By the end of 1925, Montagu Norman and the British Establishment were seemingly monarch of all they surveyed. Backed by Strong and the Morgans, the British had had everything their way: they had saddled the world with a new form of pseudo gold standard, with other nations pyramiding money and credit on top of British sterling, while the United States, though still on a gold-coin standard, was ready to help Britain avoid suffering the consequences of abandoning the discipline of the classical gold standard.

But it took little time for things to go very wrong. The crucial British export industries, chronically whipsawed between an overvalued pound and rigidly high wage rates kept up by strong, militant unions and widespread unemployment insurance, kept slumping during an era when worldwide trade and exports were prospering. Unemployment remained chronically high. The unemployment rate had hovered around 3 percent from 1851 to 1914. From 1921 through 1926 it had averaged 12 percent; and unemployment did little better after the return to gold. In April 1925, when Britain returned to gold, the unemployment rate stood at 10.9 percent. After the return, it fluctuated sharply, but always at historically very high levels. Thus, in the year after return, unemployment climbed above 12 percent, fell back to 9 percent, and jumped to over 14 percent during most of 1926. Unemployment fell back to 9 percent by the summer of 1927, but hovered around 10 to 11 percent for the next two years. In other words, unemployment in Britain, during the entire 1920s, lingered around severe recession levels.Peter Clarke, "The Treasury's Analytical Model of the British Economy Between the Wars," in The State and Economic Knowledge: The American and British Experiences, Mary Furner and Barry Supple, eds. (Cambridge: Cambridge University Press, 1990), p. 177. See also Melchior Palyi, The Twilight of Gold 1914–1936 (Chicago: Henry Regnery, 1972), p. 109

The unemployment was concentrated in the older, previously dominant, and heavily unionized industries in the north of England. The pattern of the slump in British exports may be seen by some comparative data. If 1924 is set equal to 100, world exports had risen to 132 by 1929, while Western European exports had similarly risen to 134. United States exports had also risen to 130. Yet, amid this worldwide prosperity, Great Britain lagged far behind, exports rising only to 109. On the other hand, British imports rose to 113 in the same period. After the 1929 crash until 1931, all exports fell considerably, world exports to 113, Western European to 107, and the United States, which had taken the brunt of the 1929 crash, to 91; and yet, while British imports rose slightly from 1929 to 1931 to 114, its exports drastically fell to 68. In this way, the overvalued pound combined with rigid downward wage rates to work their dire effects in both boom and recession. Overall, whereas, in 1931, Western European and world exports were considerably higher than in 1924, British exports were very sharply lower.

Within categories of British exports, there was a sharp and illuminating separation between two sets of industries: the old, unionized export staples in the north of England, and the newer, relatively nonunion, lower-wage industries in the south. These newer industries were able to flourish and provide plentiful employment because they were permitted to hire workers at a lower hourly wage than the industries of the north.Benjamin M. Anderson, Economics and the Public Welfare: Financial and Economic History of the United States, 1914–1946 (New York: D. Van Nostrand, 1949), p. 166; D. E. Moggridge, British Monetary Policy, 1924–1931: The Norman Conquest of $4.86 (Cambridge: Cambridge University Press, 1972), p. 117. Some of these industries, such as public utilities, flourished because they were not dependent on exports. But even the exports from these new, relatively nonunionized industries did very well during this period. Thus from 1924 to 1928–29, the volume of automobile exports rose by 95 percent, exports of chemical and machinery manufactures rose by 24 percent, and of electrical goods by 23 percent. During the 1929–31 recession, exports of these new industries did relatively better than the old: machinery and electrical exports falling to 28 percent and 22 percent respectively below the 1924 level, while chemical exports fell only to 5 percent below and automobile exports remained comfortably in 1931 at fully 26 percent above 1924.

On the other hand, the older, staple export industries, the traditional mainstays of British prosperity, fared very badly in both these periods of boom and recession. The nonferrous metal industry rose only slightly by 14 percent by 1928–29 and then fell to 55 percent of 1924 in the next two years. In even worse shape were the once-mighty cotton and woolen textile industries, the bellwethers of the Industrial Revolution in England. From 1924 to 1929, cotton exports fell by 10 percent, and woolens by 20 percent, and then, in the two years to 1931, they plummeted phenomenally, cottons to 50 percent of 1924 and woolens to 46 percent. Remarkably, cotton and woolen exports were at this point their lowest in volume since the 1870s.

Perhaps the worst problem was in the traditionally prominent export, coal. Coal exports had declined to 69 percent of 1924 volume in 1931; but perhaps more ominously, they had fallen to 88 percent in 1928–29, slumping, like textiles, in the midst of worldwide prosperity.

So high were British price levels compared to other countries, in both of these periods, that Britain’s imports, remark ably, rose in every category during boom and recession. Thus, imports of manufactured goods into Britain rose by 32.5 percent from 1924 to 1928–29, and then rose another 5 percent until 1931. So costly, too, was the once-proud British iron and steel industry that, after 1925, the British, for the first time in their history, became net importers of iron and steel.

The relative rigidity of wage costs in Britain may be seen by comparing their unit wage costs with the U.S., setting 1925 in each country equal to 100. In the United States, as prices fell about 10 percent in response to increased productivity and output, wage rates also declined, falling to 93 in 1928, and to 90 in 1929. Swedish wages were even more flexible in those years, enabling Sweden to surmount without export depression and return to gold at the prewar par. Swedish wage rates fell to 88 in 1928, 80 in 1929, and 70 in 1931. In Great Britain, on the other hand, wage rates remained stubbornly high, in the face of falling prices, being 97 in 1928, 95 the following year, and down to only 90 in 1931.Moggridge, British Monetary Policy, p. 117–25. In contrast, wholesale prices in England fell by 8 percent in 1926 and 1927, and more sharply still thereafter.

The blindness of British officialdom to the downward rigidity of wage rates was quite remarkable. Thus, the powerful deputy controller of finance for the Treasury, Frederick W. Leith-Ross, the major architect of what became known as the “Treasury view,” wrote in bewilderment to Hawtrey in early August 1928, wondering at Keynes’s claim that wage rates had remained stable since 1925. In view of the substantial decline in prices in those years, wrote Leith-Ross, “I should have thought that the average wage rate showed a substantial decline during the past four years.” Leith-Ross could only support his view by challenging the wage index as inaccurate, citing his own figures that aggregate payrolls had declined. Leith-Ross doesn’t seem to have realized that this was precisely the problem: that keeping wage rates up in the face of declining money may indeed lower payrolls, but by creating unemployment and the lowering of hours worked. Finally, by the spring of 1929, Leith-Ross was forced to face reality, and conceded the point. At last, Leith-Ross admitted that the problem was rigidity of labor costs:

If our workmen were prepared to accept a reduction of 10 percent in their wages or increase their efficiency by 10 per- cent, a large proportion of our present unemployment could be overcome. But in fact organized labor is so attached to the maintenance of the present standard of wages and hours of labor that they would prefer that a million workers should remain in idleness and be maintained permanently out of the Employment Fund, than accept any sacrifice. The result is to throw on to the capital and managerial side of industry a far larger reorganization than would be necessary: and until labor is prepared to contribute in larger measure to the process of reconstruction, there will inevitably be unemployment.Draft memorandum to Chandellor of Exchequer Churchill, April 1929. Clarke, "Treasury's Analytical Model," p. 186. See also ibid., pp. 179–80, 184–87.

Leith-Ross might have added that the “preference” for unemployment was made not by the unemployed themselves but by the union leadership on their alleged behalf, a leadership which itself did not have to face the unemployment dole. More- over, the willingness of the workers to accept this deal might have been very different if there were no generous Employment Fund for them to tap.

It was in fact the highly militant coal miners’ union, led by the prominent leftist Aneurin “Nye” Bevan, that was the first to stir up grave doubt about the glory of the British return to gold. Not only was coal a highly unionized export industry located in the north, but already overinflated coal-mining wages had been given an extra boost during the first Labor government of Ramsay MacDonald, in 1924. In addition to the high wage rates, the miners’ union insisted on numerous cost-raising restrictive, featherbedding practices, some of them resurrected from the defunct postmedieval guilds. These obstructionist tactics helped rigidify the British economy, preventing changes and adaptations of occupation and location, and hampering rationalizing and innovative managerial practices. As Professor Benham trenchantly pointed out:

Employers who wished to make changes had to face the powerful opposition of organized labor. The introduction of new methods, such as the “more looms to a weaver” system, was resisted. Strict lines of demarcation between occupations were maintained in engineering and elsewhere. A plumber could repair a pipe conveying cold water; if it conveyed hot water, he had to call in a hot water engineer. Entry into certain occupations was rendered difficult. A man can become an efficient building operative in a few months; an apprenticeship of four years was required. British railways could not have their labour force as they chose. A host of restrictions, insisted upon by the Trade Unions, made this impossible.Palyi, Twilight of Gold, p. 79. Frederic C. Benham, British Monetary Policy (London: P.S. King, 1932), pp. 27f. A manifestation of this obstructive and restrictive trade-union spirit circulated to the members of the union of Building Trade Workers in 1926: “You should keep a keen control of overtime. Adopt a militant policy against all forms of piece work; be watchful and limit apprentices; remember the power you now occupy is conditioned by the scarcity of your labor.”

By 1925, the year of the return to gold, British coal was already facing competition of rehabilitated, newly modernized, low-cost coal mines in France, Belgium, and Germany. British coal was no longer competitive, and its exports were slumping badly. The Baldwin government appointed a royal commission, headed by Sir Herbert Samuel, to study the vexed coal question. The Samuel Commission reported in March 1926, urging that miners accept a moderate cut in wages, and an increase in working hours at current pay, and suggesting that a substantial number of miners move to other areas, such as the south, where employment opportunities were greater. But this was not the sort of rational solution that would appeal to the spoiled, militant unions, who rejected those proposals and went on strike, thereby generating the traumatic and abortive general strike of 1926.

The strike was broken, and coal-mining wages fell slightly, but the victory for rationality was all too pyrrhic. Keynes was able to convince the inflationist press magnate, Lord Beaverbrook, that the miners were victims of a Norman–Churchill–international banker conspiracy to profit at the expense of the British working class. But instead of identifying the problem as inflationism, cheap money, and the gold bullion–gold-exchange standard in the face of an overvalued pound, Beaverbrook and British public opinion pointed to “hard money” as the villain responsible for recession and unemployment. Instead of tightening the money supply and interest rates in order to preserve its own created gold standard, the British Establishment was moved to follow its own inclinations still further: to step up its disastrous commitment to inflation and cheap money.Palyi, Twilight of Gold, pp. 102–04.”

During the general strike, Britain was forced to import coal from Europe instead of exporting it. In olden times, the large fall in export income would have brought about a severe liquidation of credit, contracting the money supply and lowering prices and wage rates. But the British banks, caught up as they were in the ideology of inflationism, instead expanded credit on a lavish scale, and sterling balances piled up on the continent of Europe. “Instead of a readjustment of prices and costs in England and a breaking up of the rigidities, England by credit expansion held the fort and continued the rigidities.”Anderson, Economics and Public Welfare, p. 167.

The massive monetary inflation in Britain during 1926 caused gold to flow out of the country, especially to the United States, and sterling balances to accumulate in foreign countries, especially in France. In the true gold-standard days, Britain would have taken all this as a furious signal to contract and tighten up; instead it persisted in continuing inflationism and cheap money, lowering its crucial “bank rate” (Bank of England discount rate) from 5 percent to 4.5 percent in April 1927. This action further weakened the pound sterling, and Britain lost $11 million in gold during the next two months.

France’s important role during the gold-exchange era has served as a convenient whipping boy for the British and for the Establishment ever since. The legend has it that France was the spoiler, by returning to gold at an undervalued franc (pegging the franc first in 1926, and then officially returning to gold two years later), consequently piling up sterling balances, and then breaking the gold-exchange system by insisting that Britain pay in gold. The reality was very different. France, during and after World War I, suffered severe hyperinflation, fueled by massive government deficits. As a result, the French franc, classically set at 19.3¢ under the old gold standard, had plunged down to 5¢ in May 1925, and accelerated its decline to 1.94¢ in late July 1926. By June 1926, Parisian mobs protesting the runaway inflation and depreciation surrounded the Chamber of Deputies, threatening violence if former Premier Raymond Poincaré, known as a staunch monetary and fiscal conservative, was not returned to his post. Poincaré was returned to office July 2, pledging to cut expenses, balance the budget, and save the franc.

Armed with a popular mandate, Poincaré was prepared to drive through any necessary monetary and fiscal reforms. Poincaré’s every instinct urged him to return to gold at the prewar par, a course that would have been disastrous for France, being not only highly deflationary but also saddling French taxpayers with a massive public debt. Furthermore, returning to gold at the prewar par would have left the Bank of France with a very low (8.6-percent) gold reserve to bank notes in circulation. Returning at par, of course, would have gladdened the hearts of French bondholders as well as of Montagu Norman and the British Establishment. Poincaré was talked out of this path, however, by the knowledgeable and highly perceptive Emile Moreau, governor of the Bank of France, and by Moreau’s deputy governor, distinguished economist Charles Rist. Moreau and Rist were well aware of the chronic export depression and unemployment that the British were suffering because of their stubborn insistence on the prewar par. Finally, Poincaré reluctantly was persuaded by Moreau and Rist to go back to gold at a realistic par.

When Poincaré presented his balanced budget and his monetary and financial reform package to Parliament on August 2, 1926, and drove them through quickly, confidence in the franc dramatically rallied, pessimistic expectations in the franc were changed to optimistic ones, and French capital, which had understandably fled massively into foreign currencies, returned to France, quickly doubling its value on the foreign exchange market to almost 4¢ by December. To avoid any further rise, the French government quickly stabilized the franc de facto at 3.92¢ on December 26, and then returned de jure to gold at the same rate on June 25, 1928.Dr. Anderson estimates that it would have been “safer” for France to have gone back at 3.5¢ (which it could have done at the market rate in November). Anderson, Economics and Public Welfare, p. 158. On the saga of France and the French franc in this period, see ibid., pp. 154–61, 168–73; and Palyi, Twilight of Gold, pp. 185–90. For the influence of Moreau and Rist, see Judith L. Kooker, “French Financial Diplomacy: The Interwar Years,” in Benjamin M. Rowland, Balance of Power or Hegemony: The Interwar Monetary System (New York: New York University Press, 1976), pp. 91–93.

At the end of 1926, while the franc was now pegged, France was not yet on a genuine gold standard. Officially, and de jure, the franc was still set at the prewar par, when one gold ounce had been set at approximately 100 francs. But now, at the new pegged value, the gold ounce, in foreign exchange, was worth 500 francs. Obviously, no one would now deposit gold at a French bank in return for 100 paper francs, thereby wiping out 80 percent of his assets. Also, the Bank of France (which was a privately owned firm) could not buy gold at the current expensive rate, for fear that the French government might decide, after all, to go back to gold de jure at a higher rate, thereby inflicting a severe loss on its gold holdings. The government, however, did agree to indemnify the bank for any losses it might incur in foreign exchange transactions; in that way, Bank of France stabilization operations could only take place in the foreign exchange market.

The French government and the Bank of France were now committed to pegging the franc at 3.92¢. At that rate, francs were purchased in a mighty torrent on the foreign exchange market, forcing the Bank of France to keep the franc at 3.92¢ by selling massive quantities of newly issued francs for foreign exchange. In that way, foreign exchange holdings of the Bank of France skyrocketed rapidly, rising from a minuscule sum in the summer of 1926 to no less than $1 billion in October of the following year. Most of these balances were in the form of sterling (in bank deposits and short-term bills), which had piled up on the continent during the massive British monetary inflation of 1926 and now moved into French hands with the advent of upward speculation in the franc, and with continued inflation of the pound. Willy-nilly, and against their will, therefore, the French found themselves in the same boat as the rest of Europe: on the gold-exchange or gold-sterling standard.See the lucid exposition in Anderson, Economics and Public Welfare, pp. 168–70.

If France had gone onto a genuine gold standard at the end of 1926, gold would have flowed out of England to France, forcing contraction in England and forcing the British to raise interest rates. The inflow of gold into France and the increased issue of francs for gold by the Bank of France would also have temporarily lowered interest rates there. As it was, French interest rates were sharply lowered in response to the massive issue of francs, but no contraction or tightening was experienced in England; quite the contrary.The open market discount rate in Paris fell from 7 percent in August 1926 to 2 percent in August of the following year. Ibid., p. 172.

Moreau, Rist, and the other Bank of France officials were alert to the dangers of their situation, and they tried to act in lieu of the gold standard by reducing their sterling balances, partly by demanding gold in London, and partly by exchanging sterling for dollars in New York.

This situation put considerable pressure upon the pound, and caused a drain of gold out of England. In the classical gold-standard era, London would have responded by raising the bank rate and tightening credit, stemming or even reversing the gold outflow. But England was committed to an unsound, inflationist policy, in stark contrast to the old gold system. And so, Norman tried his best to use muscle to prevent France from exercising its own property rights and redeeming sterling in gold, and absurdly urged that sterling was beneficial for France, and that they could not have too much sterling. On the other hand, he threatened to go off gold altogether if France persisted—a threat he was to make good four years later. He also invoked the spectre of France’s World War I debts to Britain.Kooker, “French Financial Diplomacy, pp. 86–90. He tried to get various European central banks to put pressure on the Bank of France not to take gold from London. The Bank of France found that it could sell up to £3 million a day without attracting the angry attention of the Bank of England; but any more sales than that would call forth immediate protest. As one official of the Bank of France said bitterly in 1927, “London is a free gold market, and that means that anybody is free to buy gold in London except the Bank of France.”Anderson, Economics and Public Welfare, pp. 172–73.

Why did France pile up foreign exchange balances? The anti-French myth of the Establishment charges that the franc was undervalued at the new rate of 3.92¢, and that therefore the ensuing export surplus brought foreign exchange balances into France. The facts of the case were precisely the reverse. Before World War I, France traditionally had a deficit in its balance of trade. During the post–World War I inflation, as usually occurs with fiat money, the foreign exchange rate rose more rapidly than domestic prices, since the highly liquid foreign exchange market is particularly quick to anticipate and discount the future. Therefore, during the French hyperinflation, exports were consistently greater than imports.Thus, in 1925, the last full year of the hyperinflation, French exports were 103.8 percent of imports; the surplus was concentrated in manufactured goods, which had an export surplus of 23.8 billion francs, partially offset by a net import deficit of 5.4 billion in food and 16.8 billion in industrial raw materials. Palyi, Twilight of Gold, p. 185. Then, when France pegged the franc to gold at the end of 1926, the balance of trade reversed itself again to the original pattern. Thus, in 1928, French exports were only 96.1 percent of imports. On the simplistic-trade, or relative-purchasing-power criterion, then, we would have to say that the post-1926 franc was over- rather than undervalued. Why didn’t gold or foreign exchange flow out of France? For the same reason as before World War I; the chronic trade deficits were covered by perennial “invisible” net revenues into France, in particular the flourishing tourist trade.

What then accounted for the amassing of sterling by France? The inflow of capital into France. During the French hyperinflation, capital had left France in droves to escape the depreciating franc, much of it finding a haven in London. When Poincaré put his monetary and budget reforms into effect in 1926, capital happily reversed its flow, and left London for France, anticipating a rising or at least a stable franc.

In fact, rather than being obstreperous, the French, succumbing to the blandishments and threats of Montagu Norman, were overly cooperative, much against their better judgment. Thus, Norman warned Moreau in December 1927 that if he persisted in trying to redeem sterling in gold, Norman would devalue the pound. In fact, Poincaré prophetically warned Moreau in May 1927 that sterling’s position had weakened and that England might all too readily give up on its own gold standard. And when France stabilized the franc de jure at the end of June 1928, foreign exchange constituted 55 percent of the total reserves of the Bank of France (with gold at 45 percent), an extraordinarily high proportion of that in sterling. Furthermore, much of the funds deposited by the Bank of France in London and New York were used for stock market loans and fueled stock speculation; worse, much of the sterling balances were recycled to repurchase French francs, which continued the accumulation of sterling balances in France. It is no wonder that Dr. Palyi concludes that

[i]t was at Norman’s urgent request that the French central bank carried a weak sterling on its back well beyond the limit of what a central bank could reasonably afford to do under the circumstances. No other major central bank took anything like a similar risk (percentage-wise).Ibid., p. 187. The recycling of pounds and francs was pointed out by a leading French banker, Raymond Philippe, Le’Drame Financier de 1924–1928, 4th ed. (Paris: Gallimard, 1931), p. 134; cited in Palyi, Twilight of Gold, p. 194., 84,Moreau did resist Norman’s pressure to inflate the franc further, and he repeatedly urged Norman to meet Britain’s gold losses by tightening money and raising interest rates in England, thereby checking British purchase of francs and attracting capital at home. All this urging was to no avail, Norman being committed to a cheap-money policy. Rothbard, America’s Great Depression, p. 141

Monty Norman could neutralize the French, at least temporarily. But what of the United States? The British, we remember, were counting heavily on America’s continuing price inflation, to keep British gold out of American shores. But instead, American prices were falling slowly but steadily during 1925 and 1926, in response to the great outpouring of American products. The gold-exchange standard was being endangered by one of its crucial players before it had scarcely begun!

So, Norman decided to fall back on his trump card, the old magic of the Norman-Strong connection. Benjamin Strong must, once more, rush to the rescue of Great Britain! After Norman turned for help to his old friend Strong, the latter invited the world’s four leading central bankers to a top-secret conference in New York in July 1927. In addition to Norman and Strong, the conference was attended by Deputy Governor Rist of the Bank of France and Dr. Hjalmar Schacht, governor of the German Reichsbank. Strong ran the American side with an iron hand, keeping the Federal Reserve Board in Washington in the dark, and even refusing to let Gates McGarrah, chairman of the board of the Federal Reserve Bank of New York, attend the meeting. Strong and Norman tried their best to have the four nations embark on a coordinated policy of monetary inflation and cheap money. Rist demurred, although he agreed to help England by buying gold from New York instead of London, (that is, drawing down dollar balances instead of sterling). Strong, in turn, agreed to supply France with gold at a subsidized rate: as cheap as the cost of buying it from England, despite the far higher transportation costs.Ibid.

Schacht was even more adamant, expressing his alarm at the extent to which bank credit expansion had already gone in England and the United States. The previous year, Schacht had acted on his concerns by reducing his sterling holdings to a minimum and increasing the holdings of gold in the Reichsbank. He told Strong and Norman: “Don’t give me a low [interest] rate. Give me a true rate. Give me a true rate, and then I shall know how to keep my house in order.”Anderson, Economics and Public Welfare, p. 181. Schacht had stabilized the German mark in a new Rentenmark after the old mark had been destroyed by a horrendous runaway inflation by the end of 1923. The following year, he put the mark on the gold-exchange standard. Thereupon, Schacht and Rist sailed for home, leaving Strong and Norman to plan the next round of coordinated inflation themselves. In particular, Strong agreed to embark on a mighty inflationary push in the United States, lowering interest rates and expanding credit—an agreement which Rist, in his memoirs, maintains had already been privately concluded before the four-power conference began. Indeed, Strong gaily told Rist during their meeting that he was going to give “a little coup de whiskey to the stock market.”Charles Rist, “Notice Biographique,” Revue d’Economie Politique (November–December, 1955): 1006ff. Strong also agreed to buy $60 million more of sterling from England to prop up the pound.

Pursuant to the agreement with Norman, the Federal Reserve promptly launched its greatest burst of inflation and cheap credit in the second half of 1927. This period saw the largest rate of increase of bank reserves during the 1920s, mainly due to massive Fed purchases of U.S. government securities and of bankers’ acceptances, totaling $445 million in the latter half of 1927. Rediscount rates were also lowered, inducing an increase in bills discounted by the Fed. Benjamin Strong decided to sucker the suspicious regional Federal Reserve banks by using Kansas City Fed Governor W.J. Bailey as the stalking horse for the rate-cut policy. Instead of the New York Fed initiating the rediscount rate cut from 4 percent to 3.5 percent, Strong talked the trusting Bailey into taking the lead on July 29, with New York and the other regional Feds following a week or two later. Strong told Bailey that the purpose of the rate cuts was to help the farmers, a theme likely to appeal to Bailey’s agricultural region. He made sure not to tell Bailey that the major purpose was to help England pursue its inflationary gold-exchange policy.

The Chicago Fed, however, balked at lowering its rates, and Strong got the Federal Reserve Board in Washington to force it to do so in September. The isolationist Chicago Tribune angrily called for Strong’s resignation, charging correctly that discount rates were being lowered in the interests of Great Britain.Anderson, Economics and Public Welfare, pp. 182–83. See also Rothbard, America’s Great Depression, pp. 140–42; Beckhart, “Federal Reserve Policy,” pp. 67ff.; and Lawrence E. Clark, Central Banking Under the Federal Reserve System (New York: Macmillan, 1935), p. 314.

After generating the burst of inflation in 1927, the New York Fed continued, over the next two years, to do its best: buying heavily in prime commercial bills of foreign countries, bills endorsed by foreign central banks. The purpose was to bolster foreign currencies, and to prevent an inflow of gold into the U.S. The New York Fed also bought large amounts of sterling bills in 1927 and 1929. It frankly described its policy as follows:

We sought to support exchange by our purchases and thereby not only prevent the withdrawal of further amounts of gold from Europe but also, by improving the position of the foreign exchanges, to enhance or stabilize Europe’s power to buy our exports.Clark, Central Banking Under the Federal Reserve, p. 198.

If Strong was the point man for the monetary inflation of the late 1920s, the Coolidge administration was not far behind. Pittsburgh multimillionaire Andrew W. Mellon, secretary of the Treasury throughout the Republican era of the 1920s, was long closely allied with the Morgan interests. As early as March 1927, Mellon assured everyone that “an abundant supply of easy money” would continue to be available, and he and President Coolidge repeatedly acted as the “capeadores of Wall Street,” giving numerous newspaper interviews urging stock prices upward whenever prices seemed to flag. And in January 1928, the Treasury announced that it would refund a 4.5-percent Liberty Bond issue, falling due in September, in 3.5-percent notes. Within the administration, Mellon was consistently Strong’s staunchest supporter. The only sharp critic of Strong’s inflationism within the administration was Secretary of Commerce Herbert C. Hoover, only to be met by Mellon’s denouncing Hoover’s “alarmism” and interference.Unfortunately, Hoover shortsightedly attacked only credit expansion in the stock market rather than credit expansion per se. Rothbard, America’s Great Depression, pp. 142–43; Anderson, Economics and Public Welfare, p. 182; Ralph W. Robey, “The Capeadores of Wall Street,” Atlantic Monthly (September 1928); and Harold L. Reed, Federal Reserve Policy, 1921–1930 (New York: McGraw-Hill, 1930), p. 32.

The motivation for Benjamin Strong’s expansionary policy of the late 1920s was neatly summed up in a letter by one of his top aides to one of Montagu Norman’s top henchmen, Sir Arthur Salter, then director of Economic and Financial Organization for the League of Nations. The aide noted that Strong, in the spring of 1928, “said that very few people indeed realized that we were now paying the penalty for the decision which was reached early in 1924 to help the rest of the world back to a sound financial and monetary basis.”O. Ernest Moore to Sir Arthur Salter, May 25, 1928. In Chandler,Benjamin Strong, pp. 280–81. Similarly, a prominent banker admitted to H. Parker Willis in the autumn of 1926 that bad consequences would follow America’s cheap-money policy, but that “that cannot be helped. It is the price we must pay for helping Europe.” Of course, the price paid by Strong and his allies was not so “onerous,” at least in the short run, when we note, as Dr. Clark pointed out, that the cheap credit aided especially those speculative, financial, and investment banking interests with whom Strong was allied—notably, of course, the Norman complex.Willis was a leading and highly perceptive critic of America’s inflationary policies in the interwar period. H. Parker Willis, “The Failure of the Federal Reserve,” North American Review (May 1929): 553. Clark’s study was written as a doctoral thesis under Willis. Clarke, Central Banking Under the Federal Reserve, p. 344. The British, as early as mid-1926, knew enough to be appreciative. Thus, the influential London journal, The Banker, wrote of Strong that “no better friend of England” existed. The Banker praised the “energy and skillfulness that he has given to the service of England,” and exulted that “his name should be associated with that of Mr. [Walter Hines] Page as a friend of England in her greatest need.”Page was the Anglophile ambassador to Great Britain under Wilson and played a large role in getting the United States in the war. Clark, Central Banking Under the Federal Reserve, p. 315.

On the other hand, Morgan partner Russell C. Leffingwell was not nearly as sanguine about the Strong-Norman policy of joint credit expansion. When, in the spring of 1929, Leffingwell heard reports that Monty was getting “panicky” about the speculative boom in Wall Street, he impatiently told fellow Morgan partner Thomas W. Lamont, “Monty and Ben sowed the wind. I expect we shall all have to reap the whirlwind. . . . I think we are going to have a world credit crisis.”Chernow, House of Morgan, p. 313.

Unfortunately, Benjamin Strong was not destined personally to reap the whirlwind. A sickly man, Strong in effect was not running the Fed throughout 1928, finally dying on October 16 of that year. He was succeeded by his handpicked choice, George L. Harrison, also a Morgan man but lacking the personal and political clout of Benjamin Strong.

At first, as in 1924, Strong’s monetary inflation was temporarily successful in accomplishing Britain’s goals. Sterling was strengthened, and the American gold inflow from Britain was sharply reversed, gold flowing outward. Farm produce prices, which had risen from an index of 100 in 1924 to 110 the following year, and had then slumped back to 100 in 1926 and 99 in 1927, now jumped up to 106 the following year. Farm and food exports spurted upward, and foreign loans in the United States were stimulated to new heights, reaching a peak in mid-1928. But, once again, the stimulus was only temporary. By the summer of 1928, the pound sterling was sagging again. American farm prices fell slightly in 1929, and agricultural exports fell in the same year. Foreign lending slumped badly, as both domestic and foreign funds poured into the booming American stock market.

The stock market had already been booming by the time of the fatal injection of credit expansion in the latter half of 1927. The Standard and Poor’s industrial common stock index, which had been 44.4 at the beginning of the 1920s boom in June 1921, had more than doubled to 103.4 by June 1927. Standard and Poor’s rail stocks had risen from 156.0 in June 1921 to 316.2 in 1927, and public utilities from 66.6 to 135.1 in the same period. Dow Jones industrials had doubled from 95.1 in November 1922 to 195.4 in November 1927. But now, the massive Fed credit expansion in late 1927 ignited the stock market fire. In particular, throughout the 1920s, the Fed deliberately and unwisely stimulated the stock market by keeping the “call rate,” that is, the interest rate on bank call loans to the stock market, artificially low. Before the establishment of the Federal Reserve System, the call rate frequently had risen far above 100 percent, when a stock market boom became severe; yet in the historic and virtually runaway stock market boom of 1928–29, the call rate never went above 10 percent. The call rates were controlled at these low levels by the New York Fed, in close collaboration with, and at the advice of, the Money Committee of the New York Stock Exchange.Rothbard, America’s Great Depression, p. 116; Clarke, Central Banking Under the Federal Reserve, p. 382; Adolph C. Miller, “Responsibilities for Federal Reserve Policies, 1927–1929,” American Economic Review (September 1935). The stock market, during 1928 and 1929, went into overdrive, virtually doubling these two years. The Dow went up to 376.2 on August 29, 1929, and Standard and Poor’s industrials rose to 195.2, rails to 446.0, and public utilities to 375.1 in September. Credit expansion always concentrates its booms in titles to capital, in particular stocks and real estate, and in the late 1920s, bank credit propelled a massive real estate boom in New York City, in Florida, and throughout the country. These included excessive mortgage loans and construction from farms to Manhattan office buildings.On the real estate boom of the 1920s, see Homer Hoyt, “The Effect of Cyclical Fluctuations upon Real Estate Finance,” Journal of Finance (April 1947): 57.

The Federal Reserve authorities, now concerned about the stock market boom, tried feebly to tighten the money supply during 1928, but they failed badly. The Fed’s sales of government securities were offset by two factors: (a) the banks shifting their depositors from demand deposits to “time” deposits, which required a much lower rate of reserves, and which were really savings deposits redeemable de facto on demand, rather than genuine time loans, and (b) more important, the fruit of the disastrous Fed policy of virtually creating a market in bankers’ acceptances, a market which had existed in Europe but not in the United States. The Fed’s policy throughout the 1920s was to subsidize and in effect create an acceptance market by standing ready to buy any and all acceptances sold by certain favored acceptance houses at an artificially cheap rate. Hence, when bank reserves tightened as the Fed sold securities in 1928, the banks simply shifted to the acceptance market, expanding their reserves by selling acceptances to the Fed. Thus, the Fed’s selling of $390 million of securities was partially offset, during latter 1928, by its purchase of nearly $330 million of acceptances.On the unfortunate Fed acceptance policy of the 1920s, see Rothbard, America’s Great Depression, pp. 117–23. The Fed’s sticking to this inflationary policy in 1928 was now made easier by adopting the fallacious “qualitativist” view, held as we have seen also by Herbert Hoover, that the Fed could dampen down the boom by restricting loans to the stock market while merrily continuing to inflate in the acceptance market.

In addition to pouring in funds through acceptances, the Fed did nothing to tighten its rediscount market. The Fed discounted $450 million of bank bills during the first half of 1928; it finally tightened a bit by raising its rediscount rates from 3.5 percent at the beginning of the year to 5 percent in July. After that, it stubbornly refused to raise the rediscount rate any further, keeping it there until the end of the boom. As a result, Fed discounts to banks rose slightly until the end of the boom instead of declining. Furthermore, the Fed failed to sell any more of its hoard of $200 million of government securities after July 1928; instead, it bought some securities on balance during the rest of the year.

Why was Fed policy so supine in late 1928 and in 1929? A crucial reason was that Europe, and particularly England, having lost the benefit of the inflationary impetus by mid-1928, was clamoring against any tighter money in the U.S. The easing in late 1928 prevented gold inflows from the U.S. from getting very large. Britain was again losing gold; sterling was again weak; and the United States once again bowed to its wish to see Europe avoid the consequences of its own inflationary policies.

Leading the inflationary drive within the administration were President Coolidge and Treasury Secretary Mellon, eagerly playing their roles as the capeadores of the bull market on Wall Street. Thus, when the stock market boom began to flag, as early as January 1927, Mellon urged it onward. Another relaxing of stock prices in March spurred Mellon to call for and predict lower interest rates; again, a weakening of stock prices in late March induced Mellon to make his statement assuring “an abundant supply of easy money which should take care of any contingencies that might arise.” Later in the year, President Coolidge made optimistic statements every time the rising stock market fell slightly. Repeatedly, both Coolidge and Mellon announced that the country was in a “new era” of permanent prosperity and permanently rising stock prices. On November 16, the New York Times declared that the administration in Washington was the source of most of the bullish news and noted the growing “impression that Washington may be depended upon to furnish a fresh impetus for the stock market.” The administration continued these bullish statements for the next two years. A few days before leaving office in March 1929, Coolidge called American prosperity “absolutely sound” and assured everyone that stocks were “cheap at current prices.”Rothbard, America’s Great Depression, p. 148. See also ibid., pp. 116–17; and Robey, “Capeadores.” The leading “bull” speculator of the era, former General Motors magnate William Crapo Durant, who was to get wiped out in the crash, hailed Coolidge and Mellon as the leaders of the boom. Commercial and Financial Chronicle (April 20, 1929): 2557ff.,Some of Strong’s apologists claim that, if Strong had been at the helm, he would have imposed tight money in 1928. For an example, see Carl Snyder, Capitalism, the Creator: The Economic Foundations of Modern Industrial Society (New York: Macmillan, 1940), pp. 227–28. Snyder worked under Strong as head of the statistical department of the New York Fed. But we now know the contrary: that Strong protested against even the feeble restrictive measures during 1928 as being too severe, in a letter from Strong to Walter W. Stewart, August 3, 1928. Stewart, formerly head of the Fed’s research division, had a few years earlier shifted to become economic adviser of the Bank of England, and had written to Strong warning of unduly tight restriction on American bank credit. Chandler, Benjamin Strong, pp. 459–65.

The clamor from England against any tighter money in the U.S. was driven by England’s loss of gold and the pressure on sterling. France, having unwillingly piled up $450 million in sterling by the end of June 1928, was anxious to redeem sterling for gold, and indeed sold $150 million of sterling by mid-1929. In deference to Norman’s threats and pleas, however, the Bank of France sold that sterling for dollars rather than for gold in London. Indeed, so cowed were the French that (a) French sales of sterling in 1929–31 were offset by sterling purchases by a number of minor countries, and (b) Norman managed to persuade the Bank of France to sell no more sterling until after the disastrous day in September 1931 when Britain abandoned its own gold-exchange standard and went on to a fiat pound standard.Palyi, Twilight of Gold, pp. 187, 194.

Meanwhile, despite the great inflation of money and credit in the U.S., the massive increase in the supply of goods in the U.S. continued to lower prices gradually, wholesale prices falling from 104.5 (1926=100) in November 1925 to 100 in 1926, and then to 95.2 in June 1929. Consumer price indices in the U.S. also fell gradually in the late 1920s. Thus, despite Strong’s loose money policies, Norman could not count on price inflation in the U.S. to bail out his gold-exchange system. Montagu Norman, in addition to pleading with the U.S. to keep inflating, resorted to dubious short-run devices to try to keep gold from flowing out to the U.S. Thus, in 1928 and 1929, he would sell gold for sterling to raise the sterling rate a bit, in sales timed to coincide with the departure of fast boats from London to New York, thus inducing gold holders to keep the precious metal in London. Such short-run tricks were hardly adequate substitutes for tight money or for raising bank rate in England, and weakened long-run confidence in the pound sterling.Anderson, Economic and Public Welfare, p. 201.

In March 1929, Herbert Clark Hoover, who had been a powerful secretary of commerce during the Republican administrations of the 1920s, became president of the United States. While not as intimately connected as Calvin Coolidge, Hoover long had been close to the Morgan interests. Mellon continued as secretary of the Treasury, with the post of secretary of state going to the longtime top Wall Street lawyer in the Morgan ambit, Henry L. Stimson, disciple and partner of J.P. Morgan’s personal attorney, Elihu Root.Undersecretary of the Treasury Ogden Mills, Jr., who was to replace Mellon in 1931 and who was close to Hoover, was a New York corporate lawyer from a family long associated with the Morgan interests. Hoover’s secretary of the Navy was Charles F. Adams, from a Boston Brahmin family long associated with the Morgans, and whose daughter married J.P. Morgan, Jr. Perhaps most important, Hoover’s closest, but unofficial adviser, whom he regularly consulted three times a week, was Morgan partner Dwight Morrow.Philip H. Burch, Jr., Elites in American History, vol. 3, The New Deal to the Carter Administration (New York: Holmes and Meier, 1980), p. 280. For the important but private influence on President Hoover by Morgan partner Thomas W. Lamont, including Lamont’s inducing Hoover to conceal his influence by faking entries in a diary that Hoover left to historians, see Ferguson, “From Normalcy to New Deal,” p. 79.

Hoover’s method of dealing with the inflationary boom was to try not to tighten the money supply, but to keep bank loans out of the stock market by a jawbone method then called “moral suasion.” This too was the preferred policy of the new governor of the Federal Reserve Board in Washington, Roy A. Young. The fallacy was to try to restrict credit to the stock market while keeping it abundant to “legitimate” commerce and industry. Using methods of intimidation of business honed when he was secretary of commerce, Hoover attempted to restrain stock loans by New York banks, tried to induce the president of the New York Stock Exchange to curb speculation, and warned leading editors and publishers about the dangers of high stock prices. None of these superficial methods could be effective.

Professor Beckhart added another reason for the adoption of the ineffective policy of moral suasion: that the administration had been persuaded to try this tack by the old manipulator, Montagu Norman. Finally, by June 1929, the moral suasion was at last abandoned, but discount rates were still not raised, so that the stock market boom continued to rage, even as the economy in general was quietly but inexorably turning downward. Secretary Mellon once again trumpeted our “unbroken and unbreakable prosperity.” In August, the Federal Reserve Board finally agreed to raise the rediscount rate to 6 percent, but any tightening effect was more than offset by the Fed’s simultaneously lowering its acceptance rate, thereby once again giving an inflationary fillip to the acceptance market. One reason for this resumption of acceptance inflation, after it had been previously reversed in March, was, yet again, “another visit of Governor Norman.”Benjamin H. Beckhart, “Federal Reserve Policy and the Money Market, 1923–1931,” in The New York Money Market, Beckhart, et al. (New York: New York University Press, 1931), pp. 142ff. See also ibid., p. 127. Thus, once more, the cloven hoof of Montagu Norman was able to give its final impetus to the boom of the 1920s. Great Britain was also entering upon a depression, and yet its inflationary policies resulted in a serious outflow of gold in June and July. Norman was able to get a line of credit of $250 million from a New York banking consortium, but the outflow continued through September, much of it to the United States. Continuing to help England, the New York Fed bought heavily in sterling bills from August through October. The new subsidization of the acceptance market, mostly foreign acceptances, permitted further aid to Britain through the purchase of sterling bills.

A perceptive epitaph on the qualitative-credit politics of 1928–29 was pronounced by A. Wilfred May:

Once the credit system had become infected with cheap money, it was impossible to cut down particular outlets of this credit without cutting down all credit, because it is impossible to keep different kinds of money separated in water-tight compartments. It was impossible to make money scarce for stock-market purposes, while simultaneously keeping it cheap for commercial use. . . . When Reserve credit was created, there was no possible way that its employment could be directed into specific uses, once it had flowed through the commercial banks into the general credit stream.A. Wilfred May, “Inflation in Securities,” in The Economics of Inflation, H. Parker Willis and John M. Chapman, eds. (New York: Columbia University Press, 1935), pp. 292–93; Charles O. Hardy, Credit Policies of the Federal Reserve System (Washington, D.C.: Brookings Institution, 1932), pp. 124–77; Oskar Morgenstern, “Developments in the Federal Reserve System,” Harvard Business Review (October 1930): 2–3; and Rothbard, America’s Great Depression, pp. 151–52.

Original Article: "Bretton Woods and the Spoliation of Europe"

This Audio Mises Wire is generously sponsored by Christopher Condon. Narrated by Michael Stack.

Original Article: "The End of the Gold Standard. Fifty Years of Monetary Insanity"

This Audio Mises Wire is generously sponsored by Christopher Condon. Narrated by Michael Stack.

