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Here is a passage from my 1998 book
entitled Gold and Interest that will soon be released as an e-book.
As these pages are written (late 1997), chrysophobes make much of the weak dollar-price of gold
and of the fact that more central banks, including the Swiss, join the
company of those that have been dumping gold on the market. In addition,
self-styled experts on deflation submit that, while under
an inflationary spiral gold hoards may have been a reasonable
investment, gold is the worst possible place to be under a deflationary
spiral.
It is undeniable that the gold market
has been highly charged psychologically for the past thirty years. This will
likely continue into the 21st century. It is also true that the great bull
market in bonds that started in 1980 has so far coincided with the great bear
market in gold. From a high of $850 in 1980 gold went to a low of $ 285 in 1985 and is trading
near the low end of that range at the time of writing. However, it does not
follow from this that the gold bear must march hand-in-hand with the bond
bull, or that they must expire together. There are reasons to believe that
the gold dumping is orchestrated and is meant as a scarecrow tactic. A
central bank advertising its future gold sales stinks: it cannot be sincere
about its real intentions. As every student of the market well knows, selling
at low and falling prices is a sign of weakness -- never a sign of strength.
Central bank selling of gold is no exception.
Hecatomb of currencies
At this juncture the gold market is a
mere side-show. The main show is the foreign exchange market where a
clandestine trade war is being waged. Presumably there will be a lot of
casualties in the form of fallen currencies before it is all over. The
dollar, for the time being, is the obvious refuge for the victims of the hecatomb
of currencies. This makes it appear strong. But the dollar has its own problems.First,
it suffers from exactly the same ills that are plaguing all falling
currencies. Second, the American political establishment has a very low
tolerance for a strong dollar. Recall that in 1985, under a conservative
President, the dollar was diagnosed 'too strong' and was subsequently
scuttled -- making the price of gold rise from its lows. Rumors
of the demise of gold are grossly exaggerated. At the risk of belaboring the obvious I would like to make the following
points.
The only financial asset that is
nobody's liability
The volatility of the dollar-price of
gold is not a reflection of the uncertainty in the value of gold. It is in
fact a reflection of the uncertainty in the value of the dollar in which the
gold price is quoted. A lower gold price shows a momentary strength of the
dollar; not a reluctance on the part of people to hold gold. Nobody is
suggesting that the world no longer needs a financial asset that is nobody's
liability.
A currency immune to debasement,
default, and devaluation
The lower gold price also reflects the
reluctance of the people to put the central bankers out of their misery. After
all, they could call the bluffing of central bankers at any time if they
wanted to. For the time being they don't. Central bank gold dumping may or
may not be good politics, but it is certainly poor economics. Gold is the
only sound asset in the balance sheet. It is the only asset in the
balance sheet that is not at the same time a liability in the balance sheet
of someone else. For this reason, gold is immune to deliberate debasement,
defaults or devaluations. By contrast, dollars in the balance sheet represent
irredeemable promises to pay, with the obligor having a history of deliberate
debasement, defaults and devaluations. When a central bank discards a sound
asset from its balance sheet at a low price, and replaces it with a dubious
one at a high price, it makes its own currency weaker, not stronger. It is
especially foolish to do this at a time when the world is entering
shark-infested waters where the sharks are preying on paper currencies.
Central bankers making themselves the
laughing stock of the world
We must distinguish between gold sales
by a weak central bank from that by a strong one. A weak central bank prefers
to conduct its gold sales in perfect secrecy. It does not want the world to
know about the timing and the extent of its selling program lest the market's
unfavorable reaction cause the proceeds from the
sale to suffer. Even so, the market has an uncanny way of bringing down the
gold price ahead of the sale just long enough to accommodate the central bank
eager to unload its gold, only to put the price back
up once the sale is completed. By contrast, a strong central bank wants to
show off that its gold is 'surplus'. All the same, the central banks has to proceed carefully lest it become the laughing
stock of the world in selling its patrimony for a pittance. Embarrassing
questions might be asked such as this: "why is it that central bankers
always sell at the bottom, and never at the top?"
Hidden agenda?
Especially suspicious is a central bank
drumming up its proposed sales. It is the height of incompetence and
ineptitude to proceed this way -- unless the central bank has a hidden
agenda. It may want to camouflage its intention to buy, so it is
bringing down the price to facilitate its purchasing program.
External demand for dollars
The strength of the dollar, such as it
is, is entirely due to external demand. This demand is, as it has been since
1971, subject to withdrawal without notice. Internally, there is nothing to
justify the strength of the dollar. There is no end in sight to U.S. trade
deficits. All the optimistic predictions about eliminating the U.S. budget
deficit that have been made in the past turned out to be ill-founded. It
remains to be seen whether the latest optimistic prediction is better
founded. If the deflationary cancer metastasizes across the Pacific, as
appears likely, then the present falling trend in the U.S. budget
deficit could make a nasty U-turn. The U.S. is still the greatest debtor
in the world and in history. And it is still true that nothing comes from
nothing.
