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This essay
originally appeared in a newsletter called The Objectivist published in 1966 and was
reprinted in Ayn Rand's "Capitalism:
The Unknown Ideal"
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An almost hysterical
antagonism toward the gold standard is one issue which unites statists of all
persuasions. They seem to sense - perhaps more clearly and subtly than many
consistent defenders of laissez-faire - that gold and economic freedom are
inseparable, that the gold standard is an instrument of laissez-faire and
that each implies and requires the other.
In order to understand
the source of their antagonism, it is necessary first to understand the
specific role of gold in a free society.
Money is the common
denominator of all economic transactions. It is that commodity which serves
as a medium of exchange, is universally acceptable to all participants in an
exchange economy as payment for their goods or services, and can, therefore,
be used as a standard of market value and as a store of value, i.e., as a
means of saving.
The existence of such a
commodity is a precondition of a division of labor
economy. If men did not have some commodity of objective value which was
generally acceptable as money, they would have to resort to primitive barter
or be forced to live on self-sufficient farms and forgo the inestimable
advantages of specialization. If men had no means to store value, i.e., to
save, neither long-range planning nor exchange would be possible.
What medium of exchange
will be acceptable to all participants in an economy is not determined
arbitrarily. First, the medium of exchange should be durable. In a primitive
society of meager wealth, wheat might be
sufficiently durable to serve as a medium, since all exchanges would occur
only during and immediately after the harvest, leaving no value-surplus to
store. But where store-of-value considerations are important, as they are in
richer, more civilized societies, the medium of exchange must be a durable
commodity, usually a metal. A metal is generally chosen because it is
homogeneous and divisible: every unit is the same as every other and it can
be blended or formed in any quantity. Precious jewels, for example, are
neither homogeneous nor divisible. More important, the commodity chosen as a
medium must be a luxury. Human desires for luxuries are unlimited and,
therefore, luxury goods are always in demand and will always be acceptable.
Wheat is a luxury in underfed civilizations, but not in a prosperous society.
Cigarettes ordinarily would not serve as money, but they did in post-World
War II Europe where they were considered a luxury. The term "luxury
good" implies scarcity and high unit value. Having a high unit value,
such a good is easily portable; for instance, an ounce of gold is worth a
half-ton of pig iron.
In the early stages of a
developing money economy, several media of exchange might be used, since a
wide variety of commodities would fulfill the
foregoing conditions. However, one of the commodities will gradually displace
all others, by being more widely acceptable. Preferences on what to hold as a
store of value, will shift to the most widely
acceptable commodity, which, in turn, will make it still more acceptable. The
shift is progressive until that commodity becomes the sole medium of
exchange. The use of a single medium is highly advantageous for the same
reasons that a money economy is superior to a barter economy: it makes
exchanges possible on an incalculably wider scale.
Whether the single medium
is gold, silver, seashells, cattle, or tobacco is optional, depending on the
context and development of a given economy. In fact, all have been employed,
at various times, as media of exchange. Even in the present century, two
major commodities, gold and silver, have been used as international media of
exchange, with gold becoming the predominant one. Gold, having both artistic
and functional uses and being relatively scarce, has significant advantages
over all other media of exchange. Since the beginning of World War I, it has
been virtually the sole international standard of exchange. If all goods and
services were to be paid for in gold, large payments would be difficult to
execute and this would tend to limit the extent of a society's divisions of labor and specialization. Thus a logical extension of the
creation of a medium of exchange is the development of a banking system and
credit instruments (bank notes and deposits) which act as a substitute for,
but are convertible into, gold.
A free banking system
based on gold is able to extend credit and thus to create bank notes
(currency) and deposits, according to the production requirements of the
economy. Individual owners of gold are induced, by payments of interest, to
deposit their gold in a bank (against which they can draw checks). But since
it is rarely the case that all depositors want to withdraw all their gold at
the same time, the banker need keep only a fraction of his total deposits in
gold as reserves. This enables the banker to loan out more than the amount of
his gold deposits (which means that he holds claims to gold rather than gold
as security of his deposits). But the amount of loans which he can afford to
make is not arbitrary: he has to gauge it in relation to his reserves and to
the status of his investments.
When banks loan money to
finance productive and profitable endeavors, the
loans are paid off rapidly and bank credit continues to be generally
available. But when the business ventures financed by bank credit are less
profitable and slow to pay off, bankers soon find that their loans outstanding
are excessive relative to their gold reserves, and they begin to curtail new
lending, usually by charging higher interest rates. This tends to restrict
the financing of new ventures and requires the existing borrowers to improve
their profitability before they can obtain credit for further expansion.
Thus, under the gold standard, a free banking system stands as the protector
of an economy's stability and balanced growth. When gold is accepted as the
medium of exchange by most or all nations, an unhampered free international
gold standard serves to foster a world-wide division of labor
and the broadest international trade. Even though the units of exchange (the
dollar, the pound, the franc, etc.) differ from country to country, when all
are defined in terms of gold the economies of the different countries act as
one-so long as there are no restraints on trade or on the movement of
capital. Credit, interest rates, and prices tend to follow similar patterns
in all countries. For example, if banks in one country extend credit too
liberally, interest rates in that country will tend to fall, inducing
depositors to shift their gold to higher-interest paying banks in other
countries. This will immediately cause a shortage of bank reserves in the
"easy money" country, inducing tighter credit standards and a
return to competitively higher interest rates again.
A fully free banking
system and fully consistent gold standard have not as yet been achieved. But
prior to World War I, the banking system in the United States (and in most of
the world) was based on gold and even though governments intervened
occasionally, banking was more free than controlled. Periodically, as a
result of overly rapid credit expansion, banks became loaned up to the limit
of their gold reserves, interest rates rose sharply, new credit was cut off,
and the economy went into a sharp, but short-lived recession. (Compared with
the depressions of 1920 and 1932, the pre-World War I business declines were
mild indeed.) It was limited gold reserves that stopped the unbalanced
expansions of business activity, before they could develop into the
post-World Was I type of disaster. The readjustment periods were short and
the economies quickly reestablished a sound basis
to resume expansion.