Original Article: "The Demise of the Gold Standard"

This Audio Mises Wire is generously sponsored by Christopher Condon. Narrated by Michael Stack.

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On the 50th anniversary of Nixon's gold shock, The Fiat Standard is an amazing explication of how the West fell to its current state. You don't want to miss this show, especially Saifedean's epic takedown of fiat academia at the end!

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Original Article: "They Don't Hate Gold Because It's Gold. They Hate It Because It's Not Government Money."

This Audio Mises Wire is generously sponsored by Christopher Condon. Narrated by Michael Stack.

Key Words: gold standard, monetary policy, austrian economics, populism

Kristoffer Mousten Hansen (kristoffi@gmail.com) is a research assistant at the Institute for Economic Policy at Leipzig University and a PhD candidate at the University of Angers. He is also a Mises Institute research fellow.

The author thanks Dr. Joseph Salerno for comments as well as an anonymous referee.

We will proceed by first analyzing the shortcomings of the present fiat-money order, indicating how it distorts the market and society through inflation, redistribution, by artificially increasing the importance of financial markets, and by hampering US industrial production in international trade. Then we will show that these problems would cease to exist under the gold standard, and we will indicate a possible reform for returning to gold in the US. Finally, we will argue that such a reform in order to be successful must become a popular crusade—i.e., it must become a populist issue.

Politics have become increasingly populist throughout the Western world since the Great Recession. Both left-wing and right-wing parties thunder against political and other elites, suggesting that their specific programs and ideologies will put an end to what they see as unfair exploitation of the people by an unaccountable and increasingly out-of-touch elite. In the United States recent populist movements are the Tea Party movement and Occupy Wall Street, and both Donald Trump and Bernie Sanders used populist rhetoric in their presidential campaigns.

The rise of populism is, in hindsight, perfectly understandable. The war in Iraq would be a “cakewalk”; “if you like your health insurance, you can keep it”; my opponent’s voters are a “basket of deplorables”—mainstream politicians have again and again shown themselves to be out of touch with reality and increasingly, it seems, also with more and more of their voters. Most important for our purposes, the Federal Reserve, charged with managing the money supply and securing low inflation and low unemployment, was oblivious to all dangers on the eve of the Great Recession, and seemed to do what it could to help big banks and investors weather the storm, no matter what the price would be for the rest of the country.

Indeed, the Federal Reserve has proven unable to achieve the goals set for it since its establishment and especially since the final end of the gold standard and the introduction of the fiat dollar in 1971, when its control over the money supply was vastly expanded. The Fed did manage to break the inflationary expectations that had led to double-digit inflation in the 1970s, but this slight improvement has not canceled out the many evil effects of fiat money. The harmonious development of society and the economy depends on sound money, which is itself a spontaneous social institution (Mises 1981, 421), while monetary policy leads to accumulating economic distortions. These distortions favor political and financial elites (Sennholz 1985, 1979): they have greatly expanded the scope of the financial sector and its importance to the economy, and politicians now have greatly increased resources at their disposal to pursue their dreams of remaking society. With our present fiat money system it is much easier for politicians to engage in deficit spending, as this spending artificially enlarges the market for government bonds as well as other financial titles. The public at large, on the other hand, is more and more dependent on financial markets if not outright on the state, while political elites are less beholden to the taxpayers for the resources they need.

More than any other institution, it is our contention that the Federal Reserve has caused economic distortions and increased popular resentment toward elites in general. This is why the gold standard should be the eminently populist cause: against unaccountable elites and for the general welfare of the public at large. Not only that, it is only by making the gold standard a populist crusade that there is any hope of restoring gold to its monetary role (Mises 1981; Sennholz 1985; Paul 1985). Fiat money has greatly distorted the economy and harmed the common man, and returning to the gold standard would resolve these distortions. This does not mean that the restoration of the gold standard would mean the fulfillment of every policy currently advocated by populists, nor that the advocates of gold should stoop to demagogy. The case for gold must be presented honestly. All we mean by making the gold standard a populist cause is to make the appeal directly to the public at large, and especially to that part of the public who are the most victimized by the present system, and who have the most to gain by returning to sound money. The gold standard cannot be just an academic exercise: we must show how a return to gold would improve the economic situation and prospects of the common man.

We will proceed as follows: first, we will present some of the main problems of fiat money. In particular, we will focus on how these problems affect the broad classes of producers in the private sector. Then, we will show how these problems would disappear, or at least be more manageable, under a gold standard. We then sketch how the gold standard would look in the present day and how we could move from fiat dollars to gold and, eventually, to complete monetary freedom. Finally, we will briefly discuss the ways monetary reform might become a populist movement.

We do not pretend to any great originality with this proposal, rather it should be seen as an updated and slightly modified version of Mises’s proposed reform from the 1950s.

What follows is a brief survey of the main problems of fiat money. They are all variations of the effects that additions to the money supply have as new money enter and spread through the economy, the Cantillon effects (named after the Irish economist Richard Cantillon, who first analyzed them in 1755. Cantillon 2010), and are as such all connected. They can be broadly categorized as inflation, redistribution, financialization, and deindustrialization.

Inflation

Price inflation is a constant presence in the age of fiat money. It is true that the high inflation of the 1970s gave way to more moderate inflation in the following decades, but the purchasing power of the dollar has continued to fall steadily (see figures 1 and 2). This moderation might partly have been due to greater restraint on behalf of the Federal Reserve, but it should be pointed out that the money supply continued to grow throughout the period. A more likely explanation is that the advent of moderate price inflation was due to exogenous factors beyond the control of US monetary authorities. The last forty years or so of globalization have seen the integration of first the East Asian tiger economies, then the formerly Communist countries, and especially China, into the world economy, massively increasing global production and trade. Former Fed chairman Alan Greenspan frankly admitted that the period of low inflation was not due to activist central bank policy (Greenspan 2007, 12–15; cf. Stockman 2013, 63–64); indeed, more recently he admitted in an interview with the Gold Investor that during his tenure as chair of the Federal Reserve “US monetary policy tried to follow signals that a gold standard would have created. That is, sound monetary policy even with a fiat currency” (Greenspan 2017, 14). We may question just how effective merely playing at the gold standard is compared to the real deal,One reason to be skeptical of the extent to which Greenspan really imitated the gold standard, or at least to question his success in doing so, is that under the gold standard, the US balance-of-payments deficit would have been eliminated by the outflow of gold. As the deficit grew at an almost constant rate (see figure 4) throughout the 1990s and first decade of the 2000s, the great moderation was clearly not a good imitation of the gold standard. Jacques Rueff (1972) in his The Monetary Sin of the West gives a good explanation of how and why the US balance-of-payments deficit persisted under the gold-exchange standard. The same causes he identified back then are still at work today. but this policy may have led monetary authorities along a less inflationary path for a time.

Figure 1: Purchasing Power of the US Dollar, 1960–2019.

Figure 2: Purchasing Power of the US Dollar, 1960–2019, YOY Change.

Nevertheless, the effect of these positive developments across the globe would, in the absence of government manipulation of the money supply, have been a steep fall in the prices of consumer goods. The 1990s and the first decade of the 2000s should have been marked by deflation, as the amount of goods offered to consumers increased while the supply of money remained steady. This would have spread the benefits of globalization and increased production to all holders of US dollars. But the Fed’s inflationary policy neutralized this beneficial effect, as it pumped more money into the economy in pursuit of its goal of low but stable price inflation. The hollowing out of the purchasing power of the dollar therefore continued at a time when we should have expected a general appreciation in the value of money.

The inflation engineered by the Fed did not cause uniform price increases across the board. The effects of additions to the money supply depend on where the new money enters the economy and how it spreads through the economy. So some consumer goods did fall in price—e.g., consumer electronics—while others rose drastically, such as housing. Figure 3 shows this clearly by comparing changes in the Case-Shiller housing index to the general Consumer Price Index. Housing became drastically more expensive relative to other consumer goods over the last thirty years.

Figure 3: Case-Shiller Housing Index Compared to CPI (1987 = 100).

Figure 4: United States Trade Balance, 1992–November 2018.

Inflation and the erosion of purchasing power do not affect only the consumers; they are also important factors for producers. In an inflationary environment, the entrepreneur cannot simply allow for yearly depreciation based on the purchase price of his assets. He has to also estimate how monetary factors will distort future prices in order to calculate his replacement costs and make adequate allowance for depreciation. At the very least, this increases the costs of doing business, as more time and resources must be spent on accounting; more seriously, it can lead to capital consumption and reduced productivity, as the entrepreneur fails to foresee replacement costs adequately (Rothbard 2009, 993–94; Baxter 1955; cf. Reisman 2002).

Monetary inflation, furthermore, is not simply a hydraulic process, with prices being raised gradually as new money percolates through the economy. Rather, inflation may also affect the quality of products offered for sale by entrepreneurs (Sieroń 2017). Increases in the money supply often affect the prices of producer goods before those of consumer goods, especially when the new money enters the economy in the form of credit expansion. It is not possible to simply pass on the higher costs to the consumers if the demand for goods is elastic, as higher prices would then simply mean lower total revenues. Rather, the entrepreneur must somehow reduce his costs in order to stay profitable, which usually means substituting lower-quality for higher-quality inputs (ibid., 153, 155).

This process of product degradation also takes place over the long term: given that the broad mass of consumers will only receive increased monetary incomes late in the Cantillon process, the entrepreneurs will have to cut costs long before they can raise prices for consumers in order to stay in business. As inflationary credit expansions are perennially reoccurring, entrepreneurs will have to shift their innovative activities toward cost-cutting technologies and finding ever-cheaper substitutes for inputs, at the expense of research into higher-quality products. In the long run, we should therefore expect the inflationary environment of the fiat dollar system to yield progressively worse consumer products over time compared to what would have been produced under a sounder monetary regime.

While it is difficult to isolate this effect in the real world of complex phenomena, there are some clear indications that such product degradation has in fact been taking place. When we look at the consumption of foodstuffs in the United States during the twentieth century, there are some clear trends of changing consumption patterns that follow very closely the change to inflationary fiat money. This is not to say that every change in the diet for the worse is caused by monetary phenomena. For instance, the fall in butter consumption (figure 6) occurred mainly before the end of Bretton Woods and was probably due to the crusade of Dr. Ansel Keys against it (Teicholz 2014), but other changes have a clearer connection to the increasingly inflationary monetary systems of the postwar period and especially after 1971.

The changing trends in the consumption of meats have a clear connection with monetary phenomena. We will make two assumptions for the purposes of our presentation: that people, at least in Europe and America, eat more meat the more prosperous they are and that most people in the western world consider beef a higher-quality meat than pork or chicken. There was a rising trend in per capita consumption of the main kinds of meat—beef, pork, and chicken—until 1971. After this date, however, overall consumption of meat virtually stagnated: it only returned to the 1971 level for an extended period in the 2000s and was in 2017 only 3.5 percent above the 1971 level. What is more, the kinds of meats consumed have changed dramatically: pork consumption has declined and beef consumption has collapsed by more than 30 percent, while the amount of chicken consumed per capita has more than doubled since 1971, and has increased sixfold since 1909 (see figure 5). While changing consumer tastes may account for part of this change, it is hard not to suspect that most people can simply no longer afford the same amount and quality of tasty beef that they could in the 1960s and 1970s.Changing consumer attitudes are not necessarily independent of changes in the relative prices of foodstuffs: if beef is not only more expensive but also rising in price relative to chicken, as it has been, it may be much easier for housewives to accept government propaganda and corporate marketing extolling the supposed superior nutritional qualities of the lower-quality foodstuff. There are, at the very least, some interesting indications here of the way that fiat money has led to the production and consumption of lower-quality products.

Figure 5: Per Capita Availability of Leading Meats, Indexed 1971 = 100.

Figure 6: Proportion of Per Capita Availability of Fats.

Redistribution

It is a fact of nature that economic resources are distributed unevenly. Even if everybody had the same resources initially, different choices would quickly lead to differences in wealth and income. In a market economy, such differences are due to differences in productivity and in entrepreneurial skill. Workers will tend to be paid according to the value of their contribution to production; savers will earn a return on their investment based on the social rate of time preference; successful entrepreneurs will earn higher profits than unsuccessful entrepreneurs; all will earn an income and accumulate wealth based on their contribution to satisfying consumer demand. This inequality is not wrong or evil, but simply a fact of life that results from the free actions of economic agents.

Inflationary monetary policy distorts this picture of market-determined natural inequalities, as Cantillon effects redistribute income and wealth to the early receivers of new money and away from those who receive the new money last or who are on fixed incomes. This process was restricted under the gold standard, since gold cannot be created at will and gold mining does not lead to Cantillon effects, as we shall see below. Increases in the issue of fiduciary media did mean some redistribution, but these increases were severely limited by the danger of an outflow of gold. Since the final destruction of the gold standard in 1971, however, this is no longer an issue: the monetary authorities can keep inflating the money supply and banks can continue to create fiduciary media to the benefit of some at the expense of others.

The result has been stagnating incomes for workers and for the middle class generally, while the politically well connected and the financial operatives who are closest to the source of new money benefit. Recent studies (Bachman 2017; Brill et al. 2017; Bivens et al. 2014) suggest that for the median US worker, earnings (in real terms) have not only been stagnant, but have fallen slightly since 1973. This is not due to falling productivity: rather, the growth in productivity has far outstripped growth in compensation to workers since 1970 (Brill et al. 2017, 8). Up to that point, increasing productivity was reflected in higher wages, as we should expect according to economic theory. While the economy has continued to become more productive, then, the average worker sees less and less of this increased productivity.

Who are the beneficiaries of this hidden redistribution? The main clients of the central bank: the government and the commercial banks (Hülsmann 2013). These have generally been the first to receive the new money, as the banks have been able to expand their issue of fiduciary media and the government has always had a ready market for new debt issues. Since the 1970s, finance has become an increasingly important part of the economy, and even in nonfinancial firms, financial income constitutes an increasing proportion of total revenue (Lin and Tomaskovic-Devey 2013). The reason for this should be clear: as money is pumped into the economy through financial markets, firms that position themselves to take advantage of monetary infusions and easy financial conditions will win out over their less savvy competitors (although this is an advantage that depends on the conditions of easy money and credit expansion). The company officers guiding this process and the workers skilled in financial dealings will naturally earn higher compensations than their colleagues engaged in more mundane activities.Note that Lin and Tomaskovic-Devey attribute the rise of financialization to deregulation.

This does not invalidate the conclusion of economic reasoning that wages are set in accordance with the discounted marginal revenue product (DMRP) of the worker (Rothbard 2009, chap. 7). However, this is the long-run tendency of the market and will only ever be reached in final equilibrium. In the meantime, inflation, especially in the form of credit expansion, temporarily increases the revenue to be gained from financial transactions and makes indebtedness more attractive. It is therefore clear that so long as the inflation lasts, financial incomes will be higher than they otherwise would be. In our inflationary environment, the DMRP of financial wizardry is simply higher than it would otherwise be, and that of workers correspondingly lower.

While real wealth has increased as a result of globalization and increased productivity, the distribution of wealth and incomes has been increasingly skewed since 1970 due to continuous inflation. Private sector workers see their wages stagnate while government employees, government contractors, and the financial sector benefit.Hülsmann (2013) also stresses the redistribution of wealth from “have-nots” to “haves” in general.

Financialization

Fiat money, as we have seen, tends to lose its purchasing power over time. This means that plain saving—hoarding of money and accumulation of durable goods—and direct investment of accumulated funds in capital goods are discouraged. Instead, both the supply and the demand for financial assets increase as savers look for some way to protect their accumulated wealth (Hülsmann 2013, 6). The quality of fiat money is such that it is not a good store of wealth, since price inflation and a falling purchasing power are inherent to fiat money (cf. Bagus 2015b on the importance of the quality of money). Furthermore, as a consequence of central bank policy, the prices of financial assets tend to increase relative to those of nonfinancial assets (Žukauskas and Hülsmann 2019), so saving in forms other than financial titles is discouraged. In order to protect themselves from the wealth-destroying effects of inflation, savers have to engage in financial speculation: they take on debt to invest in financial assets, just to stay ahead of inflation and the redistributive effects of central bank policy.

This all leads to increased dependence on the financial sector, not only for consumers who want to acquire durable consumer goods such as houses and cars, but also for savers who want to accumulate wealth for later consumption and for businesses that want to expand operations (Hülsmann 2008b, 180–85). There is nothing wrong with financial institutions or financial markets in themselves. They provide a valuable service for the individual saver or borrower, and they provide a valuable service for society as a whole by helping to allocate funds to the most valued uses. The problem is that the destruction of sound money has led to a situation where everybody has to make use of financial services simply to preserve their wealth, while the financial markets increasingly depend on central bank interventions, not on the objective facts concerning the real assets underlying the various financial claims (Hülsmann 2014, 11–12). A paper issued by the Bank of England (Bush, Farrant, and Wright 2011) makes a similar point: severe imbalances have been allowed to build up in the international monetary and financial system, and capital movements do not seem be guided by considerations of productivity.

There is also evidence that overreliance on financial markets has had spillover effects on the real economy, as it has distorted the process of valuation and calculation guiding economic action (Ehret 2014). This leads us to the next problem generated by fiat money and privileged financial markets: the perennially reoccurring business cycle.

It should come as no surprise that banks and other financial institutions’ knowledge that they can depend on the central bank to bail them out leads to moral hazard. They can now engage in risky speculation in the hope of huge profits, and when the financial system periodically experiences a crisis or collapse, the taxpayers and hapless depositors are left with the bill. This speculation generally takes the form of increased lending to businesses in the form of fiduciary media, that is, uncovered money substitutes. As this increase in lending is not matched by an increase in saving, the result is that the market rate of interest is driven below its natural level and the business cycle is set in motion (Mises 1981, 357–64).

Austrian economists have thoroughly explained the business cycle resulting from credit expansion (e.g., Hayek 1935; Mises 1998, 535–83; Rothbard 2009, 989–1041; Skousen 1990; Hülsmann 2002; Huerta de Soto 2009; Salerno 2012). Cheap credit initially fuels a boom, as entrepreneurs invest in a longer structure of production. But the real savings needed to complete all investment projects are not available, and this becomes apparent when the infusion of cheap credit has passed through the system and the interest rate again rises to a level determined by the time preference of the economic agents. The boom inevitably turns to bust as nonviable investments are liquidated, workers laid off, and inconvertible capital goods in unprofitable production processes abandoned.

As part of the adjustment process during the bust, there is often so-called secondary or credit deflation (Rothbard 1963, 14–19; Salerno 2012, 37–41). Faced with bankruptcies and financial difficulties among borrowers, banks contract credit, or refuse to roll over short-term loans. At the same time, there is often an increased demand for money, as, faced with greater uncertainty, entrepreneurs and consumer hold off on spending until they are more sure of the economic environment. However, monetary authorities often intervene to prevent this deflation. To do this, they recapitalize overextended banks with new money, and the financial system that initiated the business cycle is largely saved from the ensuing recession. At the same time, workers and entrepreneurs have to scramble to reconstitute the structure of production along sustainable lines, while living through periods of unemployment and reduced incomes.

Deindustrialization

It is difficult to know how much of the decline in manufacturing and deindustrialization in the United States we can ascribe to the natural development of the economic system. The integration of vast areas of the globe into the world economy over the last several decades means that some industries are simply no longer competitive in the United States. Workers and investment will have to shift to other employment where the US still has a comparative advantage. There is no way around this adjustment, but there is some reason to believe that industry in the United States has been disadvantaged by the monetary policy of the Federal Reserve.

The first indication that something is amiss is the permanent deficit in the US balance of payments. Except for periods of recession, the deficit in the trade balance has only grown since the early 1990s (see figure 4). This would not normally be a problem, since the trade deficit would be offset by investments in the US economy. Increasingly, however, the trade deficit is paid for by a continuous outflow of newly created fiat dollars. Under the gold standard, this would be impossible (cf. below), and in this world of fluctuating fiat currencies, inflation should have led to a depreciation of the dollar in terms of foreign currencies, as its supply increased and its purchasing power fell. Yet this has manifestly not happened; the dollar’s exchange rate is by and large stable.

The reason for this is that the fiat dollar deliberately continues to be overvalued against foreign currency. David Stockman (2013) has repeatedly spoken of the “China price,” the downward pressure on prices caused by the flow of goods from China. Yet it is not just increased productivity and market integration that cause this. Lewis Lehrman (2013, 191–95) has argued that China is in effect a financial colony of the United States: by pegging the yuan to the dollar at an undervalued rate, Chinese exports to the US are boosted, and the People’s Bank of China can then inflate its own currency against its artificially overvalued dollar holdings. Indeed, the current international monetary system is best seen as a continuation of the gold-exchange standard introduced in 1922 and reintroduced at Bretton Woods, where the dollar became the world’s reserve currency and the only link to gold. This allowed the US to build up a balance of payments deficit, especially from the late 1950s on. Instead of an outflow of gold from Fort Knox, dollar balances simply accumulated abroad, especially in Western Europe, stoking inflation there, and in effect meant (and means) that the citizens of any country with a positive balance of payments vis-à-vis the United States were financing Americans’ acquisition of tangible assets in their own countries as well as the foreign spending of the US government. Jacques Rueff called this “an unprecedented system of spoliation” (Rueff 1972, 191) and it has continued since the end of Bretton Woods in 1971.Robert Lucas (1990) in an important paper has asked why doesn’t capital flow from rich countries to poor? He suggests several possible answers, but does not consider monetary problems. Yet it is here that the solution lies, as we have indicated in the text. See also the comments to this effect in the paper from the Bank of England already cited (Bush, Farrant, and Wright 2011, 9), as well as the analyses of the gold-exchange standard and Bretton Woods—they are really the same thing—by Jacques Rueff (1964; 1972) and Robert Triffin (1960; 1964). Their diagnosis is, mutatis mutandis, still applicable today: the US is still able to run a “deficit without tears” (Rueff 1972, 23) and benefit from what the French finance minister Valéry Giscard d’Estaing called the “exorbitant privilege” of issuing the world’s only reserve currency (Eichengreen 2011, 4).

The best description of this system is as a policy of American financial imperialism in which the Chinese government and other creditor nations are the junior partners.See Hoppe (2006) for an account of how the modern international monetary system in general functions along similar lines. It should be clear that it is at most the governments of the creditor nations that can be considered junior partners, since they can increase their money supply and government spending on the basis of accumulated dollar reserves. The populations of foreign countries lose, as their purchasing power is diminished: in a free system, either their currencies would be revaluated, or should the gold standard be adopted, gold would flow into the creditor nations. Not only are the incomes of Chinese workers artificially diluted, but the permanent overvaluation of the dollar has made it impossible for American industries to compete with those of other nations, and the result has been widespread deindustrialization in America (ibid., 195). It has been persuasively argued that increased trade contributed significantly to the collapse of manufacturing employment in the 2000s (Houseman 2018), which would corroborate the theory advanced here: monetary policy distorted the benefits from globalization and hobbled American industry. Had the dollar been allowed to depreciate as a consequence of inflationary Fed policy, it is plausible that the dislocations from the emergence of the Chinese economy and its integration into the world economy would not have been as severe. In that scenario Chinese and American industry would both have adapted and evolved according to the law of comparative advantage, to the benefit of both countries. Instead, American workers have had to suffer far more than necessary from the inevitable dislocations of globalization, while the benefits of globalization have been redirected to the people in control of the fiat dollar system: politicians, career bureaucrats, and crony capitalists well connected to the Fed’s money-creating operations.

The fiat dollar, then, has bred serious ills for American economy and society. Yet can the reintroduction of the gold standard—or, rather, the introduction of a pure gold standard—overcome these problems? And how can we go about reestablishing gold as money? We turn now to these questions.

The goal of this section is to establish that a return to the gold standard would overcome the severe problems that the fiat dollar has caused and that such a return is not only desirable but also eminently feasible. We will also briefly explain why the gold standard is preferable to some other commodity standard, such as a silver standard or a bitcoin standard.

Previous Reform Proposals

There have been very many proposals for a return to or a reform of the gold standard ever since the gradual deformation of the classical gold standard began. The following is not a complete list of these proposed reforms. We are only interested in recent reforms along the lines of a “true” or “pure” gold standard, where gold truly is money and money is seen as a market institution (Salerno 2010a). Money originated in the market as the outcome of the free actions of human beings (Menger 2007, 257–85; 2009), and the ultimate goal of any reform should be to reestablish money as a market institution and banish all government interventions from the monetary sphere. In a way, returning to the gold standard is just a means to this end—once the reform is accomplished, it is up to the actors in the market to either validate the experience of millennia by freely using gold as money or to discard the gold standard in exchange for their preferred medium of exchange.

The “gold standard” of such reforms is Mises’s from 1953 (Mises 1981, 413–57), and this is the one we will use as a blueprint for our own proposal. Rothbard wrote several works calling for a return to gold at a legal par that would lead to 100 percent reserves, and while we agree with his views on fractional reserve banking, we do not agree with this proposed method of achieving 100 percent reserves (Rothbard 2005, 1985; more on this below). Jesús Huerta de Soto has also proposed a reform of money and banking along Rothbardian lines (Huerta de Soto 2009, 715–812). Hayek in his writings on monetary reform in the 1970s does not endorse a gold standard, but his call for full freedom in monetary matters is definitely consonant with the gold standard as envisioned by its champions (Hayek 1976, 1990, 2008). Hans Sennholz (1969, 1979, 1985) and Ron Paul (Paul 1985; Paul and Lehrman 1982) both emphasize the need for complete freedom in monetary matters as part of their reform proposals. The Misesian reform we will outline below is superior to both the Rothbardian approach and a reform that calls for full freedom in monetary affairs but stops short of abolishing the paper dollar.

The way of returning to gold that Rothbard proposes is that the definition of the dollar be changed so that the total stock of gold becomes 100 percent equal to the supply of dollars in circulation (Rothbard 2005, 181–83; Huerta de Soto 2009, 800). When Rothbard wrote this in 1962, it would have required a ten- or twenty-fold rise in the price of gold , and it would require an even greater increase today, but this would simply be the equivalent of a massive inflation and would itself cause grave dislocations. It would also amount to a massive intervention in the monetary sphere, which is not the best strategy when the goal of the reform is the elimination of all such interventions. Rothbard sees a massive deflation of the dollar supply as the only alternative, but if this is so, that is probably the better alternative. In the end, Mises’s plan is preferable, as it depends on the free action of men in the marketplace, not government fiat, to set the new legal par between dollars and gold. If the goal is monetary freedom, then the price of gold should be set by free markets, not by politicians (cf. Salsman 1995, 120). Once the market has established the price, paper money is to be made freely convertible into gold and vice versa. This plan is not a guarantee against a deflationary destruction of fiduciary media, but is the reform least likely to entail such radical economic dislocation. And should such a deflation happen anyway, it will be due to the choices of freely acting men, not a government policy.

The problem with reforms along the lines suggested by Sennholz and Hayek that look only to freedom in establishing a new monetary system is that they overlook the great advantage fiat dollars have in competition with alternative potential moneys. Since it is already established as money, the fiat dollar will generally be preferred to other media of exchange, as it simply fulfills the primary purpose of money better than the alternatives (White 2002, 2004). Since prices are expressed in dollars, it is much easier to continue to use the incumbent money rather than speculate on some other commodity that might in time become widely used as a medium of exchange. This advantage of incumbency could be countered if the issuer of the fiat money, addicted to highly inflationary policies, in the end completely destroyed the monetary system. If we rely only on freedom, only on economic actions and not on political reforms in the establishment of sound money, all we can do is to wait for and even cheer on the complete destruction of the monetary system, while we stock up on the commodities that we think will emerge as media of exchange after the economic apocalypse. This is, however, an immoral and destructive course of action (Hülsmann 2008b, 241), as it amounts to resignation and surrender in the face of a great evil. There is, furthermore, no reason to think that the advocates of sound money will be in a position to prevent the perversion of the monetary regime that would emerge after the end of the fiat dollar.

The goal of all these reforms and of the reform we will present below is not simply anchoring the dollar to gold; rather, the goal is to completely replace fiat money with commodity money. Only in this way can the evils of fiat money be permanently banished.

How the Gold Standard Would Solve the Problems of Fiat Money

Inflation

Unlike with fiat money, there are definite limits to the possible increases in the supply of gold. Gold is an economic good and its production is subject to the same economic laws as all other goods (Hülsmann 2003, 39). In particular, the production of gold is limited by the law of costs (Sennholz 1975, 47–48): over time, the costs of production will tend to equal the selling price, as entrepreneurs bid up the prices of factors of production until the return to capital (the interest rate) is the same in all industries. Should a producer of gold go beyond this limit, he will lose money, just as would be the case in the production of other goods: he would spend more on inputs and wages than he would receive in revenue, so attempts to become rich simply by producing money would be self-defeating.

Furthermore, gold is indestructible; virtually the whole stock ever mined is still in existence, so current annual production is just a fraction of the total aboveground stock, usually 1–2 percent (Skousen 1996, 83–85). The possibilities for monetary inflation, then, are clearly limited under a gold standard.

This does not mean that the supply of gold is completely fixed; the production of gold will respond to an increase in the demand for money. As the demand for money increases, the purchasing power of money increases, meaning that it is now relatively more profitable to produce money. Gold miners will therefore expand their operations and less gold will be used for industrial purposes, as the gold is more highly valued in monetary uses, and manufacturers will search for substitutes to replace the more costly gold. Current production of gold and supply for monetary uses will also respond to a decrease in the demand for money: if the demand for gold for monetary purposes falls, its price will fall and gold miners will curtail their activities, reducing the additions to the present stock of gold. It may also prove possible to use more gold for industrial purposes or for consumer goods at the lower price, and more gold will therefore be switched to these uses, away from the monetary use (Salerno 2010b, 345; White 1999, 31–39).

It is theoretically possible for there to be short-term, localized inflation in gold-producing countries during a gold rush (Skousen 1996, 88), but these are unlikely now that the whole earth has been explored. Should they happen, however, they will only be temporary: the new gold will spread across the globe in such a way that its purchasing power will tend toward equality throughout the world (Mises 1981, 170–78), as it indeed did during the period of the classical gold standard (McCloskey and Zecher 1985). Speculation will speed up this process, further limiting the local inflationary effects of sudden increases in gold production.

Deflation of the money supply will be very limited, since gold is indestructible. Two kinds of changes on the demand side may cause the money supply to fall: a fall in the demand for money will lead to a lower purchasing power of money and higher prices, which would mean a relative increase in the profitability of gold for industrial purposes, leading to increased industrial demand. Similarly, an increase in industrial demand for gold will lower the supply of money, causing a general fall in prices and an increase in the purchasing power of money. In both cases, gold does not disappear completely: it will still be a potential part of the money supply, ready to reenter people’s cash balances should their demand for money increase or the possibility for profitable industrial uses disappear. There will very probably be price deflation during periods of economic growth, but this is on the whole beneficial (cf. Saul 1969; Bordo, Landon-Lane, and Redish 2010), as it just means that the value of everybody’s money holdings will increase slightly, which will not hamper economic growth (Selgin 1997; Thornton 2003; Hülsmann 2008a; Bagus 2015a). A falling price level will tend to stimulate gold production, and increased gold production will then tend to stabilize the price level. This is indeed what happened historically: in the period of 1890–1910, for instance, there was a tremendous economic expansion, but the overall level of prices was much the same in 1910 as it had been in 1890. The reason was that falling prices had stimulated gold production to such an extent that the monetary gold stock increased threefold (Rueff 1972, 45).

The problem of inflation leading to lower-quality products will also disappear under the gold standard. Recall that the substitution of lower-quality for higher-quality inputs was a response to the cost squeeze experienced by entrepreneurs as a result of fiat money inflation affecting input prices before affecting the prices of the final products. These problems will disappear on the gold standard, as money will be produced by entrepreneurs in response to consumer demand, not created arbitrarily.

Redistribution

Unlike the production of fiat money, money production on the free market does not imply redistribution away from producers. Just as in other industries, the incomes to gold miners are due to their productive efforts and entrepreneurial foresight, to how well they satisfy consumer demand.

It might be argued that gold, after all, is money, and that Cantillon effects mean that the production of gold leads to redistribution. But the similarity between the two cases is only on the surface. The “redistribution” to the entrepreneurs operating gold mines is no different from the “redistribution” to entrepreneurs engaged in producing consumer goods and capital goods. The new money produced will be paid out to the entrepreneurs, capitalists, and workers engaged in gold mining, and should increased demand for money or reduced costs increase the profitability of mining, more workers and capitalists will be attracted to the business. Conversely, should the profitability of gold mining decrease for some reason, workers will be laid off and have their wages reduced, capitalists will shift their investments from gold mining to more profitable areas, and entrepreneurs will suffer losses until all the adjustments have been made. All these changes are no different from what happens in other industries, and they do not lead to the kind of redistribution described by the Cantillon effect.

It is true that during a gold rush the workers and capitalists will be able to enjoy their increased incomes before the price effects of the increased money supply have taken effect, but a comparison to the production of a nonmonetary commodity will show that this is no different from increased profits in other sectors. Let us imagine that there is a sudden increase in demand for steel. Steel mills will make larger profits, as their selling prices increase before their buying prices, and these profits will be distributed among the entrepreneurs and workers and capitalists engaged in steel production. Entrepreneurs will bid up factor prices for their inputs in order to expand their production to satisfy the increased demand until production has been expanded and the profits have been distributed to workers and factor owners. The permanent effect of the change in demand has been increased incomes to all the workers and factor owners engaged in steel production, and they can enjoy these incomes before the prices of consumer goods have adjusted fully to the change in consumer demand brought about by the change in income distribution.

When we have commodity money, then, a boom in the production of money does not have effects, when it comes to the distribution of incomes, that are different from those of a boom in any other industry. It will lead to a rise in money incomes, but everybody is free to try their luck in the gold mines, and so the increased monetary incomes here will quickly bid up money wages in other industries. The distribution of incomes will change accordingly as productivity and consumer demand change.

Financialization

Financial markets offer an important service to the economy—what we may call the financial division of laborThis is Jörg Guido Hülsmann’s term—it has not, to my knowledge, been used in published writings.—as they transfer savings to where they are most valued. Savers benefit, as they gain a return on their savings and borrowers benefit, as they can now raise the funds they need for their planned investments instead of having to fund them out of their own savings. Financial intermediaries simply facilitate the process of investment by searching out and evaluating possible investment opportunities, pooling savings, and organizing markets (cf., e.g., Mishkin and Eakins 2016 for more on the true benefits of financial institutions).

However, as detailed above, the role of financial markets has been much exaggerated under the rule of fiat money, as virtually all saving has had to be in the form of financial assets to guard against inflation and as the costs of borrowing have been artificially lowered. Under a gold standard, we can expect money with a stable, probably even increasing, purchasing power. The artificially elevated demand for financial assets will therefore disappear, as it will no longer be necessary to guard against the erosion of one’s savings by investing in financial markets as fast as possible. We can imagine that people would instead accumulate funds and make long-term investments—perhaps in bonds, perhaps in various market funds, and probably to a larger extent in non-financial assets. There will still be an important role for financial markets, and it might even be, as Salerno (2010a, 364–65) speculates, that some financial assets (specifically, money market mutual funds) will supplement gold in its monetary role. But the artificial impetus forcing every small-time saver into the financial market and inducing everybody to take on debt will be gone, as it will no longer be necessary for everybody to dabble in financial markets to protect their savings.

The business cycles and periodic financial collapses will also disappear with the return of the gold standard. There will still be entrepreneurial errors and bad business decisions, and these may lead to the collapse and bankruptcy of companies from time to time. But we will not see the systematic boom of the economy as a whole followed by crisis and recession as the bad investments are liquidated. This phenomenon is dependent on infusions of money into the credit market that drive down the market rate of interest from its natural level—and this simply will not be possible under the pure gold standard. All lending will have to be backed by savings; there will be no fiduciary media. Credit will only be what Machlup (1940, 224n; cf. Mises 1981, 265) called transfer credit and Mises called commodity credit, that is, credit provided out of real savings, not simply granted ex nihilo by banks.

Even the case of a gold-induced business cycle that Mises (1998, 571) thought at least theoretically possible—increases in the supply of commodity money that reach the credit markets first—will not, in our opinion, trigger the business cycle, for what has happened here is not an artificial lowering of the rate of interest; rather, some entrepreneurs with a lower time preference have increased their incomes by better satisfying consumer demand. They have chosen, at the market rate of interest, to increase their investments relative to consumption. There is no difference between this scenario and the case where an entrepreneur in some other sector is successful, amasses a fortune, and invests most of it rather than consuming it. In Machlup’s terms, it is still an (perhaps temporary) increase in transfer credit, not created credit, and such fluctuations are simply part of the dynamic market process (Rothbard 1963, 34–36).

Deindustrialization

We live in a changing world and industries that were once competitive may suddenly find that new competitors in the global economy are undercutting them. This is simply part of reality, and to the extent that worldwide economic integration has made manufacturing in the United States noncompetitive, being on the gold standard would not have changed this. Some short-term pain for some producers is inevitable when the whole world economy has to adjust to the integration of large nations like China into the international division of labor.

The problem of the permanent balance-of-payments deficit and the artificially overvalued dollar would, however, be solved by returning to gold. Increased imports would mean an outflow of gold, and this would lead to a higher purchasing power for gold in the country. Foreigners taking advantage of this would increase their purchases of goods from the United States and the outflow of gold would be reversed to an inflow as speculators exploited the profit opportunity created (Salsman 1995, 34). Gold would tend to be distributed in such a way that its purchasing power is the same in all countries (Mises 1981, 170–72, 178). There are very definite limits to the supply of commodity money and a balance-of-payments deficit could not go on for long. Eventually, it would be reversed and money would start pouring back into the country (Heilperin 1939, 145, 152–53). These adjustments would happen automatically—that is, without the need for intervention by the monetary authorities—and would result in imports, in the long run, being paid for with exports or with foreign investments. Only the gold-producing countries would have a sustained outflow of money.

How would the gold standard affect trade between industrializing nations and the United States and would it limit the tendency for manufacturing to decline in the US? To the extent that imports into the US have been artificially stimulated and production in the United States has been disadvantaged by the fiat dollar system, to that extent the gold standard would restore competitiveness to industry in the United States. This does not mean that the gold standard would hamper international trade; quite to the contrary, it would promote sustainable trade and integration between all trade partners. We can imagine that under the gold standard, the United States would specialize in producing and exporting higher order goods such as specialized machinery, advanced electronics and the like to China, while China exported lower order goods and consumer goods to the United States. Yet all this is speculation; all we can say with any degree of certainty is that the balance of payments would tend to balance in the long term, and that capital flows would finance expansion of production in the most profitable locations and not simply support government and private consumption in the United States.Much more could be said on the international aspects of a restored gold standard. The reader is invited to consult the works referred to in The section on “Previous Reform Proposals” and in footnotes 5 and 6.

The Outline of a Gold Standard for the Twenty-First Century

The gold standard would be a vast improvement over fiat money, as it would solve most of the problems identified above. Furthermore, it is clear that it is the broad strata of the public who would gain from the reform, while only the narrow elites controlling the production of fiat dollars would lose out. The goal of our reform should not, however, be to simply return to the gold standard as it existed before 1933 or 1914, as this system still left the government and the central bank with some influence over monetary policy. Rather, we should aim at complete monetary freedom, at getting the government completely out of the business of producing and managing money.

Mises’s reform plan is, as indicated above, the main inspiration for the present proposal. His reform consists of two simple steps: 1) cease all inflationary activity; this also means 100 percent reserves for all future bank deposits; and 2) once the market price of gold stabilizes, this market price of gold is decreed the new legal parity for the dollar and the dollar is to be convertible unconditionally at this parity (Mises 1981, 448–49). A conversion agency independent of the Federal Reserve should be set up to accomplish this. The goal of this reform is not simply to stabilize the value of the dollar, but to make sure gold coins again circulate as money, that gold is again in everybody’s cash holdings, in order that the common man understands the importance of commodity money and is alerted in time should inflationary schemes be tried (ibid., 450–52). It is therefore important that all five-, ten-, and twenty-dollar bills are withdrawn against new gold coins within a year of the reform.

The first step in any reform, then, must be to stop inflating the money supply. The market can only be expected to find the correct price if disturbing factors are eliminated and the goal of reform is openly announced. It is therefore also necessary that all legal tender laws and all laws and taxes discriminating against the use of gold for monetary purposes be repealed (Paul and Lehrman 1982, 179–81). Naturally, all measures prohibiting or limiting private coinage of gold and silver coins must also be repealed. This will greatly facilitate the production and spread of such coins and prepare the way for the complete privatization of the monetary system.

Once these measures have been implemented and the commitment to restore the gold standard been openly and forcefully communicated, markets will in a short time establish a new dollar-gold ratio that will then be elevated to the new legal parity. It is impossible to say beforehand what this new price will be. Mises thought that the price of gold would settle around $36–$38, but this is obviously nowhere near the present-day market price. The legal price of $42.22 per troy ounce that the Treasury still insists on using in its accounts is equally outdated (Bureau of the Fiscal Service 2019). We can imagine that the imminent reintroduction of gold for monetary uses will create additional demand for gold, although it must be realized that a lot of the present demand for gold is for monetary and investment purposes: out of a total production of 4,490 tons in 2018, 1,810.6 tons were bought by investors and central banks (World Gold Council 2019).See also the additional charts and resources at Goldhub’s research library, https://www.gold.org/goldhub/research. Most likely, a great proportion of the 2,200 tons used for jewelry was also really investment demand, but how much we can only speculate.

For present purposes, imagine that the announcement of the reform and the initial actions suggested above lead the gold price to settle around $1,500—a slight increase from its present level.Since first writing this essay, gold has appreciated somewhat and is now fluctuating in a range between $1,700 and $1,750. I have retained the suggested price of $1,500, since it merely serves an illustrative purpose and is not too far removed from what the price can be expected to settle at should the reform be put in motion today. The basic principles of the suggested reform remain the same no matter what the price of gold rises to. The figures for the money supply used in this paper are also outdated, as the latest data used is from 2019. This price is then decreed the new legal parity—that is, the dollar is now defined as 1/1,500 troy ounce of fine gold. The conversion agency envisioned by Mises then proceeds to exchange all paper dollars presented to it at the legal parity into newly minted gold coins.

Several problems immediately present themselves when we contemplate this plan. For one thing, what kind of dollars, that is, what range of money substitutes should be accepted for redemption? Whether we choose M1 or M2, or just the currency component of M1, it is clear that the Treasury does not have enough gold to fully redeem all fiat dollars now in existence. At our suggested price of $1,500, the gold reserves of about 8,140 metric tons would be valued at about 400 billion dollars (precision is not important for our purposes here). This would be enough to redeem about one-quarter of the currency component of M1, or one-tenth of M1 or one-thirty-sixth of M2 (see figure 7).