Misunderstanding economics and
mismanaging public resources
The current rush of central banks to
sell their shrinking gold assets in the face of their burgeoning liabilities
is just another case of misunderstanding economics and mismanaging public
resources as completely as only government bureaucrats can misunderstand and
mismanage them.
35 years of Keynesian and Friedmanite agitation for confetti money
The folly of central bankers and
Treasury officials managing the patrimony of their countries in the face of
gathering storm is unprecedented. This is the result of 35 years of Keynesian
and Friedmanite agitation in favor
of irredeemable currency, and the systematic badmouthing of sound economics,
finance, and debt-management. I am grateful to Dr. Theo Megalli
of Germany for translating into English a paper of the late Hungarian
monetary economist Melchior Palyi with the title Gold
Standard and Economic Order that appeared in the book Geld, Kapital und Kredit --
Festschrift for the seventieth birthday of Heinrich Rittershausen
(Stuttgart, 1968) from which the following quotations are taken.
The Gold Standard and economic order
The gold standard was sacrosanct to
generations brought up on Adam Smith's ideal of the free market, free, that
is, from arbitrary and discriminatory intervention by the powers that be. Indeed,
it was an essential instrument of economic freedom. It protected the
individual against arbitrary government measures by offering a convenient
hedge against confiscatory taxation as well as against currency depreciation
and devaluation. Gold provided essential mobility of funds beyond national
boundaries. Above all it raised a mighty barrier to authoritarian
interference with the economic process. In the words of Adam Smith:
"That insidious and crafty animal calling himself 'statesman' whose
councils are guided by the momentary fluctuations of affairs" was forced
to keep the national budget in good order. Authoritarians of all
denominations had to control their inflationary propensities and to refrain
from excessive taxation in order to forestall the loss of confidence in the
currency on the part of the people. The public purse had to be held tight.
The business community had to learn to live with the salutary threat that
illiquidity caused by short-sighted over-investment and irrational
speculation could be penalized by loss of gold and an automatic tightening of
the money-supply.
The gold standard in the classical sense
was part and parcel of an economic order. It was the corner-stone of the
system of public law, social customs and institutions that Marx pejoratively
called "capitalism" -- a system that rested on nearly unlimited
freedom of consumer choice, of enterprise, and of markets...
Unity of the economic world
The meaning of the gold standard -- with
unrestrained and uncontrolled private ownership of gold -- cannot be appreciated
in isolation from the institutional and psychological background that
characterized the civilized world in the decades before 1914. The outstanding
feature of that period was the unity of the economic world as it has not been
achieved before or thereafter.
Quoting from Oscar Morgenstern's International
Financial Transactions and Business Cycles, New York,1957, pp
17-19: "There was freedom of travel without passports, freedom of
migration, no exchange controls or other monetary restrictions. Citizenship was
freely granted to immigrants... capital could move unsupervised in any direction, and these movements could take any form... International
trade had to overcome tariffs, yes, but... tariffs were exceedingly low. There
were hardly any qualitative restrictions on international trade (quotas,
import prohibitions, etc.)... It was a world of which recently many... would
have been inclined to assert that it could not be created because it would
never work..."
It was a world of low wages and lower
still prices. Taxes were almost nominal. It was a world in which virtual
freedom of enterprise, 'workable' competition and highly flexible wage-price
structures prevailed in which private property and contracts were held
inviolable. Defaulting governments had to face boycott or worse.
It was a world, by and large, of
balanced national budgets. Public debt had to be amortized as a matter of
course, just as private debts had to be repaid. Fiat money was anathema.
Emergency public expenditures were financed by long-term bonds. There was no
monetization of public debt.
A world of steady real growth
Above all, it was a world of steady real
growth -- at an average annual rate of 5 percent during the six decades
before 1914 -- of steadily rising living standards for the masses, with
'social security' provided by the automatic protection of savings...
The role of the gold standard in
unifying the civilized world can scarcely be overestimated. It was the sine
qua non opening up the world for economic progress, for the diffusion of
modern civilisation. Capital flows that were instrumental could allow the
gold standard to operate with a minimum of actual gold transfer and with
relatively modest gold reserves. The gold standard presupposed a high degree
of freedom in foreign trade helping the debtor nations in liquidating their
debt through exports to the creditor...
