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From
the archive
A Chinese Tale
Once upon a time the standard of measuring
length, the foot, was defined in China as the length of the foot
of the emperor. A change of the standard occurred upon the death of the old
emperor, as a proclamation heralding the length of the foot of the new
emperor was made. Later emperors discovered to their delight that they did
not have to die in order to bring about a change of the standard. Imperial
pleasure could proclaim a change in imperial footage at any time.
The ropemakers of
the Celestial Empire learned to live with
this capricious and whimsical system. They withheld production when they
suspected that a shrinkage of the imperial foot was
imminent. One day the ropemakers became even
smarter. They formed a lobby in the Celestial
Court, to persuade the Son of Heaven to have his
toes amputated in order to make the imperial foot even shorter. This was
thought to have a salutary effect on the ropemaking
business. When, however, the people of the Celestial
Empire found out what was afoot at their expense, they rose in
anger, beheaded the emperor, and made the new emperor declare the length of a
platinum rod as the official standard. It was thought that platinum was
impervious to changes inspired by minority pressure groups.
How to replenish water
in New York City's
water reservoir
The basic characteristic of any good standard
of measurement is that of fixity. And a nation has no standard of measurement
more important than its standard monetary unit, because its money reaches and
affects virtually every activity of all its people
in domestic commerce as well as in foreign trade.
Changing the standard of value,
or the devaluation of a currency is like the amputation of one's arm or leg:
it is a great misfortune. Informed people do not engage in either sort of
amputation unless it is unavoidable. We pride ourselves on being infinitely
more scientific than the Celestial Empire of
old. as we define the unit of length in terms of the
wavelength of the orange color in the light
spectrum. Nowadays, we respect such standards of measurement as the foot, the
pound, the gallon, etc.
For example, if the water supply of New York City is
depleted, say by one-half, Congress could conceivably change the definition
of the gallon to one-half of the original as the easiest way to restore the
number of gallons in the reservoir and forestall panic among city dwellers.
But Congress knows that such tampering would be unscientific. Changing the
definition of the gallon would do nothing to restore the original amount of
water in the reservoir, while it would cause havoc at the gas pump. Congress
knows that people would see through the mischief and would react unfavorably to the farce.
When best is worst, and
worst is best
When it comes to the standard of monetary
value, which also serves as the standard of deferred payments such as
pensions and life insurance, a peculiar confusion and inconsistency reveals
itself. As national profligacy depletes the reservoir of wealth in the
country the Congress has found it expedient to resort to tampering with the
standard measuring the quantity of wealth in the nation. Congress reduced the
value of the monetary standard, the dollar, in order to conceal the alarming
news from its constituents. And in 1971, Congress abolished the standard
altogether, when it abdicated its Constitutional responsibility by allowing
the dollar to float. Today the length of the foot of the incumbent Chairman
of the Federal Reserve Board is the effective standard, and it is up to him
and his colleagues on the Open Market Committee to say what this length is.
The amazing thing is that we accept the alteration of the definition of the
dollar when the things it is supposed to measure do not conform to their
wishful thinking, although we would not accept the alteration of the
definition of the gallon motivated by the same considerations. The
explanation of this irrationality cannot apparently be compressed
sufficiently for inclusion here. As though struck with a fever or some sort
of madness, government officials and powerful groups of industrial and
agricultural leaders took the position that a country with weak currency has
an advantage over a country with a strong one, and that it is necessary to
pull the strong currency down to the level of the weak. The worst currency is
really the best, and the best currency really the worst.
Squandering the wealth
In our wild embracing of this madness, we
never settled down to state clearly just what is the target of currency
depreciation or "goodness" in money The secret of that mystery is
ostensibly in the hand of the currency manipulators who perform as though
they had a hotline to Heaven. They never can bring themselves to face the
logic of their basic position that, if a depreciated currency is better for
our country than one based on a fixed monetary standard, the best currency
would be the one having no value at all, and that country would gain most
which simply gave away its goods and services. The extent to which the nation, and particularly its leaders in Washington, are
afflicted by this phantasmagoria that we can maintain prosperity and increase
our standard of living by giving away wealth should be apparent from the
September 22, 1985 announcement of the plot by the Group of Five industrial
nations to beat down the value of the dollar.