Figure 7: US Money Stock, 2019.

Clearly, despite the large gold reserves, immediate redemption of every dollar in existence is not possible at gold prices below $15,000 at a minimum. However, there is no reason to think that the whole dollar stock will be presented for redemption at once. The dollar will, after all, improve considerably in quality once all inflation stops and redemption in gold is resumed. Hopefully, this means that an orderly withdrawal of paper money and its substitution with gold will be possible, and the Treasury will be able to gradually buy up gold in the market as necessary to redeem all dollars with gold as they are presented to the conversion agency. How the Treasury is to find the resources to buy gold as needed is a different question: it might fund the purchases out of tax receipts, which would mean an increase in taxation or a reduction in government expenditures and would therefore be unpopular, as well as keeping paper dollars in circulation, or it might fund its gold purchases by selling off government assets. The government held assets worth $3.48 trillion at the end of fiscal year 2017, to which should be added stewardship land not on the books (Department of the Treasury 2018, 55, 155). Selling off these assets to fund the necessary gold purchases would have the double benefit of not burdening the taxpayer and liberating substantial resources for use by the private sector, increasing real wealth and the production of desirable goods and services. This is clearly preferable to diverting taxes to gold purchases, since taxation not only is unpopular, but it is also destructive of real wealth.

Another serious problem is how to most easily get rid of the paper money in daily use. The use of cash is still widespread, and especially so for small purchases (Kumar, Maktabi, and O’Brien 2018). We agree wholly with Mises that it is desirable to replace banknotes with hard currency, but that is more easily said than done. The smallest gold coin produced by the US Mint is the one-tenth- ounce gold eagle, which at the suggested price of $1,500 per ounce would have a purchasing power equal to $150. Even were it technically possible to produce a one-twentieth-ounce coin, this too would be unusable for smaller purchases. Clearly, some other solution is necessary.

One possibility would be to allow for the existence of the old Federal Reserve notes, which could then assume the function of a token money for small purchases (Paul 1985, 137). This, however, leaves open the possibility of government interference in monetary matters, as only a legal monopoly on the issue of such notes can ensure their monetary character, and the point of the reform is precisely to finally achieve the complete separation of money and the state. Another possibility is to let banks take care of the problem by issuing money certificates and token coinage in small denominations. We can easily imagine that banks and other intermediaries will already be helping the citizens redeem their dollars for gold, so it is not too farfetched to think that the process will to a large degree consist in the transfer of gold bullion from the government to banks rather than of coins to citizens. This will save the cost of coinage for the government and economize on the costs of redemption for the citizens, and the citizens, if they so chose, could then continue to keep their gold in the bank and use money certificates.

There is a risk that the old paper currency will continue in use, simply because its value will be stabilized by the reform. As already said, this is undesirable, as it leaves the government a role in monetary affairs—and thus leaves the door open for the government to start meddling again. The solution to this problem is simple: allow the market to set a premium for gold above paper. Only at the conversion agency should the legal parity be enforced (Paul 1985, 135–36; Sennholz 1985, 82), market actors should be free to prefer gold in exchange and even to refuse to accept paper dollars. It is natural that sound money and trusted money certificates should be preferred to and command a slight premium over paper, since it is a more honest and secure form of money. By allowing this premium to emerge on the market – i.e., by abstaining from government intervention in the market process—while still enforcing the legal parity at the conversion agency, we should see a steady stream of gold out of the US Treasury and into private holdings. The premium may not amount to more than 1 percent, and will perhaps even be less, but that should be enough. This trend can be strengthened by forcing the US government as a whole, not just the conversion agency, to accept paper dollars in payment of fines and taxes at the legal parity. Since paper currency is also not very durable, we should expect it to disappear relatively quickly as old notes are turned in before they disintegrate.

Returning to the gold standard would usher in an era of increased productivity and prosperity for all. This has been the historical experience: the monetary reform in Germany in 1948, for instance, did not lead to a crisis, but rather straight out of a depression (Rueff 1964, 103–21; Lutz 1949) and was an important cause of the German Economic Miracle.See also Concise Encyclopedia of Economics, s.v. “German Economic Miracle,” by David R. Henderson, accessed April 4, 2020, https://www.econlib.org/library/Enc/GermanEconomicMiracle.html. It is true that returning to the gold standard would mean that the government would have to balance it budget in short order, and this may evidently be problematic for companies whose main business is in government contracts of various kinds, but these difficulties would be minor compared to the great prosperity unleashed in the rest of the economy. The financial system too should be able to adapt to sound money quickly, as most banks have ample reserves compared to their demand deposits (see figure 8). These reserves will be a more than adequate cushion for any short-term turbulence in financial markets that might result, especially since the quality of the banks’ reserves will improve as they are gradually swapped for gold through the process of redemption.

Figure 8: Total Reserves and Total Checkable Deposits, 2009–19.

Mises suggested that a monetary reform should be accompanied by the elimination of further issues of fiduciary media (Mises 1981, 438). His idea was to institute a 100 percent reserve requirement on new issues of money substitutes, whether in the form of demand deposits or banknotes.It should be clear that in this Mises was inspired by Peel’s Act. The main difference is that Mises recognized the correct character of demand deposits as money substitutes, and that Mises insisted on complete freedom in banking, subject to the normal commercial code. There is a lively debate over the issues of banking and money among supporters of the gold standard, but here we will limit ourselves to suggesting a reform targeting base money, or money in the narrower sense. A banking reform liberalizing financial institutions and removing undue protections and privileges would be of great benefit in itself and has previously been suggested as an integral part of monetary reform by, for instance, Judy Shelton (1994, 305–6), but we will not here enter into a discussion of the problems or benefits of fractional reserve banking and fiduciary media.I would, however, suggest that there is a clear parallel between the problems of the gold-exchange standard, which Rueff (1972, 28) identified as “a dual pyramidal credit structure based on the world’s gold stock” and a “duplication of the credit structure,” and fractional reserve banking, and that if one accepts Rueff’s criticisms of the former, it is very hard to explain how they do not apply to the latter.

Once the reform has been accomplished and all fiat dollars have been exchanged for gold, it will be a small matter to move on to complete monetary freedom. No special privileges should be afforded the use of gold for monetary purposes. Merchants, banks, and other financial institutions are free to favor one medium of exchange over another, should they so desire, but the same freedom of choice cannot be allowed to the government. While it may continue to keep its accounts in terms of the defunct dollar or in terms of gold, it should be forced to accept any commodity in current use as money in payment of taxes and other dues. This will ensure that, going forward, the market will be free to confirm gold as money, or to replace it with its preferred commodity.

Why Not Silver or Cryptocurrencies?

We have throughout emphasized that the goal of the reform is not simply the gold standard, but full monetary freedom. So why not choose another commodity, such as silver, or something more modern such as bitcoin?

It is entirely possible that the market may, in time, come to prefer these media of exchange to gold. We have proposed a gold standard that would put the minimum of artificial obstacles in the way of such a substitution. Yet there are still good reasons to think that gold is the better choice for a commodity money.

There is, first of all, a long tradition across the globe of gold as a medium of exchange and store of value. This means that there is widespread ownership of gold throughout society and that it would not take much mental effort for the citizenry at large to again come to think of money as gold and gold as money. This is probably as true of silver as it is of gold. Bitcoin, on the other hand, is a recent invention (cf. Barta and Murphy 2017; Ammous 2018 for an introduction to bitcoin). While it could theoretically serve as money, it is not used or owned widely in society yet. Unlike gold and silver, bitcoin requires at least some familiarity with modern digital technologies. This will, in our view, slow down its widespread adoption for some time, even if it should prove to be a higher-quality medium of exchange than gold. The payment of transaction fees is also inherent in the use of bitcoin, while it is free to use gold and silver, although banks might very well charge a fee for the use of their services and credit card companies already charge such fees.

Our preference for gold over silver is purely pragmatic: both metals could conceivably perform the functions of money equally well and have done so historically. However, the US government is in a better position to replace the paper dollar with gold than with silver. The Treasury possesses 8,140 metric tons of gold, or about 261 million troy ounces—enough to redeem a sizable portion of the outstanding paper dollars, as outlined above. Its stock of silver is slight by comparison: only 498 metric tons, or about 16 million troy ounces (US Geological Survey 2018). The conversion agency is bound to buy more gold than the US government already possesses anyway, but the US government is in a much better position to return to gold than to institute a silver standard.

Nevertheless, should the public prefer silver to gold, we can conceive of the conversion agency supplying silver currency as well, although this can only be done if the government buys up large quantities of silver. Having silver circulate as money as well as gold might be one way to solve the problem of small change outlined above, but it should be made clear that a fixed exchange between the two metals is not what we advocate. That would run into the problems described by Gresham’s law, and would at best result in silver becoming a rather expensive token coinage. Instead, it might simply be possible for the citizens to buy silver coins from the conversion agency instead of redeeming their dollars for gold. But this would be a purchase transaction, not an act of redemption, and silver would continue to fluctuate in value in terms of gold. Expanding the possibilities for purchasing silver coins even before the reform is completed would also be in keeping with the ultimate goal of monetary freedom.Strictly speaking, the US Mint need not be involved in coining silver at all. It is enough to repeal all legal tender laws early on and decree that all commonly accepted media of exchange are also acceptable in payment of taxes. The government would still have to use gold as the money of account, but it could then accept silver in payments according to the prevailing market rate at the time. Naturally, such acceptance should be forced on the government, but private parties should be free to accept or refuse payment in whatever money they chose.

“[We] must show how the money system impoverishes most people and benefits politicians, government officials, and entitlement cronies.” - Hans Sennholz (1985, 78)

Such a reform as we have presented above is ambitious, and it might well be asked how it can be a popular cause. However, any social institution depends on popular support for its continued existence, and this is true also of money. In order to promote sound money, the public at large must be convinced of the justice and utility of that reform (Mises 1981, 456).

The reason for making the cause of the gold standard a populist cause is not simply that all branches of government have proved impotent or unwilling to defend sound money (Mises 1981, 452); unfortunately, there does not seem to be any clear political gain to be made from championing sound money, while there is a clear financial and bureaucratic interest in maintaining the status quo. There also seems to be very little understanding of the importance of the gold standard, which to this day is still too often confused with the gold-exchange standard in official circles and academia and therefore dismissed as a barbarous relic.

It is, however, clearly in the interest of the public at large to see a return to sound money, and it is especially in the interest of that portion of the public employed in the private sector or who live off their own funds. We tried to outline in the last two sections how such people are hurt by the fiat dollar and how a return to gold might benefit them especially. Only by making such appeals to the tangible benefit that the public can expect from sound money can we expect them to join a movement for gold (Paul 1985, 131), and only if we can make the cause of the gold standard a popular movement on a par with the free trade movement of the nineteenth century (Hayek 1990, 133) can unwilling politicians and bureaucrats be forced to accept it. It is, in other words, necessary to make sound money a popular crusade in order for a return to the gold standard to become at all possible.

Making the cause for the gold standard a populist one does not mean that just any argument in its favor can be used. The arguments used must always be true and in accord with reality. A popular movement for sound money and gold should not create unrealistic expectations in the public; the gold standard can solve some problems but it is not an economic panacea. The agitation for the gold standard should never go beyond what can reasonably be expected, but we should not be afraid to show the relevance of sound money to whatever question holds the public’s attention at the moment. Some arguments are clearly not compatible with the gold standard: the gold standard imposes golden shackles on the state, and it would be dishonest to pretend otherwise, nor can or should it be hidden that advocacy for sound money was and is intimately connected with the main goals of classical liberalism and libertarianism: laissez-faire, personal freedom, and peace. This does not mean that the public has to be converted to the whole liberal/libertarian program, but it does mean that it would be dishonest and counterproductive to hide the fact that sound money would mean severe limits to the possibilities for expanding state power.

The case for gold probably cannot sustain continued support on its own. A sound money movement would want to ally with other popular movements to advance its cause (Sennholz 1985, 79). Sennholz suggested the tax revolt movement in the 1980s, but there is no reason to be picky. Gun owners, advocates of First Amendment rights, of privacy rights, of religious freedom—wherever there is a movement whose objectives are consonant with the objectives of the sound money movement, there the possibilities for cooperation should be explored. Some causes, no matter how popular, cannot be allies of a movement for restoring the gold standard. Specifically, any movement that seeks to expand the scope of government significantly in pursuit of its goals cannot be an ally of a movement for sound money, as the objectives of such a movement are incompatible with the institution of sound money.

How can the populist appeal, then, be made? This, as already indicated, depends on the specific circumstances of time and place and the problems exercising the public. In general, in the American context, appeals might be made to the injustice of Roosevelt’s confiscation of gold in 1933 and how it would be just to restore the gold to the current owners of dollars; the long tradition of adherence to gold and sound money might also be invoked, from the Jeffersonians and Jacksonians to the late nineteenth century. Fundamentally, any policy rests on the popular acceptance of the doctrines on which it is grounded, which is why any long-term reform must be based on popular support for true principles:

The first condition of any real monetary reform is still to rout completely all populist doctrines advocating Chartalism,The text reads “Chartism,” but this must be an error by the translator: chartalism was the state theory of money made famous be Georg Friedrich Knapp in 1908, whose modern epigones are the promoters of so-called modern monetary theory (MMT). Chartism, on the other hand, was a movement for the extension of suffrage in nineteenth-century Britain. the creation of money, the dethronement of gold and free money. Any imperfection and lack of clarity here is prejudicial. Inflationists of every variety must be completely demolished. We should not be satisfied to settle for compromises with them. The slogan, “Down with gold,” must be ousted. The solution rests on substituting in its place: “No governmental interference with the value of the monetary unit!” (Mises 2011, 21)

The gold standard, and sound money generally, is still the only solution to the problems generated by fiat money. We have argued in this paper that the economy and society of the United States is still plagued by the evils of fiat money, even though the high inflation of the 1970s gave way to the “Great Moderation”. We have also tried to show how returning to gold would solve the specific problems caused by fiat money, and how a feasible reform returning the dollar to gold would look now, after close to 50 years of fiat money.

The crucial point is that any restoration of the gold standard must originate as a popular movement, and the advocates of the gold standard must therefore make their appeal to the public, not to politicians and central bankers. The benefits of sound money are very real, and so are the abuses of fiat money. There is therefore no reason that sound money cannot become a popular idea at the center of a political program as it once was (Mises 1981, 414).

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Abstract: Treating bitcoin from the point of view of Austrian economics, Saifedean Ammous’ The Bitcoin Standard relates bitcoin to the theory of the market economy as a whole. Bitcoin is not necessarily an alternative to gold, but can function as a global reserve currency and disrupt the role of central banks. Though the book is entertaining and enlightening, there are some aspects of monetary theory, monetary history, and the theory of banking that warrant critique. Overall, Ammous has succeeded in producing a book that clearly demonstrates the possible usefulness of bitcoin under present conditions.

monetary policy — austrian economics — central bank — gold standard — bitcoin

Kristoffer M. Hansen (kristoffi@gmail.com) is a Ph.D. candidate at the University of Angers and a Mises Institute research fellow.

From time to time, bitcoin enthusiasts vent their frustration at the preference of benighted investors for gold. At the time of writing, the digital assets management company Grayscale Investments, LLC, has launched another crusade against the barbarous relic, encouraging investors to #DropGold. The seriousness of their marketing campaign can be judged from the fact that their main arguments are that one, gold represents the past (after all, Nixon dropped gold already in the ’70s!) and two, gold is physically very heavy.See Drop Gold, Grayscale Investments, LLC, 2019, https://dropgold.com.

In such an environment, it is always with some trepidation that I read a new book on bitcoin. Is this going to be a fanatical screed or a thoughtful study that tries to advance our knowledge? Happily, Professor Ammous of the Lebanese American University has written a book that falls squarely in the latter category. Treating bitcoin from the point of view of Austrian economics, Ammous not only discusses it in terms of monetary theory but also relates it to the theory of the market economy as a whole. His assessment of bitcoin is conservative but still optimistic. Bitcoin is not necessarily an alternative to gold, he argues, but it can function as a global reserve currency and disrupt the role of central banks.

The Bitcoin Standard goes over all the basics of money, investment, and production, the role of time preference, the importance of sound money, and the history of money before he introduces bitcoin. Although this may seem roundabout, there is a clear and reasonable method to this approach: we must know what money is and how society functions before we can understand what possible function bitcoin could have in the modern economy.

Along the way, we are treated to Ammous’s very amusing descriptions of modern art:

A stroll through a modern art gallery shows artistic works whose production requires no more effort or talent than can be mustered by a bored 6-year-old. Modern artists have replaced craft and long hours of practice with pretentiousness, shock value, indignation, and existential angst as ways to cow audiences into appreciating their art, and often added some pretense to political ideals, usually of the puerile Marxist variety, to pretend-play profundity. (pp. 100–01)

And:

Only with unsound money could we have reached this artistic calamity where the two largest economic, military, and political behemoths in the world were actively promoting and funding tasteless trash picked by people whose artistic tastes qualify them for careers in Washington and Moscow spy agencies and bureaucracies. (p. 102)

There is also an acerbic commentary on Keynesians and Monetarists woven through the book. Ammous’s brutal putdown of Friedman and Schwartz’s Monetary History of the United States alone is worth the price of the book:

it is an elaborate exercise in substituting rigor for logic. The book systematically and methodically avoids ever questioning the causes of the financial crises that have affected the US economy over a century, and instead inundates the reader with impressively researched data, facts, trivia, and minutiae. (p. 121)

The book is thus very entertaining as well as enlightening, but also, at times, very frustrating. For although Ammous presents economic theory and history lucidly, it seems that at times he does not get it exactly right. There are three points that merit critique in particular: some aspects of monetary theory, of monetary history, and of the theory of banking.

When it comes to monetary theory, Ammous begins quite correctly with the state of barter and the problem of the double coincidence of wants. He goes on to present a theory of salability, showing the different criteria that a good medium of exchange needs to fulfill: salability across scales, across space, and across time (pp. 2–4). These clearly correspond to the classic criteria for a good medium of exchange: divisibility, portability, and durability, and his presentation of them is very lucid. The problem arises when we turn to the supply of money. Here Ammous focuses on the relation between stock and flow, existing supply and current production of the monetary commodity. This relation, he says, is a good indicator of how hard or sound a money is, and monetary history shows how harder money wins out over easier money—up to and including the displacement of silver by gold. Gold has a much higher stock-to-flow ratio than silver; it is therefore a better money and was eventually chosen as money on this basis (pp. 5–7, 19–25).

This telling of monetary history is, however, not entirely correct, and the claims about the importance of the relation between stock and flow are specious.With thanks to Chris Calton. Let’s take the last point first: money is always demanded to be held—it is always in somebody’s cash balance. Any commodity that is used for monetary purposes will therefore exist in large quantities, spread out between the different holders of money, and the very fact of its being used as money will lead it to have a high stock-to-flow ratio.

Present production obviously cannot be expanded infinitely, since this would mean that the factors of production are not scarce. Rather, production of the money commodity will be directed by the search for profits on the part of entrepreneurs, and in the long run the law of costs will hold—meaning that there is no special profit to be gained from producing money and increasing the money supply. What will happen is that increased production of the money commodity will cause an excess supply of money at the given price or purchasing power of money (PPM). If the commodity is only used for monetary purposes, all that would happen is that the increased supply of money would lead to a fall in PPM and an increase in the quantity of money demanded until demand and stock were again equal. However, both gold and silver are commodities that also have use value in consumption and production. A higher supply leading to a lower PPM would therefore lower the opportunity cost of using the money for a nonmonetary purpose, and the commodity would flow from monetary holdings to consumption and industrial use. Not only would this increase production of consumer goods and thereby the satisfaction of consumers, it would also mitigate the effect of increased production of the monetary commodity on the PPM and on monetary demand.On the workings of the gold standard, see Salerno (2010), Skousen (1996), and White (1999).

All this is not to say that there is no meaningful distinction to be made between hard and easy, sound and unsound money. But focusing on the stock-to-flow ratio is, to my mind, a red herring; the important distinction is between a money that can be increased at will (fiat money), and one that must be produced like any other commodity. That silver has (and had) a lower stock-to-flow ratio than gold is therefore not a reason to conclude that it is a less hard form of money—it may simply be used more for nonmonetary purposes than gold is and was. Figure 3 on page 33 of the book itself gives clear confirmation that the proportion of stock to flow is not important: it depicts the gold/silver price ratio from 1687 to 2017. What is remarkable is the stability of the ratio, with very little fluctuation from year to year (within the band between 14 and 16) until the early 1870s. Now, what changed in the early 1870s? There were no source discoveries or advances in mining that radically changed the stock-to-flow ratio of silver. There was, however, a radical change in the monetary systems of the industrial world, as virtually all countries adopted a monometallic gold standard, leading to the virtual disappearance of monetary demand for silver.The interested reader can check this development by referring to Officer and Williamson (2020). But if stock-to-flow ratios are of crucial importance, why did silver have an almost constant value in terms of gold until it was demonetized even though it does not have the same stock-to-flow ratio?

This brings me to the problems with Ammous’s description of monetary history. He describes the evolution of money and especially the change from silver to gold as a consequence of the gradual realization of the inherent superiority of the gold standard. There is no mention of Gresham’s law or of the problems of bimetallism. It would be much closer to the truth to say that the gold standard was the unintended consequence of monetary manipulations and attempts to set a legal ratio between the prices of gold and silver, first in England at the Royal Mint,See Cantillon (2010, 213–16), for a contemporary discussion of the policies of the Royal Mint critical of Newton’s role. then in France after Napoleon. When Germany and the Scandinavian countries adopted the gold standard in the early 1870s, it was a conscious governmental decision, not the spontaneous outcome of an unimpeded market process.

The other reason for the dominance of gold, according to Ammous, is the growth of banking and specifically the fact that it was necessary to centralize gold holdings, first in banks and then in central banks, in order to facilitate payment (pp. 37–38). This argument, I must confess, baffles me. Now, it is true that international clearing and settlement is a good way to minimize the need to transport gold between countries, and it is also true that this clearing increasingly took place between central banks—but it is quite a leap to say that therefore gold holdings had to be centralized. Banking is not the only way to facilitate clearing, as merchants can facilitate it just as well through the use of bills of exchange. Indeed, perhaps the first discussion of clearing and international trade, by Richard Cantillon, is conducted in terms of bills of exchange drawn on correspondent banks (Cantillon 2010, 195–201). The growth of banking systems pyramided on top a central bank cannot be explained by the need to store gold in clearinghouses, as a decentralized system could function just as well, if not better. The history behind the growth of central banking is, rather, one of government privilege given to banks seeking profit through credit expansion, and of government involvement in this business to get a share of those profits. Ammous is clearly familiar with banking theory, and it is a shame that this part of the book is not informed by it.

Finally, this brings us to Ammous’s case for bitcoin. What role can bitcoin play in the modern economy? The discussion of the pros and cons of bitcoin is both clear and frank. The advantage of bitcoin is seen against modern banking institutions: with bitcoin, we need not rely on trust in third parties of dubious repute to facilitate payments around the world (p. 208). This can be done simply via the medium of bitcoin. Although it is not strictly correct to say that it eliminates third parties—the whole network becomes, in effect, the third party to any and all transactions—it is correct to assert that the need for trust is completely eliminated. The discussion of possible challenges to bitcoin is also very convincing, although some will certainly be upset with Ammous’s dismissal of alternatives to bitcoin as inherently inferior.

Does this mean that bitcoin will replace cash? The conclusion arrived at is, surprisingly, no. It is simply too expensive to transact in bitcoin, especially since we can expect transaction fees to rise as demand for bitcoin increases. There are also inherent constraints to the technology, which limit how many transactions can be performed. The bitcoin network will never, in Ammous’s estimation, be able to compete with the likes of Visa and Mastercard when it comes to processing payments (pp. 233–34). It will simply be too costly in terms of processing power. The role of bitcoin, argues Ammous, will rather be to settle transactions between large institutions such as central banks. Here it is superior, because there is no need for trust in a third party, and auditing is extremely cheap—anyone can look at the blockchain. A supporting infrastructure will then be built around bitcoin that allows the common man to exchange using tokens or through institutions based on bitcoin. The growth of the lightning network that is being adopted now is one possible way that this can come about, but how exactly digital cash based on bitcoin will be made available is up to entrepreneurial experimentation.

Although he argues convincingly, Ammous’s conclusion fails to persuade in the end. It seems to rest on the spurious problem of centralized gold holdings criticized above, and on seeing trust in third parties as a problem. But there is no reason that trust should be a problem—on the market, we trust third parties all the time, and generally without issues. The problem is government control over and involvement in monetary affairs. Governments and privileged banks have again and again proven themselves untrustworthy, as they have engaged in destructive and antisocial policies again and again, while bamboozling the general public. In the absence of government involvement, it does not seem probable that bitcoin would win out over gold as the money of choice of a free society.

This does not mean that bitcoin is useless, or perhaps just a speculative bubble fed by easy money and ideological fervor. Ammous has pinpointed exactly what the function of bitcoin is in the present context: just as owning money in general is a hedge against uncertainty, so too is owning bitcoin a hedge against a specific kind of uncertainty. Owning bitcoin is a way to get around capital controls and embargoes, and other obstacles governments place in the way of free exchange. In short, owning bitcoin is a hedge against what Robert Higgs called regime uncertainty (Higgs 1997). As such, it will regrettably prove very useful for many people in the foreseeable future.

Its weaknesses notwithstanding, however, The Bitcoin Standard is a book well worth reading. Ammous’s treatment of bitcoin, though marred by some of the issues I have criticized above, is very good, and any blockchain enthusiast would do well to consider Ammous’s strictures on the utility of blockchain technology. The book is full of many thought-provoking remarks about the relations between money and a host of economic and social issues, about art, about the family, and about the impact of easy money on food quality. One is left feeling that a whole monograph could be written on each of these topics. Above all, Ammous has succeeded in producing a book that clearly demonstrates the possible usefulness of bitcoin under present conditions.

The Origin of the Prolonged Economic Stagnation in Contemporary Japan: The Factitious Deflation and Meltdown of the Japanese Firm as an Entityby Masayuki OtakiOxfordshire, UK: Routledge, 2016x + 136 pp.

Abstract: While Otaki has seen what the Japanese economic disease is, he has failed to understand what fundamentally causes it. Somehow, Otaki attributes the Japanese troubles to a failure to follow the teachings of John Maynard Keynes. A Japanese economy on the gold standard would be insulated from the endless boom-and-bust cycle of the Keynesian shell game. There would have been no bubble, no collapse, and no lost decades. But Otaki does not see this, and clings to a sincere belief that Keynesianism is the cure for what ails Japan.

Economics writing has a reputation for stolidity unto soporiferousness. To be fair, prose that trades in margins, utils, and curves-named-after-other-economists is perhaps a bit difficult to jazz up enough to read like For Whom the Bell Tolls. If one asked the average undergrad to rate his or her econ textbook on spiciness, the response might clock in somewhere between “cell phone contract” and “house dust.”

That may be true, but let no one—and I mean no one—lay the blame for it at the feet of Masayuki Otaki. The Origin of the Prolonged Economic Stagnation in Contemporary Japan: The Factitious Deflation and Meltdown of the Japanese Firm as an Entity (whew!) is, hands down, the most raucous economics volume I have ever read. This is gripping, dramatic stuff, larded with high-flown moralizing about policy and theory that is sure to grab and hold the attention of even the most indifferent reader. In the Preface alone, a mere two pages, Otaki manages to deploy “grievous,” “precarious,” “vicious,” “spurious,” and even “egregious,” a running of the “-ous” adjectives that is perhaps even more thrilling than the running of the Pamplona bulls. I was hooked. Otaki had me at “acute roundabout trespass”; I swooned at “substantively surcharged nominally on account of keeping the Japanese border from the menus of China”; I went all doe-eyed at “fanatic captives in the quantity theory of money”. Who could put this book down? Not I. I read it in one sitting, straight through, anxiously, even rambunctiously, turning pages to find out what would happen next.

So, what happened? Well, to be honest, I’m not exactly sure. Otaki has a gift for making economics read like dispatches from the French and Indian War, but I confess I was a little too thick-headed to penetrate the meaning of some of the more esoteric passages (and there are many). Here are the main points, as near as I can tell. (Otaki very helpfully includes a “concluding remarks” section at the end of each of his seven chapters. Without those, I would have been quite lost.)

- Otaki does not like Japanese prime minister Abe Shinzō or, more specifically, his economic policies, which critics and supporters alike refer to as “Abenomics.”

- One of the main reasons Otaki does not like Abenomics is that he sees it as an extension of “Koizuminomics” (a term that I just made up and which I do not expect to catch on, for obvious reasons). Koizumi Jun’ichirō was the prime minister of Japan from 2001 to 2006, and made it the centerpiece of his administration, at least in the early days, to privatize the financial arm of the Japanese postal service. Unlike the United States, where the post office is responsible mainly for delivering grocery store circulars while racking up billions of dollars in taxpayer-funded deficits and campaigning on the side for Democrats, the Japanese postal service is generally efficient and well-managed. So efficient and well-managed, in fact, that it also has its own bank. (US post offices provided this service, too, until about fifty years ago.) The postal bank remains in a state of semi-privatization almost two decades after Koizumi’s initial attempts at reforms, but it still holds the equivalent of some three trillion dollars US in savings and insurance assets. Otaki argues that the Koizumi brand of “privatization” was really a kind of crony capitalism that Otaki calls “pseudo laissez faire.”

- The Japanese people overall have been sold a bill of goods by the late-postwar pseudo laissez fairers. While early-postwar Japan still took seriously the firm as an entity that allowed for transactions not possible in the broader market (Otaki relies heavily here on Coase and Williamson, and also on the alternative firm theory of Uzawa Hirofumi and Edith Penrose), the advent of neo-liberalism and globalism, and in particular Japanese foreign direct investment (FDI) in other Asian countries, have combined to drive down wages for the average Japanese worker and hollow out the firm. Also, in the past, many Japanese companies held shares of one another’s stock, which encouraged at least a modicum of regard for the wider social costs of corporate actions, but today the neo-liberal shareholder has taken the place of the worker and the firm as the beneficiary of corporate profits.

- The Japanese stock market (as well as the American stock market) has boomed following the Lehman shock of 2008 because of foreign investors, and has nothing to do with Abenomics except negatively, because investors are looking for something more profitable than the zero or even negative interest rates currently on offer by Japanese banks.

This is the basic scope and outline of the book. There are thus, according to Otaki, major structural problems with the Japanese economy. This much is clear, and even those who have not quite broken the code of Otaki’s highly idiomatic English should have no trouble grasping that he is against crony capitalism (he calls the politically-connected president of Japan Railways Tokai “a pharaoh who decided to build his pyramid”), finds Prime Minister Abe and his “right-wing” ideas “appalling,” and urges an “evacuation from the myopic policy decisions” such as zero-interest rates and the spending debacle of the Tokyo 2020 Olympics.

One is inclined to agree with much of Otaki’s diagnosis. Surely, the Japanese economy is in bad shape, and surely it should be obvious to everyone but government bankers by this point that more “stimulus” spending has as much chance of “reincarnat[ing]” (to use Otaki’s term) the Japanese economy as a savings account at a Japanese bank has of generating interest. Otaki is right about all that, and I would argue that he is also right (I tend to agree with Uzawa) that one of the secrets to Japanese economic success was its very strong communal culture, which has been largely undermined in an age of crony-capitalist “rigging” (again, Otaki) of the labor market and the economy overall. There are things that firms in Japan have tended to do that have helped to humanize global competition and shield average workers from much of the destruction side of creative destruction. As the firm has changed and as Japanese business practices have been caught up in a political economy faced with major social and geopolitical upheavals, the old ways have faltered and younger workers have noticed that things just aren’t what they used to be. Stimulus doesn’t stimulate because the patient is, for all intents and purposes, already dead. Otaki is largely on the mark in this general assessment.

But here is also precisely where Otaki’s analysis breaks down. For, while he has very nicely seen what the disease is, he has failed, in my view, to understand what fundamentally causes it. In fact, I think he may be very much misinformed. For, while Otaki sees the out-of-control government spending and jerry-rigged “disinflation” and “deflation” as creatures of the “fanatic advocates of the exorbitant expansionary monetary policy [who] are only naïve captives of the quantity theory of money that has been apparently rebutted by the recent experience both in Japan and the United States,” he somehow, in a way that I just cannot figure out, at the same time manages to attribute all of this to a failure to follow the teachings of John Maynard Keynes. “Those who have common sense can hardly deny that the exorbitant expansionary policy fails in recovering the economy,” Otaki swashbuckles in the closing chapter, the excellently titled “We still have time and power.” Bravo! But wait. What’s this? Otaki also seems to think that Keynes, of all people, supplies the antidote to this recklessness. Somehow this all begins to sound like the Atkins Diet.

Alas, Otaki’s devotion to Keynes is apparently real. There’s this passage, for example:

[…] the prominent disinflation in [the] Japanese economy is not a monetary phenomenon caused by the shortage of the quantity of money, but a real phenomenon which comes from the stagnation of the labor productivity progress.

Well, OK, labor and productivity are certainly very important. But the problem arises when Otaki next introduces a kind of ingrown Keynesianism to explain how “price stability” is the answer to stagnation in labor productivity. “In this sense,” Otaki continues,

the concurrent monetary policy by the BOJ [Bank of Japan], which unreasonably aims to promote inflation via perturbing the confidence of money, is quite precarious. Keynes [citing Keynes (2013)] asserts that “[a] policy of price stability is the very opposite of a policy of permanently cheap money.” One of his reasons is that “[m]odern individualistic society, organized on lines of capitalistic industry, cannot support a violently fluctuating standard of value, whether the movement is upwards or downwards. Its arrangements presume and absolutely require a reasonably stable standard.”

Keynes is half right. There must be a “reasonably stable standard” if an economy is not to fly off the rails and spiral out of control, as the Japanese economy did when it overheated at the end of the 1980s and then imploded just as Debbie Gibson was going out of style. The reason that Japan has not found its feet again is precisely because of the failure to find this “reasonably stable standard,” coupled with the handicap of not having the advantage that the American economy has (and which Otaki also mentions) of being able to print the world’s common currency.

But how can Otaki fail to see that the very problems he diagnoses in the Japanese economy are inherent in Keynesianism? For example, this “vicious cycle” which Otaki laments just three pages after citing Keynes could also be read as Keynesianism’s calling card:

The Busted Bubble and the Surge of FDI -> Stagnant Domestic Markets -> [Rising] Unemployment -> [Decreased] Labor Productivity -> Disinflation -> [Reduced] Consumption -> Stagnant Domestic Markets

“We consider that the current Japanese economy is entrapped by the vicious cycle,” Otaki concludes. I concur. But this vicious cycle is the creature of Keynesianism, not something alien to Keynes’s ideas.

An economy must have a “reasonably stable standard” because, as Mises proved in great detail in Human Action, people act for a myriad of reasons and there is really no way to index and organize the totality of their interactions—an economy—without a standard that is infinitely fungible and common to all. The problem with fiat money, such as that printed by the ream by the Bank of Japan, the Federal Reserve, and other Houses of Keynes around the world, is that it is not money at all, but so many admission tickets to a political con game.

So, of course the Japanese government is rigging the Japanese economy. What did Otaki expect? The Roman emperors debased their own currency (also covered at length in Human Action), and virtually every other sovereign, prime minister, president, and chief of the exchequer who could get away with it has done the same. If someone is OK with being a member of an organization which commits armed robbery from hundreds of millions of bank accounts once every April 15th, then he or she is probably also OK with purloining money in other ways, for example by setting up a monopoly on Gresham’s Law and turning all of a given polity’s money into political scrip. It’s quite a racket. It’s what central banks do. Otaki seems to think that the Bank of Japan will one day wake up and start acting morally and for the good of the country—perhaps in the same way that a python might one day start atoning for his past life by volunteering at the Small Mammals Nursing Home. This chicanery is the essence of Keynesianism, and there is no way to prescribe the doctrine without also administering the “fatal conceit” that goes along with it.

Fortunately, there is a “reasonably stable standard” which has long proven capable of thwarting the designs of evil men “enamored with the supposed beauty of his own ideal plan of government”: gold. Gold is real money. Gold works as money precisely because nobody can make gold but God. (The reason Isaac Newton spent so much time on alchemy experiments was not because he was kooky, but because as the Master of the Royal Mint he spent decades fighting counterfeiters and wanted to be sure that they could not reproduce the coin of the realm.) Government bankers, who have never been known to scruple about any possible differences between themselves and the Deity, elide this one sticking point and end up running a nationwide—even, in the case of the Fed, a worldwide—counterfeiting scheme of their very own, to enormous profits for themselves. But with gold, this is not possible. Governments and their bankers are kept on a gilded leash. The bad that a state would do—and, boy, would it do it if it could—is caged up by an eternally sound currency. Keynesianism is the Houdini act that lets governments wriggle out of this pen and do whatever they please with the people’s cash.

But Otaki is having none of this. He wants Keynesianism both ways. For example, he compares the collapse of the Japanese bubble economy in the early 90s and the subsequent lost decades to the Showa Depression, when the Great Depression in the United States began to affect the Japanese economy in the early 1930s. Otaki attributes the worsening of the Showa Depression to the return to the gold standard, something that Otaki says was “genetically infeasible for Japan judging from the incessant current account deficits adjacent to huge fiscal deficits.” Investors saw the return to gold coming and cashed out, thus triggering an avalanche of defaults and business closings.

[…] the rejoining at the excessively high parity only triggered the tremendous outflow of the fiducial currency. Every subtle speculator foresaw the embargo in the near future (December 1931) at the very beginning of return to gold standard. They purchased huge amounts of USD in exchange for fiducial currency, and thus severe domestic monetary contraction occurred.

To summarize, the most prominent feature of the Showa Depression is the appalling domestic monetary contraction owing to the unreasonable return to gold standard. Such contraction choked bank loans especially towards small and fragile firms in the fabric industry. [Japan’s economy had relied especially heavily on silk production in the early days of Meiji industrialization.] Facing the hardship, these entrepreneurs were forced to sell their products at damping prices, cut wages and fire some parts of their employees. Consequently, prominent deflation progressed.

Otaki sees the return to the gold standard as the problem, then. Like Keynes quoted above, Otaki is half right. Yes, returning to the gold standard can wreak havoc on an economy, but only in the way that restoring law and order occasionally wreaked havoc in Tombstone. Wyatt Earp had to crack a few heads to get folks to settle down. When “subtle investors” saw the sheriff on the horizon, they stuffed their carpetbags full of the locals’ flatware and hightailed it out of town. But this is hardly the sheriff’s fault.

Amazingly, in the very next paragraph after the one quoted above, Otaki blames the “current prolonged stagnation” in Japan on “easy monetary policy.” Otaki wants to contrast this with the Showa Depression, but on closer analysis it is obvious that the two things are the same. Keynesianism is the hocus pocus that seeks to cover over naked theft with highfalutin words. It is hard to see how Otaki can reconcile his support for Keynes with statements such as this:

The stimulations to the economy, which only involve the maintenance of the current spurious prosperity, are immoral, because such policies and projects gravely disturb the income distribution of the future generations via the debt-management policy. The imprudence in the fiscal policy and the huge scale project of the private sector stems [sic] not only from moral hazard in the limited liability but also from the illusion based on the rootless expansionism [emphasis in original] that is a negative inheritance of the High Growth Era.

Otaki seeks to accomplish this with an appeal to Burke, and to measured reform overall. But as Otaki’s own telling of just recent Japanese history makes clear (and as a wider survey of Japanese history, or of any other country’s history, will confirm), it is not reform that is the problem, but the so-called reformers. The weakness of any economy boils down essentially to just this: some people will try to hijack it via its money system and turn the entire thing to their own ends. There is no way to prevent this with laws and policies. There must be a sound currency, impregnable to human folly. That currency is gold.

A Japanese economy on the gold standard would be insulated from the endless boom-and-bust cycle of the Keynesian shell game. There would have been no bubble, no collapse, and no lost decades. Japanese firms would be healthy and diversified, and there would be no tax-guzzling boondoggles like World’s Fairs and Olympic Games to dazzle the very populace which has been railroaded by the captains of crony capitalism, who always grow rich while the economy and everyone else within it grow poor.

The Origin of the Prolonged Economic Stagnation in Japan is a very good overview of one theory of why the Japanese economy has been in the doldrums for so long. Masayuki Otaki is certainly sincere in his belief that Keynesianism is the cure for what ails Japan. But he is also wrong. I recommend this book as a very helpful primer on some of the more esoteric aspects of Japanese economics, and also as a foil for figuring out what Keynesianism is, and why it offers no future for any economy besides more of the same.

So why does gold still matter? Why does it hold value over millennia? Why does it threaten inflationist governments? Why does it seem to be flowing West to East? Why does an ounce of it still trade for more than $1,000, if the critics are right? This is the comprehensive show on gold and its enduring role in today's economy, with Keith Weiner of Monetary Metals.

Presented at the Libertarian Scholars Conference on 28 September 2019, at The King's College in New York City. Includes an introduction by Jeff Deist.

Are you a Murray Rothbard fan? Do you love his writing? His clarity and style? His razor-sharp economic analysis? His penchant for slaying sacred cows?

One of the most remarkable aspects of Murray Rothbard's career wasn't simply the power of his ideas, or his razor-sharp wit, but the sheer breadth of his knowledge. 

A brilliant economist, revolutionary political philosopher, bold revisionist historian, and even joyful cultural commentator, Rothbard was one of the most prolific scholars — perhaps one of the most quotable.

This is the ultimate Rothbard reference book, and your single source for his best excerpts and quotes on all the core subjects: economics, philosophy, epistemology, ethics, history, law, and libertarianism.

Considering Rothbard's 62-page bibliography — consisting of 30 full-length books, 100 full chapters for edited works, and more than 1,000 scholarly and popular articles — consuming all of his work is almost impossible. Now, thanks to Rothbard A to Z, the ability to search for Rothbard's unique views on hundreds of topics is now at your fingertips. 

Compiled by Edward W. Fuller and edited by David Gordon, this massive book is a must-have for any true Rothbard aficionado.

Prolific and radical hardly begin to describe him — but his important work has never been brought together like this, a reference guide and a fun book you can open at random for the best “Murrayisms” on any topic!

