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The $800 billion bailout, and billions
more being pumped less obviously into the global economy, will cure nothing. Americans
are clamoring for a savior.
No one is willing to believe that the party is over. In the past, someone
always came to our rescue.
Like a parent dispelling a childhood
nightmare, FDR soothed the masses with the assurance that they had nothing to
fear but fear itself. To this day, he is revered for
turning a depression into the Great Depression. In the aftermath of the
dot-com bubble,
Fed Chairman Alan Greenspan came to the rescue with a brand-new bubble in
real estate.
Even if there was someone out there who
could pull off one more illusionary rescue, it would only delay the
inevitable and worsen the pain. Pain now or more pain later. The
compassionate solution is to let Adam Smith’s invisible hand guide us,
as should have been happening all along. Almost no public figures have the
backbone to speak honestly about what’s wrong. There is no free lunch.
Still, voters believe the promise that “I will give you what you want and
make someone else pay for it.” Neither Congress nor either presidential
candidate can take us back to the fairytale world of mortgaged opulence we
blissfully enjoyed in the recent past.
It pained me to see former Fed Chairman
Alan Greenspan struggle to salvage some remnant of his tattered legacy under
the brutal and self-righteous questioning of Henry Waxman’s House
Oversight and Government Reform Committee. Waxman chided Greenspan that “The Federal Reserve had the
authority to stop the irresponsible lending practices that fueled the subprime mortgage market.” Talk about the pot calling the
kettle black! Greenspan failed to come to the defense
of the free market, even conceding that his faith in free markets was “flawed.” He declined to remind Waxman that
congressional pressure to make mortgage loans available to those who had no
business living in a house, not to mention owning one, rendered the markets
less than free.
How could this one-time compatriot of Ayn Rand have strayed so far from his roots? Even today,
Greenspan’s 1966 essay “Gold and Economic Freedom”
provides a refreshingly simple and straightforward explanation for how we
arrived at this sorry state of affairs. The Maestro’s essay appeared in
the newsletter The
Objectivist in
1966 and was later reprinted in Rand's Capitalism: The Unknown Ideal. This is what Greenspan wrote:
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.
November 4 is right around the corner. Once
again, the masses are clamoring for a savior. To rephrase Walt Kelly and the famous words of
the possum Pogo, “We
have met our savior and he is us.”
Donald
Grove
Washington Correspondent
Caseyresearch.com
Donald Grove is a
Washington D.C.-based lawyer and Washington correspondent for Casey Research,
LLC., one of the nation’s oldest and most
respected newsletter publishers, providing unbiased investment guidance for
individual and institutional investors. You can now kick the tires on Casey
Research’s flagship publication, The Casey Report, risk-free -- learn more about our special
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