The proper monetary
standard
The typical currency system has various kinds
of moneys in circulation, and it is the proper function of the monetary
standard to keep the value of each unit of each kind of money equal to that
of each unit of every other kind of money in the system. A standard monetary
unit should be something which itself has value. It cannot be an abstraction,
a legal fiction. It cannot be a promise to pay let alone an irredeemable
promise. It must be material property commanding the most universal
acceptability. To serve its purpose best, it should have a relatively high
value in small bulk; it must be permanent, resistant to tarnish; it must be
homogeneous, divisible without loss of value; and it must be readily
recognizable. For these reasons gold has evolved, over thousands of years, as
the material of which the monetary standard is made.
Fate of a government
prophecy
The value of gold is not derived from its
monetary applications. Back in 1967 government economists prophesied that if
the U. S. Treasury stopped bidding for gold. the
dollar price of gold would drop, perhaps by as much as 50%. On March 15,1968,
the U. S. Treasury and the cartel of central banks known as the Gold Pool
withdrew their long-standing offer to buy unlimited quantities of gold - and
the rest is history Refusing to fall, the dollar price of gold started rising
immediately and has followed a checkered path
upwards ever since. The government economists were wrong. The monetary
economists who maintained that a dollar is a promise to pay a fixed amount of
gold on demand, and that the repudiation of that promise cannot enhance the
dollar's value, were right. Since March 15.1968, the dollar has lost almost
90% of its gold value - and a commensurate amount of its purchasing power.
Marginal utility of
gold
The most important quality of gold as monetary
metal is its universal acceptability In technical economic language, the
marginal utility of gold is constant in contrast with that of any other good,
all of which have more or less declining marginal utilities. In other words,
the acceptability of gold in exchange for goods and service does not depend
on the amount of gold possessed by the parties to the exchange.
The recent collapse of the price of oil and
tin* shows the rapidly declining marginal utility of these resources. Unlike
gold. the acceptability of oil and tin depends on
the amount in the possession of the market participants: the more they have. the less acceptable these resources become. Gold is the
only commodity that can be offered in unlimited quantities in exchange for
goods and services across all national boundaries. Without apparently harming
its exchange value. Moreover, gold is the only asset that individuals and
governments will carry in the balance sheet without any promise of return to
capital. Gold is the only asset that can balance a liability without being at
the same time a liability of someone else. It is the only financial asset
that can survive the consolidation of the balance sheets of any combination
of individuals or governments.
(*1985)
Most abundant commodity
on earth
Economics accounts for this anomalous behavior of gold. not by
appealing to psychology or to human weaknesses such as vanity or
superstition, but by appealing to logic. Even if we regard the choice of gold
as monetary standard as an historical accident, by now gold is so firmly
entrenched that its replacement is virtually unthinkable. Almost all the gold
that has been produced since the dawn of history is still available in
marketable form. The same simply cannot be said of other commodities. They
all disappear in consumption. The ratio of stocks of gold to annual
production flows is a high multiple, estimated to be between 80 and 100. For
other goods, the ratio of stocks to flows is a small fraction, e.g., 1:3 for
copper. The latter is an interesting example because copper, like gold. also has a long and rich history including its history of
monetary applications. Yet, if copper stocks were to double overnight,
raising the stock/flow ratio to 2:3, then the price of copper would collapse
and all but the most efficient producers of copper would be ruined. No matter
how many marginal applications for copper we may find. the
marginal utility of copper would be testing zero. i.e., copper would be a
"free" good, like drinking water. By contrast, if the stock/flow
ratio of gold went from 100 to 200, hardly anybody would take notice. Gold
producers would continue to prosper. The increase in the ratio would be
looked upon as another confirmation of the supreme confidence individuals
have in gold as a store of value.
In these terms, gold is the most abundant
commodity known to and produced by man. Gold does not owe its value to its
alleged scarcity On the contrary, gold owes its value to the fact that, in
spite of its abundance and steady increase of abundance, gold continues to be
in universal demand, and it continues to be acceptable in unlimited
quantities. No other asset can match the record of gold in this regard. No
other commodity can withstand the wear and tear the monetary standard is
constantly exposed to.
Like the Chinese platinum foot, gold may not
be a perfect standard, but it is the only conceivable monetary standard we
have.
Antal
E. Fekete
September, 2005
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