Here are just a few teasers:

The decks were now cleared for the McKinley administration to submit its bill, and the Congress that met in December 1899 quickly passed the measure; Congress then passed the conference report of the Gold Standard Act in March 1900.

The currency reformers had gotten their way. It is well known that the Gold Standard Act provided for a single gold standard, with no retention of silver money except as tokens. Less well known are the clauses that began the march toward a more “elastic” currency. As Lyman Gage had suggested in 1897, national banks, previously confined to large cities, were now made possible with a small amount of capital in small towns and rural areas. And it was made far easier for national banks to issue notes. The object of these clauses, as one historian put it, was to satisfy an “increased demand for money at crop-moving time, and to meet popular cries for ‘more money’ by encouraging the organization of national banks in comparatively undeveloped regions.”Livingston, Origins, p. 123

The reformers exulted over the passage of the Gold Standard Act, but took the line that this was only the first step on the much-needed path to fundamental banking reform. Thus, Professor Frank W. Taussig of Harvard praised the act, and greeted the emergence of a new social and ideological alignment, caused by “strong pressure from the business community” through the Indianapolis Monetary Convention. He particularly welcomed the fact that the Gold Standard Act “treats the national banks not as grasping and dangerous corporations but as useful institutions deserving the fostering care of the legislature.” But such tender legislative care was not enough; fundamental banking reform was needed. For, Taussig declared, “The changes in banking legislation are not such as to make possible any considerable expansion of the national system or to enable it to render the community the full service of which it is capable.” In short, the changes allowed for more and greater expansion of bank credit and the supply of money. Therefore, Taussig concluded, “It is well nigh certain that eventually Congress will have to consider once more the further remodeling of the national bank system.”Frank W. Taussig, “The Currency Act of 1900,” Quarterly Journal of Economics 14 (May 1900): 415.

In fact, the Gold Standard Act of 1900 was only the opening gun of the banking reform movement. Three friends and financial journalists, two from Chicago, were to play a large role in the development of that movement. Massachusetts-born Charles A. Conant (1861–1915), a leading historian of banking, wrote A History of Modern Banks of Issue in 1896, while still a Washington correspondent for the New York Journal of Commerce and an editor of Bankers Magazine. After his stint of public relations work and lobbying for the Indianapolis convention, Conant moved to New York in 1902 to become treasurer of the Morgan-oriented Morton Trust Company. The two Chicagoans, both friends of Lyman Gage, were, along with Gage, in the Rockefeller ambit: Frank A. Vanderlip was picked by Gage as his assistant secretary of the Treasury, and when Gage left office, Vanderlip came to New York as a top executive at the flagship commercial bank of the Rockefeller interests, the National City Bank of New York. Meanwhile, Vanderlip’s close friend and mentor at the Chicago Tribune, Joseph French Johnson, had also moved east to become professor of finance at the Wharton School of the University of Pennsylvania. But no sooner had the Gold Standard Act been passed when Joseph Johnson sounded the trump by calling for more fundamental reform.

Professor Johnson stated flatly that the existing bank note system was weak in not “responding to the needs of the money market,” that is, not supplying a sufficient amount of money. Since the national banking system was incapable of supplying those needs, Johnson opined, there was no reason to continue it. Johnson deplored the U.S. banking system as the worst in the world, and pointed to the glorious central banking system as existed in Britain and France.Joseph French Johnson, “The Currency Act of March 14, 1900,” Political Science Quarterly 15 (1900): 482–507. Johnson, however, deplored the one fl y in the Bank of England ointment—the remnant of the hard-money Peel’s Bank Act of 1844 that placed restrictions on the quantity of bank note issue. Ibid., p. 496. But no such centralized banking system yet existed in the United States:

In the United States, however, there is no single business institution, and no group of large institutions, in which self-interest, responsibility, and power naturally unite and conspire for the protection of the monetary system against twists and strains.

In short, there was far too much freedom and decentralization in the system. In consequence, our massive deposit credit system “trembles whenever the foundations are disturbed,” that is, whenever the chickens of inflationary credit expansion came home to roost in demands for cash or gold. The result of the inelasticity of money, and of the impossibility of interbank cooperation, Johnson opined, was that we were in danger of losing gold abroad just at the time when gold was needed to sustain confidence in the nation’s banking system.Ibid., pp. 497f.

After 1900, the banking community was split on the question of reform, the small and rural bankers preferring the status quo. But the large bankers, headed by A. Barton Hepburn of Morgan’s Chase National Bank, drew up a bill as head of a commission of the American Bankers Association, and presented it in late 1901 to Representative Charles N. Fowler of New Jersey, chairman of the House Banking and Currency Committee, who had introduced one of the bills that had led to the Gold Standard Act. The Hepburn proposal was reported out of committee in April 1902 as the Fowler Bill.Kolko, Triumph, pp. 149–50.

The Fowler Bill contained three basic clauses. One allowed the further expansion of national bank notes based on broader assets than government bonds. The second, a favorite of the big banks, was to allow national banks to establish branches at home and abroad, a step illegal under the existing system due to fierce opposition by the small country bankers. While branch banking is consonant with a free market and provides a sound and efficient system for calling on other banks for redemption, the big banks had little interest in branch banking unless accompanied by centralization of the banking system. Thus, the Fowler Bill proposed to create a three-member board of control within the Treasury Department to supervise the creation of the new bank notes and to establish clearinghouse associations under its aegis. This provision was designed to be the first step toward the establishment of a full-fledged central bank.See Livingston, Origins, pp. 150–54.

Although they could not control the American Bankers Association, the multitude of country bankers, up in arms against the proposed competition of big banks in the form of branch banking, put fierce pressure upon Congress and managed to kill the Fowler Bill in the House during 1902, despite the agitation of the executive committee and staff of the Indianapolis Monetary Convention.

With the defeat of the Fowler Bill, the big bankers decided to settle for more modest goals for the time being. Senator Nelson W. Aldrich of Rhode Island, perennial Republican leader of the U.S. Senate and Rockefeller’s man in Congress,Nelson W. Aldrich, who entered the Senate a moderately wealthy wholesale grocer and left years later a multimillionaire, was the father-in-law of John D. Rockefeller, Jr. His grandson and namesake, Nelson Aldrich Rockefeller, later became vice president of the United States, and head of the “corporate liberal” wing of the Republican Party. submitted the Aldrich Bill the following year, allowing the large national banks in New York to issue “emergency currency” based on municipal and railroad bonds. But even this bill was defeated.

Meeting setbacks in Congress, the big bankers decided to regroup and turn temporarily to the executive branch. Foreshadowing a later, more elaborate collaboration, two powerful representatives each from the Morgan and Rockefeller banking interests met with Comptroller of the Currency William B. Ridgely in January 1903, to try to persuade him, by administrative fi at, to restrict the volume of loans made by the country banks in the New York money market. The two Morgan men at the meeting were J.P. Morgan and George F. Baker, Morgan’s closest friend and associate in the banking business.Baker was head of the Morgan-dominated First National Bank of New York, and served as a director of virtually every important Morgan-run enterprise, including: Chase National Bank, Guaranty Trust Company, Morton Trust Company, Mutual Life Insurance Company, AT&T, Consolidated Gas Company of New York, Erie Railroad, New York Central Railroad, Pullman Company, and United States Steel. See Burch, Elites, pp. 190, 229. The two Rockefeller men were Frank Vanderlip and James Stillman, longtime chairman of the board of the National City Bank.On the meeting, see Livingston, Origins, p. 155. The close Rockefeller-Stillman alliance was cemented by the marriage of the two daughters of Stillman to the two sons of William Rockefeller, brother of John D. Rockefeller, Sr., and longtime board member of the National City Bank.Burch, Elites, pp. 134–35.

The meeting with the comptroller did not bear fruit, but the lead instead was taken by the secretary of the Treasury himself, Leslie Shaw, formerly presiding officer at the second Indianapolis Monetary Convention, whom President Roosevelt appointed to replace Lyman Gage. The unexpected and sudden shift from McKinley to Roosevelt in the presidency meant more than just a turnover of personnel; it meant a fundamental shift from a Rockefeller-dominated to a Morgan-dominated administration. In the same way, the shift from Gage to Shaw was one of the many Rockefeller-to-Morgan displacements.

On monetary and banking matters, however, the Rockefeller and Morgan camps were as one. Secretary Shaw attempted to continue and expand Gage’s experiments in trying to make the Treasury function like a central bank, particularly in making open market purchases in recessions, and in using Treasury deposits to bolster the banks and expand the money supply. Shaw violated the statutory institution of the independent Treasury, which had tried to confine government revenues and expenditures to its own coffers. Instead, he expanded the practice of depositing Treasury funds in favored big national banks. Indeed, even banking reformers denounced the deposit of Treasury funds to pet banks as artificially lowering interest rates and leading to artificial expansion of credit. Furthermore, any government deficit would obviously throw a system dependent on a flow of new government revenues into chaos. All in all, the reformers agreed increasingly with the verdict of economist Alexander Purves, that “the uncertainty as to the Secretary’s power to control the banks by arbitrary decisions and orders, and the fact that at some future time the country may be unfortunate in its chief Treasury official … [has] led many to doubt the wisdom” of using the Treasury as a form of central bank.Livingston, Origins, p. 156. See also ibid., pp. 161–62. In his last annual report of 1906, Secretary Shaw urged that he be given total power to regulate all the nation’s banks. But the game was up, and by then it was clear to the reformers that Shaw’s as well as Gage’s proto–central bank manipulations had failed. It was time to undertake a struggle for a fundamental legislative overhaul of the American banking system to bring it under central banking control.On Gage’s and Shaw’s manipulations, see Rothbard, “Federal Reserve,” pp. 94–96; and Milton Friedman and Anna Jacobson Schwartz, A Monetary History of the United States, 1867–1960 (Princeton, N.J.: National Bureau of Economic Research, 1963), pp. 148–56.

Narrated by Jim Vann.

Topics for this wide ranging interview include: booms and busts, private money, bitcoin, central banks, Brexit, protectionist policy under Trump, and trade barriers. 

ABSTRACT: One hundred percent reserve banking is an essential foundation and prerequisite for a country to establish long-term financial stability and sustained economic growth. It is also an essential element for a country contemplating the adoption of a stable gold standard monetary system. Debt money, i.e., debt created by banks, was once called malum per se, a thing that is evil in its nature. It has supported excessive government debt, inflated speculative bubbles, fueled inflation, reduced investment and growth, and resulted in an unjust redistribution of wealth. In this paper, we discuss some of the detrimental consequences of fractional reserve banking and outline its abolition as the principal reform before one or more countries can establish a viable gold standard.

The most challenging monetary reform in any country is the adoption of 100 percent reserve banking, or 100 percent money. Governments and banks have resisted this reform. A domestic gold standard becomes simply an appendix to 100 percent reserve banking or money by connecting money to the supply of gold. A 100 percent reserve banking system separates money from debt obligations; a bank can no longer create money in the form of demand deposits; and money would be independent of fluctuations in debt. A 100 percent reserve banking system was practiced by the Bank of Amsterdam (1609), the Bank of Hamburg (1619), the Postal System, and other 100 percent depository institutions that restricted their business to purely safe depository and transfer functions.

A fundamental condition for establishing a stable banking system has been the abolishment of fractional reserve banking, i.e., debt money, in favor of 100 percent reserve banking. This condition was stipulated by David Hume (1752), William Gouge (1833), Amasa Walker (1873), Charles H. Carroll (1850s), Frederick Soddy (1934), the authors of the Chicago PlanThe authors of the Chicago Plan were: Henry Simons, Frank Knight, Aaron Director, Garfield Cox, Lloyd Mints, Henry Schultz, Paul Douglas, and A. G. Hart. Professor Irving Fisher of Yale University was a strong supporter of the Plan. His book, 100 Percent Money (1936), was an attempt to win support for the plan among academics and policy makers. (1933), Irving Fisher (1936), Ludwig von Mises (1953), Murray Rothbard (1962), Maurice Allais (1999), and a number of other economists and authors. They essentially proposed a two-tier banking system:

i.      100 percent reserve banking strictly for depository and payments operationsii.     Investment banking for financial intermediation and channeling savings into investments

One hundred percent reserve banking has been recommended for a number of reasons that include avoiding: (i) frequent bank failures and losses suffered by depositors;The Bank of England, founded in 1694, suspended convertibility of its notes into gold and silver as early as 1696, and not infrequently thereafter. It suspended convertibility during 1797–1821. (ii) wide expansion and contraction of the money supply that created speculative bubbles, crashes, deep recessions, and loss of output and employment; (iii) unjust wealth redistribution via fictitious credit in favor of borrowers and speculators; (iv) debt money that was too costly to use, since interest has to be paid on outstanding debt; and (v) debt money contracts if interest cannot be paid. With fractional reserve banking, many banks have been bankrupted with ominous financial losses for their depositors, or by taxpayers through subsidized deposit insurance schemes and bailouts. Hence, many writers deemed it essential to separate the deposit of money from the lending and debt obligations.With this separation, there is no need for insuring the safety of bank deposits through corporations such the Federal Deposit Insurance Corporation (FDIC). This separation was needed to sever the relation between the money supply and debt, so money would not fluctuate with debt, and to insure that banks hold and lend true savings and do not issue fictive credit. Money should not be created and destroyed through debt expansion and contraction via the credit multiplier.

The depository system is a fundamental feature of a modern economy and could be provided by private banks, or the state (e.g., Bank of Amsterdam and Bank of Hamburg). It accepts deposits for safekeeping and undertakes domestic and foreign payments against fees paid by the depositors. Some authors have suggested that the government could provide the deposit system through a banking and postal system so as to minimize fees and increase the quantity of money for the economy (Gouge, 1833; Simons, 1947). Investment banks in implementing their investment banking function create no money and accept no demand deposits; they borrow or issue equities and debt securities; and lend or buy securities. Essentially, investment banks would operate as other businesses, they issue shares and attract capital that they invest on behalf of their shareholders.

Debt-based money is associated with the advent of fractional reserve banking. By definition, the state grants a charter for a bank to create money. In countries with fractional reserve banking, debt money made economies navigate from booms to busts (Juglar, 1862) and destroyed the gold standard.Eminent writers stressed that debt money would certainly evict gold: David Hume (1752), Charles Jenkinson (1805), US Presidents Thomas Jefferson and Andrew Jackson, William Gouge (1833), Charles Holt Carroll (1850s), and Amasa Walker (1873). Ironically, it was the United Kingdom, the cornerstone of the gold standard and the world financial center, that dealt a fatal blow to the gold standard in 1931, which many of its eminent economists called a barbarous system. It was followed immediately by the United States, another model of the gold standard, abolishing gold money and sequestering the gold from its citizens in 1933, with the rest of the world following along. Proponents of debt money referred to the gold standard as gold shackles. But it was debt and paper money that have led to frequent financial crises after the gold standard was abolished (e.g., Greece 2009–2015, US and Eurozone 2009–2015, etc.). Moreover, debt-money system cannot stand on its own; it needs a central bank for liquidity and occasional government bailouts. It was the debt system that undermined the Bretton Woods gold exchange standard in 1971. Endless regulations in the 19th and 20th centuries have not prevented rapid creation of debt and financial booms and busts.

Money has been considered a principal pillar of the human civilization; it has enabled the development of commerce, industry, exchange and travel within and across countries and continents, and high level of scientific progress. If this pillar is undermined, economic decline follows, and social stability is put at risk.Examples of horrifying hyperinflations that ruined the real economy were John Law’s system in France (1716–1720), the French assignats (1789–1795), the US continental currency (1785–1790), and the German hyperinflation (1919–1923). In all these episodes, paper became worthless, the economy lost its money, and famine spread in the country. With the advent of fractional reserve banking, debt-based money has risen to prominence. In the pursuit of gains from interest on fictitious loans, banks and central banks kept issuing debt money, out-of-thin air, until the breakout of a financial crisis. Debt money calls for more debt to provide for rapidly rising prices, replace repaid debt, and pay interest. The central bank and banks validate any price and wage rise through more debt money. As soon as the debt process slows down or hits general bankruptcy, a severe financial crisis breaks out and wipes a large part of the debt money causing severe economic and financial disorders.Irving Fisher (1936) noted that US money was reduced by 35 percent during 1929–1933 following the collapse of debt money. He strongly advocated 100 percent reserve money so to eliminate the banks’ power in creating and destroying money. With debt organized as currency (Carroll, 1850s), financial crises became frequent; the most ominous was the Great Depression (1929–1936). The 2008 financial crisis was another ominous collapse of the debt money. Each financial crisis destroys money (Frederick Soddy, 1934; Irving Fisher, 1936), paralyses the economy, and spreads bankruptcies and human hardship. Governments resort to even pushing more interest-debt in order to cope with the disorders of the financial crisis. Hence, each economy is entangled in a vicious circle of debt followed by crises.

A 100 percent (or at least a long way toward 100 percent) reserve banking system or 100 percent money has become pressing in view of growing money disorders in the world. Many eminent writers had urged the abolition of debt-money and proposed reforms along the principles of 100 percent reserve banking and risk-sharing investment banking.We may cite David Hume (1752), Thomas Jefferson, Andrew Jackson, William Gouge (1833), Charles. H. Carroll (1850s), Amasa Walker (1873), Irving Fisher (1936), the numerous authors of the Chicago Plan (1933), Ludwig von Mises (1953), Murray Rothbard (1994), and Maurice Allais (1999). Despite repeated calls for reforms during the 18th–20th centuries, both governments and financial interests have remained adamantly against abolishing debt money. In what follows, we address the following themes:

•     The nature of debt money•     Inherent inflationism, instability, and uncertainty of debt money•     Some notable rejections of debt money and proposals for 100 percent reserve banking•      Suggested reforms for reintroducing 100 percent reserve banking and a domestic gold standard•     100 percent reserve banking and a convertible 100 percent domestic gold standard•     Structural reforms to support 100 percent money

Debt money has been rising without limit in almost every country at rates that far exceed real GDP growth. Money supply, measured by M2 (currency plus deposits) may increase at a double-digit rate for decades in many countries. The source of this increase is simply debt. Simons (1947) stated:

We have reached a situation where private-bank credit represents all but a small fraction of our total effective circulation medium. ... Thus the State has forced the free-enterprise system, almost from the beginning, to live with a monetary system as bad as could well be devised. ... An enterprise system cannot function effectively in the face of extreme uncertainty as to the action of the monetary authorities or, for that matter, as to monetary legislation. We must avoid a situation where business venture becomes largely a speculation on the future of monetary policy. (p. 55)

If we examine the balance sheet of the US Federal Reserve (Fed), we see that gold and foreign assets ($30 billion) are negligible in relation to total liabilities ($4,452 billion), i.e., 0.6 percent. All money expansion was through money creation, with money becoming overly dependent on domestic debt. Moreover, as the latter expands, imports tend to rise faster while exports tend to shrink, which results in reduced net foreign assets. Moreover, debt money is costly; banks earn interest and commissions on the outstanding debt.

Debt money has fueled inflation.Two definitions of inflation are proposed. The most common one is a persistent general rise of prices. Another definition considers the general rise of prices as an effect of a rise of money supply that is not offset by a corresponding increase in the demand for broad money so that a fall in the objective exchange-value of money must occur. In this definition, inflation is measured by the increase in broad money supply.  The latter has been considered as a form of fraud, which has to be eradicated.Inflation is an inherent feature of paper and debt money. It emanates from money created out-of-thin air in form of a monetization of fiscal deficits or issues of unbacked loans. Commodities are purchased against paper and not commodities. The practice of appropriating wealth unjustly was severely condemned by John Locke (1691). It is a fallacy that inflation stimulates employment and growth.Bastiat, The Seen and the Unseen, 1877. Inflation is a tax that unduly transfers free wealth to one group at the expense of another group. The income distribution is altered by a heavy inflation tax, which deprives labor from a sizable part of its real contribution to real GDP. At a high rate of money depreciation, holders of cash will get rid of it as soon as they receive it. Financial savings is discouraged (McKinnon, 1973; Shaw, 1973). Forced savings will replace voluntary savings, imposed upon creditors and workers through the inflation tax (Hayek, 1932). Production will be discouraged as producers hike prices and reduce output.In an inflationary context, producers reconstitute their money working capital through increasing prices and reducing quantities. In a non-inflationary context, they have to generate money working capital through higher quantities sold. They are compelled to produce much more to generate cash. The drop in prices improves in turn external competitiveness and exports. Exports will be reduced. Figure 1 portrays the Consumer Price Index (CPI) for the US and the Retail Price Index (RPI) for the UK under the metallic system during 1800–1913. In both countries, there was a significant trickling down of productivity gains and technical change in form of long-term trends of price declines. In 1913, the US CPI stood at 79 (1800 = 100) and the UK RPI stood at 82 (1800 = 100). Workers had shared in the fruits of growth (Farrer, 1898). Such sharing has been diminished under the debt money in almost every country where this system is in effect. Figure 2 portrays the inherent inflationary feature of the debt-money system supported by central banking in the UK and the US. Inflation tax has become permanent, penalizing the holders of the currency, workers, pensioners, and creditors. The inflation tax benefits the government, debtors, and speculators. Inflation is vital for the perpetuation of the debt system. There has been little trickling down of productivity gains to consumers.Mises (1953) noted that CPI underestimated inflation during 1922–1929, a period characterized by high productivity gains. Let the recorded CPI be 3 percent, let productivity gains be 7 percent; the true CPI would be 10 percent. In 2013, US CPI stood at 1,294 (1945 = 100), and the UK RPI stood at 3,766 (1945 = 100).

Figure 1: The United Kingdom and the United States Annual Price Indices, 1800–1913

Figure 2: The United Kingdom and the United States Annual Price Indices, 1945–2013

The debt money model has resulted in adverse social consequences in many countries where it has been adopted.Interest-based bank money has been severely condemned by Thomas Jefferson, William Gouge, Charles Holt Carroll, Frederick Soddy, Amasa Walker, and many others. Mises, Rothbard, Irving Fisher, authors of Chicago Plan, Maurice Allais, and many authors proposed abolishing debt money and its replacement by a non-interest money. Recurring financial crises and ensuing economic dislocation have been its inherent features. In each debt crisis episode, economic prosperity was reversed into decline and mass-unemployment as demonstrated by the 2008 financial crisis. Being interrelated by a web of trade, banks and capital flows, a crisis breaking out in one country spreads to other countries. Fractional reserve banking was a violation of the original and authentic 100 percent reserve banking that characterized goldsmith houses as well as the Bank of Venice, the Bank of Amsterdam, and the Bank of Hamburg.These institutions were created as depository and payments institutions and not to economize on gold and silver, which were abundant in supply to the point of causing high inflation worldwide. It developed very fast in Europe and the US during the 18th–19th centuries mainly because of the leverage it provides to bank owners from the emission of banknotes and discounts, and ease of obtaining charters.

Figure 3: Monthly Central Bank Interest Rates, 2000–2013

By turning money into a policy tool, to secure full-employment of labor, devalue exchange rates, and inflate asset and housing prices, central bank actions could become somewhat arbitrary.Friedman (1959) opposed the discretion power of the Fed; he proposed a fixed rule according to which money supply ought to increase at about 2 percent-3 percent. He reiterated that the Fed could only control the money supply; it cannot control the unemployment rate, the interest rate, or the rate of inflation. Simons deplored money as an instrument policy and called discretionary policy as a form of lawlessness. He urged the abolition of fractional reserve banking and central banking, and the creation of a “National Monetary Authority” that controls money according to fixed rules. The systemic risk and uncertainty could be described by the cheap money policy of major central banks as portrayed by the interest rates in Figure 3. The Fed practiced a repressive policy, which lowered money rate to 1 percent during 2002–2004 under the guise of fighting deflation at a time the economy was operating at near full-employment for more than a decade. Credit rose at 12 percent year at the expense of creditworthiness; asset, housing, and commodities prices spiked. A financial collapse followed thereafter in 2008, creating massive unemployment in the US and Europe. After 2008, the Fed forced interest rates to near zero, this time, to fight unemployment. Hence, the Fed used a cheap money policy as a panacea for both diseases. The Fed decided to inflate money under quantitative easing programs; it hiked up without any restraint its credit to $4.5 trillion in 2015 from $0.8 trillion in 2008 (Figure 4).Excess reserves of banks at the Fed were $2.5 trillion in December 2015. If this amount is drawn down, credit expansion will be too gigantic and will increase credit risk as well as inflation. This gigantic money-out-of-thin air printing was aimed at monetizing record fiscal deficits and pushing cheap loans in the economy. The Fed, and most politicians and academics are convinced that near-zero interest and unlimited money were most appropriate policy for full-employment and economic growth.

Fed’s policy has in part led the Eurozone and other countries into monetary difficulties. As long as the dollar is a reserve currency, the Fed faces no external constraint in printing as much money as it wishes and in setting interest rates at near zero. The latter measure is dangerously distortive and assumes that real capital supply is overly abundant in relation to demand for capital. The danger of this policy was already established by the 2008 financial crisis.

Figure 4: The Federal Reserve Credit, 2002–2014 (Trillions of Dollars)

Debt money created too much uncertainty. The monetary base, credit, interest rates, exchange rates, asset prices and commodity prices are all moving in a most unpredictable and volatile way. Huge resources are devoted to hedging against high volatility of exchange rates and asset prices, which increases inefficiencies. In stable markets, hedging resources would have been used for productive investment.  

With near-zero interest rates and cheap money, the US government debt skyrocketed to about $18 trillion in 2014 (103 percent of US GDP) and is still rising due to large deficits. Private debt had already reached bankruptcy point in 2008 and is still rising fast. The huge indebtedness makes inflation the only way out of debt. Most likely, the Fed will maintain ultra-cheap policy for some time, since any tightening of money policy will send debt into bankruptcy and result in a crash of asset prices.

Only reserve currency countries, today principally the United States, can afford the luxury of near-zero interest rates without setting off hyperinflation as happened in Germany 1919–1923. In 2015, central bank interest rates were 0.08 percent (US), 0.20 percent (Eurozone), 10 percent (Brazil), and 10 percent (India) (Figure 4). The contrast is obvious. Being non-reserve currency countries, Brazil and India could not afford to set interest rates at near zero. They face a foreign exchange constraint. Low interest rates would fire up inflation, undermine their banking sector, and destroy their export sector.

Setting interest rates at zero or near zero is most distortive policy. It leads to unlimited borrowing by subprime markets, encourages consumption through loans that may never be repaid, it consumes savings and depletes capital, and by introducing distortions enables mal-investment. It confiscates real capital from one group in favor of the group who benefits from cheap money. It exposes the banking sector to significant interest and credit risks. It pushes up asset and commodity prices, and creates an environment of economic uncertainty. Speculation becomes intense. Income and wealth inequality becomes aggravated. The harmful effects of cheap money policy appear only when a financial crisis breaks out. Abolition of fractional reserve banking is the reform that would reduce the depletion of capital, volatility, and ominous free redistribution of wealth via inflationism. Under a gold standard, low interest rates would immediately drain all the gold from the country, and force gold suspension as happened in the UK in 1931 and the US in 1971.

Fractional reserve banking has provided the foundation for high leverageIn 1694, the Bank of England made a loan to the government; it immediately monetized the loan and issued banknotes in equal amount, extending more loans to both the government and business. Through leverage, the bank earned interest income on capital, which it did not possess. and swindling schemes, inflation of banknotes, financial crises resulting in economic dislocation and bankruptcies. As a result, numerous authors have called for a definitive end of fractional reserve banks, a cancellation of their charters, and the re-introduction of 100 percent reserve banking and money. A partisan of gold and 100 percent money, David Hume (Political Discourses) wrote: “of those institutions of banks, funds, and paper credit, with which we are in the kingdom so much infatuated. These render paper equivalent to money (i.e., gold), circulate it throughout the whole state, make it supply the place of gold and silver. ...” (Hume, 1752) The same discredit was held by Charles Jenkinson, Earl of Liverpool (1805): “Paper currency, which is carried to so great an extent, that it is become highly inconvenient to Your Majesty’s subjects, and may prove in its consequences, if no remedy is applied, dangerous to the credit of the kingdom.”

Aware of the danger of debt-money, the US Third President Thomas Jefferson wanted to abolish fractional reserve banking and preserve metallic money. In fact, he opposed the renewal of the charter of the First Bank of the United States. Witnessing the severe dislocation caused by banks and their corrupt nature, President Andrew Jackson pronounced to a delegation of bankers discussing the re-charter of the Second Bank of the United States in 1832: “You are a den of vipers and thieves. I intend to rout you out, and by the eternal God, I will rout you out.” He abolished central banking in the United States and allowed the country to enjoy sustained prosperity. The re-establishment of central banking in 1913 with the Federal Reserve inflicted on the US its worst economic depression during 1929–1936, and has been since destabilizing the economy and falsifying prices and income distribution.Ron Paul (2009) considered “the creation of the Fed the most tragic blunder ever committed by Congress. The day it was passed, old America died and a new era began. A new institution was born that was to cause the unprecedented economic instability in the decades to come. The longer we delay a conversion to sound money and away from central banking, the worse our crises will grow and the more the government will expand at the expense of our liberties. Our wealth is drained, our productivity is sharply diminished. Our freedoms are eroded. We have been through nearly a hundred years of this same repeating pattern, so it is time to wise up and learn something. When the printing presses are available to the government and the banking cartel, they will use them rather than do the right thing.”

Maurice Allais wrote (1999): “In essence, the present creation of money, out of nothing, by the banking system is, I do not hesitate to say it in order to make people clearly realize what is at stake here, similar to the creation of money by counterfeiters, so rightly condemned by law. In concrete terms, it leads to the same results.” Bastiat (1877) deplored the redistributive injustice of paper inflation. It steals wealth from losers and showers it for free on the gainers. He wrote:

I must also inform you that this depreciation, which, with paper, might go on till it came to nothing, is effected by continually making dupes; and of these, poor people, simple persons, workmen and countrymen are the chief. […] Sharp men, brokers, and men of business, will not suffer by it; for it is their trade to watch the fluctuations of prices, to observe the cause, and even to speculate upon it. But little tradesmen, countrymen, and workmen will bear the whole weight of it. (Bastiat, [1849] 2011, p. 131)

Carroll (1850s) severely condemned the redistributive injustice of fictive money and credit, favorably quoting Daniel Webster: “that of all the contrivances for cheating mankind, none has been more effectual than that which deludes them with paper money. This is the most effectual of inventions to fertilize the rich man’s field with the sweat of the poor man’s brow.” (Carroll, [1856] 1972, p. 35) Carroll noted that “the truth is, an expanded and consequently cheap currency is the most costly and wasteful machinery a nation can possess; the history of the world shows it to be uniformly unprofitable or disastrous. … There was never a greater mistake in any science, and never one so fatal to the stability of property and the well-being of society.” (Carroll, [1858] 1972, p. 76) Carroll deplored the devastating effects of paper money. He stated that “the value of money is regulated to disorder, to the impairing of contracts, and to the confusion of all just ideas regarding the rights of property, as effectually by the powers exercised by the States in granting bank charters, with authority to issue bills of credit.” (Carroll, [1855] 1972, p. 6) He described the notion of “price without value”; namely, currency generated by bank lending pours forth only to drive up prices without creating additional value.Figure 1 showed that an item that cost £1 in 1945 would cost £38 in 2013.

In 1833, William Gouge noted: “Our American Bankers have found that for which the ancient alchemists sought in vain; they have found that which turns everything into gold — in their own pockets; and it is difficult to persuade them that a system which is so very beneficial to themselves, can be very injurious to the rest of the community.” (Gouge, 1933, p. 227) He regretted the evils caused by banks of issues. These institutions constantly altered the measures of value, caused uncertainty to trade, and conferred undeserved advantages on some men over others. He stated: “It has always been my opinion, that of all evils which can be inflicted on a free state, banking establishments are the most alarming. They are the vultures that prey upon the vitals of the Constitution, and rob the body politic of its life-blood.” (Gouge, 1833, p. 111)

Gouge stressed the redistributive evils of bank money.

It made a lottery of all private property. These Banks, moreover, give rise to many kinds of stock-jobbing, by which the simple-minded are injured and the crafty benefitted. …They see wealth passing continually out of the hands of those whose labor produced it, or whose economy saved it, into the hands of those who neither work nor save. The natural reward of industry then goes to the idle, and the natural punishment of idleness falls on the industrious. The reckless speculator, who has no capital of his own, but who operates extensively on the capital of other people, has much cause to be well pleased with this system. (Gouge, 1833, p. 31)

Gouge rejected the notion of over-production as pure nonsense as huge human needs in food, shelter, medication, etc., in every country remain unfulfilled; he attributed the business disruption to the disappearance of fictive money created by banks.  Irving Fisher (1936) explained the Great Depression (1929-1936) by the evaporation of bank money. His reform plan (100 percent money) urged the abolition of fractional reserve banking. He rejected the notion of elastic money, which underlined the Federal Reserve Act in 1913. He noted that

the flexibility or elasticity of Bank medium is not an excellence, but a defect, and that “expansions” and “contractions” are not made to suit the wants of the community, but from a simple regard to the profits and safety of the Banks. The uncertainty of trade produced by these successive “expansions” and “contractions,” is but one of the evils of the present system. That the Banks cause credit dealings to be carried to an extent that is highly pernicious — that they cause credit to be given to men who are not entitled to it, and deprive others of credit to whom it would be useful. (Gouge, 1833, p. 136)

He rejected the notion that banks make money plentiful, saying,

Banks make money plenty. Nay, they make real money scarce. As Bank notes are circulated, gold and silver are driven away. It is contrary to the laws of nature that two bodies should fill the same space at the same time; and no fact is better established than that, where there are two kinds of currency authorized by law or sanctioned by custom, that which has the least value will displace the other. (Gouge, 1833, p. 45)

Gouge challenged the principle that paper was cheaper than specie. That paper money has some advantages must be admitted; but its abuses are also inveterate. Gouge rejected also government paper stating that: “Government issues of paper would be incentives to extravagance in public expenditures in even the best of times; would prevent the placing of the fiscal concerns of the country on a proper basis, and would cause various evils. Further than this, Government should have no more concern with Banking and brokerage than it has with baking and tailoring.” In terms of reforms, Gouge was ahead of both the 1933 Chicago Plan and Irving Fisher’s 100 Percent Money (1936). For Gouge, debt-money is an evil that has no remedy, except be abolished or extinguish itself through bankruptcy or when paper become worthless. He stated:

[N]o legislative enactments can afford an adequate remedy for the evils which flow from incorporated paper money Banks. The system is, to use the language of the lawyers, malum per se — or a thing which is evil in its nature. The very principle of its foundation is wrong. No immunities should, in a Republican Government, be granted to any, save those which are common to all. (Gouge, 1833, p. 52)

And, “’You may say what you will, paper is paper, and money is money.’” (Gouge, 1833, p. 232)

Gouge proposed prohibition of all incorporated paper money banks; that is, to eliminate their privileges of limited liability and note issue. In their place he would have banks subject to unlimited liability, lending only their own capital plus savings deposits (time deposits) and maintaining a hundred percent specie reserve. “With private Banks, and public Offices of Transfer and Deposit, we should have all that is good in the present system, without the evil.” (Gouge, 1833, p. 230) For Gouge, money is metallic:

The high estimation in which the precious metals have been held, in nearly all ages and all regions, is evidence that they must possess something more than merely ideal value. It is not from the mere vagaries of fancy, that they are equally prized by the Laplander and the Siamese. It was not from compliance with any preconceived theories of philosophers or statesmen, that they were, for many thousand years in all commercial countries, the exclusive circulating medium. Men chose gold and silver for the material for money, for reasons similar to those which induced them to choose wool, flax, silk, and cotton, for materials for clothing, and stone, brick, and timber, for materials for building. They found the precious metals had those specific qualities, which fitted them to be standards and measures of value, and to serve, when in the shape of coin, the purposes of a circulating medium…. (Gouge, 1833, p. 10).

No instance is on record of a nation’s having arrived at great wealth without the use of gold and silver money. Nor is there, on the other hand, any instance of a nation’s endeavoring to supplant this natural money, by the use of paper money, without involving itself in distress and embarrassment. (Gouge, 1833, p. 17)

Gouge was cognizant of the time dimension of reform:

[T]he sudden dissolution of the banking system, without suitable prepa-ration, would put an end to the collection of debts, destroy private credit, break up many productive establishments, throw most of the property of the industrious into the hands of speculators, and deprive laboring people of employment. …[T]he system can be got rid of, without difficulty, by prohibiting, after a certain day, the issue of small notes, and proceeding gradually to those of the highest denomination. (Gouge, 1833, p. 138)

All that it will be necessary for Congress to do, will, probably, be to declare that, after a certain day, nothing but gold and silver shall be received in payment of dues to Government, and that no corporation shall be an agent in the management of its fiscal concerns. The people will then begin to distinguish between cash and credit; and public opinion will operate with so much force on state governments, that they will, one by one, take the necessary measures for supplanting paper by metallic money. (Gouge, 1833, p. 234)

The obstacles to reform noted by Gouge would not be very different from those of today. Besides political and deep-vested financial groups, Gouge recognized a degree of ignorance of people about the nature of the paper system.

Their only misfortune was, being ignorant of the principles of currency, and having rulers as ignorant as themselves. Certain individuals who have never caught a glimpse of a more improved state of society, boldly affirm that it cannot exist: they acquiesce in established evils, and console themselves for their existence by remarking that they could not possibly be otherwise. (Gouge, 1833, p. 227)

Henry Ford once said, “It is well that the people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning.” Holding similar views as Gouge and Carroll, the 1921 Nobel Prize winner in chemistry, Frederick Soddy (1934), condemned debt money as a form of legal swindling and counterfeiting and a violation of democracy. He accused it of sending millions of workers into unemployment and poverty and presenting a stumbling block to progress of technology, full employment, and the smooth distribution of the produce of industry. He urged abolition of debt-money and reconstitution of mints that would issue a state paper currency as a relief from taxation. Aware of hyperinflations in Germany, Austria, and many other countries, he recommended that state paper be regulated by a stable price index.

The money system condemned by Gouge, Carroll, and Walker was superior to the money system that has become deeply rooted since early 20th century. During their times labor, capital, and commodities markets were competitive with no customs barriers, no government-set prices and wages, no central bank, no labor unions, no formidable taxation, and oversized government.During the 19th century, labor markets recovered very quickly from depression caused by banking failure through a free market mechanism. In the depth of the Great Depression, with unemployment close to 25 percent, the US hiked up wage rates tremendously in the effort to stimulate spending. Not surprisingly, unemployment remained above 19 percent until the breakout of the war (1939–1944). With the war, unemployment fell to less than 1 percent. Simons (1947) lamented the erosion of competition, and the institutions that control capital and labor market. He was appalled by the use of government force in money area and money as policy tool, often referring to central bankers as “dictators” who inflicted great uncertainty and upheavals on the economy; he deplored the wide contraction and expansion of the money supply and the consequent alteration in the value of contracts which he called a perverse elasticity. He deemed that too much uncertainty was created needlessly by money policy. He strongly supported 100 percent money and abolition of both central banking and fractional reserve banking. Opposition to fractional reserve banking and its pillar central banking was not limited to the monetary system but also to the economic system it helped to shape in the form of too much government, too-powerful interest groups, and a totally rigid price and wage structure.Greece is an example of an economy saddled by oversized bureaucracy and deeply rooted rigidities that kept the economy in a depressed state during 2009–2015, with little scope for removing structural rigidities and downsizing government. Mises (1953) explained that rigidities and government support of monopolies of all kinds hindered recovery from depression. Massive quantitative easing in the US and the Eurozone illustrates clearly the belief of Mises, Simons, and many others on how deeply rigid the system has become. Mises argued that the best approach to unemployment was to remove legal restrictions on wage flexibility and let the labor markets clear on their own. Instead, governments force money expansion as the road to full-employment.

The principle of 100 percent reserve banking, (100 percent money) and the gold standard can be stated as follows. Banks are essential intermediaries in payments and investment; however, they should have no prerogative for money creation. Gold and silver are purely economic commodities and not an interest-based debt. Gold producers sell gold in the same manner as a farmer sells wheat. Gold is exchanged against wheat. As money, gold does not contract in the same fashion as a debt money, which contracts when borrowers pay it back or when issuers refuse to issue or when it goes into a general default. Gold does not expand at the stroke of a pen as debt-money does. Gold does not confer to any country a privilege status of a reserve currency. Under the gold standard, countries may not use their own currencies as a means of settlement and may have to settle balance of payments in gold if no other commodities are available for exports. Gold exerted the development of exports; nations exchanged commodities, and rarely settled in gold. With paper money, many countries neglected exports since they import with paper. Other countries, mainly developing countries, relied on borrowing, and in turn neglected their export sectors.

Restoring a gold standard following a suspension of gold convertibility is technically simple; it is purely a political decision. It requires relating changes in money (paper and demand deposits) to the flows of gold and foreign exchanges until the national currency reaches a stable rate vis-à-vis gold, at which point convertibility may be implemented on a permanent basis.The International Monetary Fund (IMF) adjustment programs imposed a strict ceiling or even reduction on the money supply in order to allow a country to reconstitute net foreign assets to a desired target. The IMF used the monetary approach to the balance of payments, which considered that the balance of payments reflected changes in domestic monetary aggregates. For instance, the German rentenmark was instantly pegged to gold in 1923, with no convertibility provision and almost no gold reserves, simply based on a full commitment to control the German money supply. Restoring a gold standard is exactly the same experience as restoring convertibility of a currency. After World War II, many European currencies, such as the French franc, were not convertible into foreign currencies at par as stipulated by the Bretton Woods system of fixed exchange rates. To reestablish convertibility, countries had to regain control of both money and fiscal policies and achieve macroeconomic stability. As long as the fiscal deficit was out of control and was being constantly monetized, countries could not attain convertibility.

Historical experiences of restoring the gold convertibility and gold standard are numerous. The basic principle was the same: strictly controlling banknotes and deposits emission. This principle was observed by the Bank of England in 1819 to pave the way for convertibility of its banknotes in 1821 following the suspension in 1797. In like manner, the US Treasury established gold convertibility of the greenbacks in 1879 through running fiscal surpluses that reduced paper money. As major industrial powers such as the United States, Germany, and France adopted gold standards during 1870–1900, the value of silver in relation to gold depreciated considerably. Numerous partner countries that were on a silver standard saw their currencies depreciate significantly, causing serious fiscal and external difficulties. Many silver standard countries had to introduce currency reforms consisting of achieving a fixed exchange rate of their currencies in relation to gold. These reforms were needed to establish stability of exchange rates and settle trade and capital operations in gold with gold standard countries (Kemmerer, 1916).

