money illusion Bastiat wrote about had nothing to do with gold vs. paper money. You really should read him; he’s great! Bastiat referred to gold when he wrote about money. The money illusion is that gold is wealth. It’s not. An abundance of goods and services is wealth. In Bastiat’s day, the French were upset that their gold was leaving the country in exchange for goods and they thought they were becoming poorer because of it.
As for GATA, I wouldn’t trust them. They’re conspiracy theorists.
Maybe I’m neither naive nor a statist, but just right!
Do not worry about what to do with gold and how to issue out currency. Banks naturally take care of that. They issue their own currencies relating to their deposits of gold. In the 19th century banks would advertise their reserve rates and it was common to show potiential depositors the vault containing the gold.
During the gold standard days there were fewer bank failures and significantly less inflation.
Twice in the history of the US, the government disbanded the central bank and ran without a currency. (The second time the central bank tried to wreck the economy to prove the country needed it.) Unfortunately both times the appitite for power by the central government with its large propaganda and coersive resources took back the monopoly on currency.
Roger,
I’d say your mistrust is misplaced — http://www.financialsense.com/editorials/murphy/2006/0310.html — but so be it. If perchance we meet on the other side of the self-consuming fiat fandango, I hope you will have seen the light in time to fill your pockets with real money.
Then again, maybe you’ve already got a sufficient store of goods and services (though I don’t know how you store things like haircuts) that real money won’t be necessary.
David,
What good will gold do you if there’s nothing to buy because production shut down?
David,
Also, I’ve read all about the conspiracy of central banks to keep the price of gold down, and I’ve read the opposite side. I think the conspiracy theorists have taken comments out of context. Besides, if the conspiracy were real, why have they failed in the past 3 years?
Roger,
“What good will gold do you if there’s nothing to buy because production shut down?”
Barring nuclear Armegeddon, I have no idea how that could possibly be the case, but amid such an extreme scenario, subsistence would lead to barter, which in turn would lead to monetary exchange.
The world would start over, in other words, with gold eventually reasserting itself.
As for gold price suppression, it would appear that the jig is finally up, as the conspirators are all but out of ammo.
Conspiracy or not, however — and if THIS wasn’t a conspiracy, I don’t know what a conspiracy is: http://www.wealth4freedom.com/creature.htm — I do but quote Nobel Laureate in economics Robert Mundell in his 2000 acceptance speech:
“The absence of gold as an intrinsic part of our monetary system today makes our century, the one that has just passed, unique in several thousand years.”
Nick Bradley: In a modern, unregualted fractional reserve system, most consumers would inquire about their bank’s Reserve requirement, much like they inquire about an interest rate.
Haha. Yeah, right! “Excuse me, Mr. Bank Manager, but would you mind telling me how much fraud your bank commits?” “Certainly, sir! We’re only 8% fraudulent!”
Roger M: As for GATA, I wouldn’t trust them, They’re conspiracy theorists.
Well, they’re “conspiracy theorists” with plenty of powerful evidence, and high-placed persons in positions to know forced to admit they’re right…
“It’s not paranoia if they really are out to get you”, as they say.
“What good will gold do you if there’s nothing to buy because production shut down?”
On these questions I break ranks with the Austrians. In that I think Rothbards Big Bang transition might be a little risky now. It was probably still viable when he suggested it but with the information revolution it might be a little bit risky.
“What good will gold do you if there’s nothing to buy because production shut down?”
Your question only relates to transitional problems. We get the transition right and your question is meaningless.
See other like threads for how to go about moving on a smooth transition.
In response to “averros” who said that gold is too heavey to carry around, consider this: at today’s gold prices, a refrigerator would cost somewhere between 1 and 2 gold ounces. (2 ounces being the price for a pretty high end fridge, 1 oz. for a more compact, economy model.) A week’s groceries would cost me something less than 1/4 oz. I don’t mind carrying a coin the size of a quarter to the grocery store to do my weekly shopping, and getting back change to boot.
I vote for 100% gold currency and no paper, period.
I just don’t quite understand how you could return to gold standard, despite the fact it sounds theoretically very much desirable.
No government can possibly promise at once to back its currency at actual market prices, because as it has been said… gold owners would become very quickly the richest people on the planet as an accidental consequence. The only way I can figure is thus perhaps, if ALL governments would agree to make all actual private possession of gold illegal at FIRST, forcing owners to accept certificates of ownership for their real gold and THEN, practically devaluate GOLD certificates as to re-establish the link between currency and scarce metal. BUT, how would you want to guarantee that someone doesn’t hide an old gold tooth in the back of his mouth somewhere, hoping for trading it later at real prices? So that doesn’t really work.
How could it possibly work though?
oops please forget about that rubbish post, I was just dreaming!
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