Throughout the 19th century most major
central banks remained privately owned commercial institutions and were
supposed to conduct themselves as financial enterprises -- to earn profits. They
were to "suffer" the impact of gold flows, rather than influencing
them...
Real Bills -- the safest earning asset
In Britain,
the Banking School argued that no authoritarian
control or discretionary power was needed to sustain the balance between the
production of marketable goods and the creation of currency. Enlightened
self-interest would compel the central bank to maintain the liquidity of its
earning assets that were to consist of "real bills", that is,
short-term self-liquidating commercial paper growing out of the actual sale
of goods.
The Currency School
on the other hand doubted that stability could be guaranteed by asset
liquidity rules which, notoriously, could be violated when most needed -- at
times of business upturn and rising prices. Adherents of this school believed
that the money-creating power of the central bank was the crux of the
situation and insisted on curtailing this power by requiring 100 percent gold
reserve for the note issue. The idea was that the automatism of the gold
standard was to be preserved by putting the central bank into a
strait-jacket. The volume of the outstanding note issue was to expand and
contract in exact proportion with the inflow and outflow of gold.
The Currency School
won a Pyrrhic victory in 1844. By the Peel Act the Bank of England was
obliged at all times to maintain 100 percent gold reserve behind its note
issue beyond a modest amount... But the necessity to suspend limitation on
the note issue in the monetary panics of 1846, 1858 and 1867 taught that
tying the Bank of England to a formula was a senseless undertaking. Not only
did the Peel Act fail to extend the 100 percent reserve requirement to the
central bank's deposit liabilities, which grew faster than the note
liability, but the tying of the bank's hands behind its back, as it were,
left the problems of monetary policy unresolved.
The flame of liberty
Before World War I economic
considerations dominated political agenda, not the other way around. Wars
could not be waged to the bitter end, bankrupting vanquished and victors
alike. Peace following war was genuine, rather than a continuation of
hostilities through other, economic means. The vanquished were allowed to
recover through hard work and hard saving, thanks to the operation of the
gold standard.
All this was to change with the outbreak
of World War I. Economic considerations were sacrificed on the altar of
political expediency. A new regime, one of prepetual
and total war was inaugurated. When the gold standard refused to play along,
it was given a bad name, and a dishonorable
discharge. People were not consulted. Through a series of confidence tricks
they had been weaned from the gold coin. The Warfare State
went all out to bribe the electorate with the newly-invented Welfare State. The
golden thorn in the flesh of the establishment remains. The Constitution of
the United States of
America, primarily because of its monetary
provisions, was thrown to the winds. The powers that be wanted to unshackle
themselves in preparation of enslaving the American people. Confiscation of
the gold coin of the people was the necessary first step. Trying to bribe
people with an avalanche of confetti money was the second.
If the flame of liberty is to flare up
again from the ember barely glowing underneath layers of ashes left behind by
a century of total war, it will be thanks to the indelible mark that the gold
standard, once the epitomy of unity of the entire
civilized world, has left on human affairs as no religion, ideology, literary
or scientific movement ever did.
Gold Standard University
Session Two is scheduled for August
15-29, 2007, in
Szombathely, Hungary. It will include a
blue-ribbon panel discussion under the title The Last Contango:
the First Sign of Disintegration of the International Monetary System, on
the gold/silver basis as a most sensitive market indicator that is being
developed by a team of researchers. For further information please contact: GSUL@t-online.hu.
Antal E. Fekete
Professor,
Intermountain Institute of Science and Applied Mathematics, Missoula, MT 59806, U.S.A.
Gold Standard University
aefekete@hotmail.com
DISCLAIMER AND CONFLICTS
THE PUBLICATION OF THIS LETTER IS FOR YOUR INFORMATION AND AMUSEMENT ONLY. THE
AUTHOR IS NOT SOLICITING ANY ACTION BASED UPON IT, NOR IS HE SUGGESTING THAT
IT REPRESENTS, UNDER ANY CIRCUMSTANCES, A RECOMMENDATION TO BUY OR SELL ANY
SECURITY. THE CONTENT OF THIS LETTER IS DERIVED FROM INFORMATION AND SOURCES
BELIEVED TO BE RELIABLE, BUT THE AUTHOR MAKES NO REPRESENTATION THAT IT IS
COMPLETE OR ERROR-FREE, AND IT SHOULD NOT BE RELIED UPON AS SUCH. IT IS TO BE
TAKEN AS THE AUTHORS OPINION AS SHAPED BY HIS EXPERIENCE, RATHER THAN A
STATEMENT OF FACTS. THE AUTHOR MAY HAVE INVESTMENT POSITIONS, LONG OR SHORT,
IN ANY SECURITIES MENTIONED, WHICH MAY BE CHANGED AT ANY TIME FOR ANY REASON.
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