With the outbreak of war in 1914, many countries suspended the gold standard, meaning that their currencies were no longer convertible into gold; the currencies were floating in the exchange markets against each other. As soon as the war ended, countries were eager to restore the gold standard. An important feature of the return to a gold standard was the contrast between the doomed British experience and the successful French experience. The British experience restored gold at prewar parity in 1925 in the context of very high inflation. This rate did not reflect the very high degree of inflation since 1914 and was totally unrealistic. It necessitated a grave deflation that severely impaired the economy as well as external competitiveness. Mass unemployment developed, as wages could not be reduced. However, France was not as fast as the United Kingdom in restoring gold; it stabilized its economy until it reached a stable market rate of its currency in relation to gold that reflected past inflation as well as trade equilibrium. France restored a stable gold standard in 1928 at a highly devalued market rate, about one-fifth of the prewar parity, which enhanced external competitiveness without any reduction in nominal wages and was maintained with no difficulty thereafter.

Mises emphasized that a return to sound money, i.e., a gold standard, is technically simple; however, politically very difficult. His gold plan required an end to inflation by setting an insurmountable barrier to any further increase in paper and demand deposits; it required a safeguard against deflation. He proposed the establishment of a conversion agency, different from the central bank, which would be entrusted with exchange operations. The agency would have the monopoly to issue paper money against 100 percent gold and foreign exchange coverage. The banking system would be 100 percent reserve banking, with no discounting by the central bank. No privileges would be accorded to the agency, other than paper money issuance. It would not get a monopoly for dealing in gold or foreign exchange. The foreign exchange market would be perfectly free from any restrictions. Everybody would be free to buy or sell gold or foreign exchange. There would be no centralization of such transactions; any bank or dealer could settle foreign payments with foreign correspondents. Nobody would be forced to sell gold or foreign exchange to the agency or to buy gold or foreign exchange from it. Mises emphasized that the United States should restore the classical gold standard, which existed in the United States until 1933 with gold coins circulating freely, and not the gold-exchange standard. Gold should be in everybody’s cash holdings. Everybody should see gold coins changing hands, and everyone should be used to having gold coins in their pockets, receiving gold coins when they cash their paychecks, and spending gold coins when buying something from a store.

Rothbard (1962) proposed a gold standard with the dollar tied to gold permanently at a fixed weight, and redeemable in gold coin at that weight. The dollar should once again be defined as a unit of weight of gold. Rothbard urged the replacement of the name “dollar” by gold ounce or gold gram. Rothbard insisted that gold coins should circulate and be used in transactions. He emphasized that there seemed little point in advocating fundamental reforms while neglecting the causes that undermined the gold standard in the past. Besides abolishing the Federal Reserve, Rothbard wanted to eliminate, or at least dramatically reduce, inflation and business cycles. Consequently, he proposed 100 percent reserve banking, along the Chicago Plan (1933), Irving Fisher’s 100 Percent Money (1936), and Simons (1947) that would take away the ability of banks to create money and thus reduce leverage and inflationary and deflationary pressures. David Hume, Thomas Jefferson, Andrew Jackson, John Adams, W. Gouge, Charles H. Carroll, Amasa Walker, Isaiah W. Sylvester, Elgin Groseclose, and Ludwig von Mises all adhered to the 100 percent gold reserve tradition, i.e., paper and deposits are 100 percent covered by gold reserves. They considered the issuing of demand liabilities greater than reserves as a fraud.

Ron Paul (1985) asserted that Menger (1892) and Mises (1953) showed that money emerged by evolution from the market process. Namely, governments did not invent gold bullion as money. He proposed a new troy ounce gold coinage. Paul supported Mises’s Conversion Agency that would be responsible for issuing gold coins and bullion to the public and for exchanging gold and paper. Only the conversion agency should be allowed by law to legally exchange genuine coin for paper dollars at the par value. In Paul’s plan, a main step to restoring the gold monetary system is gold coinage; gold must be in the cash holdings of everyone. As with Mises, everybody must see gold coins changing hands; everybody must be used to having gold coins in their pockets, to receiving gold coins when they cash their paychecks, and spending gold coins when they go to buy goods in a store. In the critical importance of the gold coinage lies the key to establishing a new gold standard. In Paul’s gold standard plan, the coinage should be based on exact units of bullion weight. The coins should be denominated in troy ounces, half-ounces, and smaller sizes if feasible. The denomination of the coinage is the secret to success in the later stages of the political agenda.

Mises, Rothbard and Paul considered that a single country could go it alone and adopt the gold standard without waiting for the rest of the world to be under the gold standard.Soddy (1934) insisted that monetary reform is purely a national matter and should not require an international conference. The United Kingdom was the only gold standard country during 1816–1873. It introduced its gold legislation in 1816, without approval from another country; it rejected bimetallism proposed by the international monetary conferences of late 19th century in favor of its own gold standard. They rejected the idea of an international conference for restoring a gold standard, since in the past each country had gold money established by a sovereignty act and not by coordinating with partner countries. Mises (1944) wrote:

No international agreements or international planning is needed if a government wants to return to the gold standard. Every nation, whether rich or poor, powerful or feeble, can at any hour once again adopt the gold standard. The only condition required is the abandonment of an easy money policy and of the endeavors to combat imports by devaluation (p. 252).

In the same vein, Walker (1873) wrote:

If the principles we have previously laid down, and the practical results which follow, are such as we have stated, then no one nation needs to hesitate in making this experiment for fear that other nations may not follow their example; for the community which has the soundest currency will, other things being equal, have the most profitable industry and the most advantageous commerce. There need be no legal restriction whatever upon the issue of such a currency, and it matters not how voluminous it may be since it will be composed in fact of value money, will obey the laws of value, and, of course, will regulate itself. There would then be no expansions or contractions, except from the legitimate operations of trade; and the currency of the nation would be perfectly sound (p. 245).

An essential reform, even before thinking about restoring the gold standard, is establishing 100 percent (or close to 100 percent) reserve banking or 100 percent money. The introduction of this reform has been thoroughly described by Soddy (1934), and Fisher (1936). Legislation has to change the banking into two components: (i) a 100 percent depository system, which issues no loans; and (ii) investment banking, which borrows or issues securities and bonds, and invests, lends or buys bonds and securities (Walker, 1873). This component cannot create money, i.e., issuing a loan, which has no money available, by simply crediting a borrower account and creating deposits. An investment bank operates like a development bankFor instance, the World Bank cannot lend without raising the funds prior to its lending by selling bonds. These funds are held at depository institutions. Certainly, it cannot create deposits in favor of its borrowers. or a mutual fund whose funds are held by a depository institution. Hence, starting from an implementation date, legislation has to require that a new loan issued by an investment bank would have to be fully covered by funds held in a separate depository institution. This decision will arrest the creation of new debt money; it will stabilize the money supply; and will enable the banking system to transit to a two-tier banking.To prevent a resurgence of fractional reserve banking, depository institutions issue no loans; they are payments institutions. Investment banks have no money creation role. The depository banks settle all their payments. Money holders would have to decide how much non-interest earning deposits they wish to keep, and how much interest-earning assets they acquire through the investment banking system. Simons stated that the best investment banking is the one that has no fixed money contracts at all:

What arrangements as to the financial structure would be conducive to lesser or minimum amplitude of industrial fluctuations? An approximate ideal condition is fairly obvious — and an unattainable. The danger of pervasive, synchronous, cumulative maladjustments would be minimized if there no fixed money contracts at all — if all property were held in residual equity or common stock form. With such a financial structure, no one would be in a position either to create effective money substitutes (whether for circulation or for hoarding) or to force enterprises into wholesale efforts of liquidation. (Simons, 1947, p. 165)

This reform enables the implementation of the McKinnon-Shaw financial deepening scheme. McKinnon and Shaw emphasized the importance of money deepening and a well-developed banking and financial sector. Large saving is pooled from small savers, large scale and efficient projects may be implemented, and risk is highly reduced. Investment banks borrow, or issue bonds, and stocks, and buy securities or extend loans to investment projects. Simons preferred that investment banks issue more equities than interest-bearing loans in mobilizing savings. Accordingly, the investment bank reduces its risk by linking the cost of its resources to the performance of its assets and to be able to raise long-term capital. Moreover, equity financing reduces the conflict between debtors and creditors and changes in value of debt due to changes in the price level.

The introduction of gold standard becomes an appendix to 100 percent reserve banking and 100 percent money, since a main obstacle to its existence has been removed, which is debt money. A gold standard with debt money would fail, since gold and debt money were like water and fire (Carroll, 1850s). A non-reserve currency country has nothing to lose by adopting a gold standard. It is presently in a pseudo-gold standard, since its foreign exchange can be converted instantly into gold at prevailing gold market prices. The gold standard cannot operate in any country with restrictions on the trade of gold. Gold restrictions were most futile and were imposed as a measure to force devalued paper on people as shown in France in 1720 and 1789–1795, the US after 1933, and the United Kingdom after 1931. A country has to establish a fully free gold market with no taxes on imports or exports of gold. The state assumes a role of quality control to prevent fraud. A free gold market establishes an equilibrium price free of distortions and contributes to a return to gold at true prices.

Peel’s Act in 1844 split the Bank of England into two departments: the Issue Department and the Banking Department. The issue department was in charge of issuing banknotes with 100 percent gold coverage. In like fashion, the central bank of a country envisaging 100 percent money with a gold standard will be re-organized into an issue department; the banking department becomes purely redundant in 100 percent money and may be eliminated. The issue department will issue national paper money only against foreign exchange and gold at floating market rates. The issue department has the strict monopoly of paper money. However, it has no monopoly in foreign exchange and gold markets. Banks, foreign exchange bureaus, and gold and silver dealers are entirely free in their trade of gold and foreign exchange within the regulatory framework. The issue department has no banking operations within or outside the country. It immediately turns its foreign exchange into gold at market rates and sells gold against national money at market rates.

A gold standard act would re-establish the mints and the gold and silver coins. The mints would be open to all the public, including domestic and foreign gold dealers, as well as to the issue department of the central bank. The mints would turn gold into coins and certify the quality of the coin at a simple fee for covering the cost of assaying and coining the gold metal. Nationals should be allowed to acquire gold coins minted locally or abroad. If residents export commodities, say, wheat, oil, and others, they may elect to import gold and transform the gold into coins. These coins should be allowed to circulate in the economy especially in settling large transactions. The purchase of gold coins should be facilitated through licensed banks and foreign exchange dealers. Monetary gold would be acquired through external trade, local mining if available, and diversion from non-money uses. The import of gold would be paid for by foreign exchange earned from exports of merchandise and services. Gold trade would be carried out at international prices in the same way as for all tradable commodities such as corn, crude oil, sugar, coffee, and others. The economy would have to export commodities in order to import gold or any other commodity. Gold would be bought and sold against national paper at the issue department or any appointed dealer at the market rate. Gold coins and bars may be deposited for safekeeping at depository institutions and used in payment operations. Depository institutions have to keep deposited gold in coins or bars and reconstitute them in coins or bars and never in paper money. Customers would convert their gold into national paper in separate operations at authorized banks and foreign exchange bureaus or directly at the issue department. During the transition period, gold would circulate alongside paper at floating rates in the same way as foreign currencies circulate alongside the paper. Traders may directly use their foreign currencies or convert them into paper to settle payments. Silver coins, to be issued by the mints, would circulate at a free rate as a commodity.

The issue department should monitor the exchange rate of the paper money in relation to gold only and not to foreign currencies; there should be no effort to economize on gold circulation or limit it only to bullion. The length of the transition is of little relevance, provided the issue department operates strictly as a conversion agency and the 100 percent money is in force. When paper is about to appreciate considerably in relation to gold, following a period of floating in relation to gold, a country would have reached the end of the transition period and would be ready to operate under a classical gold standard. The government may then fix the value of the paper in terms of gold. From this point of time onward, the issue department will buy and sell gold against paper at par. The paper has a denomination in units of accounts, and the gold coins and bars will continue to be denominated in weights. At par, paper will be as good as gold.

A country would have 100 percent coverage of any newly issued currency; that is, each new paper will have a full gold back up. Inversely, gold sold by the issue department entails a withdrawal from circulation of an equal amount of paper. The risk of a speculation against paper, once it is pegged to gold, is nil, since with 100 percent money, no money can be emitted as a debt. The paper has been strictly controlled and tightly linked to the transaction needs; there is no more redundancy of paper. However, there may be crop failure that necessitates considerable gold for imports, which may strain the gold holdings of the issue department or the foreign exchange dealers. In such contingency, the issue department may consider temporarily floating the currency until it reestablishes the previous parity again. We may observe that there should be a subsidiary metallic coin system in silver, copper, bronze, and nickel to supplement gold in the settlement of small transactions, as was the case with the UK system during 1816–1914. The subsidiary coinage is denominated not in weight but in decimals of units of account. To prevent inflation through subsidiary coinage, a number of paper money has to be drawn for each equivalent amount of decimal coins.

We should underscore that no initial condition is needed for the stock of the paper currency or the stock of gold. A country would not have to amass gold before it moves to a gold standard nor does it have to withdraw its paper currency from circulation through taxation and budget surpluses.A country can instantly peg its currency to gold at prevailing market rate, as the case of the German Rentenmark in 1923 with no convertibility provision. It reduces its currency when gold appreciates and expands when gold depreciates in relation to the fixed rate. The prior conditions would be to lift any restriction on gold as money and establish a totally free gold and silver market; establish a monopoly issue agency; and apply 100 percent reserve banking. The stock of gold acquired would be determined by the demand for gold; the higher the demand for gold, the more the country has to increase its exports and reduce its non-gold imports. The market would also determine the composition of its money in stocks of paper currency and gold and the convenience offered by each form of asset.

The Chicago Plan (1933) stressed 100 percent reserve money and equity-based banking without specific reference to gold. Why insist on re-introducing gold in a country when 100 percent reserve money would secure financial stability with paper money? We observe that all previous 100 percent money plans during the 18th and 19th centuries assumed a gold standard and aimed at securing gold convertibility. The authors of the Chicago Plan might have stressed a return to gold had they experienced a pure paper system such as prevailed after 1971. A removal of debt money is essential for stability under a paper or a gold system. Debt and money have to be split; money should not vary in relation to debt. Inconvertible paper is not natural money and did not emanate from market forces. As a result, the state has found paper money convenient to finance deficits. Paper representing gold may be coined as fully backed money; inconvertible paper is not, since it is often created through debt or fiscal deficit monetization. Moreover, gold is both a standard of value and an equivalent (i.e., exchanged commodity). Inconvertible paper has no intrinsic value and is not a standard of value. Hence, a country may not benefit by holding its foreign reserves in inconvertible paper. It will be safe to hold them in gold. A national paper pegged to gold has a known metal content and is stable money. It is no longer influenced by inconvertible and rapidly depreciating foreign currencies. A country will shelter its economy against the instability and uncertainties caused by reserve currencies countries. If not pegged to gold, the national paper will have an unstable exchange rate, and may suffer a degree of depreciation as reserve countries keep inflating their respective currencies. This will discourage investment and increases exchange rate risk and uncertainty.

In almost every country, governments intervene in a multitude of sectors and areas of the economy. The more the government expands and intervenes, the more it needs resources, which it does by increasingly resorting to an inflation tax. Adam Smith, who demonstrated the fallacies of tariffs and bounties and warned against the expansion of the unproductive government sector, has detailed the dangers of government expansion and intervention. He confined the role of government to defense, justice, education, and public works. Among opponents to government intervention was Lysander Spooner (1886) who called for abolishing tariffs and monopolies and restoring free markets in capital, labor, and commodities. He stated:

[I]f a government is to “do equal and exact justice to all men,” it must do simply that, and nothing more. If it does more than that to any, that is, if it gives monopolies, privileges, exemptions, bounties, or favors to any, it can do so only by doing injustice to more or less to others. It can give to one only what it takes from others; for it has nothing of its own to give to anyone.(Spooner, 1886, p. 15)

Historically, therefore, the government had to force paper currency, make it a legal tender, to be able to levy inflation taxes and promote interest groups.

Paper money and fractional reserve banking have led to large government bureaucracies and powerful interest groups; the economy has reduced mechanisms for adjustment, except through inflation. Numerous writers have criticized the model of excessive intervention of the state in the economy. Mises (1949, 1953) stressed the necessity of unhampered markets and elimination of inflation as conditions for re-introducing a gold standard. He noted that government needed inflation to finance its expanding size. Simons (1947) deplored the devastating consequences of statism, and stressed that a monetary reform along the lines of 100 percent money has to be accompanied with abolishing monopolies and price rigidities. Hayek (1944) called it “the road to serfdom.” Anderson (1945), and a number of other writers showed the dangers of the present system of statism. The government keeps expanding in size.In his book, Our Enemy, the State, Albert Jay Nock (1935) showed the adverse consequences of an ever-bigger government in terms of economic decline, despotism, and social decline. F.A. Hayek (1944) deplored statism in many Western countries, which reduced people to serfdom. Failure of the state is called failure of the market. In spite of financial crises, economic decline and social inequities, this system is fully supported by politicians. Reserve currencies were able to finance their excessive statism by printing money. After 2008, reserve currency countries set interest rates at near zero with a view to running fiscal deficits and transferring part of the bailout cost to other countries. A non-reserve country has a strict external constraint. Admittedly, no Western country has the adoption of a gold standard on its radar, especially given wage and price rigidities, the dominance of statism, high spending, monetization of deficits, huge public and private debt, as well as the dominance of powerful financial groups. In many countries, the statist economic model has damaged exports, turned a previously rich agricultural economy into a food deficit country, and caused high external debt. With statism and rigid labor and control laws, a country will not be able to adopt a gold standard, or even, a restrictive money policy to tame inflation. It has to rely on inflation taxation to run large budget deficits.

A gold standard embedded in 100 percent reserve banking has been proposed by many writers since the 17th century because of the extensive damage caused by paper and fractional reserve banking. Although such a system has not existed in a recent past and there is no historical experience to prove its superiority, there are instead a great number of counterfactual cases regarding the disruptive consequences of inconvertible paper and debt money, by which leading industrial countries as well as developing countries are suffering economic stagnation, high unemployment, high inflation, high indebtedness, and continued financial instability. Very high income and wealth inequality prevails through redistribution caused by money printing, leverage and financial crises. The income distribution is no longer determined by the real contribution to the national output but by non-market advantages. In contrast, there is a substantive evidence that economic growth was rapid under the gold standard and benefited labor considerably in the form of substantial real wage increases with full-employment fully maintained in all gold standard countries (Farrer, 1898). Exchange rates were fixed for decades, and international trade was flourishing. However, the gold standard could not survive alongside fractional reserve banking. A system of 100 percent money, which abolishes debt money, does not allow money creation out of thin air.

Opponents of the gold standard have claimed that gold scarcity would prevent circulation of increasing volume of commodities, ignoring the role of clearing that clears almost all transactions in asset, commodities, international trade, etc., with almost no cash. Unlike the US Fed, which printed $4 trillion in money within 5 years to finance government expenditures, there is no mining company that could dig out as much gold within the same period. Banks, in emitting money, were guided by profit maximization and much less by commodity circulation. The redundancy of debt money evolved into a rampant inflation showing that too much paper was crippling the economy.Paradoxically, inconvertible paper creates money shortages. Cagan (1956) showed that real money was almost non-existent in hyperinflation countries. The US dollar has a purchasing power in 2016 that is less than 2 cents of what it had in 1914. Gold was used essentially as a standard; it rarely circulated as a means of payments as illustrated by the establishment of goldsmith houses, and the Bank of Venice, Bank of Amsterdam, Bank of Hamburg, and other similar banks that settled accounts without physical gold movements. By late 19th century, actual gold payments represented less than 2 percent of total payments in the United Kingdom. Be it for gold or paper, only the economy determines the actual real money in the economy via changes in prices. Moreover, there is a huge stock of gold buried deep in storage that could be released and used as money. Opponents also claim that gold impaired external competitiveness. In case of many countries, paper money inflation ruined the export sector as some countries relied on foreign debt to finance their external deficit, instead of exports. Moreover, domestic inflation impaired competitiveness. Improving external competitiveness via inflation and exchange rate depreciation amounts simply to a subsidy to exporters at the expense of importers and the fixed income groups; it is not a true improvement in competitiveness, which emanates from productivity gains and innovation. There is plenty of evidence that the gold standard improved competitiveness via substantial gains in productivity and a consequent drop in prices as witnessed during 1871–1914.

We have recommended 100 percent (or realistically closer to 100 percent) reserve banking as the most important reform in restoring sound money and financial stability. This would also provide the foundation and a stepping stone to re-introducing a domestic gold standard in one or more countries that wished to do so. Sound monetary reform would help a country restore economic growth and social equity. As Gouge (1833) stated, fractional reserve banking is a malum per se, and has no remedy, except to be abolished and replaced by 100 percent reserve banking, in other words 100 percent money, as strongly advocated by the Chicago Plan (1933), Soddy (1934), and Irving Fisher (1936).  

In the context of a cheap money policy by reserve currencies countries and consequent uncertainty, a non-reserve country might consider a gold standard to immunize its economy against fluctuations in exchange rates and prices. China has expressed such an interest at different times over the last 10 or so years. Besides 100 percent money, a country ought to encourage risk-sharing equity investment banking as suggested by Simons, thus alleviating the conflict between debtors and creditors and securing financial stability.

The inconvertible paper system has become highly unstable, as shown by the 2008 crisis, its aftermath as well as the turbulences that caused it. Controlling interest rates at near-zero bound will reduce savings, foster debt-financed consumption and misallocate resources away from their best physical investment opportunities in the real sector; increasing the level of debt, redistributing wealth with growing inequalities, fueling volatile exchange rates and asset prices, and all damaging growth, social equity, and international trade. By re-establishing 100 percent money, a country will have a most propitious money that will extricate an economy from inflation, restore fast growth, full employment, and enhance social justice, with its money and interest rates being market determined and not administered by the state.

In this wide-ranging interview, Jeff Deist and Jim Rickards discuss gold in the context of current geopolitics and enduring myths about monetary growth. While the "anti-gold reflex" is strong among older generation monetary economists in the west, a new gold-friendly order is emerging in Asia. Jeff and Jim even discuss whether Hillary will be indicted, leading to a Joe Biden/Elizabeth Warren ticket. This is a fascinating interview that you won't want to miss.

This audio Mises Daily is narrated by Ben Wiegold.

More recently, gold has been replaced by the state’s unredeemable fiat money — for reasons rather more political than economic. The state prefers money whose value can be altered at will — say, to influence overall demand, redistribute income, and to benefit some at the expense of the many. Gold money stands in the way of such machinations. Fiat money doesn’t. On the contrary, fiat money can simply be printed up; can be created out of thin air.

Fiat money has serious economic and ethical drawbacks, though. It is chronically inflationary, widens the gap between poor and rich, triggers boom-and-bust cycles, and compounds the economy’s debt burden. Most important, a fiat money regime allows the state to expand actually without limit, over time potentially transforming even a minimum state into a maximum state at the expense of individual liberty and freedom.

In the wake of the most recent financial and economic crisis of 2007–2008, many people have become concerned that their savings, mostly invested in fiat-denominated bank accounts and bonds, could be devaluated. This has prompted a search for “good” money.

Somewhat new to the mix are the digital currencies, most famous of which is the virtual unit “bitcoin.” It is a digital currency generated by decentralized, internet-based computers rather than a central authority.

Transactions through digital currencies such as bitcoin are confirmed, or validated, by a decentralized consensus system that uses a “blockchain.” The latter is essentially a public digital ledger, an account statement for transactions among computers. The blockchain is saved on many computers so that it is practically impossible to manipulate. In the case of bitcoin specifically, the blockchain ensures that only the bitcoin’s owner can make a transaction with his bitcoin, that the same bitcoin cannot be created manifold.

In this article, I’ll use bitcoin as my main example, although this technology can be applied to any number of similar digital currencies.

However, this technology has now been used to provide a new means of transferring assets among people: the “colored bitcoin.” A colored bitcoin — or something comparable using blockchain technology — represents a certain asset. For instance, physical gold can be made available for day-to-day transactions — for purchases and sales in supermarkets and on the internet — simply by transferring a gold-backed colored bitcoin from the bitcoin wallet of the buyer to the bitcoin wallet of the seller.

How could one obtain such a gold-backed bitcoin? You would buy, say, physical gold at a gold shop. The latter then issues a colored bitcoin, which represents the ownership of physical gold. The colored bitcoin is, economically speaking, a gold substitute (a money substitute, fully backed by physical gold). It can be used for making purchases and, upon the wish of its owner, it can be redeemed into physical gold at the gold shop at any time.

A colored bitcoin represents a physical thing or asset that exists outside the bitcoin network. It therefore carries with it a risk that the issuer will not live up to his promise. However, there are market solutions to this problem. For instance, the gold can be stored with a particularly trustworthy third party. Or, people hold colored bitcoins issued by various issuers. If the latter are seen to be of the same riskiness, they would trade at par to each other (after making allowance for possible storage and handling costs).

That said, the gold-on-the-blockchain technology appears to hold great potential when it comes to making possible a world of digital gold money transactions. So far, governments use regulation and taxation to inhibit and even prevent unencumbered competition among monies. However, the evolution of the blockchain largely circumvents many of the obstacles governments put in the way of a free market in money. Where it will lead is, of course, is impossible to predict with certainty.

In any case, when we’re comparing to government fiat money, digital currencies can offer attractive alternatives. The same goes for gold lovers, who may see blockchain technology as the means of conveying physical gold; and in the end digitized gold money could become a practical option.

The best known proposal to separate money from the state is that of F.A. Hayek and his followers. Hayek’s “denationalization of money” would eliminate legal tender laws, and allow every individual and organization to issue its own currency, as paper tickets with its own names and marks attached. The central government would retain its monopoly over the dollar, or franc, but other institutions would be allowed to compete in the money creation business by offering their own brand name currencies.

Thus, Hayek would be able to print Hayeks, the present author to issue Rothbards, and so on. Mixed in with Hayek’s suggested legal change is an entrepreneurial scheme by which a Hayek-inspired bank would issue “ducats,” which would be issued in such a way as to keep prices in terms of ducats constant. Hayek is confident that his ducat would easily outcompete the inflated dollar, pound, mark, or whatever.

Hayek’s plan would have merit if the thing — the commodity — we call “money” were similar to all other goods and services. One way, for example, to get rid of the inefficient, backward, and sometimes despotic US Postal Service is simply to abolish it; but other free-market advocates propose the less radical plan of keeping the post office intact but allowing any and all organizations to compete with it. These economists are confident that private firms would soon be able to outcompete the post office. In the past decade, economists have become more sympathetic to deregulation and free competition, so that superficially denationalizing or allowing free competition in currencies would seem viable in analogy with postal services or fire-fighting or private schools.

There is a crucial difference, however, between money and all other goods and services. All other goods, whether they be postal services or candy bars or personal computers, are desired for their own sake, for the utility and value that they yield to consumers.

Consumers are therefore able to weigh these utilities against one another on their own personal scales of value. Money, however, is desired not for its own sake, but precisely because it already functions as money, so that everyone is confident that the money commodity will be readily accepted by any and all in exchange. People eagerly accept paper tickets marked “dollars” not for their aesthetic value, but because they are sure that they will be able to sell those tickets for the goods and services they desire. They can only be sure in that way when the particular name, “dollar,” is already in use as money.

Hayek is surely correct that a free-market economy and a devotion to the right of private property requires that everyone be permitted to issue whatever proposed currency names and tickets they wish. Hayek should be free to issue Hayeks or ducats, and I to issue Rothbards or whatever. But issuance and acceptance are two very different matters. No one will accept new currency tickets, as they well might new postal organizations or new computers. These names will not be chosen as currencies precisely because they have not been used as money, or for any other purpose, before.

One crucial problem with the Hayekian ducat, then, is that no one will take it. New names on tickets cannot hope to compete with dollars or pounds which originated as units of weight of gold or silver and have now been used for centuries on the market as the currency unit, the medium of exchange, and the instrument of monetary calculation and reckoning.

Hayek’s plan for the denationalization of money is Utopian in the worst sense: not because it is radical, but because it would not and could not work. Print different names on paper all one wishes, and these new tickets still would not be accepted or function as money; the dollar (or pound or mark) would still reign unchecked. Even the removal of the legal tender privilege would not work, for the new names would not have emerged out of useful commodities on the free market, as the regression theorem demonstrates they must. And since the government’s own currency, the dollar and the like, would continue to reign unchallenged as money, money would not have been denationalized at all. Money would still be nationalized and a creature of the state; there would still be no separation of money and the state. In short, even though hopelessly Utopian, the Hayek plan would scarcely be radical enough, since the current inflationary and state-run system would be left intact.

Even the variant on Hayek whereby private citizens or firms issue gold coins denominated in grams or ounces would not work, and this is true even though the dollar and other fiat currencies originated centuries ago as names of units of weight of gold or silver. Americans have been used to using and reckoning in “dollars” for two centuries, and they will cling to the dollar for the foreseeable future. They will simply not shift away from the dollar to the gold ounce or gram as a currency unit. People will cling doggedly to their customary names for currency; even during runaway inflation and virtual destruction of the currency, the German people clung to the “mark” in 1923 and the Chinese to the “yen” in the 1940s. Even drastic revaluations of the runaway currencies which helped end the inflation kept the original “mark” or other currency name.

If people love and will cling to their dollars or francs, then there is only one way to separate money from the state, to truly denationalize a nation’s money. And that is to denationalize the dollar (or the mark or franc) itself. Only privatization of the dollar can end the government’s inflationary dominance of the nation’s money supply.

How, then, can the dollar be privatized or denationalized? Obviously not by making counterfeiting legal. There is only one way: to link the dollar once again to a useful market commodity. Only by changing the definition of the dollar from fiat paper tickets issued by the government to a unit of weight of some market commodity, can the function of issuing money be permanently and totally shifted from government to private hands.

If it is imperative that the dollar be defined once again as a weight of a market commodity, then what commodity (or commodities) should it be defined as, and what should be the particular weight in which it is set? In reply, I propose that the dollar be defined as a weight of a single commodity, and that that commodity be gold.

Many economists, beginning with Irving Fisher at the turn of the twentieth century, and including Benjamin Graham and an earlier F.A. Hayek, have hankered after some form of “commodity dollar,” in which the dollar is defined, not as a weight of a single commodity, but in terms of a “market basket” of two or many more commodities.

There are many deep-seated flaws in this approach. In the first place, such a market-basket currency has never emerged spontaneously from the workings of the market. It would have to be imposed (to use a derogatory term from Hayek himself) as a “constructivist” scheme from the top, from government to be inflicted upon the market.

Second, and as a corollary, the government would be obviously in charge, since a market-basket currency does not, unlike the use of units of weight in exchange, arise from the free market itself. The government could and would, then, alter the ratios of weights, adjust the various fixed terms, and so forth.

Third, the hankering for a fixed market basket is an out-growth of a strong desire for the government to regulate the economy so as to keep the “price level” constant. As we have seen, the natural tendency of the free market is to lower prices over time, in accordance with growing productivity and increased supplies of goods. There is no good reason for the government to interfere. Indeed, if it does so, it can only create a boom-and-bust business cycle by expanding credit to keep prices artificially higher than they would be on the free market.

Furthermore, there are other grave problems with the commodity-basket approach. There is, for one thing, no such unitary entity as “the price level” which would be kept constant. The entire concept of price level is an artificial construction masking the fact that it can only consist of individual prices, each varying continually in relation to each other.

Irving Fisher’s intense desire for a constant price level stemmed from his own fallacious philosophic notion that, just as science is based upon measurable standards (such as a yard comprising 36 inches), so money is supposed to be a measure of values and prices. But since there is no single price level, his very idea, far from being scientific, is a hopeless chimera. The only scientific measurement that properly applies is the currency unit as a true measure of weight of the money commodity. Furthermore, the only scientific measure is a definition which, once selected, remains eternally the same: “the pound,” or “the yard.”

Juggling definitions of weight within a market basket violates any proper concept of definition or of measure. A final and vital flaw in a market-basket dollar is that Gresham’s law would result in perpetual shortages and surpluses of different commodities within the market basket. Gresham’s law states that any money overvalued by the government (in relation to its market value) will drive out of circulation money undervalued by the government. In short, control of exchange rates has consequences like any other price control: A maximum rate below the free market causes a shortage; a minimum rate set above the market will cause a surplus.

From the origin of the United States, the currency was in continuing trouble because the United States was on a bimetallic rather than a gold standard, in short a market basket of two commodities, gold and silver. As is well known, the system never worked, because at one time or another, one or the other precious metal was above or below its world market valuations, and hence one or the other coin or bullion was flowing into the country while the other would disappear. In 1873 partisans of the monometallic gold standard, seeing that silver was soon to be overvalued and hence on the point of driving out gold, put the United States on a virtual single gold standard, a system that was ratified officially in 1900.

We conclude, then, that the dollar must be redefined in terms of a single commodity, rather than in terms of an artificial market basket of two or more commodities. Which commodity, then, should be chosen? In the first place, precious metals, gold and silver, have always been preferred to all other commodities as mediums of exchange where they have been available. It is no accident that this has been the invariable success story of precious metals, which can be partly explained by their superior stable nonmonetary demand, their high value per unit weight, durability, divisibility cognizability, and the other virtues described at length in the first chapter of all money and banking textbooks published before the US government abandoned the gold standard in 1933.

Which metal should be the standard, then, silver or gold? There is, indeed, a case for silver, but the weight of argument holds with a return to gold. Silver’s increasing relative abundance of supply has depreciated its value badly in terms of gold, and it has not been used as a general monetary metal since the nineteenth century. Gold was the monetary standard in most countries until 1914, or even until the 1930s. Furthermore, gold was the standard when the US government in 1933 confiscated the gold of all American citizens and abandoned gold redeemability of the dollar, supposedly only for the duration of the depression emergency. Still further, gold and not silver is still considered a monetary metal everywhere, and governments and their central banks have managed to amass an enormous amount of gold not now in use, but which again could be used as a standard for the dollar, pound, or mark.

It is important to realize what a definition of the dollar in terms of gold would entail. The definition must be real and effective rather than nominal. Thus, the US statutes define the dollar as 1/42.22 gold ounce, but this definition is a mere formalistic accounting device. To be real, the definition of the dollar as a unit of weight of gold must imply that the dollar is interchangeable and therefore redeemable by its issuer in that weight, that the dollar is a demand claim for that weight in gold. Furthermore, once selected, the definition, whatever it is, must be fixed permanently. Once chosen, there is no more excuse for changing definitions than there is for altering the length of a standard yard or the weight of a standard pound.

The press is resounding with acclaim for the accession to Power of Alan Greenspan as chairman of the Fed; economists from right, left, and center weigh in with hosannas for Alan’s greatness, acumen, and unparalleled insights into the “numbers.” The only reservation seems to be that Alan might not enjoy the enormous power and reverence accorded to his predecessor, for he does not have the height of a basketball player, is not bald, and does not smoke imposing cigars.

The astute observer might feel that anyone accorded such unanimous applause from the Establishment couldn’t be all good, and in this case he would be right on the mark. I knew Alan thirty years ago, and have followed his career with interest ever since.

I found particularly remarkable the recent statements in the press that Greenspan’s economic consulting firm of Townsend-Greenspan might go under, because it turns out that what the firm really sells is not its econometric forecasting models, or its famous numbers, but Greenspan himself, and his gift for saying absolutely nothing at great length and in rococo syntax with no clearcut position of any kind.

As to his eminence as a forecaster, he ruefully admitted that a pension-fund managing firm he founded a few years ago just folded for lack of ability to apply the forecasting where it counted — when investment funds were on the line.

Greenspan’s real qualification is that he can be trusted never to rock the establishment’s boat. He has long positioned himself in the very middle of the economic spectrum. He is, like most other long-time Republican economists, a conservative Keynesian, which in these days is almost indistinguishable from the liberal Keynesians in the Democratic camp. In fact, his views are virtually the same as Paul Volcker, also a conservative Keynesian. Which means that he wants moderate deficits and tax increases, and will loudly worry about inflation as he pours on increases in the money supply.

There is one thing, however, that makes Greenspan unique, and that sets him off from his Establishment buddies. And that is that he is a follower of Ayn Rand, and therefore “philosophically” believes in laissez-faire and even the gold standard. But as the New York Times and other important media hastened to assure us, Alan only believes in laissez-faire “on the high philosophical level.” In practice, in the policies he advocates, he is a centrist like everyone else because he is a “pragmatist.”

As an alleged “laissez-faire pragmatist,” at no time in his prominent twenty-year career in politics has he ever advocated anything that even remotely smacks of laissez-faire, or even any approach toward it. For Greenspan, laissez-faire is not a lodestar, a standard, and a guide by which to set one’s course; instead, it is simply a curiosity kept in the closet, totally divorced from his concrete policy conclusions.

Thus, Greenspan is only in favor of the gold standard if all conditions are right: if the budget is balanced, trade is free, inflation is licked, everyone has the right philosophy, etc. In the same way, he might say he only favors free trade if all conditions are right: if the budget is balanced, unions are weak, we have a gold standard, the right philosophy, etc. In short, never are one’s “high philosophical principles” applied to one’s actions. It becomes almost piquant for the Establishment to have this man in its camp.

Over the years, Greenspan has, for example, supported President Ford’s imbecilic Whip Inflation Now buttons when he was Chairman of the Council of Economic Advisers. Much worse is the fact that this “high philosophic” adherent of laissez-faire saved the racketeering Social Security program in 1982, just when the general public began to realize that the program was bankrupt and there was a good chance of finally slaughtering this great sacred cow of American politics. Greenspan stepped in as head of a “bipartisan” (i.e., conservative and liberal centrists) Social Security Commission, and “saved” the system from bankruptcy by slapping on higher Social Security taxes.

Alan is a long-time member of the famed Trilateral Commission, the Rockefeller-dominated pinnacle of the financial-political power elite in this country. And as he assumes his post as head of the Fed, he leaves his honored place on the board of directors of J.P. Morgan & Co. and Morgan Guaranty Trust. Yes, the Establishment has good reason to sleep soundly with Greenspan at our monetary helm. And as icing on the cake, they know that Greenspan’s “philosophical” Randianism will undoubtedly fool many free market advocates into thinking that a champion of their cause now perches high in the seats of power.

Narrated by Jeff Riggenbach. Includes "The Case for a 100% Gold Dollar" by Murray N. Rothbard

Includes "The Case for a 100% Gold Dollar" by Murray N. Rothbard.

This audiobook is also available on iTunes and Google Play.

The question of rigging has been brought to media attention in the past few months when ten banks came under investigation by the US Commodity Futures Trading Commission (CFTC) and the US Department of Justice in price-manipulation probes. Also around that time, the Swiss regulator FINMA settled a currency manipulation case in which UBS was accused of trading ahead of silver-fix orders. Then, the UK Financial Conduct Authority, which regulates derivatives, ordered Barclays to pay close to $45 million in fines against a trader who artificially suppressed the price of gold in 2012 to avoid payouts to clients. Such manipulations are not limited to the precious-metals market: in November of last year, major banks had to pay several billion dollars in fines related to the rigging of foreign-exchange benchmarks, including LIBOR and other interest-rate benchmarks.

These cases followed on the heels of a set of lawsuits in May 2014 filed in New York City in which twenty-five plaintiffs consisting of hedge funds, private citizens, and public investors (such as pension funds) sued HSBC, Barclays, Deutsche Bank, Bank Scotia, and Société Génerale (the five traditional banks of the former London Gold Fix) on charges of rigging the precious-metals and foreign-exchange markets. "A lot of conspiracy theories have turned out to be conspiracy fact," said Kevin Maher, a former gold trader in New York who filed one of the lawsuits that May, told The New York Times.

The lawsuits were given more prominence with the introduction of the London Bullion Market Association (LBMA) on February 20, 2015. The new price-fixing body was established with seven banks: Goldman Sachs, J.P. Morgan, UBS, HSBC, Barclays, Bank Scotia and Société Génerale. (On June 16, the Bank of China announced, after months of speculation, that it would join.)

While some economists have deemed the new electronic fix a good move in contrast to behind-closed-door, phoned-in price-fixing, others beg to differ. Last year, the commodities exchange CME Group came under scrutiny for allowing volume trading discounts to central banks, raising the question of how "open" electronic pricing really is. Then, too, the LBMA is itself not a commodities exchange but an Over-The-Counter (OTC) market, and does not publish — does not have to publish — comprehensive data as to the amount of metal that is traded in the London market.

According to Ms. Ruth Crowell, the chairman of LBMA, writing in a report to that group: "Post-trade reporting is the material barrier preventing greater transparency on the bullion market." In the same report, Crowell states: "It is worth noting that the role of the central banks in the bullion market may preclude 'total' transparency, at least at the public level." To its credit, the secretive London Gold Fix (1919–2015) featured on its website tracking data of the daily net volume of bars traded and the history of gold trades, unlike current available information from the LBMA as one may see here (please scroll down for charts).

There is further the problem of what is being sold as "paper" gold. At first glance, that option seems a good one. Gold exchange-traded funds (ETFs), registered with The New York Stock Exchange, have done very well over the past decade and many cite this as proof that paper gold, rather than bars in hand, is just as sure an investment. The dollar price of gold rose more than 15.4 percent a year between 1999 and December 2012 and during that time, gold ETFs generated an annual return of 14 percent (while equities registered a loss).

As paper claims on trusts that hold gold in bank vaults, ETFs are for many, preferable to physical gold. Gold coins, for instance, can be easily faked, will lose value when scratched, and dealers take high premiums on their sale. The assaying of gold bars, meanwhile, with transport and delivery costs, is easy for banking institutions to handle, but less so for individuals. Many see them as trustworthy: ETF Securities, for example, one of the largest operators of commodity ETFs with $21 billion in assets, stores their gold in Zurich, rather than in London or Toronto. These last two cities, according to one official from that company, "could not be trusted not to go along with a confiscation order like that by Roosevelt in 1933."

Furthermore, shares in these entities represent only an indirect claim on a pile of gold. "Unless you are a big brokerage firm," writes economist William Baldwin, "you cannot take shares to a teller and get metal in exchange." ETF custodians usually consist of the likes of J.P. Morgan and UBS who are players on the wholesale market, says Baldwin, thus implying a possible conflict of interest.

Still more complicated is the love-hate relationship between governments and gold. As independent gold analyst Christopher Powell put it in an address to a symposium on that metal in Sydney, October 2013: "It is because gold is a competitive national currency that, if allowed to function in a free market, will determine the value of other currencies, the level of interest rates and the value of government bonds." He continued: "Hence, central banks fight gold to defend their currencies and their bonds."