But the process of cure
was misdiagnosed as the disease: if shortage of bank reserves was causing a business decline-argued economic interventionists-why
not find a way of supplying increased reserves to the banks so they never
need be short! If banks can continue to loan money indefinitely-it was
claimed-there need never be any slumps in business. And so the Federal
Reserve System was organized in 1913. It consisted of twelve regional Federal
Reserve banks nominally owned by private bankers, but in fact government sponsored,
controlled, and supported. Credit extended by these banks is in practice
(though not legally) backed by the taxing power of the federal government.
Technically, we remained on the gold standard; individuals were still free to
own gold, and gold continued to be used as bank reserves. But now, in
addition to gold, credit extended by the Federal Reserve banks ("paper
reserves") could serve as legal tender to pay depositors.
When business in the
United States underwent a mild contraction in 1927, the Federal Reserve
created more paper reserves in the hope of forestalling any possible bank
reserve shortage. More disastrous, however, was the Federal Reserve's attempt
to assist Great Britain who had been losing gold to us because the Bank of
England refused to allow interest rates to rise when market forces dictated
(it was politically unpalatable). The reasoning of the authorities involved
was as follows: if the Federal Reserve pumped excessive paper reserves into
American banks, interest rates in the United States would fall to a level
comparable with those in Great Britain; this would act to stop Britain's gold
loss and avoid the political embarrassment of having to raise interest rates.
The "Fed" succeeded; it stopped the gold loss, but it nearly destroyed
the economies of the world, in the process. The excess credit which the Fed
pumped into the economy spilled over into the stock market-triggering a
fantastic speculative boom. Belatedly, Federal Reserve officials attempted to
sop up the excess reserves and finally succeeded in braking
the boom. But it was too late: by 1929 the speculative imbalances had become
so overwhelming that the attempt precipitated a sharp retrenching and a
consequent demoralizing of business confidence. As a result, the American
economy collapsed. Great Britain fared even worse, and rather than absorb the
full consequences of her previous folly, she abandoned the gold standard
completely in 1931, tearing asunder what remained of the fabric of confidence
and inducing a world-wide series of bank failures. The world economies
plunged into the Great Depression of the 1930's.
With a
logic reminiscent of a generation earlier, statists argued that the
gold standard was largely to blame for the credit debacle which led to the
Great Depression. If the gold standard had not existed, they argued,
Britain's abandonment of gold payments in 1931 would not have caused the
failure of banks all over the world. (The irony was that since 1913, we had
been, not on a gold standard, but on what may be termed "a mixed gold
standard"; yet it is gold that took the blame.) But the opposition to
the gold standard in any form-from a growing number of welfare-state
advocates-was prompted by a much subtler insight: the realization that the
gold standard is incompatible with chronic deficit spending (the hallmark of
the welfare state). Stripped of its academic jargon, the welfare state is
nothing more than a mechanism by which governments confiscate the wealth of
the productive members of a society to support a wide variety of welfare
schemes. A substantial part of the confiscation is effected
by taxation. But the welfare statists were quick to recognize that if they
wished to retain political power, the amount of taxation had to be limited
and they had to resort to programs of massive deficit spending, i.e., they
had to borrow money, by issuing government bonds, to finance welfare
expenditures on a large scale.
Under a gold standard,
the amount of credit that an economy can support is determined by the
economy's tangible assets, since every credit instrument is ultimately a
claim on some tangible asset. But government bonds are not backed by tangible
wealth, only by the government's promise to pay out of future tax revenues,
and cannot easily be absorbed by the financial markets. A large volume of new
government bonds can be sold to the public only at progressively higher
interest rates. Thus, government deficit spending under a gold standard is
severely limited. The abandonment of the gold standard made it possible for
the welfare statists to use the banking system as a means to an unlimited
expansion of credit. They have created paper reserves in the form of
government bonds which-through a complex series of steps-the banks accept in place
of tangible assets and treat as if they were an actual deposit, i.e., as the
equivalent of what was formerly a deposit of gold. The holder of a government
bond or of a bank deposit created by paper reserves believes that he has a
valid claim on a real asset. But the fact is that there are now more claims
outstanding than real assets. The law of supply and demand is not to be
conned. As the supply of money (of claims) increases relative to the supply
of tangible assets in the economy, prices must eventually rise. Thus the
earnings saved by the productive members of the society lose value in terms
of goods. When the economy's books are finally balanced, one finds that this
loss in value represents the goods purchased by the government for welfare or
other purposes with the money proceeds of the government bonds financed by
bank credit expansion.
In the absence of the
gold standard, there is no way to protect savings from confiscation through
inflation. There is no safe store of value. If there were, the government
would have to make its holding illegal, as was done in the case of gold. If
everyone decided, for example, to convert all his bank deposits to silver or
copper or any other good, and thereafter declined to accept checks as payment
for goods, bank deposits would lose their purchasing power and
government-created bank credit would be worthless as a claim on goods. The
financial policy of the welfare state requires that there be no way for the
owners of wealth to protect themselves.
This is the shabby secret
of the welfare statists' tirades against gold. Deficit spending is simply a
scheme for the confiscation of wealth. Gold stands in the way of this
insidious process. It stands as a protector of property rights. If one grasps
this, one has no difficulty in understanding the statists' antagonism toward
the gold standard.
Alan Greenspan, Ph.D.
Chairman,of the Board of Governors of the Federal
Reserve System
1987
to 2006
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