It is a relationship that has had a turbulent history since the foundation of the Bretton Woods system in 1944 and up through August 1971, when President Nixon declared the convertibility of the dollar to gold suspended. During those intervening decades, gold lived a kind of strange dual existence as a half state-controlled, half free market-driven money-commodity, a situation that Nobel Prize economist Milton Friedman called a "real versus pseudo gold standard."

The origin of this cumbersome duality was the post-war two-tiered system of gold pricing. On the one hand, there was a new monetary system that fixed gold at $35 an ounce. On the other, there was still a free market for gold. The $35 official price was ridiculously low compared to its free market variant, resulting in a situation in which IMF rules against dealing in gold at "free" prices were circumvented by banks that surreptitiously purchased gold from the London market.

The artificial gold price held steady until the end of the sixties, when the metal's price started to "deny compliance" with the dollar. Still, monetary doctrine sought to keep the price fixed and, at the same time, to influence pricing on the free market. These attempts were failures. Finally, in March 1968, the US lost more than half its reserves, falling from 25,000 to 8,100 tons. The price of other precious metals was allowed to move freely.

Meawhile, private hoarding of gold was underway. According to The Financial Times of May 21, 1966, gold production was rising, but it was not going to official gold stocks. This situation, in turn, fundamentally affected the gold clauses of the IMF concerning repayments in currency only in equal value to the gold value of such at the time of borrowing. This led to a rise in "paper gold planning" as a substitution for further increases in IMF quotas. (Please see "The Paper Gold Planners — Alchemists or Conjurers?" in The Financial Analysts Journal, Nov–Dec 1966.)

By the late 1960s, Vietnam, poverty, the rise in crime and inflation were piling high atop one another. The Fed got to work doing what it does best: "Since April [1969]," wrote lawyer and economist C. Austin Barker in a January 1969 article, "The US Money Crisis," "the Fed has continually created new money at an unusually rapid rate." Economists implored the IMF to allow for a free market for gold but also to set the official price to at least $70 an ounce. What was the upshot of this silly system? That by 1969 Americans were paying for both higher taxes and inflation. The rest, as they might say, is the history of the present.

Today, there is no “official” price for gold, nor any “gold-exchange standard” competing with a semi-underground free gold market. There is, however, a material legacy of “real versus pseudo” gold that remains a terrible menace. Buyer beware of the pivotal difference between the two.

The Left wants more welfare, better schools, free college, enhanced job training, and more. The Right, in contrast, wants welfare reform, charter schools, tax reform — not to be confused with tax cuts — and use of the negative income tax.

Both sides get it wrong. Neither side understands economic inequality, nor what causes it to change. Recently I argued that the problem of urban blight is caused by too much government and the solution is to radically reduce government in key areas in order to create jobs and entrepreneurial opportunities. The same thing applies to economic inequality: tinkering with government policies in one direction or the other does not solve the problem.

The first thing to note is that inequality is a natural feature of all societies, whether it is libertarian, socialist, or primitive. A well developed libertarian society tends to have a large middle class, a small lower class, and a revolving upper class. The low-income class is small because there are no legal barriers to opening new businesses, there are incentives to earn and save and be entrepreneurial. The upper class is “revolving” because there are no monopoly privileges or bailouts to maintain wealth.

The second thing to note is that public policy impacts or alters the natural inequality of society. Say, for example, that a government requires all doctors and lawyers to have a license to practice and then limits the number of licenses. Bingo! Doctors and lawyers are now almost immediately richer because they have used the law to limit their competition which means higher fees and salaries for those protected professions.

Naturally, the size and shape of government policies have an impact on economic inequality. The job of the economist is to make sure everyone understands that government policies have obvious effects that can be seen, but also have effects that are not seen. In most cases, the effects that are seen are some direct immediate benefit to a particular group of people. Likewise, the unseen effects have circuitous, indirect negative consequences on a large group of people that grow larger over time. Frédéric Bastiat said that “the ultimate consequences are fatal.”

If the state provides generous welfare payments to poor people, this becomes an obvious direct benefit to the poor people who receive the money. However, in order to make those payments it is necessary to tax productive citizens, thus reducing their incentive to be productive. If being poor is the stipulation for receiving welfare payments, then people will have less incentive to be productive and escape from poverty. In the long run you end up with more poor people, a permanent poverty class, and a smaller economic pie to support the population.

The impact of taxes and welfare on income distribution are fairly well known. However, these well-known effects are generally disregarded or dismissed by those who want to “do something about economic inequality.”

Money is one important factor that is also ignored by both those on the political left and the political right. However, the monetary system and monetary policy have obvious and historically validated effects on economic inequality.

A monetary system dominated by a central bank, such as the Federal Reserve, that uses fiat money can expect to benefit certain people, such as bankers and people with debt. Likewise, because such a system is inflationary, it tends to hurt workers and savers. Such a system can be expected to hurt the lower and middle classes and enrich those in the financial industry and the upper class.

A gold standard has historically had a tendency to be slightly deflationary. This means that wage rates, cash balances, savings, and bonds tend to gain purchasing power over time. So this type of monetary system rewards the hard working and frugal classes which leads to an expansion of the middle class.

This graph from the Pew Research Center provides enticing evidence of the differential impact of gold versus fiat paper money:

The graph shows that economic inequality declined in the US from 1917 to the early 1970s when Nixon took America off of the gold standard. The shaded areas of the graph represent the 99 percent, while the lightest colored area at the top represent the upper 1 percent. Economic inequality increased during the inflationary 1920s, but the lower income classes rapidly improved versus the 1 percent when the gold standard was restored after WWII. The graph shows both marginal improvement and stability in economic inequality from the late 1940s to the early 1970s. The trend has been for greater economic inequality ever since.

Austrian economists do not advocate any particular income distribution except the one determined by the market economy. Part of the answer to the problem of economic inequality is to return to an honest and sound monetary system including — but not limited to — the gold standard.

That wisdom and foresight was once upon a time institutionalized throughout an international monetary culture — gold-based, wary of credit, and contemptuous of debt, public or private. This world included central banks including the Bank of England, the Bank of France, the Swiss National Bank, the early Federal Reserve, the Imperial Bank of Austria-Hungary, and the German Reichsbank. But the entrenched hard-money ideology of the time restrained all of them. The Bank of Russia, for example, which once required 50 percent to 100 percent gold backing of all notes issued, possessed the second largest gold reserves on the planet at the turn of the twentieth century.

"The countries that were tied together in the gold standard system represented to a not inconsiderable degree a community of interest in and responsibility for the maintenance of economic and financial stability throughout the world," recounted Aldoph C. Miller, member of the Federal Reserve Board from 1914 to 1936, in The Proceedings of the Academy of Political Science, in May 1936. "The gold standard was the one outstanding symbol of unity and economic solidarity which the nineteenth century world had developed."

It was a time when "automatic market forces," as economists of the day referred to them, prevailed over monetary management. Redeemability of money in (fine) gold ensured, within limits, stability in foreign exchange rates. Credit was extended only as far as reserve ratios would allow, and central banks were required to keep fixed reserves of gold against notes-in-circulation and against demand deposits.

Gold flows regulated international price relationships through markets, which adjusted themselves accordingly: prices rose when there was an influx of gold — for example, when one country received a debt payment from another country (always in gold), or during such times as the California or Australian gold rushes of the 1870s. These inflows meant credit expansion and a rise in prices. An outflow of gold meant credit was contracted and price deflation followed.

The efficiency of that standard was not impeded by the major central banks in such a way that "any disturbance of economic or financial character originating at any point in the world which might threaten the continued maintenance of economic equilibrium was quickly detected by foreign exchanges," Miller, the Federal Reserve board member, noted in his paper. "In this way, the gold standard system became in a very real sense a regime or rule of economic health, a method of catching economic disturbances in the bud."

The Bank of England, the grand master of them all, was the financial center of the universe, whose tight handle on its credit policies was so disciplined that the secured the top spot while not even holding the largest gold reserves. Consistent in its belief that protection of reserves was the chief, and only important, criterion of credit policy, England became the leading exporter of capital, the free market for gold, the international discount market, and international banker for the trade of other countries, as well as her own. The world was in this sense on the sterling standard.

The Bank of France, wisely admonished by its founder, Napoleon, to make sure France was always a creditor country, was so replete with reserves it made England a 500 million franc loan (in 1915 numbers) at the onset of the World War I. Switzerland, perhaps the last "19th-century-style" hold-out today with unlimited-liability private bankers and strict debt-ceiling legislation, also required high standards of its National Bank, founded in 1907. By the 1930s that country had higher banking reserves than the US; the Swiss franc was never explicitly devalued, unlike nearly every other Western nation’s currency, and the country’s domestic price level remained the most stable in the world.

For a time, the disciplined mindset of these banks found its way across the Atlantic, where the idea of a central bank had been long the subject of hot debate in the US. The economist H. Parker Willis, writing about the controversy in The Journal of the Proceedings of the Academy of Political Science, October 1913, admonished: "The Federal Reserve banks are to be 'bankers' banks,' and they are intended to do for the banker what he himself does for the public."

At first, the advice was heeded: in September 1916, almost two years after its founding on December 23,1913, the fledgling Fed worked out an amendment to its gold policy on the basis of a very conservative view of credit. This new policy sought to restrain "the undue and unnecessary expansion of credit," wrote Fed board member Miller, in an article for The American Economic Review, in June 1921.

The Bank of Russia, during the second half of the nineteenth century steered itself through the Crimean War, the Russo-Turkish War, the Russo-Japanese War, impending Balkan wars — not to mention all that was to follow — and managed to emerge with sound fiscal policies and massive gold reserves. According to The Economist of May 20, 1899, Russian holdings were 95 million pounds sterling of gold, while the Bank of France held 78 million sterling worth. (Austria-Hungary held 30 million sterling worth of gold and the Bank of England 30 million sterling worth of both gold and silver.) "Russia up to the very moment of rupture [with Japan, 1904–1905], was working imperturbably at the progressive consolidation of her finances," reported Karl Helfferich of the University of Berlin, at a meeting of The Royal Economic Society [UK] in December 1904. "Even in years of industrial crises and defective harvest, her foreign trade showed an excess of exports over imports more than sufficient to compensate payments sent abroad. And, as guarantee her monetary system she has succeeded in a amassing and maintaining a vast reserve of gold."

These banks, in turn, drew on the medieval/Renaissance and Baroque-era banking traditions of the Hanseatic League, the Bank of Venice, and Amsterdam banks. Payment-on-demand "in good and heavy gold" was like a blood-oath binding the banker-client relationship. The transfer of credit "did not arise from any such substitution of credit for money," noted Charles F. Dunbar, in The Quarterly Journal of Economics of April 1892, "but from the simple fact that the transfer in-bank saved the necessity of counting coin and manual delivery of every transaction."

Bankers were forbidden to deal in certain commodities, could not make loans or create credit for the purchase of such commodities, and forbade both foreigners and citizens from buying silver on credit unless the same amount in cash was in the bank. According to Dunbar, a Venetian law of 1403 on reserve requirements became the basis of US banking law on the deposits of public securities in the late 1800s.

After the fall of bi-metallism in the 1870s, gold continued to perform monetary functions among the main countries of the Western world (and the well-administered Bank of Japan). It was the only medium of exchange and the only currency with unrestricted legal tender. It became the vaunted "measure of value." Bank currency notes were simply used as auxiliary to gold and, in general, did not enjoy the privilege of legal tender.

It was certainly not a flawless system, or without periodic crises. But central banks had to act in an exceptionally prudent manner given the all-over public distrust of paper money.

As economist Andrew Jay Frame of the University of Chicago, writing in The Journal of Political Economy, in January 1912, noted: "During panics in Britain in 1847 and 1866, when cash payments were suspended, the floodgates of cash were opened [by The Bank of England], the governor sent word to the street that solvent banks would be accommodated, and the panic was relieved." Frame then adds: "However, this extra cash and the increased loans that went with it were very quickly put to an end to avoid credit expansion."

The US was equally confident of its prudent attitude. Aldoph Miller, writing of Federal Reserve policy, remarked: "The three chief elements of the policy of a central bank or system of reserve holding institutions are best disclosed in connection with the attitude towards 1) gold 2) currency 3) credit." He noted proudly: "The federal reserve system has met [these] tests on the whole with remarkable success."

But after World War I, a different international landscape was left behind. England had been displaced as the center of international finance; the US and France emerged as the chief post-war creditor countries. The mechanism of the gold standard to which depreciated currencies could be related no longer existed. Only the US was left with a full gold standard. England and France had a gold bullion standard and other countries (Germany, primarily) had a gold-exchange standard.

A matrix of unbalanced trade relationships began to saturate the international economy. Then, with so many foreign countries attendant upon its speculative boom, the US manipulated its own domestic credit policies to ease credit and exchange-standard controls. This eventually culminated in an international financial crisis of 1931. Under Bretton Woods (1944), the gold standard was effectively abandoned: domestic convertibility was illegal and the role of gold was very constrained in favor of the dollar.

"It was, at least in theory, simple enough in the old days," wrote a wistful W. Randolph Burgess, head of the New York Federal Reserve, in 1938. "In the present strange new world, where the old gold portents have lost their former meaning, where is the radio beam which the central banker may follow? What is the equivalent of gold?"

The men of his era and of the late nineteenth century understood the meaning of such a question and, more importantly, why it is one that must be asked. But theirs was a different world, indeed — one without "QE," ZIRP," or "Unknown Knowns" as fiscal policy. And there were no helicopters, either.

Though a far-fetched idea at first glance, many factors suggest that remonetization in gold may be a logical next step for Moscow.

First, for years Moscow has been expressing its unwillingness to remain at the monetary mercy of the US and its NATO allies and this view has been most vehemently expressed by President Putin’s long-time economic advisor, Sergei Glazyev. Russia is prepared to play strategic hardball with the West on the issue: the governor of Russia’s central bank took the unusual step last November of presenting to the international media details of the bank’s zealous gold-buying spree. The announcement, in sharp contrast to that institution’s more taciturn traditions, underscores Moscow’s outspoken dismay with dollar hegemony; its timing suggests coordination with the top rungs of government to present gold as a possible currency-war weapon.

Second, despite international pressure, Russia has been very wary of the sell-off policies that led the UK, France, Spain, and Italy to unload gold over the past decade during unsuccessful attempts to prop up their respective ailing economies — in particular, of then-Prime Minister Gordon Brown’s sell-off of 400 metric tons of the country's reserves at stunningly low prices. Moscow’s surprise decision upon the onset of the ruble’s swift decline in early December 2014 to not tap into the country’s gold reserves, now the world's sixth largest, highlights the ambitiousness of Russia’s stance on the gold issue. By the end of December, Russia added another 20.73 tons, according to the IMF in late January, capping a nine-month buying spree.

Third, while the Russian economy is structurally weak, enough of the country's monetary fundamentals are sound, such that the timing of a move to gold, geopolitically and domestically, may be ideal. Russia is not a debtor nation. At this writing in January, Russia’s debt to GDP ratio is low and most of its external debt is private. Physical gold accounts for 10 percent of Russia’s foreign currency reserves. The budget deficit, as of a November 2014 projection, is likely to be around $10 billion, much less than 1 percent of GDP. The poverty rate fell from 35 percent in 2001 to 10 percent in 2010, while the middle class was projected in 2013 to reach 86 percent of the population by 2020.

Collapsing oil prices serve only to intensify the monetary attractiveness of gold. Given that oil exports, along with the rest of the energy sector, account for 45 percent of GDP, the depreciation of the ruble will continue; newly unstable fiscal conditions have devastated banks, and higher inflation looms, expected to reach 10 percent by the end of 2015. As Russia remains (for the foreseeable future) mainly a resource-based economy, only a move to gold, arguably, can make the currency stronger, even if it does limit Russia’s available currency.

In buying as much gold as it has, the country is, in part, ensuring that it will have enough money in circulation in the event of such fundamental transformation. In terms of re-establishing post-oil shock international prestige, a move to gold will allow the country to be seen as a more reliable and trustworthy trading partner.

The repercussions of Russia on a gold-exchange standard would be immense. Above all, it would mean the first major schism in the world's monetary order. China would quite likely follow suit. It could mean the threat of a severe inflation in the United States should rafts of unwanted dollars make their way back across the Atlantic — the Fed's ultimate nightmare. Above all, the country will avoid the extreme debt leverages which would not have happened had Western capitals remained on gold.

“A gold standard would be politically appealing, transforming the ruble to a formidable currency and reducing outflows significantly,” writes Dr. Enrico Colombatto, economics professor at the University of Turin, Italy.

He notes that the only major drawback would be that the imposed discipline of a gold standard would deprive authorities of discretionary political power. The other threat would be that of a new generation of Russian central bankers becoming too heavily influenced by the monetary mindset of the European Central Bank (ECB) and the Fed.

As Alisdair MacLeod, a two-decade veteran of off-shore banking consulting based in the UK, recently wrote, Russia (and China) will “hold all the aces” by moving away from any possible currency wars of the future into the physical gold market. In his article, he adds that there is currently a low appetite for physical gold in Western capital markets and longer-term foreign holders of rubles would be unlikely to exchange them for gold, preferring to sell them for other fiat currencies.

Mr. Macleod cites John Butler, CIO at Atom Capital in London, who sees great potential in a gold-exchange standard for Russia. With the establishment of a sound gold-exchange rate, he argues, the Central Bank of Russia would no longer be confined to buying and selling gold to maintain the rate of exchange. The bank could freely manage the liquidity of the ruble and be able to issue coupon-bearing bonds to the Russian public, allowing it a yield linked to gold rates. As the ruble stabilizes, the rate of the cost of living would drop; savings would grow, spurred on by long term stability and lower taxes.

Foreign exchange also would be favorable, Mr. Butler maintains. Owing to the Ukraine crises and commodities crises, rubles have been dumped for dollar/euro currencies. Upon the announcement of a gold-exchange, demand for the ruble would increase. London and New York markets would in turn be countered by provisions restricting gold-to-ruble exchanges of imports and exports.

The geopolitics of gold also figure into Russia’s increasingly close relations with China, a country that also has made clear its preference for gold over the dollar. (Russia recently edged out China as the world's top buyer of the metal.) In the aftermath of the $400 billion, 30-year deal signed between Russian gas giant Gazprom and the China National Petroleum Company in November 2014, China turned its focus to the internationalization of its own gold market. On January 15, 2015, the Shanghai Gold Exchange, the largest physical gold exchange worldwide, and the World Gold Council, concluded a strategic cooperation deal to expand the Chinese gold market through the new Shanghai Free Trade Zone.

This is not the first time the gold standard has been seen as the ultimate cure for Russia’s economic problems. In September 1998, the noted economist Jude Wanninski predicted in a far-sighted essay for The Wall Street Journal that only a gold ruble would get the the country out of its then-debt crises. It was upon taking office about two years later, in May 2000, that President Putin embarked upon the country’s massive gold-buying campaign. At the time, it took twenty-eight barrels of crude just to buy an ounce of gold. The gold-backed ruble policy of those years was adopted to successfully pay down the country's external debt.

As a pro-gold stance is, essentially, anti-dollar, speculation about how the US would react raises the question of whether an all-out currency war would follow. The West would have to keep Russia regionally and militarily marginalized, not to mention kept within the confines of the Fed, the ECB, and the Bank of England (BOE).

Nor is that prospect too far-fetched. As Dutch author Willem Middelkoop has written in his 2014 book The Big Reset: War on Gold and the Financial Endgame,

A system reset is imminent. Even before 2020 the world's financial system will need to find a different anchor. ... In a desperate attempt to maintain this dollar system, the United States waged a secret war on gold since the 1960s. China and Russia have pierced through the American smokescreen around gold and the dollar and are no longer willing to continue lending to the United States. Both countries have been accumulating enormous amounts of gold, positioning themselves for the next phase of the global financial system.

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This is part one of a two part interview.

The central bank is currently defending a 1.2 Swiss-francs-to-the-euro floor. By pegging its currency, the Swiss central bank has basically opted to follow its neighbor’s excessively easy monetary policy. To keep the peg, the Swiss central bank has been purchasing euros by printing Swiss francs. The central bank then returns the euros to the Euro money supply by purchasing European government bonds. It could have just as easily used those euros to buy dollars for gold. In either case, the euros or dollars are returned to the market, and therefore the Swiss action does not influence the respective Euro or US money supplies. We must remember that exchange rates are determined by differences in monetary growth rates and anticipation of what those differences will be in the future.

The Swiss government and Swiss central bank opposed the initiative. This should not be surprising. It is standard government policy to use fear tactics to justify continued government theft.

By this means government may secretly and unobserved, confiscate the wealth of the people, and not one man in a million will detect the theft.

—John Maynard Keynes

The Swiss central bank said that the initiative would limit its flexibility to deal with a liquidity crisis or runaway inflation. Since the central bank could not sell its gold, it claims it would be hard pressed to provide liquidity in the event of a banking crisis. Of course this assumes that the central bank would keep its balance sheet from expanding, which is nonsense. There is nothing stopping the central bank from printing Swiss francs for liquidity and print even more Swiss francs to buy gold.

It also claims that if it had to conduct open market sales of its assets to combat inflation, the inability to sell 20 percent of its assets would limit its maneuvering room. This is less than ingenious. There is nothing in the initiative that would limit the central bank’s ability to sell the 80 percent of its assets that would not have to be held as gold. Also we must never forget that inflation is a monetary phenomenon. The central bank is asking for flexibility to handle a problem created by giving the central bank flexibility in the first place.

While the initiative has been portrayed as extreme or revolutionary by many critics, the initiative is very mild when compared to the role of gold at the Swiss central bank in the past. For example, Switzerland held 40 percent of its assets in gold between 1936 and the year 2000. Did this more-binding constraint limit the central bank’s ability to print money? Relative to gold, the Swiss franc has lost 90 percent of its value since 1914. Did the bank’s gold assets during this time seriously limit the central bank’s policy-maneuvering room? A cursory reading of the financial press during this period clearly shows it did not.

Although the initiative would have done little to constrain central banking, it would have nonetheless been a step in the right direction much like Ron Paul’s attempt to audit the Fed in the United States. What the initiative does highlight is the general public’s feeling that something is rotten in Denmark! Every dollar, euro, or yen that central banks create is a tax on cash balances. A tax no one has voted for. It is theft while you sleep. Although central bankers may attend fancy lunches in thousand dollar Armani suits, it does not diminish the reality that they are nothing more than counterfeiters. The only difference between them and the guy printing currency in his basement is they do not fear the police breaking down their doors.

The balance sheet of the SNB currently amounts to 522.3bn CHF (Swiss francs), with its gold holdings and claims from gold transactions amounting to 39.4bn CHF. The share of gold of the SNB’s assets is therefore about 7.5 percent — substantially lower than what the Initiative calls for.

If the referendum is successful, that is, if the Initiative is adopted, the SNB will have to increase its gold holdings relative to its total assets. This can be done in two ways:

Let us assume that the SNB has to buy additional gold — and that this would require a fairly sizable amount of money. An important question is: how can the gold purchases be financed? And what are the consequences?

The SNB may finance its gold purchases by exchanging its foreign currency reserves — which are largely held in euros, but also in US dollars, Japanese yen and British Pounds — against gold. Three effects would follow from this:

Once it complies with the 20-percent rule, the SNB can still increase the domestic quantity of money: namely by buying gold and/or warehouse gold from private persons (Swiss or foreign) against issuing newly created Swiss francs.Strictly speaking, increasing the amount of Swiss franc through warehousing is only possible if the SNB records the gold on the asset side of its balance sheet.

That said, the Initiative would not put Switzerland on a gold standard, under which the SNB has to, for instance, redeem Swiss francs in gold. Nevertheless, the Initiative would certainly have some very positive implications.

First and foremost, the 20-percent rule would make the SNB policy of money expansion more difficult. For increasing the quantity of money, the SNB would have to buy gold equivalent to 20 percent of the Swiss franc amount issued.

The expansion of the Swiss franc would not only be linked to physical gold — that is the ultimate means of payment, which is in short supply. Moreover, such transactions would be “visible” and could be more easily sanctioned by the Swiss public.

Furthermore, the 20-percent rule would force banks to adopt a much more cautious business approach. Fractional reserve banking, for instance, would be much less attractive and possible, as banks could no longer expect the SNB to bail them out by printing up new money.

Last but not least, the Initiative would make the Swiss franc less inflationary, especially so as it discourages greatly commercial banks’ money creation out of thin air — which is also the central cause for boom-and-bust cycles.

Since the outbreak of the international financial and economic crisis, the SNB has fought against the appreciation of the Swiss franc against the euro. To this end, the SNB has been buying euros against issuing newly created Swiss Francs.

At the end of 2008, the SNB’s foreign reserve holdings amounted to just 47.4bn CHF. At the end of 2011, they had already increased to 257.5bn CHF. At the same time, the monetary base rose from 99.1bn CHF to 137.7bn CHF.

Since September 6, 2011, the SNB defends a “minimum rate” of 1.20 Swiss franc per euro,See the SNB’s press release dated 6 September 2011. a policy under which the SNB’S foreign reserves climbed further to 471.4bn CHF in August 2014; the monetary base increased to 373.5bn CHF.

If the SNB is subjected to the 20-percent rule, the SNB could no longer continue with this kind of policy. Why? The Initiative, if put into practice, would presumably make the Swiss franc even more attractive from the viewpoint of international investors.

The Swiss currency would appreciate, especially against the euro. For the European Central Bank (ECB) may very well embark upon money printing on the grandest scale, setting into motion a sizable capital flow from the euro area into Switzerland.

Under the 20-percent rule, the SNB’s policy of buying euros against issuing newly created Swiss francs would no longer be possible: because new Swiss francs can only be issued if they are issued for the purchase of gold.

Would an appreciation of the exchange rate hurt Switzerland economically? The answer is no. The Swiss would have to work and export less for importing the same quantities as before. Companies can slash prices and wages, should they need to ramp up their competitiveness.

If put into practice, the Swiss Gold Initiative increases the chances that the Swiss can protect themselves effectively against the destructive policies which are at work in the international unbacked paper money world.

It seems that the SNB cannot, or does not dare to, deviate from the money printing schemes pursued in all major currency areas. It is only the Swiss people who can bring to a halt a monetary policy that will sooner or later end in a debasement of their currency.

The 20-percent rule might not live up to what a perfectly sound money regime should look like: free market money, free banking, and no central banking. However, if strictly adhered to, the 20-percent rule is by all means a highly promising starting point on a journey to truly sound money.

If the Swiss put the Initiative into practice, the world will realize that there are alternatives to today’s unbacked paper money madness. In that sense, a successful Initiative could be a game changer for the better, for Switzerland and also for many other countries in this world.

The author would like to thank Kristoffer Mousten Hansen, UK, for his support in preparing this article.

My reading of Tamny’s critique of Gordon finds the absence of two key elements of Austrian economics from which Mises was certainly no dissenter – namely, 1) the subjective nature of value and 2) the claim that “there is only one coherent body of economics,” and it, “does not allow of any breaking up into special branches.”

The subjective nature of value is an Austrian tenet that virtually every mainstream principles of economics text pays lip service to in its first chapter, but almost immediately proceeds to jettison on specific topics. This is especially true in the areas of macroeconomics, where aggregates based on national income accounting are devoid of any grounding in the logic of choice based on people’s subjective evaluations of the utility of economic goods hold sway.

Failure of the mainstream to abide by the second key element of Austrian economics has long plagued monetary theory. Indeed, one of the main contributions of Ludwig von Mises to economics — unfortunately little appreciated outside the Austrian school — was to integrate the theory of money with general value theory.

It is precisely these two areas on which Gordon critiques the Forbes and Ames book. While Gordon seems to find much of value in that book — after all, the policies the authors favor would be preferable to those we currently endure — the critiques he does make accurately reflect differences between Austrian and more mainstream views. As far as I can tell, Steve Forbes is a supply-sider rather than an Austrian, so it is hardly shocking that Austrians would find some non-trivial points of disagreement with him.

The biggest violation of the tenet of the subjective nature of value in Tamny’s piece is to try to set up money as a constant measuring rod of objective value. The only way in which an Austrian economist would find the “measuring rod” metaphor valid, and a limited one at that, would be if the dollar were actually defined as gold. In that case, each dollar would be either a certain weight of gold (say, 25.8 grains of gold, nine-tenths fine) or a claim to that weight of gold. When the world was on the classic gold standard, each country’s currency was described in that way, so that each currency unit was a specific weight of gold. In that case, and that case alone, would gold be like a “measuring rod.” Not fiat money, mind you, but gold. However, once the link of redeemability between paper money — and the gold it had been a claim to — is broken, then indeed using gold in the way Forbes and Ames describe is a price control, although enforced by market interventions rather than diktat.

Their system has much in common with the Bretton Woods system, whereas the one Gordon favors is closer to the classical 1815–1914 gold standard. This is far from a meaningless difference. While Bretton Woods’ breakdown was seen as inevitable by many Austrians, most conspicuously Henry Hazlitt in his New York Times editorials (which cost him that job), because of the flaws in the system, the classical gold standard did not break down, but was abandoned because of its virtues. Had the classical gold standard been adhered to, it would have made it much more difficult, if not impossible, to finance the war that made the world safe for Lenin and Hitler.

Tamny quotes Mises in Human Action as saying that, “money is nothing but a medium of personal exchange,” then commits the non sequitur of inferring from this that Mises sees money as a, “measure [my emphasis] that fosters the exchange of actual economic goods.” To the contrary, Mises’s Theory of Money and Credit states in no uncertain terms that money is not and cannot be a constant measuring rod. To wit, when Mises refers to, “the naïve popular belief in the stability of the value of money,” he is debunking that view, not endorsing it.

The most serious point of dispute between the Forbes-Ames view espoused by Tamny and disparaged by Gordon is their proposed policy that the, “Federal Reserve would use its tools, primarily open market operations, to keep the value of the dollar tied to that rate of gold.” It facilitates matters that both Tamny and Gordon appear receptive to using Mises to decide the issue. Mises’s judgment on this matter can be found in Chapter 13 of The Theory of Money and Credit:

The ideal of a money with an exchange value that is not subject to variations due to changes in the ratio between the supply of money and the need for it … demands the intervention of a regulatory authority in the determination of the value of money; and its continued intervention.

While this quote seems to support the Forbes-Ames policy over that of Gordon, Mises makes it crystal clear in the same chapter that their policy will not reach their intended goal, which is one of Gordon’s key claims. As he says:

Once the principle is so much as admitted that the state may and should influence the value of money, even if it were only to guarantee the stability of its value, the danger of mistakes and excesses immediately arises again.

These possibilities … have subordinated the unrealizable ideal of a money with an invariable exchange value to the demand that the state should at least refrain from exerting any sort of influence on the value of money. A metallic money, the augmentation or diminution of the quantity of the metal available for which is independent of deliberate human intervention, is becoming the modern monetary ideal.

This amply demonstrates that it is not David Gordon who disagrees with Mises or believes he knows what the right quantity of money should be. Rather, it is John Tamny whose views are at odds with those of Mises, and Forbes and Ames who are the ones who may not know the right amount of money themselves, but believe that the Fed does, at least if they are guided by the price of gold.

“The world is in permanent monetary crisis,” Murray N. Rothbard once observed, “but once in a while, the crisis flares up acutely, and we noisily shift gears from one flawed monetary system to another.” Monetary systems built on floating fiat currencies are fragile things. Most of the world currently operates under this arrangement.

The only thing worse, in Rothbard’s estimation, was fixed exchange rates based on fiat money and international coordination. Markets are fluid and changing. The government fixed exchange rate is bound to be either too high or too low — with problems in either case. The history of attempting to maintain some fixed exchange rates by international agreement has a long, rich history of failure, once again illustrating that government power is no match for the relentless and merciless forces of the market. All of which does not bode well for China’s ability to maintain its own fixed exchange rate against the dollar.

Our own dollar has led the life of a tempestuous teenager, seemingly unable to stay within the bounds of the rules laid down for it by the powers that be. The Bretton Woods Agreement lasted from 1944 to 1971 and was a form of a fixed exchange rate system based on international coordination. The dollar was defined as 1/35 ounce of gold; all other currencies were fixed in terms of the dollar. Importantly, the dollar was only redeemable in gold for foreign governments.

As expected, the US government inflated the currency, as governments are prone to do. Dollars grew rapidly; the supply of gold did not. Inevitably, as foreign governments began to turn in their dollars for gold, Uncle Sam found out that his gold stash was getting light. Naturally, he had to break the agreement. So, Nixon closed the gold window in 1971. In its place came the Smithsonian Agreement, which called for an 8 percent devaluation of the dollar, among other things. But that could not stop the push of market forces, which like the swollen Potomac River in the days before Hurricane Isabel, simply ignored whatever man put in its way. In February 1973, the dollar was devalued again. By March, the Smithsonian Agreement was no more. Ever since, the dollar has been a fluctuating fiat currency with no ties to gold.

Europe, too, has been unable to build a durable system based on fiat currency. The European Economic Community established one of the better-known pegged rate exchange systems in April 1972. EEC members decided that their currencies were to be maintained within established limits of each other. This arrangement became colorfully known as “the snake.” Market pressures also busted the snake, as governments were unable to keep their currencies within these bands.

The next step was the European Monetary System, in March 1979. Here currencies were held together by the European Currency Unit (ECU), a unit of account based on a weighted average of the exchange rates of member countries. That went bust in the fall of 1992, after experiencing severe problems, and despite the attempts of numerous European Central Banks to maintain it by intervening directly in the foreign exchange markets. Again, government dictates held up like straw houses in gale force winds — which is to say, they didn’t.

The latest system created the euro, which began in 1999. The euro is relatively young even by monetary standards. There are not yet actuarial tables accurately devised for the life expectancy of paper money, but, theory and history agree that it’s something less than permanent.

Pegged rate systems are great for fueling crises, like oily combustibles lying around in a garage; a small flame can start a great fire and take down a house. Another instructive case is the peso meltdown in 1994–95, or the so-called Tequila Crisis.

Before the crisis, Mexico linked the peso to the dollar, but allowed a band within which it could float. The Mexican government would frequently have to intervene in the market to enforce this band. Mexico experienced a large trade deficit in 1994, perhaps indicating that the pegged peso was stronger than a peso would have been without government intervention. Money supply growth was brisk in the years preceding the crisis, and 20 percent or more per annum throughout most of 1994.

As always seems to happen in these types of systems, the Mexican government could not control the growing supply of pesos, nor could it bolster the weakening demand for pesos — while at the same time trying to maintain the peso’s value in terms of the dollar.

In December, the endgame began for this arrangement. Mexico’s central bank finally devalued the peso by 13 percent on December 20. By the end of December, the peso floated freely and fell another 15 percent. In the four-month period beginning on December 20th, the peso lost 50 percent of its value.

Who can forget the Asian Crisis of 1997? Originating in Thailand, it spread throughout Southeast Asia — the Malaysian ringgit, Singapore dollar, Philippine peso, Taiwan dollar, and Indonesian rupiah all declined. The Asian Crisis sent ripples across financial markets all over the world.

Prior to the Asian Crisis, Thailand had a pegged exchange rate tied to the dollar. Again, the Thai baht became weaker in the marketplace and investors exchanged the baht for dollars. The Thai central bank spent more than $20 billion trying to maintain its pegged rate but ultimately had to lift it. Quite simply, the supply of baht exceeded the market’s demand for it and the government’s intervention only delayed and exacerbated the crisis. Over a five-week period, the Thai baht lost more than 20 percent against the dollar. Other Southeast Asian countries also had to surrender their fixed exchange rates.

This brings us, in a roundabout way, to the current feud surrounding the yuan and dollar. As we have blazed through a selective short history of currency blow-ups, it should be clear that maintaining a peg not in harmony with market forces is a recipe for a costly disaster.

For ten years, the Chinese have maintained a fixed exchange rate of about 8.28 yuan to the dollar. As has been well documented, the US has been a great importer of Chinese goods. We take their merchandise and they take our dollars.

According to James Grant, “the dollars pile up on the balance sheet of the People’s Republic of China at the rate of $10 billion per month.” Such trends are unsustainable. At some point, the Chinese are going to have to stop acquiring dollars at the fixed rate. The yuan, it seems, is too cheap at that rate and the Chinese money supply is booming. People are eagerly swapping their dollars for yuan.

Meanwhile, money and credit are booming in China. As Grant writes, “It is therefore no accident that the Shanghai real estate market is on fire, that Chinese loan growth is burgeoning or that frightened Chinese monetary authorities have been unable to keep the lid on Chinese money-supply growth. By making the yuan too cheap, they have also, necessarily, made it too plentiful.”

The resulting artificial boom in China is no good for the Chinese. A bust follows every such boom. If allowed to float, the yuan would presumably get stronger, and some of the money flows would slow or even reverse. It may be too late for China, whose government seems just as intent on destroying their currency as American officials seem bent on destroying the dollar — whether knowingly or not.

Count the yuan dollar fiasco as just another chapter in the long saga of man’s futile struggle to master paper money. The unattainable dream is to be able to produce as much of it as possible at near zero cost and yet also have it maintain its purchasing power in the real world of things.

Murray Rothbard wrote “Governments don’t know, and don’t want to know, that the only successful fixing of exchange rates occurred, not coincidentally, in the era of the gold standard.” The reason is easy enough to understand. It worked because monetary units, like the dollar, were fixed in terms of their weight in gold. Gold has to be extracted, manufactured within the market, and cannot be created out of thin air.

But government planners don’t like gold. It ties their hands. They can’t spend so freely because they know they have to redeem their monetary issues in gold. It checks their inflating ways.

It’s easy to be depressed when you look around and see the state of monetary affairs. But, as Rothbard noted, and as the short historical vignettes above show, we have one great force in our favor. As Rothbard cheerfully noted, “Free markets, not only [in] the long run but often in the short run, will triumph over government power.” The inability of governments to maintain fixed exchange rates in the face of opposing market forces is only further proof of their impotency.

David Morgan: Could you give us your personal assessment on the current economic landscape?

Mark Thornton: Well, I guess we’re at the point in history that I always thought was going to occur. Ever since I was a young man, very young man, I realized through study that going off the gold standard was a big mistake. That was really my first interest in economics and it just expanded outward from there and I found the Austrian School and got involved with the Mises Institute and went on and got my graduate degree.

I have been studying this issue ever since. The only thing that has really surprised me about this is that it has taken so long to get to this place in time and by this place, I mean a world in which fiat money is the sole circulating means of exchange and where central banks are engaged in a world currency war, trying to manipulate the value of their currencies downward in a simultaneous battle across the globe. But in particular the United States, the European Central Bank, Japan, and China and then of course many other countries engaged in the war in a defensive status where countries like Switzerland and Norway are pumping up their money supplies and engaged in quantitative easing in order to stabilize the exchange value of their currency.

So here in the United States, the ramifications of that are fairly easy to see that the Federal Reserve has manipulated markets to an extreme and to a level that I never thought they were going to be willing to go to. But they’ve manipulated stock markets and bond markets have created bubbles throughout the economy in the US in terms of, of course, the stock market reaching all-time high levels, bond markets reaching all-time high levels, junk bond yields down to historically low levels, rising real estate prices, rising art prices.

It’s truly remarkable to the extent that they’ve been able to engineer this. They’ve taken so many unprecedented measures. I really never thought that central bankers would go to this extreme but they’ve done it. So right now, what we’re looking at is a worldwide currency war. We’re looking at real estate housing bubbles all around the planet, whether it’s Canada, in Asia, in Manhattan, in Washington DC.

There are these housing bubbles and real estate bubbles rising to the extreme. Then one of the things that I like to follow as an indicator is the Skyscraper Index. The Skyscraper Curse is the eerie correlation of the building of record setting skyscrapers and world economic crises.

Basically going around the planet, we see all sorts of huge skyscrapers being built and even more recently, China and Saudi Arabia have announced plans to build worldwide record-setting skyscrapers. So that’s the way I view it, that we’re in unprecedented territory at this point and time in terms of markets.

DM: The way I see it, all debts are either paid, defaulted upon, or partially paid off. But at some point in time, there is a reconciliation of the monetary system.

You’re either going to default outright saying that we cannot pay back the debt or you’re going to default on a currency, which means that you’re going to continue to print money until the currency becomes worth less, worth less, and then it’s worthless.

Can we default outright? Can we default via currency default, or do we have a combination? What are your thoughts?

MT: Well, David, it’s a very good question and it’s a very, very important question. As you say, all debts are ultimately paid. The question is, “By whom?” Is it going to be the borrower or is it going to be some other party that ends up footing the bill for those debts?

The governments of the world have built up huge national debts and obligations going forward that are unsustainable and that in my view cannot be paid off in a rational way which is using part of your revenues to pay off or pay down those debts.

Right now, we’re living in a world where governments are able to borrow money very inexpensively at low interest rates. But if and when interest rates were to rise primarily through an inflation premium, the interest burden of those debts would be very difficult and put enormous pressures both on the treasury as well as the economy itself. Both would be burdened of those higher interest rates.

So the question becomes, as you suggest, “Are you going to try to pay off those debts in a rational way or are you going to use, resort to inflation in the printing press to pay off those debts?”

The problem with fiat money is that it always leads policy makers and politicians to the second answer which is using the printing press to pay it off because that’s more politically acceptable in the short run. But in the long run of course, it eventually causes the economy and the government to fall into a vortex where they’re required to print up ever increasing quantities of money to keep that system going.

So generally speaking, of course it’s better not to go into debt unless you’re buying productive assets that are going to be able to pay off those debts. The government is clearly not doing that. The second best alternative is to either pay off or default outright on those debts. This is something that governments and central banks are also loath to do, although that imposes the least economic burden on society across the board.

So the more likely, the most likely alternative and one that looks increasingly obvious to me is that they will continue to use the printing press. They can pull back at anytime but the pain, the political pain and the economic pain in the short run is so difficult for them to accept, that it’s likely that they’re going to go down the path of printing up ever-increasing quantities of money, engaging in quantitative easing and so forth.

The people that they brought in to engineer this process are PhD economists, and PhD economists are some of the most dangerous people in the world in terms of economic policy. Right now we have a world in which many of the financial and even some of the political institutions are controlled by PhD economists, mainstream economics, Keynesian economists, many of them MIT economists.

We shouldn’t forget for example that Mario Draghi who is in charge of the European Central Bank was officemates with Ben Bernanke at MIT when they were in graduate school. So they’re out of the same exact mindset where the professional economist can engineer an economy, can manipulate policy in such a way, in the same way a child plays with a toy.

In my estimation, it’s a very dangerous situation. I don’t think the world has ever been in a more dangerous economic situation than it is today.

We just had some photographs taken of our summer research fellows who are graduate students from around the world who come here for the summer to study.

We were doing this photo shoot and one of my bosses came in and said, “OK. Which one of these geniuses is going to be the next billionaire?” I thought to myself, “All of these people could be billionaires in the very short run, just as soon as hyperinflation is ignited in the economy.”

It’s a very short path to where the standard of wealth has jumped from being a millionaire to a multi-millionaire, now to a billionaire, multi-billionaire. But when the hyperinflation, when that process is sped up tremendously, and then you will be looking at people who are trillionaires and multi-trillionaires because the value of the currency can very rapidly deflate when faced with the enormous increase in the money supply which has so far been pent up on the balance sheets of central banks, on the balance sheets of treasuries, and on the balance sheets of the large money central banks.

So it’s not directly flowing to consumers and so if consumers don’t have the money, it doesn’t show up in the consumer price index. But it has shown up in terms of stock market values and bond values because all that money has been funneled in that direction.

But money doesn’t stay put forever and any safe outcome would rely on the completely unfeasible idea that somehow central banks are going to be able to wiggle their way out of this process.

DM: I get a call for a consultation and Mr. X says, “I had a big real estate portfolio and now it has declined 30 percent. I can’t borrow against it even anymore, even though I have great equity still. You advocate precious metals as a protection, David. They really haven’t done much the last three years. I have good liquidity. I have good cash flow. What do I do now? I don’t know if we’re having the inflationary blow-off or if we’re actually going into a deflation as Robert Prechter states.” What do you say?

MT: Well, of course the inflation-deflation debate is very important and it has been muddled by mainstream economists. The traditional notion of inflation was that inflation was the government increasing the money supply and deflation was a decrease in the money supply.

Mainstream economists have flipped that on its head so that inflation is a rise in general prices and deflation is a decrease in general prices. So, the traditional version was cause and effect where it focused in on the cause which was government increasing the money supply rather than the effect, which is an overall increase in prices.

So with that muddled definition, we entered this era of central bank manipulation to an extreme and therefore you’ve gotten this somewhat confused debate about inflation and deflation.

The way I view it is that in a policy sense, the government is going to continue to engage in a monetary inflation, but one of the deflation scenarios that I see is a deflation in asset prices because the economy is always trying to work to correct the errors that occur because of the central bank’s manipulation of interest rates and central banks have been manipulating interest rates downward. This has caused entrepreneurs to make investments in capital goods, in companies. That’s what has pushed the prices up and that’s what has pushed prices up in particular industries.

So there are a lot of hot industries, the internet stocks, although they’ve come down; the social media stocks, although they’ve been hit a little bit. It has forced things like gold stock prices down until very recently.

So the way I look at it is we’re going to see a continuation of monetary inflation by central banks that will ultimately be confronted by an asset price deflation, caused by markets, realizing that there has been so many investment errors in the economy and miscalculations as to the value of companies.

So you can have those things occurring simultaneously or contemporaneously because there are really two different phenomena. One is the central banks trying to manipulate the economy with more money and artificially low interest rates and the other is the economy trying to correct the errors that the central bank is creating and that would see lower stock prices, lower bond prices, and even lower real estate prices and lower land prices.

So it’s just a battle between those two forces of central banks versus economic reality.

DM: In theory, the US dollar could be saved. What do you think of a chance of some major reform in the near future on the US dollar?

MT: Well, it doesn’t look like there’s much chance. But there has been a small ideological revolution that has taken place over the last several years and that’s the key to it. Don’t expect any policy reforms to come out of Washington DC, or Tokyo, or Brussels.

The reform is not going to come from there. It’s going to come from the hearts and the minds of people across the country and I think that to a large extent, Americans are now disillusioned with their political system that the Fed in particular is seen as arrogant and more as the cause than the solution.

Historically, the Fed has always been able to paint themselves as the solution to our problems rather than the cause of our problems. I think the percentage of people who view the Fed as the cause of our problems has risen, continues to rise, and will likely continue to rise even further.

I see more and more people both around me and around the country and around the world trying to put themselves as much as possible on their own personal gold standards, so that they’re transferring their wealth from US dollar denominated assets into either productive assets or into precious metals.

So if you transfer your cash wealth from dollar denominated deposits in banks to gold denominated accounts or physical gold, paper gold, then you’re moving yourself personally to the gold standard. So it’s impossible to predict how and when there will be a return to the gold standard. But I think that the probabilities are actually much higher than most people would predict or admit.

There has always been this long train of beliefs that the US dollar is as good as gold, that the dollar is the world reserve currency, that the dollar is the international trade currency and things like that. That the central bank of the United States is the most powerful institution and there are a lot of cracks in the Fed’s edifice and the dollar’s invincibility and you see that in the actions of other central banks, and you see that in the actions of Americans and Chinese people and Indian people and people around the globe.

They’re saying there’s a possibility which seems to be increasing that these central banks are going to be willing to depreciate the value of currencies by a significant amount, and that they don’t show any tendency over the last several years to either admit their mistakes or to let up on the pedal of monetary inflation and quantitative easing.

So I think that the probability of a return to the gold standard is relatively high but it’s only going to be the result of two things happening. One, the Fed continues to cause economic destruction of our wealth and two, is the ideological change where more and more people accept the Austrian position on economic policy and they don’t have to necessarily understand all of the details. They just need to accept the ideas that private property is the foundation of a strong economy, that free markets are the way to allocate resources and to produce the greatest consumer satisfaction and standard of living and that that is possible only under a system of sound money, which means basically gold and silver coins.

Here at the Mises Institute we are planning the Mises University, where we bring in 150 college students. Then of course we broadcast it to tons of other people on the internet.

We show them step by step the science, the economic science behind these propositions, most of these kids are not going to go out and necessarily become professional economists or teach economics at the university.

But once you go through the process of seeing the implications of free markets and seeing how free-market prices emerge and how entrepreneurs’ savings cause economic growth, how sound money produces a stable economy, providing another foundation for economic growth and prosperity, once you see the science behind all that, you don’t necessarily have to remember it all.

What you remember is the judgment that Austrian economics entails and therefore you accept the Austrian position with respect to how economic policy should be established. So I think that’s the way that things are ultimately going to turn out. When I started down this journey, there was nobody really who believed or taught Austrian economics.

Fast forward about 35 years and Austrian economics is being taught at universities around the world. Here in the United States, many, many young people, young adults, teenagers, college students, and college graduates consider themselves libertarian whereas 35 years ago, nobody knew what a libertarian was or had ever heard of the term.

Now Austrian economics is a very, very popular topic among these young people. While it’s not necessarily a majority of these young people, it is the case that the people who have already studied this and have accepted this and are advocates for Austrian economics, they are really the leaders of the future. These are the people who are going to take on leadership positions in society whether that’s in business, finance, whether they’re entrepreneurs or educators or media, journalists, so on and so forth.

So in the long run, I think you’ve got to be incredibly optimistic about where we’re heading today. It’s just that that road is fraught with a lot of dangers at the same time, economic dangers.

DM: I want your take on why gold has had a significant premium over silver especially in the last hundred years.

This follow-up question is, “Any thoughts on why Asia is accumulating gold at a rate that has really leaving silver as a secondary role, knowing that China was the last to come off the silver standard?”

MT: Well, David, that is a great question and all of the interviews I’ve done, that is the most under-asked question of them all. I think it’s really one of the most important questions in terms of a general outlook of where things are and where they’re likely to go.

I love silver. I think silver is the natural money for the last millennium and likely to go forward for the next millennium. Historically if you go back further in time, you have copper being a prominent medium of exchange, silver being a prominent medium of exchange.

But gold really wasn’t a commonly used medium of exchange throughout most of history. Generally speaking, Austrians recommend it — they talk about the gold standard but what they’re really talking about is a gold-silver-copper standard where there’s no fixed ratios of prices between one and the other.

They all would float independently and exist in markets that they were most well-suited for and so as we move into a gold reform era, where we go back to the gold standard, I think what you’re seeing right now is that people are reacting to fiat currency by investing heavily in gold because it’s the easiest commodity money to store.

The storage cost of gold, the transport cost of gold are very, very low and so you can transmit and store a huge value in terms of gold so that if you were to use gold to buy a house or buy a car, it’s very easy to transport that and also to store that, whereas if you were to try to buy a house in silver, it would be much more difficult.

On the other hand, it’s easy to make transactions in terms of silver and copper coins because of their relatively lesser value compared to gold. So I think that the type of money that would exist in hand to hand transactions would be very little in terms of gold but much more in terms of silver and copper.

So if we were to return to a commodity coin standard, I think you would see the ratio of gold to silver values return to their historical norms.

Now the only thing that would act against that is of course how we can store our gold and silver and we could theoretically store our gold and silver in bank accounts, and draw on those bank accounts in terms of checks and in terms of debit cards and so forth.

There wouldn’t be as much of a demand necessarily for silver. But I think as we do reform the monetary system, that there would be an increase in the demand for silver relative to the increase in the demand for gold.

Another reason why gold has done so well relative to silver is that the Chinese population, in particular the Indian population — of course it’s also the Thai population — have historically been more favorable toward gold and holding gold in the form of jewelry, in ornaments. They built up their wealth by acquiring gold ornaments, jewelry, etc., rather than silver.

So there’s a higher cultural demand in those areas for gold relative to silver. So there’s a cultural effect there and of course that has been compounded by the fact that the increase in relative income in China and India has been enormous in Asia, relative to the real decline in income in the US and other Western economies.

So there have been definite reasons why gold is outpaced in almost a very abnormal way. The price increase of silver, because of those factors like storage cost, transport cost — it’s also because the demand has come from countries that have historically had higher demand for gold, and their incomes are rising.

DM: Very good. I’m not going to try to lead you on this, although I might sound that way. But what I want to get a further comment on is gold really is mainstream. I mean even though Wall Street pooh-poohs it and you don’t hear it on the mainstream financial channels, etc., look, central banks still have a gold balance sheet. The Bank for International Settlements used to only settle only in gold. They quit doing it sometime ago.

So really gold is pretty much an establishment metal relative to silver. There are no central bank hordes of silver anywhere. No one in the establishment considers silver as money. So do you think that has something to do with the silver to gold ratio as well?

MT: Oh, yeah, there’s no doubt. I mean when you go from a world where people are actually exchanging gold and silver coins to where the commodity money is all horded by central banks, they’re certainly going to the central banks that left a gold standard rather than a gold and silver standard. So the central banks are the largest holders of commodity money and that’s gold. So that certainly plays into it because you have a world that went off a gold standard where central banks were the largest holder of gold. But when they disgorge themselves of that gold, that puts tremendous downward pressure on gold prices as well, so the relative value of gold versus silver would also adjust back toward historical norms.

DM: What are your thoughts on the US dollar as a reserve currency of the world going forward?

MT: I’ve written about this on mises.org as well. Barry Eichengreen came out with a book that tried to address this whole question of the dollar as the world’s reserve currency.

He basically came to the conclusion that the world had no choice. There were no competitors for the US dollar as world reserve currencies. I openly challenge that whole idea that there were no alternatives and therefore everybody would be stuck with the US dollar. I think events before that book came out and then after that book came out indicate that Barry was wrong and that there are potential and existing alternatives for central bank reserves. That would include of course gold and silver, and central banks have been purchasing gold.

It also would include other currencies and so the other currencies of the world, the British pound, the euro, the Japanese yen, and the Chinese renminbi are all potentially world reserve currencies, and of course China is actively trying to achieve that. They’re using more gold in their central banks. India is using more gold.

So a lot of central banks have already turned toward gold in other currencies, but there’s a lot of uncertainty for them. So the dollar hasn’t been completely removed. It has only been partially removed but it’s no longer the case that the dollar makes up 90 percent of the central bank’s balance sheets.

The figure is much less than that today and declining. So I think the status, the monopoly status of the US dollar as a reserve currency has already been broken and I see that trend continuing.

When money is conceived as a measure of value, the policy implication is that one of the primary objectives of the central bank should be to maintain a stable price level. This supposedly will remove inflationary noise from the economy and ensure that any changes in money prices that do occur tend to reflect a change in the relative values of goods and services to consumers. Thus, for mainstream economists, stabilizing a price index based on a basket of arbitrarily selected and weighted consumer goods, e.g., the CPI, the core CPI, the Personal Consumption Expenditure (CPE), etc., is a prerequisite for rendering money a more or less fixed yardstick for measuring value.

This idea — that a series of acts involving interpersonal exchange of certain sums of money for quantities of various goods by diverse agents over a given period of time somehow yields a measure of value — is another ancient fallacy that can be traced back to John Law. Law repeatedly referred to money as “the measure by which goods are valued.” This fallacy has been refuted elsewhere and rests on the assumption that the act of measurement involves the comparison of one thing to another thing that has an objective existence, and whose relevant physical dimensions and causal relationships with other physical phenomena are absolutely fixed and invariant to the passage of time, like a yardstick or a column of mercury.

In fact, the value an individual attaches to a given sum of money or to any kind of good is based on a subjective judgment and is without physical dimensions. As such the value of money varies from moment to moment and between different individuals. The price paid for a good in a concrete act of exchange does not measure the good’s value; rather it expresses the fact that the buyer and the seller value the money and the price paid in inverse order. For this reason neither money nor any other good can ever serve as a measure of value.

Unfortunately, advocates of a gold-price target wholeheartedly embrace this mainstream doctrine while giving it an odd twist. They begin with the wholly unsupported assumption that one commodity, gold, is stable in value and that, therefore it can serve as the lone guiding star — or “The Monetary Polaris” as Nathan Lewis terms it — for Fed monetary policy. According to Steve Forbes, writing in the introduction to Lewis’s Gold: The Monetary Polaris, real gold standards have one thing in common: “They use gold as a measuring rod to keep the value of money stable. Why? Because the yellow metal keeps its intrinsic value better than anything on the planet.”

Louis Woodhill, in a Forbes column, writes in a similar vein, explaining that “[t]he fundamental validity of the gold standard rests upon the premise that the real value of gold remains constant over time. ... The most fundamental thing about a unit of measure is that it be constant. ... Gold is not money, and it should not be money. However we can and should use gold to define the value of the dollar.” These passages reflect an almost mystical belief that the “intrinsic” or “real” value of gold is, for all practical purposes, eternally unchanging, unaffected by the continual flux of human valuations, stocks of resources (including gold itself ), technology, and entrepreneurial judgments that define the essence of the dynamic market economy. Furthermore no definition is ever given of what exactly the concept of “intrinsic value” means or in what units it is expressed.

Historical experience clearly shows that the value of gold vis-à-vis other commodities has fluctuated over the centuries, even when gold has served as the monetary standard. This was certainly the case, for example, when the US returned to the gold standard after the Civil War. From 1880 to 1896, US wholesale prices fell by about 30 percent. From 1897 to 1914 wholesale prices rose by about 2.5 percent per year or by nearly 50 percent. This rise came about mainly as the result of a nearly doubling of the global stock of gold between 1890 and 1914 due to discoveries of new gold deposits in Alaska, Colorado, and South Africa, and improvements in the technology of mining and refining gold.

Proponents of gold-price targeting thus seem to ignore both theory and history in assuming that once the dollar price of gold has been fixed, the value of money itself becomes forever stable and immune to the influence of market forces of supply and demand. Inflation and deflation are, therefore, ipso facto banished from the economy. This implies that any changes occurring in the quantity of money under a fixed-gold price regime are to be construed as benign and stabilizing adjustments of the supply of money to changes in the demand for money. Steve Forbes writes: “The fact that a foot has 12 inches doesn’t restrict the number of square feet you have in a house. The fact that a pound has 16 ounces doesn’t restrict your weight, alas — it’s a simple measurement. ... The virtue of a properly constructed gold standard is that it’s both stable and flexible—stable in value and flexible in meeting the marketplace’s natural need for money. If an economy is growing rapidly such a gold-based system would allow for rapid expansion of the money supply.”

In other words Forbes’s “stable and flexible” gold standard would facilitate and camouflage an inflationary expansion of the money supply that would, according to Austrians, distort capital markets and lead to asset bubbles. The motto of our current gold-price fixers seems to be: “We want sound money — and plenty of it.”

Most, if not all, booms and busts originate with excess credit creation from the financial sector. These respondents, incorrectly, assume that this financial system structured on fractural reserve banking is an integral part of capitalism. It isn’t. It is fraud and a violation of property rights, and should be treated as such.

In the past, we had deposit banks and loan banks. If you put your money in a deposit bank, the money was there to pay your rent and food expenses. It was safe. Loan banking was risky. You provided money to a loan bank knowing funds would be tied up for a period of time and that you were taking a risk of never seeing this money again. For this, you received interest to compensate for the risk taken and the value of time preference. Back then, bankers who took a deposit and turned it into a loan took the risk of shortly hanging from the town’s large oak tree.

During the early part of the nineteenth century, the deposit function and loan function were merged into a new entity called a commercial bank. Of course, very quickly these new commercial banks realized they could dip into deposits, essentially committing fraud, as a source of funding for loans. Governments soon realized that such fraudulent activity was a great way to finance government expenditures, and passed laws making this fraud legal. A key interpretation of law in the United Kingdom, Foley v. Hill, set precedence in the financial world for banking laws to follow:

Foley v. Hill and Others, 1848:

Money, when paid into a bank, ceases altogether to be the money of the principal; it is then the money of the banker, who is bound to an equivalent by paying a similar sum to that deposited with him when he is asked for it. ... The money placed in the custody of a banker is, to all intents and purposes, the money of the banker, to do with it as he pleases; he is guilty of no breach of trust in employing it; he is not answerable to the principal if he puts it into jeopardy, if he engages in a hazardous speculation; he is not bound to keep it or deal with it as the property of his principal; but he is, of course, answerable for the amount, because he has contracted, having received that money, to repay to the principal, when demanded, a sum equivalent to that paid into his hands.Quoted in Murray Rothbard’s, The Mystery of Banking (Auburn, AL: Mises Institute, 2008), p. 92.

In other words, when you put your money in a bank it is no longer your money. The bank can do anything it wants with it. It can go to the casino and play roulette. It is not fraud legally, and the only requirement for the bank is to run a Ponzi scheme, giving you the money deposited by someone else if they lost your money and you happen to come back asking for your money. This legalization of fraud is essentially one of the main reasons no one went to jail after the debacle of 2008.

The primary cause of the financial panics during the nineteenth century was this fraudulent nature of fractional reserve banking. It allowed banks to create excessive credit growth which led to boom and bust cycles. If credit, instead, grew as fast as slow moving savings, booms and bust cycles would be a thing of the past.

Critics of the gold standard, (namely, Krugman, et al.), usually point to these cycles as proof that it failed as a monetary system. They are confusing causation with association. The gold standard did not cause these financial panics. The real cause was fractional reserve banking that was grafted onto the gold standard. The gold standard, on the contrary, actually greatly limited the severity of these crises, by limiting the size of the money multiplier.

This is why in the early days of banking in the US, some wildcat bankers would establish themselves in the most inaccessible locations. This was to ensure that few would actually come and convert claims for gold into actual gold since banks had created claims that far exceeded the actual gold in their vaults. And, if by chance a depositor tried to convert his claims into gold, they would be treated as thieves, as though they were stealing the bank’s property by asking for their gold back.

The Federal Reserve System was created following the panics of 1903 and 1907 to counterbalance the negative impact of fractional reserve banking. One hundred years after its creation, the Fed can only be given a failing grade. Money is no longer a store of value, and the world has experienced two of its worst financial crises. Instead of a counterbalance, the central bank has fed and expanded the size of the beast. This was to be expected.

That global poll on capitalism also found that almost half (48 percent) of respondents felt that the problems of capitalism could be resolved with added regulations and reform. Janet Yellen also holds this view, and that regulation, not interest rates, should be the main tool to avoid another costly boom and bust in global finance. This is extremely naïve. We already have more compliance officers in banks than loan officers. Recent banking legislation, Dodd-Frank, and the Vickers and Liikanen reports will probably make the situation even worse. Banks will always be able to use new technologies and new financial instruments to stay one step ahead of the regulators. We continue to put bandages on a system that is rotten to the core. Banking in its current form is not capitalism. It is fraud and crony capitalism, kept afloat by ever-more desperate government interventions. It should be dismantled. Under a system of 100 percent reserves, loan banks (100 percent equity-financed investment trusts) would be like any other business and would not need any more regulation than that of the makers of potato chips.

When money is conceived as a measure of value, the policy implication is that one of the primary objectives of the central bank should be to maintain a stable price level. This supposedly will remove inflationary noise from the economy and ensure that any changes in money prices that do occur tend to reflect a change in the  relative values of goods and services to consumers. Thus, for mainstream economists, stabilizing a price index based on a basket of arbitrarily selected and weighted consumer goods, e.g., the CPI, the core CPI, the Personal Consumption Expenditure (CPE), etc., is a prerequisite for rendering money a more or less fixed yardstick for measuring value.

This idea — that a series of acts involving interpersonal exchange of certain sums of money for quantities of various goods by diverse agents over a given period of time somehow yields a measure of value — is another ancient fallacy that can be traced back to John Law. Law repeatedly referred to money as “the measure by which goods are valued.” This fallacy has been refuted elsewhere and rests on the assumption that the act of measurement involves the comparison of one thing to another thing that has an objective existence, and whose relevant physical dimensions and causal relationships with other physical phenomena are absolutely fixed and invariant to the passage of time, like a yardstick or a column of mercury.

In fact, the value an individual attaches to a given sum of money or to any kind of good is based on a subjective judgment and is without physical dimensions. As such the value of money varies from moment to moment and between different individuals. The price paid for a good in a concrete act of exchange does not measure the good’s value; rather it expresses the fact that the buyer and the seller value the money and the price paid in inverse order. For this reason neither money nor any other good can ever serve as a measure of value.

Unfortunately, advocates of a gold-price target wholeheartedly embrace this mainstream doctrine while giving it an odd twist. They begin with the wholly unsupported assumption that one commodity, gold, is stable in value and that, therefore it can serve as the lone guiding star — or “The Monetary Polaris” as Nathan Lewis terms it — for Fed monetary policy. According to Steve Forbes, writing in the introduction to Lewis’s Gold: The Monetary Polaris, real gold standards have one thing in common: “They use gold as a measuring rod to keep the value of money stable. Why? Because the yellow metal keeps its intrinsic value better than anything on the planet.”

Louis Woodhill, in a Forbes column, writes in a similar vein, explaining that “[t]he fundamental validity of the gold standard rests upon the premise that the real value of gold remains constant over time. ... The most fundamental thing about a unit of measure is that it be constant. ... Gold is not money, and it should not be money. However we can and should use gold to define the value of the dollar.”

These passages reflect an almost mystical belief that the “intrinsic” or “real” value of gold is, for all practical purposes, eternally unchanging, unaffected by the continual flux of human valuations, stocks of resources (including gold itself ), technology, and entrepreneurial judgments that define the essence of the dynamic market economy. Furthermore no definition is ever given of what exactly the concept of “intrinsic value” means or in what units it is expressed.

Historical experience clearly shows that the value of gold vis-à-vis other commodities has fluctuated over the centuries, even when gold has served as the monetary standard. This was certainly the case, for example, when the US returned to the gold standard after the Civil War. From 1880 to 1896, US wholesale prices fell by about 30 percent. From 1897 to 1914 wholesale prices rose by about 2.5 percent per year or by nearly 50 percent. This rise came about mainly as the result of a nearly doubling of the global stock of gold between 1890 and 1914 due to discoveries of new gold deposits in Alaska, Colorado, and South Africa, and improvements in the technology of mining and refining gold.

Proponents of gold-price targeting thus seem to ignore both theory and history in assuming that once the dollar price of gold has been fixed, the value of money itself becomes forever stable and immune to the influence of market forces of supply and demand. Inflation and deflation are, therefore, ipso facto banished from the economy. This implies that any changes occurring in the quantity of money under a fixed-gold price regime are to be construed as benign and stabilizing adjustments of the supply of money to changes in the demand for money. Steve Forbes writes: “The fact that a foot has 12 inches doesn’t restrict the number of square feet you have in a house. The fact that a pound has 16 ounces doesn’t restrict your weight, alas — it’s a simple measurement. ... The virtue of a properly constructed gold standard is that it’s both stable and flexible — stable in value and flexible in meeting the marketplace’s natural need for money. If an economy is growing rapidly such a gold-based system would allow for rapid expansion of the money supply.”

In other words Forbes’s “stable and flexible” gold standard would facilitate and camouflage an inflationary expansion of the money supply that would, according to Austrians, distort capital markets and lead to asset bubbles. The motto of our current gold-price fixers seems to be: “We want sound money — and plenty of it.”

Throughout much of modern history, gold served as the commodity that most widely facilitated free exchange. While its virtues as a medium-of-exchange were clear to people of previous eras, gold has fallen out of favor, both in its use as money and in the esteem in which it was once held among academics. It used to be the case that gold, the gold standard, and the various other iterations it took over its many years of employment saturated the study of money and economics, but now it is often difficult even to find substantive references to it in modern textbooks. Just what is the prevailing understanding today on the subject of the gold standard? The world is now a generation removed from any semblance of a gold standard and well over a century from its heyday. With little or no practical experience with it, almost all dialogue about it exists now in the fringes of the academic community. The minimal emphasis that mainstream economists place on a gold standard is reflected in the scant attention placed on it in modern principles of economics and monetary textbooks.

It seems odd that economists would find the idea of falling prices to be a bad thing. Likewise, it is peculiar that policymakers would fear deflation and be willing to take drastic measures to insure the so-called “defeat” of deflation. Policymakers and politicians, after all, would supposedly want the general public—their constituency—to experience the beneficial effects of falling prices over time. Lower prices create a gain of utility or satisfaction for consumers, who can either purchase more of a good or use the money saved to buy larger quantities of other goods. Deflation thus has the same effect as an increase in income.

This three-volume collection, edited by William Rees-Mogg and published in 2002 by Pickering and Chatto presents, in more than 949 pages, essays and excerpts from books written by 19 of the most remarkable monetary theorists from the sixteenth century to the present. Sir Rees-Mogg’s selection begins with Malynes’s “Treatise of the Canker of England’s Commonwealth,” includes works by most of the English classical liberals as well as by George Goschen, Stanley Jevons, Carl Menger, Ludwig von Mises, and Murray Rothbard among others, and closes the Case for Gold with an interview, dated 1965, with the French economist Jacques Rueff. Contrary to the belief inspired by the title, only two of the texts, both written by twentieth-century authors, deal exclusively with the question why gold, rather than paper, should be the money of a free society aiming at peaceful progress. The temptation is huge, therefore, to acquire only the third volume, the texts being arranged chronologically. However, this would be a great mistake, because earlier economists do provide valuable arguments for commodity money, and much more. We will try to systemize the gist of these arguments and to present some inconsistencies in the classical-liberal thought, which may be used in support of paper money.

Most economists will say a little inflation is a good thing. If an entrepreneur makes a mistake and produces something at a cost above selling price, an increase in all prices may make his bad decision profitable. He will be able to sell his costly inventories. In other words, a little inflation is good for some economists because it allows entrepreneurs who made bad decisions, today and probably tomorrow, to see another day. It is surprising to see free-market economists support such logic, however. Capitalism is a system of profits and losses where entrepreneurs who survive are those best able to meet society’s needs. Losses are actually more important than profits since they prune out those who do not serve consumers as well, allowing resources to be channeled to where they are most needed. The movement of prices relative to each other in an economy can doom some business owners, but relative prices, and not aggregate prices, are a key to understanding the economy.

A simple example will make this clear. Suppose we have a very uncomplicated economy with only two products, apples and oranges. We assume a very short run so there are no output effects. We start with 10 apples and 10 oranges and $20. Suppose that the intersection of supply and demand for oranges determines a price of $1.20. This will simultaneously set the price of apples at $0.80. Only in this situation do we have no excess money or excess output.

The relative price between oranges and apples reflects society’s demand for the two goods, in accordance to their relative abundance, or supply. Now, suppose tastes change and people now want more apples. The short-term effect will be for the prices of apples to rise and, if the money supply is held constant, for the price of oranges to fall. Suppose the new equilibrium price is $1 for both apples and oranges. This is a 25 percent increase in the price of apples and a 16.7 percent drop in the price of oranges. The economy is experiencing 8.3 percent price inflation, calculated as a weighted average of the two goods. Of course, we could have started out with different relative prices and created a situation of price deflation just as easily.

In the real world, if oil prices increase, the price of other goods and services must fall if the money supply is kept constant. In the short run, other goods and services may be sold at a loss. Their production costs are irrelevant since they are now a sunk cost. In the longer run, the ultimate impact of the higher oil prices on inflation will depend on the demand and supply elasticity of various products and services. “Cost-push” inflation is a popular misconception. A general increase in all prices, on the other hand, is a monetary phenomenon.

We are now in a better position to understand the silliness behind a policy target of 2 percent inflation for the entire economy. In our apples and oranges example, should the central bank decrease the money supply to change the absolute and relative level of prices of apples and oranges to bring inflation down from 8.3 percent to reach a target of 2 percent? If instead, we had created an example with deflation, should the central bank intervene to increase the money supply to counteract what is essentially a change in relative prices? In a capitalist economy, such large changes in relative prices are not uncommon.

With China and India coming online in the last 30 years by producing massive amounts of cheap products, average prices should have been dropping dramatically as they did during the Industrial Revolution of the 19th century. A stable average price is masking a massive shift in relative prices. The price of products and services not produced in low wage emerging markets, such as health care and education, have been recording galloping inflation while the average level of prices has hardly budged.

Suppose society wants to consume more today and less tomorrow. Under normal circumstances, the price of consumer goods (CPI) would rise while the price of capital goods would fall. These relative price changes along with higher interest rates (i.e., the price of time preferences) act as automatic stabilizers, dampening the impact on the economy from this shift in tastes. A central-bank policy of changing the money supply to correct what is an imagined problem with overall prices would simply be adding instability to this adjustment process. By targeting an aggregate, central banks distort individual prices and interfere with the efficient allocation of resources and goods and services.

The recent ECB action to lower its refinancing rate was to counter a relative price change caused mostly by an appreciating Euro, but this is a totally unjustified interference with the resource allocation function of prices.

Money is a measure of value as the ruler is a measure of length. Changing the length of a ruler, or constantly manipulating the money supply, can only create chaos. Is the ECB’s role really to micromanage every monthly change in an imperfect index? Doesn’t it realize that constantly changing the measuring stick makes entrepreneurial decisions that much more difficult?

Returning to the gold standard, ending fractional reserve banking, and closing down the central bank, would finally bring stability to the money supply and, as a consequence, stability to the world economy.

Professor Eichengreen in his book Exorbitant Privilege: The Rise and Fall of the Dollar and the Future of the International Monetary System, chronicles the rise of the dollar to world dominance, and what it means for the US. He then explores the possibilities of its demise and possible crash. The author should be commended for at times thinking outside the mainstream box, where such issues are often ignored.

He believes that the world is heading toward a state in which there are several reserve currencies, notably the euro and the Chinese renminbi. He maintains that a reserve currency status is based on economic strength: Europe has it and China and India are gaining it rapidly.

Eichengreen says that this is the type of change to expect, and even applaud, because it would mean the end of America's reserve currency monopoly and force the Federal Reserve to behave better. He does not foresee a complete breakdown of the dollar, because that is not in the interests of countries like China. He (p. 8) finds that the only thing that could create a flight from the dollar is “serious economic and financial mismanagement by the United States.”

The book begins with a quick history of money, banking, and trade. The author has a theory that economic dominance leads to monetary dominance. Yet it is noteworthy that the US became the world economic power by the end of the 19th century, while the dollar had virtually no international role well into the 20th century.

In fact, the US was only able to make its “debut” after having established a central bank to help organize the money markets and after WWI had made a US role a necessity. I was glad to see the author’s openness and honesty when describing the people who established the Federal Reserve and their motives. Eichengreen (pp. 24-25) openly described it as a conspiracy by “big finance” against the general public.

After WWII, the US dollar was far and away the dominant currency. It used this influence to establish the fundamentally flawed Bretton Woods system. This system established the dollar as the world’s reserve currency convertible into gold at $35/ounce. This system was abused by the over-issue of dollars which started to generate pressure for convertibility as early as the late 1950s.

Ludwig von Mises was a leading opponent of the Bretton Woods system and the leading proponent of returning to a real gold standard. This is an important point because one of Mises’s followers was Jacque Rueff, the popular economic advisor to French President Charles de Gaulle. Eichengreen (pp. 52-53) correctly describes the French as leading the opposition to the Bretton Woods:

Rueff acquired de Gaulle’s ear. He also acquired the public’s (due to his successful inflation-fighting policies). When de Gaulle attacked the dollar at a press conference in early 1965, castigating the Bretton Woods System as “abusive and dangerous” and arguing that the world should return to a gold-based system, he was channeling Rueff.

Of course the French would continue to pressure the dollar and eventually force it from its perch. The rest of the chapter on the dollar’s dominance provides a concise history of the 1960s and 1970s. Here the author provides real value by drawing attention to the similar problems that China faces today, like what to do with all their depreciating dollars.

The next chapter discusses the improbable euro. While the book makes Americans look like arrogant brutes, this chapter makes Europeans look like immature wimps, and Germans as dupes. Overall, it provides a convincing indictment against the idea that government should run the monetary system.

Given the post-WWII history of government management of money and banking, it was astonishing to me that Eichengreen blamed the current economic crisis on inadequate regulation and too much competition. There are over 100 regulatory agencies that supposedly oversee the financial industry and over 12,000 financial regulators in Washington, DC, alone. At the state, federal, market, and international levels virtually everything in financial markets is regulated by multiple agencies often resulting in turf warfare.

Eichengreen is correct to criticize the Federal Reserve for adding too much fuel, i.e., money and credit, to the economy. It should be obvious that this was the primary problem—the necessary condition.

However, there are two more big problems with the Fed. First, by continuing to bail out financial markets for decades, it has created an enormous moral hazard problem, encouraging participants to incur too much risk in their investments and operations. Second, by acting as a cheerleader for credit default swaps and collateralized debt obligations, the Fed created a moral suasion problem by directly encouraging their use amongst inexperienced participants.

When it comes to the conclusion we find that the dollar still dominates the world. The euro is an existing rival and the Chinese renminbi is a future rival. This rivalry should make the dollar a more responsible currency. If this book goes into a second edition, then this chapter will require some editing.

He does mention gold, but only to dismiss it. “Finally, there are some minor alternatives to be dismissed. Gold has its bugs” (p. 147). It is dismissed largely on grounds that gold is “inconvenient” and because central banks have not shown interest in it. There is really nothing inconvenient here. Gold, silver, and copper coins minted in various weights could easily serve as money, could be title-transferred electronically, and could be transferred either in its own denominations (i.e., 5 gram, 10 gram, 25 gram, etc.) or in other denominations (e.g., dollars, euros, etc.).

Eichengreen seems to downplay the possibility of a crash of the dollar and the loss of its currency reserve status. He cites three situations that could bring about a crash of the dollar: China dumping the dollar, loss of confidence by investors, or continuous runaway government spending. He also reasons why each of these situations is not highly probable.

In contrast, I view the three situations as connected and to be a higher probability. Continuing runaway government spending seems to be firmly baked into the cake of future events. Ballooning deficits and an exploding national debt being monetized by the Federal Reserve are shaking investor confidence in the long-term value of the dollar and this includes other central banks, such as the Bank of China.The reviewer believes that events occurring between the time this review was written and submitted and the time it went to press have increased the probability of monetary crisis, and that the crisis will come sooner rather than later.

There is valuable information in this book, also including an interesting discussion of oil markets and the military and the roles they play in the reserve currency status. The main problem with the book comes in the area of interpretation, where the author fails to fully challenge the status quo.

The scheme has reared its head once again in H.R. 1576, the “Dollar Bill Act of 2013,” introduced by Congressman Ted Poe, and strongly supported by Steve Forbes.

According to Laffer’s blueprint from the 1980s, at the end of a previously announced transition period of three months, the Federal Reserve would establish an official dollar price of gold “at that day’s average transaction price in the London gold market.”Laffer, Reinstatement of the Dollar, p. 4. From that date onward, the Fed would stand ready to freely convert dollars into gold and gold into dollars at the official price. In addition, “when valued at the official price, the Federal Reserve will attempt over time to establish an average dollar value of gold reserves equal to 40 percent of the dollar value of its liabilities.”Ibid. This level of gold reserves Laffer designates the “Target Reserve Quantity.”

Once Laffer’s plan was fully operational, the Fed would have full discretion in conducting monetary policy through discounting, open market operations, etc., provided that: the dollar remains fully convertible into gold at the official price; and the quantity of actual gold reserves does not deviate from the Target Reserve Quantity by more than 25 percent in either direction, i.e., actual gold reserves do not fall below 30 percent or rise above 50 percent of the Fed’s liabilities, which are also known as the “monetary base.” However, should gold reserves decline to a level between 20 percent and 30 percent of its liabilities, the Fed would lose all discretion in determining the monetary base which, as a result, would be completely frozen at the existing level. If, in spite of this, gold reserves continued to decline to between 10 percent and 20 percent of the Fed’s liabilities, the Fed would be legally constrained to reduce the monetary base at the rate of one percent per month.

Should these measures prove incapable of arresting the decline in the dollar value of gold reserves before it reaches less than 10 percent of Fed liabilities, then:

The dollar’s convertibility will be temporarily suspended and the dollar price of gold will be set free for a three month adjustment period.

During this temporary period of inconvertibility, the monetary authorities will be required to suspend all actions that would affect the monetary base. Again, the price of gold would be reset as before and convertibility would be reinstated.Ibid., p. 5.

Laffer’s plan also includes “a symmetric set of policy dicta” which are to be implemented in the case in which actual gold reserves exceed the Target Reserve Quantity.

It must first be pointed out that Laffer’s monetary reform proposal, whatever its merits or drawbacks, is not a blueprint for the gold standard. Rather, it is an outline of an elaborate scheme for legally constraining the monetary authority to adhere to a “price rule” in determining the supply of fiat money in the economy. In fact, as Laffer himself has made clear recently, gold has no necessary role in the implementation of such a price rule. According to Laffer and Miles:

… the Fed would institute its dollar “price rule” by stabilizing the value of the dollar in terms of an external standard. This standard would be a single commodity or a basket of commodities (a price index).…

Regardless of precisely which external standard is chosen, there are two basic rules of Fed behavior under the price rule. First, if the dollar price of the standard starts to rise (the dollar starts to fall in value), the Fed must reduce the quantity of dollars through open market sales of bonds, foreign exchange, gold, or other commodities. Second, if the dollar price starts to fall (the dollar rises in value), the Fed must increase the quantity of dollars through open market purchases of bonds, foreign exchange, gold or other commodities. The Fed is charged with keeping the value or price of the dollar stable in terms of the external standard.Arthur B. Laffer and Marc A. Miles, International Economics in an Integrated World (Glenview, Ill.: Scott, Foresman and Co., 1982), pp. 399–400.

Compare this to Forbes’s explanation of Poe’s 2013 plan:

Unlike in days of old we don’t need piles of the yellow metal for a new standard to operate. Under Poe’s plan—an approach I have long favored—the dollar would be fixed to gold at a specific price. For argument’s sake let’s say the peg is $1,300. If the price of gold were to go above that, the Federal Reserve would sell bonds from its portfolio, thereby removing dollars from the economy to maintain the $1,300 level. Conversely, if the gold price were to drop below $1,300, the Fed would “print” new money by buying bonds, thereby injecting cash into the banking system.

Even if gold is chosen as the “external standard” in the price-rule regime, it is not itself money, as in the case of a genuine gold standard, but merely “the intervention asset” or “the item for which dollars are exchanged.”Ibid., p. 400.

When we strip away its gold plating, Laffer’s and Poe’s price rule appears as a technique designed to control inflation under the current fiat money standard. It is thus differs only in technical detail from the quantity rule advocated by the monetarists. Laffer and Miles admit as much when they state, “in an unchanging world where all information is freely available, there of course would be a ‘quantity rule’ which would correspond to a given ‘price rule.”Ibid., p. 401. In fact, Miles and Laffer prefer a price rule to a quantity rule because they believe that, under the current monetary system, the former is technically superior to the latter in “restraining the supply of dollars.”Ibid.

Under close examination, the Laffer/Poe/Forbes approach thus turns out to be, in essence, a kind of “price-rule monetarism,” the references to gold notwithstanding. The most serious defect in both variants of monetarism is that they fail to address the underlying cause of inflation, namely, the government monopoly of the supply of money. This is true of Laffer’s plan despite the elaborate set of legal sanctions which would be invoked against the monetary authorities for their violations of the price rule. For, in the end, such sanctions, even if rigorously applied, do not prevent inflation but merely respond to a fait accompli. This point is implicitly recognized by Laffer, who includes in his plan a provision for “temporary periods” of dollar inconvertibility. These would readjust the official gold price following sustained bouts of monetary inflation which cause gold reserves to fall below the legally permissible lower limit.

Furthermore, as in the case of the gold certificate reserve, we may appeal to history for evidence regarding the success of the gold price rule in stanching the flow of government fiat currency. We need look no further than the late, unlamented Bretton Woods System (1946–1971). Under this “fixed-exchange-rate” system, the U.S. monetary authority followed a gold price rule, buying and selling gold at an officially fixed price of $35 per ounce. Foreign monetary authorities, on the other hand, pursued a dollar price rule, maintaining their respective national currencies convertible into dollars at a fixed price. According to Laffer and Miles, “as long as the rules of the system were being followed, the supplies of all currencies were constricted to a strict price relationship among one another and to gold.”Ibid., p. 260.

Unfortunately, “the rules of the system” were subjected to numerous and repeated government violations and evasions, including frequent outright “readjustment” of the price rules, i.e., exchangerate devaluations, when they became inconvenient restraints on the inflationary policies pursued by particular governments.For accounts of the breakdown of the Bretton Woods System see Jacques Rueff, The Monetary Sin of the West, trans. Roger Glémet (New York: Macmillan Co., 1972); and Guillaume Guindey, The International Monetary Tangle: Myths and Realities, trans. Michael L. Hoffman (White Plains, N.Y.: M.E. Sharpe, Inc., 1977). Needless to say, the Bretton Woods System did not prevent the development of a worldwide inflation which brought the system to its knees in 1968 and led to its final collapse in 1971.

After duly noting the political manipulations involved in the destruction of the Bretton Woods System,Laffer and Miles, International Economics, pp. 259–62. Laffer and Miles clearly delineate the reasons why governments prefer and benefit from the removal of any and all checks on their power to inflate the money supply:

Why should governments be biased toward increasing the money supply at a faster rate? There are essentially two incentives—a political incentive and a financial one. The political incentive is political survival. Many politicians, especially those up for reelection, are familiar with the theory that increases in the money supply promote expenditure, increase GNP, and reduce unemployment. These changes in turn are assumed to make the citizens of the country look more kindly upon the incumbent government. While there may be some validity in this theory, unfortunately it is often implemented under the notion that if a little money creation is good, a lot must be even better.

The financial motive for printing money is the fact that while money is practically costless to produce, it can be used for purchasing goods and services. The resulting seignorage represents revenue to the government. Revenue gathered in this way means less revenue must be gathered in another way, say, through direct taxation.

Given these incentives to print money, it can be seen why removal of the monetary constraints on governments tends to create inflation rather than deflation.Ibid., pp. 397–98.

Given his recognition of the powerful inflationary bias built into the political process and of the historical failure of monetary price rules to hold such a bias in check, Laffer’s advocacy of a renewed gold price rule was always something of a mystery.

In light of the inherent flaws of all varieties of the gold price rule, Forbes and Poe should seriously rethink their advocacy of its resurrection.

[This article was adapted from an excerpt of Money Sound and Unsound by Joseph T. Salerno]

The long-lasting imprint from FDR’s famous “Hundred Days” did not stem from the bank holiday, national industrial recovery act, the farm adjustment act, the Tennessee Valley Authority, or the public works administration.

Instead, it is lodged in the footnotes of standard histories; namely, FDR’s April 1933 order confiscating every ounce of gold held by private citizens and businesses throughout the United States. Shortly thereafter he also embraced the Thomas Amendment, giving him open-ended authority to drastically reduce the gold content of the dollar; that is, to trash the nation’s currency.

These actions did not constitute merely a belated burial of the “barbarous relic.” In the larger scheme of monetary history, they marked a crucial tipping point. They initiated a process of monetary deformation that led straight to Nixon’s abomination at Camp David, Greenspan’s panic at the time of the 1998 Long-Term Capital Management crisis, and the final destruction of monetary integrity and financial discipline during the BlackBerry Panic of 2008.

The radical nature of this break with the past is underscored by a singular fact virtually unknown in the present era of inflationary central bank money; namely, that the dollar’s gold content had been set at $20.67 per ounce in 1832 and had never been altered. There had been zero net domestic inflation for a century and the dollar’s gold value in international commerce had never varied except during war.

The Thomas Amendment nullified this rock-solid monetary foundation and instead permitted the president on his own whim to cut the dollar’s gold content by up to 50 percent. So doing, it signaled that money would no longer exist fixed, immutable, and outside the machinations of the state, but would now be an artifact of its whims and expedients.

It was a shocking deviation from FDR’s own repeated campaign pledges to preserve “sound money at all hazards” and contradicted the pro–gold standard views of even his own party’s mainstream. Likewise, the removal of gold from circulation entirely had never before been seriously proposed, not even by William Jennings Bryan, the populist Democrat presidential candidate best known for his “Cross of Gold” speech.

Self-evidently, bank notes and checkbook money had long been a more convenient means of payment than gold coins, but the function of gold was financial discipline, not hand-to-hand circulation. Redeemability of bank notes and deposits gave the people an ultimate check on the monetary depredations of the state and its central banking branch. Indeed, the public’s freedom to dump its everyday money in favor of gold coins and bullion was what kept official currency and bank money honest.

At the time, however, the shell-shocked nation—even the conservative opposition—scarcely understood that the Rubicon had been crossed. The most notable clarion call, in fact, came from Lewis Douglas, FDR’s own budget director and key economic advisor. Hearing on April 18, 1933, of the president’s intention to endorse the Thomas Amendment, Douglas famously declared, “This is the end of western civilization.”

Douglas was at least eighty years premature with respect to timing but his sense of the implication was profoundly correct. In one fell swoop, FDR’s capricious actions launched the Democrats down the road to a government-manufactured currency and a purely national form of money.

It thereby repudiated the internationalist hard-money stand of the 1932 Democratic platform, the pro–gold standard candidacies of Al Smith in 1928, John Davis in 1924, and the James Cox—Franklin Roosevelt ticket of 1920. It also nullified the pro-gold principles of Carter Glass and the Democratic majority that had instituted the Federal Reserve Act in 1913 and the Cleveland, Jackson, and Jefferson Democrats who had gone before.

In short, amid the atmosphere of public fear and alarm from his self-inflicted banking crisis, and owing to his willful insouciance in single-handedly scrapping the nation’s deep and bipartisan gold standard tradition, FDR essentially parted the waters of monetary history. Until June 1933, virtually everyone believed that gold-redeemable money was the foundation of capitalism, yet within months such convictions had gone stone-cold dormant.

It would, of course, take time for the resulting monetary vacuum to be filled by an aggrandizing central bank and a credit-money-based financial system cut loose from the discipline of gold. In the interim, the Great Depression quashed inflationary expectations and speculative instincts for decades to come, and produced a generation of conservative commercial and central bankers who earnestly attempted to replicate its discipline.

Nevertheless, it was only a matter of circumstances before the policy vacuum was filled by less wholesome propensities. Eventually, Nixonian cynicism and Professor Milton Friedman’s alluring but dangerously naïve doctrines of floating exchange rates and the quantity theory of money picked up where FDR left off. Notwithstanding Friedman’s aura of intellectual respectability, Nixon’s crass political maneuvers amounted to a primitive economic nationalism that harkened back to the worst of the disaster that FDR had first sown in the 1930s.

After Roosevelt effectively suspended convertibility in the bastion of the world gold standard, money was essentially nationalized. Most of the world’s major economies, including the United States’s, retreated into separate silos of autarky and stagnation, which in turn bred ultra-nationalism, rearmament, and finally world war. But this outcome was not inevitable.

To be sure, the survival of a liberal international economic order had been in doubt throughout the 1920s, as the world struggled to repair the inflationary mayhem of the Great War and resume convertibility of national currencies. Between 1925 and 1928, huge strides toward normalization of exchange rates, capital markets, and trade were accomplished as England, Belgium, Sweden, and even Japan (1930) restored gold standard money.

But all of this tenuous progress had been seriously jeopardized by England’s abandonment in September 1931 of the very gold exchange standard it had spent a decade promoting under the auspices of the League of Nations. So prospects for resumption of the fabulously stable and prosperous pre-1914 liberal international order were hanging by a thread. In this context, historians are agreed that it was FDR who personally delivered the coup de grâce with his famous “bombshell” message to the London Economic Conference in July 1933.

FDR capriciously defied all of his advisors, to the very last man, including the then-chief of his brain trust, Raymond Moley. Flying by the seat of his own pants, he airily dismissed the warnings of his budget director, the brilliant industrialist and financial scholar Lewis Douglas. He also disregarded the firm pro-gold viewpoint of James Warburg, his most senior financial advisor with Wall Street and international finance experience. Moreover, FDR had failed to even solicit the opinion of Senator Carter Glass. Under the circumstances, that was not merely a telling omission; it was damning.

For the better part of three decades, the legendary Virginia senator, also former secretary of the treasury under Woodrow Wilson and principal author of the Federal Reserve Act, had been the Democratic Party’s paragon of authority on matters of money and banking. Glass had been an unwavering proponent of the gold standard and had personally written the 1932 Democratic platform in such a manner as to leave no doubt that the Democrats would not resort to easy money and inflationist expedients.

For several weeks before his March 4 inauguration, Roosevelt pleaded with Glass to become his secretary of the treasury. Yet hardly sixty days after Glass finally refused the job, FDR did not even bother to consult him when launching what were epochal monetary policy actions. In essence, FDR’s April 1933 gold machinations repudiated the life’s work of the very financial statesman he first picked for the single most important job in his government.

Roosevelt’s flip-flopping on Glass and gold was a defining moment. It showed that on the raging economic crisis of the hour, Roosevelt’s insouciance knew no boundaries; he could believe almost any contradiction that came his way.

It thus happened that after the Hundred Days of emergency actions was completed in late June, FDR headed off to vacation on Vincent Astor’s yacht. He sent Moley as his personal emissary to the London conference, which by then had come to be viewed as literally the last hope for retaining an open international trading and monetary order.

The conference had the good fortune that its presiding officer was Secretary of State Cordell Hull. A former Democratic senator from Tennessee and a splendid statesman, Hull had been a staunch advocate of free trade, the gold standard, and an open international economy.

Most of the assembled financial officials, including Hull, recognized that restoration of some semblance of exchange-rate stability was the key to the rest of the conference agenda, especially to rolling back the protectionist trade barriers which were rapidly choking off world trade. The latter had sprung up everywhere after Smoot-Hawley and were being compounded by beggar-thy-neighbor currency manipulation after the sterling-based gold exchange system broke down.

After long and arduous negotiations, the framework for such a monetary stabilization agreement was reached soon after Moley arrived in London. The US delegation, Great Britain, and the French-led gold bloc nations had all managed to find common ground. While Moley had been a strident voice of nationalistic autarky in the Roosevelt inner circle, even he was persuaded by Hull and the British to endorse the tentative internationalist agreement.

The heart of the plan was repegging the dollar to pound exchange rate in a narrow band about 20 percent below the old parity (i.e., at about $4.00 versus $4.86 per pound sterling). From that pivot point, the French franc and other major currencies would be fixed to the dollar.

The significance of this breakthrough cannot be gainsaid. All sides recognized that floating currencies would poison the international trading system, encourage destructive currency speculation, and fuel violent movements of “hot money” among financial centers. The latter would continuously destabilize both national money markets and confidence in the international trading system as a whole.

In one of the great misfortunes of history, however, FDR was literally incommunicado during the hours when a global consensus to reboot the international financial system briefly flickered. Alone on Astor’s luxurious yacht, the Nourmahal, the president had the advice of only his wealthy dilettante chum Vincent Astor and Louis Howe, his butler and glorified White House “secretary.”

When Moley finally found a navy ship to track down the Nourmahal and deliver a radio message outlining the nascent London agreement, Roosevelt, Howe, Astor, and perhaps also the yacht’s captain, as it were, gathered around a kerosene lamp on the deck. There they scribbled out a handwritten response and turned it over to the navy for radio dispatch back to London.

Roosevelt’s message was undoubtedly among the most intemperate, incoherent, and bombastic communiqués ever publicly issued by a US president. It not only stunned the assembled world leaders gathered in London and killed the monetary stabilization agreement on the spot, but it also locked in a destructive worldwide régime of economic nationalism that eventually led to war.

High tariffs and trade subsidies, state-dominated recovery and rearmament programs, and manipulated fiat currencies became universal after the London conference failed. In the months which followed, Sweden, Holland, and France were driven off the gold standard, leaving international financial markets demoralized and chaotic.

[At the end of the day, it was only the outbreak of war in 1939–1940 which pulled the world out of the rut of economic nationalism and stagnation to which FDR’s quixotic action had condemned it. It also meant that the domestic economy had now been cut off from its vital export markets, condemning the nation to a halting recovery and to continuous and mostly ineffectual New Deal doctoring that succeeded primarily in planting the seeds of welfare state expansion and crony capitalism.

Roosevelt’s deplorable action from the deck of the Nourmahal tends to be dismissed by historians as a forgivable bad hair day early in the reign of the economic-savior president. In fact, it was the very opposite: FDR’s single-handed sabotage of the London conference was one bookend of a thirty-eight-year epoch. The other end was bounded by Richard Nixon’s equally impudent destruction of Bretton Woods in August 1971.

In each case the modus operandi was the same. Both Roosevelt and Nixon were aggressive politicians who lacked any enduring convictions about economic policy. Neither had any compunction at all, however, about using the taxing, spending, regulatory, and money-printing powers of the state to achieve their domestic political and electoral objectives. In the great scheme of modern financial history FDR and Tricky Dick were peas in a statist pod.

Copyright © 2013 David Stockman. Used with the author's permission.

The line is based on her famous psychiatric booth where she would say “5 cents please” for anyone seeking her advice. She most passionately expressed her love for nickels in the A Charlie Brown Christmas television special:

Boy what a sound. How I love hearing that old money clank. That beautiful sound of cold, hard cash. That beautiful, beautiful sound, nickels, nickels, nickels. That beautiful sound of clinking nickels.

But to understand her affection for the coin you have to remember that her career started when we were on the gold standard.

Most viewers will see this as just another silly little ad by MetLife. However, properly understood this should be seen as a scientific pronouncement of the highest quality.

You see, if you were to consider Lucy’s proposal as a weekly rate (after all, the lives of children revolve more around the week than the month) and adjust for inflation back to the time of the old gold standard, the proposition that, “insurance should be a nickel,” makes perfect sense. The original 1 oz. “Double Eagle” gold coin was worth 20 dollars. Therefore, 1 dollar was approximately equal to 1/20th of an ounce of gold and a nickel’s worth would be 1/400 of an ounce of gold.

When the commercial was written, I believe the price of gold was around $1,290 per ounce. Hence, an old nickel’s worth of gold would be worth almost $3.25 at the time.

Considering Lucy’s price as a weekly rate, if we took the more precisely adjusted price of $3.25 and multiplied it by 52 weeks per year, customers would be paying around $169 per year for insurance. If you took MetLife price of $14 per month, the annual cost would be $168 per year.

While we do not know the exact price of gold when the commercial was written it would seem that Lucy’s weekly price adjusted to the old gold standard is approximately the same as MetLife’s monthly price. 

Apparently Lucy was not arguing for the sake of arguing, as she is wont to do. Neither is she arguing, normatively, that the price is too high. Rather, she is making an argument for a return of the old, true gold standard.

This would make perfect sense given that we are talking about life insurance. Think of how much easier things would be in the life insurance business if we were on the gold standard.

Under the gold standard, while the purchasing power of gold does change on a day-to-day basis, it does not change much. More importantly, it changes very little over the long term.

Customers would have a much better idea of how much life insurance they would need on a gold standard. Under the fiat paper dollar, is a $1 million policy the right amount? It might be, but it might not be if prices rise significantly and the purchasing power of the dollar falls significantly over the next several years. A $1 million policy might not be worth anything if you die during a hyperinflation, and this is something that few customers even think about.

More importantly, it would also be easier for life insurance companies too. Not only would it be easier to calculate the proper policy for their clients, it would also be easier to invest the premiums because of the long term stability of the value of money.

If life insurance was an easier business for both the customers and the life insurance companies, then prices would be lower and more people would be covered by life insurance, and possibly other forms of insurance. Most people would consider this to be a good thing.

When you think about it, insurance—not government—is what protects us the most. It covers our houses against fire and theft, our cars against damage, our health and our families against illness, as well as our businesses. It protects some of our investments and many other things in everyday life that we are unaware of, like the international shipment of goods between the US and the rest of the world. It even covers the goods we purchase, like flat screen TVs, if we choose to purchase an extended warranty.

A return to the gold standard would be good for life insurance, just as it would improve so many things in our lives. The wisdom of returning to the gold standard is so obvious that even a child like Lucy understands it.

Even at the height of liberalism governments did not give up trying to put easy money schemes into effect. Public opinion is not prepared to realize that interest is a market phenomenon which cannot be abolished by government interference. Everybody values a loaf of bread available for today's consumption higher than a loaf which will be available only ten or a hundred years hence. As long as this is true, every economic activity must take it into ac­count. Even a socialist management would be forced to pay full re­gard to it.

In a market economy the rate of interest has a tendency to cor­respond to the amount of this difference in the valuation of future goods and present goods. True, governments can reduce the rate of interest in the short run. They can issue additional paper money. They can open the way to credit expansion by the banks. They can thus create an artificial boom and the appearance of prosperity. But such a boom is bound to collapse sooner or later and to bring about a depression.

The gold standard put a check on governmental plans for easy money. It was impossible to indulge in credit expansion and yet cling to the gold parity permanently fixed by law. Governments had to choose between the gold standard and their—in the long run disastrous—policy of credit expansion. The gold standard did not collapse. The governments destroyed it. It was as incompatible with etatism as was free trade. The various governments went off the gold standard because they were eager to make domestic prices and wages rise above the world market level, and because they wanted to stimulate exports and to hinder imports. Stability of for­eign exchange rates was in their eyes a mischief, not a blessing.Such is the essence of the monetary teachings of Lord Keynes. The Keynesian school passionately advocates instability of foreign exchange rates.

No international agreements or international planning is needed if a government wants to return to the gold standard. Every nation, whether rich or poor, powerful or feeble, can at any hour once again adopt the gold standard. The only condition required is the abandonment of an easy money policy and of the endeavors to com­bat imports by devaluation.

The question involved here is not whether a nation should return to the particular gold parity that it had once established and has long since abandoned. Such a policy would of course now mean deflation. But every government is free to stabilize the existing ex­change ratio between its national currency unit and gold, and to keep this ratio stable. If there is no further credit expansion and no further inflation, the mechanism of the gold standard or of the gold exchange standard will work again.

All governments, however, are firmly resolved not to relinquish inflation and credit expansion. They have all sold their souls to the devil of easy money. It is a great comfort to every administra­tion to be able to make its citizens happy by spending. For public opinion will then attribute the resulting boom to its current rulers. The inevitable slump will occur later and burden their successors. It is the typical policy of après nous le déluge. Lord Keynes, the champion of this policy, says: "In the long run we are all dead."Lord Keynes did not coin this phrase in order to recommend short-run policies but in order to criticize some inadequate methods and statements of monetary theory (Keynes, Monetary Reform, New York, 1924, p. 88). However, the phrase best characterizes the economic policies recommended by Lord Keynes and his school. But unfortunately nearly all of us outlive the short run. We are destined to spend decades paying for the easy money orgy of a few years.

Inflation is essentially antidemocratic. Democratic control is budgetary control. The government has but one source of revenue—taxes. No taxation is legal without parliamentary consent. But if the government has other sources of income it can free itself from this control.

If war becomes unavoidable, a genuinely democratic govern­ment is forced to tell the country the truth. It must say: "We are compelled to fight for our independence. You citizens must carry the burden. You must pay higher taxes and therefore restrict your consumption." But if the ruling party does not want to imperil its popularity by heavy taxation, it takes recourse to inflation.

The days are gone in which most persons in authority considered stability of foreign exchange rates to be an advantage. Devaluation of a country's currency has now become a regular means of restrict­ing imports and expropriating foreign capital. It is one of the methods of economic nationalism. Few people now wish stable foreign exchange rates for their own countries. Their own country, as they see it, is fighting the trade barriers of other nations and the progressive devaluation of other nations' currency systems. Why should they venture to demolish their own trade walls?

Some of the advocates of a new international currency believe that gold is not fit for this service precisely because it does put a check on credit expansion. Their idea is a universal paper money issued by an international world authority or an international bank of issue. The individual nations would be obliged to keep their local currencies at par with the world currency. The world authority alone would have the right to issue additional paper money or to authorize the expansion of credit by the world bank. Thus there would be stability of exchange rates between the vari­ous local currency systems, while the alleged blessings of inflation and credit expansion would be preserved.

These plans fail, however, to take account of the crucial point. In every instance of inflation or credit expansion there are two groups, that of the gainers and that of the losers. The creditors are the losers; it is their loss that is the profit of the debtors. But this is not all. The more fateful results of inflation derive from the fact that the rise in prices and wages which it causes occurs at different times and in different measure for various kinds of commodities and labor. Some classes of prices and wages rise more quickly and to a higher level than others. While inflation is under way, some people enjoy the benefit of higher prices on the goods and services they sell, while the prices of goods and services they buy have not yet risen at all or not to the same extent. These people profiteer by virtue of their fortunate position. For them inflation is good business. Their gains are derived from the losses of other sections of the population. The losers are those in the unhappy situation of selling services and commodities whose prices have not yet risen at all or not in the same degree as the prices of things they buy for their own consumption. Two of the world's greatest philosophers, David Hume and John Stuart Mill, took pains to construct a scheme of inflationary changes in which the rise of prices and wages occurs at the same time and to the same extent for all commodities and services. They both failed in the endeavor. Modern monetary theory has provided us with the irrefutable demonstration that this disproportion and nonsimultaneousness are inevitable features of every change in the quantity of money and credit.See Mises, Theory of Money and Credit (New York, 1934), pp. 137–145, and Nationalökonomie (Geneva, 1940), pp. 375–378.

Under a system of world inflation or world credit expansion every nation will be eager to belong to the class of gainers and not to that of the losers. It will ask for as much as possible of the ad­ditional quantity of paper money or credit for its own country. As no method could eliminate the inequalities mentioned above, and as no just principle for the distribution could be found, antago­nisms would originate for which there would be no satisfactory solution. The populous poor nations of Asia would, for instance, advocate a per capita allotment, a procedure which would result in raising the prices of the raw materials they produce more quickly than those of the manufactured goods they buy. The richer nations would ask for a distribution according to national incomes or ac­cording to the total amount of business turnover or other similar standards. There is no hope that an agreement could be reached.

One must understand central bank open market operations. Internationally, one must try to understand floating exchange rates, how they are manipulated by central banks, and the resulting impact on national economies. For example, is it best for a country to drive down its exchange rate in relation to other currencies or do the opposite?

These issues are never understood by policymakers, who appear to be among the most illiterate in economic matters, so monetary policy swings to-and-fro according to which economic group has temporary control over the levers of the government, and particularly of central banks.

In a sound money environment, on the other hand, there is little confusion or controversy. Under sound money—in which money is a commodity (for discussion purposes let us assume it to be gold)—everyone, to some extent, understands monetary theory. Whether it be an individual, a family, a corporation, or a nation, either one has money or one does not. It really is as simple as that. Even children learn the nature of money. A child quickly learns that the things he wants cost money and either he has it or he does not. If he does not, he quickly grasps that there are ways to get it. He can ask his parents for an increase in his allowance. Or, he can earn the money he needs by doing chores around the house or for friends and neighbors. He might be able to borrow the money for large purchases, promising to pay back his parents either from his future allowance or from anticipated future earnings from doing extra chores. His parents can evaluate this loan request simply by considering the likelihood that his allowance and chore income are sufficient.

How is this any different when applied to adults, companies, or governments? In a sound money environment, they are the same. Individuals earn what they spend on the family and may borrow from the bank to buy a home or a new car. The lender will examine whether the person’s income is sufficient to pay back the loan. If the family hits hard times, they may ask for assistance from relatives or a charity. Companies have more means with which to fund their operations. Stockholders provide the company with its initial capital. Thereafter, when normal earnings are insufficient to fund desired expansion, the company can borrow against accounts receivables and inventories, both of which provide varying degrees of security for the lender.

A national government’s finances, under a sound money system, are little different from either a household’s or a company’s. It needs to collect in taxes what it spends. If it suffers a budget deficit, it can cut back spending, attempt to raise taxes, or borrow in the open market. In a sound money environment, there is a limit to the amount of debt that even a government can incur, due to the need to pay back the loan from future tax revenue. If the market believes that this may not be forthcoming, the nation’s credit rating may suffer and its borrowing costs will rise, perhaps to the point that the nation is completely shut out of the credit market. But this is a good thing! The market instills practical discipline that even a politician can understand! Under sound money, one does not need a special education to understand the monetary system.

Taking the process one step further, anyone can understand international monetary theory in a sound money environment. The national currency is simply shorthand for a quantity of gold. A US dollar may be defined as one thirty-fifth of an ounce of gold, and a British pound defined as roughly one seventh of an ounce of gold. Exchange rates become mathematical ratios that do not vary. So an American purchasing English goods would exchange his dollars for pounds at a ratio of five dollars per British pound; i.e., one seventh of an ounce of gold (a pound) divided by one thirty-fifth of an ounce of gold (a dollar) equals five dollars to a pound. Through the banking system, the English exporter would demand gold from the issuer of dollars, whether it be from a central bank or private bank, at thirty-five dollars per ounce. When a currency is simply a substitute for gold, either the issuer has gold with which to redeem its currency or it does not.

When a nation overspends internationally, its gold reserves start to dwindle. Money, which is backed one hundred percent by gold, becomes scarce domestically. Domestic prices fall, triggering a rise in foreign demand for the nation’s goods. The process of gold depletion is halted and then reversed. This is the classical “Currency School” of international monetary theory. Commercial banks present checks drawn on one another every day and the same process would exist for gold-backed currencies. If a bank issues more scrip than it can redeem for gold at the promised price, it is guilty of fraud. Its officers and directors can be sued in court for any loss incurred by those who accepted the bank’s scrip. Furthermore, the officers and director could be prosecuted for the crime of fraud. In other words, banking would be subject to normal commercial laws and bank officers and directors would be subject to normal criminal laws.

The free market monetary system would drive bad money issuers out of the market. Plus, bad money issuers would suffer the loss of both their personal finances and, in the case of outright fraud, loss of their personal freedom. This would be a sobering incentive to deter criminals and attract only legitimate money issuers. Money would be a bailment; i.e., property held for the benefit of another, which must be surrendered upon demand for redemption. All around us exist analogous bailment examples of entrusting valuable goods to complete strangers. We leave our cars with valets at parking garages, our clothing at neighborhood cleaners, our overcoats at coat checks, our luggage to the airlines, valuable merchandise with shippers. In these cases, we fully expect that our property will be returned to us. And it almost always is! If it is not, public trust in the fraudulent outfits evaporates, and they quickly go out of business. Likewise, money issuers would thrive only when the public trusts their integrity, which would be enhanced by regular outside audits by respected firms of the existence of one-hundred-percent reserves to back the money issuer’s scrip. How different this would be from our present system in which the Fed will not allow an audit of its gold reserves even when held for the benefit of other central banks! It is clear that in a free market monetary system such a policy would drive Federal Reserve Notes out of the market through lack of demand. Even were the Fed to back its notes with its gold reserves, in a totally free market in which private banks could issue their own gold-backed scrip, the Fed would suffer from its past history of blatant money debasement and secrecy in its operations. The market would prefer the money issued by a well-respected private bank whose operations are transparent and subject to outside audit by respected accounting firms.

In a sound money environment everyone understands monetary theory. Money is like any other desired commodity, except it is not consumed. It is a medium of indirect exchange, which traders accept in order to exchange for something else at a later time. This is easily understood, whether the trader is a child, a parent, a company, or a nation. One either has money or one does not. The money can be a money substitute, a bailment, with which one can demand the redemption of the real money—gold. Money issuers must keep one-hundred-percent reserves against their money substitutes in order to abide by normal commercial and criminal law. No special agencies or monetary authorities are necessary to make the system work. The system emerges naturally and is regulated via the normal commercial and criminal legal system.

This is the system that government does not want us to have, because it provides no special favors for enhancing state power. Sound money shackles the government to the will of the people and not vice versa. As Ludwig von Mises stated in The Theory of Money and Credit:

It is impossible to grasp the meaning of the idea of sound money if one does not realize that it was devised as an instrument for the protection of civil liberties against despotic inroads on the part of governments. Ideologically it belongs in the same class with political constitutions and bills of rights.

The idea prevails that to favor gold or silver money is to be a mossback reactionary; nothing could be further from the truth. For gold (as well as silver) is the People’s Money; it is a valuable commodity that has developed, on the free market, as the monetary means of exchange. Gold has been replaced, at the dictate of the State, by fiat paper—by pieces of paper issued and imprinted by the government. Gold cannot be produced very easily; it must be dug laboriously out of the ground. But if paper tickets are to be money, and the State is to have the sole power to issue these virtually costless tickets, then we are all at the mercy of this gang of legalized, sovereign counterfeiters. Yet this is the accepted monetary system of today.

Not only is this system of the State’s having absolute control of our money been accepted by Establishment economists; it has been just as warmly endorsed by the powerful “Chicago” branch of free-market economists. Twenty years ago, almost all conservative, or free-market oriented, economists, favored a return to the gold standard and the elimination of fiat paper. But now the gold standard economists have almost all died out and been replaced by the glib, technically expert Chicagoites, to a man scoffers at gold and simple-minded endorsers of fiat paper. The gold standard has died from desertion of its cause by the right-wing and its economists. Numerous right-wingers who should know better yet continue to fawn upon Milton Friedman and his Chicagoites. Why? Presumably, because they have power and influence, and one never finds conservatives lacking these days when it comes to toadying to power.

In the midst of this monetary miasma, there has now come a voice from out of the past, from the Old Right, and it is one of the most heartwarming events of the year.

Two years ago, Jerome Daly, a citizen of Savage, Minnesota, a suburban town just south of Minneapolis, refused to make any further payments on the mortgage which he had owed to his bank. At his jury trial (First National Bank of Montgomery vs. Jerome Daly) in December, 1968 before Justice of the Peace Martin V. Mahoney, a farmer and carpenter by trade, at which the bank tried to repossess the property, Mr. Daly argued that he owed the bank nothing. Why? Because, the bank, in lending him money, had loaned him not real money but bank credit which the bank had created out of thin air. Not being genuine money, the credit was not a valid consideration, and therefore the contract was null and void. Daly argued that he did not owe the bank anything.

In making this seemingly preposterous argument, Jerome Daly was being a far better economist—and libertarian—than anyone knew. For fractional reserve banking—now a system at the behest and direction of the Federal Reserve Banks—is, like fiat paper, legalized counterfeiting, the creation of claims which are invalid and impossible to redeem. Furthermore, Daly contended that this kind of creation of money by banks is illegal and unconstitutional.

Even more remarkable than Mr. Daly’s thesis is that the jury unanimously held for him, and declared the mortgage null and void; and Justice Mahoney’s supporting decision, delivered last Dec. 9, is a gem of radical assertion of the rights of the people and a thoroughgoing assault on the unwisdom and fraudulence and unconstitutionality of fractional reserve banking.

Bewildered, the First National Bank of Montgomery, Minnesota proceeded in routine fashion to file an appeal with Justice Mahoney for a higher court. But the catch is that in order to file an appeal, the plaintiff has to pay a fee of two dollars. Justice Mahoney, O happy day, refused to accept the appeal on January 22 because Federal Reserve Notes, which of course constituted the fee, are not lawful money. Only gold and silver coin, affirmed the judge, can be made legal tender, and therefore the fee for appeal had not been paid. Justice Mahoney followed this up with supporting memoranda on January 30 and February 5, which are heartwarming blends of sound economics and strict legal constructionism, and which also declared the unconstitutionality of the Federal Reserve Act and the National Banking Act, the capstones of our current interventionist and statist monetary system.

There the matter rests at the moment; but where does it rest? We have it on the authority of Justice Mahoney that debts to fractional reserve banks (i.e. the current banking system) are null and void, that their very nature is fraudulent and illegal (in short, that the banks belong to the people!), that Federal Reserve Notes and fiat paper are unlawful and unconstitutional.

Never has there been a more radical attack upon the whole nature of our fraudulent and statist banking system.

Furthermore, with these embattled Minnesotans, their radicalism is not only rhetoric; they are prepared to back it up with still further concrete acts. Jerome Daly has already announced that if any higher court of the United States, “perpetrates a fraud upon the People by defying the Constitutional Law of the United States (Justice) Mahoney has resolved that he will convene another Jury in Credit River Township (where Savage is located) to try the issue of the Fraud on the part of any State or Federal Judge”. Daly adds, moreover, that the Constable and the Citizens’ Militia of Credit River Township are prepared to use their power to back up the jury’s decision and keep Mr. Daly in possession of his land. The people of Savage, Minnesota, in short, are prepared to fight, to resist the decrees of the state and federal governments, to use their power on the local level to resist the State.

Many dimwits in the libertarian movement—and they are, unfortunately, legion—have charged that in recent years, I have simply become a “leftist”. From the literature of Mr. Daly and his supporters, it is quite clear that this is a heroic band of Old Rightists, of people who have not been nurtured on National Review or the lesser organs of current Right-wing opinion. I am equally and eagerly as willing to hail their libertarian action for the people and against the State, as I am such “leftist” actions as People’s Park.

The test, as Karl Hess indicates in this issue of The Libertarian Forum, is action; action now vis à vis the State. Those who side with the liberties of the people against the government are our friends and allies; those who side with the State against the people are our enemies. It is as simple as all that. The problem, as far as the Right goes, is that in recent years there have been zero actions by the Right against the State; on the contrary, the Right has almost invariably been on the side of the State: against the demonstrators at Chicago, against People’s Park, against the Student Revolution, against the Black Panthers, etc. If the test is, as I hold it to be, action, and “which side are you on, the people or the State”, and not the closeness of agreement on the fifth Lemma of the third Syllogism deduced from whether or not A is A, then the Right-wing in recent years—and this means the entire right, from Buckleyites and Randians straight through to phony “anarchists” (or “anarcho-rightists”)—has been a dismal failure. Indeed, it has ranged itself on the side of the Enemy. Thus, in the matter of tax resistance, ten or fifteen years ago the banner of tax refusal was carried by such “rightists” as Vivien Kellems; now the self-same flag is carried by such “leftists” as Joan Baez.

If the “libertarians” of the Right-wing are at all interested in my approbation, there is a simple way to attain it: to acquire one-hundredth of the fortitude and the revolutionary spirit of the New Left resisters against the State; to return to the tradition of Sam Adams and Tom Paine, of Garrison and John Brown, and, in recent years, of Frank Chodorov and Vivien Kellems. Let them return to that great tradition or let them, as rapidly as possible, sink into the well-deserved dustbin of history.

In the meanwhile, all hail to the heroic rebels of Savage, Minnesota, to the perceptive and courageous Jerome Daly and Justice Martin Mahoney.

As part of its Cold War strategy, Germany stored much of its gold reserves “as west as possible.” Bundesbank officials now claim that strategy is outdated. They also say that the movement of gold back to Germany is meant to build trust and confidence in case of a currency crisis in the Euro. The move, as reported by the Wall Street Journal, was in response to “pressure from Berlin and from a remarkable grass-roots campaign by the populist press, which played on fears that the euro crisis poses a risk to Germany’s financial well being.”

The subject of repatraiting Germany’s gold was discussed on Mises.org back in October and December of 2012. Patrick Barron and Godfrey Bloom concluded that repatriating the gold is an important and necessary first step for monetary reform.

That view is not shared by mainstream economists. The Journal reports, “Economists had viewed the debate (over the location of Germany’s gold) with bewilderment, seeing it as entirely divorced from reality, given that gold has played no official role in international monetary policy since the collapse of the Bretton Woods agreement in 1973.” The Journal then quotes Holger Schmieding, chief economist for Berenberg Bank in London. “ Last year’s debate was absolutely ludicrous … driven completely by irrational fears.… I don't see any economic or financial rationale for the Bundesbank to be doing this.”

However, John P. Cochran, Dean Emeritus of the Business School at Metropolitan State University of Denver, counters that “not all economists see this as ludicrous, particularly Austrian economists. The move could be a partial step to restoring sound money; a step which would potentially protect … Germans from risks to their financial well-being.

Cochran continues, “The move is perhaps reason for optimism that arguments for a return to sound money are beginning to have some minimal impact moving discussion in a positive direction, but the key to success of any eventual gold-backed currency is on the idea that delivery of gold upon demand (to the general public) is crucial.” He provides additional cavaets in his article “‘Fool's Gold’ Standards.”

Professor Guido Hülsmann, a native German teaching at the University of Angers in France, questions the meaning of the press releases: “So why does the Bundesbank suddenly issue two press releases within four months? In order to rub it into the face of the world that it wants to have its gold back? I don't think this serves to calm down public opinion at home. Rather, this is one of the last levers they can pull before they become completely marginalized within the ECB's governing council. Now they are pulling it indeed, even though they try not to be too rash. In a world flooded by debt, gold is the ultimate safe haven. Central bankers know this better than most people, even if they have to pretend in their day job that such concerns are irrelevant. Does it mean the Eurozone is approaching its end game? I don't think so, but the protagonists are no longer playing softball.”

Peter Klein, from the University of Missouri, notes that “Gold is the ultimate long-term inflation hedge, and holding physical gold is more secure than holding legal title to gold stored elsewhere. We don’t know if the Bundesbank’s move is purely symbolic or reflects real concerns, but it’s an important signal nonetheless!” Klein also notes, “Equally interesting is why the US government is not returning the gold all at once, but in stages. Is the US holding fractional reserves?”

Professor Philipp Bagus, a native German teaching at the University of Rey Juan Carlos in Spain, and the author of The Tragedy of the Euro, was also curious: “It is startling that they (the shipments of gold) will last until 2020 in order to bring the gold back. This reinforces the suspicions that the Fed and other central banks have lent gold to bullion banks who have in turn sold the gold depressing its price. To unwind these contracts it will take some time without upsetting the gold market. The Fed needs time to get its gold back. For all we know, it may not be there physically. That is probably the reason it will take until 2020.

On a more fundamental point, Bagus noted, “Of course, this is great news since by repatriating German gold, the importance of gold for monetary purposes is stressed, and it becomes available for any possible monetary reform Germany may want to do during the Euro crisis.”

Fiat-money expansion has made the advance of statism possible through its ability to thwart the wishes of the people as the final arbiters of state spending. The state can obtain an almost limitless amount of fiat money from its central bank. It need not increase taxes or borrow honestly in the bond market, so it need not fear a tax revolt or high interest rates respectively. All it needs to do is convince the central bank to buy its debt. The state then takes control over more and more resources, squandering them on war and welfare, depriving the free-market economy of its capital base. Once the capital base has been depleted, the economy will go into a steady decline.

The poster child of this phenomenon is the (former) Soviet Union. Yes, total collapse is a real possibility — for us too. The Russian people may have believed that economic decline would reach a plateau, stop, and then reverse. As explained in stark terms by Dr. Yuri Maltsev, former economic advisor to Mikhail Gorbachev, in Requiem for Marx, the Soviet economy deteriorated into one of subsistence. The capital base of Russia had been destroyed, and collapse soon followed.

The monetary printing press is seen as an alternative to saving and investing as the means to grow the capital base. Monetary stimulus attempts to generate economic recovery mainly through exports.

If a nation can increase its exports, so the logic goes, it can increase employment, pay off debts, etc. So, rather than properly reforming the economy, monetary authorities engage in a destructive "race to the bottom" through competitive debasement of their currencies. First one country then another intervenes into its own currency markets to cheapen its currency against all others. But currency devaluation will not work, as explained in "Value in Devaluation?"

What is desperately needed is for one country to break from this failing and ultimately disastrous model of fiat-money expansion and its horrific effects. This one country must be in a special position whereby it is readily apparent that it is being harmed by currency debasement over which it has no control. Fortunately for the world there exists such a country: Germany.

Germany is the fourth-largest economy in the world, behind only the United States, China, and Japan. Amazingly, it does not control its own money supply, because it is a member of the European Monetary Union (EMU), composed of 17 nations using a common currency — the euro. Each member, regardless of size, has an equal vote over monetary policy, administered by the European Central Bank (ECB). Increasingly Germany's is the lone voice for monetary restraint — recently it was outvoted 16 to 1 over an ECB plan to print euros in greater numbers in order to bail out bankrupt members of the EMU. This is a situation that would be intolerable for any other country; however, due to Germany's history, it is reluctant to be seen as "anti-Europe" and instead has tried to work within the EMU framework to force bankrupt countries to reform their economies. But this is a hopeless exercise, as explained by Dr. Philipp Bagus of King Juan Carlos University, Madrid, in his brilliant book Tragedy of the Euro. All the benefits flow to the irresponsible countries, so there is little incentive and no enforcement mechanism for meaningful reform. Therefore, in a previous article ("A Golden Opportunity "), your authors have called for Germany to leave the EMU, reinstate the deutsche mark, and anchor it to gold.

Most recently there have been calls within Germany to repatriate substantial gold reserves held overseas. The Bundestag — federal Germany's legislature and, as such, representing all diverse elements and factions in the country — is the impetuous behind this movement. The Bundesbank, Germany's still-extant central bank, has agreed to repatriate about one-tenth of its vast overseas gold deposits over the next three years.

But this is inadequate for the real task at hand. Germany must repatriate ALL of its gold. There is only one reason that a central bank would wish to repatriate its gold: to serve as reserves in a gold backed monetary system. The market must be assured that the gold actually exists, that it is under the total control of its rightful owner, and that it is not leased or part of a swap arrangement. Furthermore, the central bank must be willing to honor demands to deliver gold in the quantity specified in exchange for its paper money certificates and the commercial-bank book-entry deposits.

If Germany is to back the deutsche mark with its own gold, markets must be certain that the Bundesbank can and will deliver the gold upon demand. For under a gold-backed system the gold is the money. The pieces of paper that people carry in their wallets and keep in cookie jars and the book-entry receipts at commercial banks are not money per se; these are money substitutes that can be exchanged for real money — gold. The central bank can meet this requirement only if it has absolute control over its gold.

The Bundesbank has significant portions of its overseas gold deposits at the Federal Reserve Bank in New York and the Bank of England in London. At one time it may have made sense to deposit gold in these countries in order to protect it from the possibility that the Red Army would overrun Germany. Fortunately that threat is no more. But the Federal Reserve Bank has been very circumspect about displaying Germany's gold to its rightful owners. Now, I ask you, is this not very suspicious behavior? Why would the Fed refuse to show the actual gold to Germany or any other nation with gold deposits? The reason usually given is one of security, but what does the Fed think is going to happen? Does it think that armed robbers will be able to abscond with some bars? This is preposterous! The gold is the property of Germany. Germany should insist on viewing its gold, counting its gold, testing its gold for fineness, and making quick arrangements for moving its gold to its own vaults in Germany.

Either the gold is all there, and rumors to the contrary are baseless, or some portion of the gold is not there or is encumbered in some way. If the former, all is well. If the latter, then let's learn about it now, so that we can stop any further theft and so that we can establish a financial-crimes tribunal to try all who had a part in the theft. If that means prosecuting central-bank officials in the United States or the United Kingdom, so be it. If that means that the exchange rates for the dollar or the pound sterling fall in relation to other currencies, so be it.

Let's learn the truth, whatever that may be, so we can get on with the important work of placing the world's finances on the solid foundation of sound money and not on promises of confidence men. Let us adopt the Latin legal concept fiat justitia ruat caelum, "Let justice be done though the heavens fall," and not lose sight of the goal of saving what remains of free-market capitalism and beginning the difficult process of restoring our liberties.

Although he admits that our "recommendation may be a step in the right direction … it leaves Germany with a central bank and a discretionary monetary policy." That it does — for now.

In no way was our essay intended to imply that central-bank control of gold-backed money was the point at which we desired monetary reform to cease. As Austrian economists, we fully understand and support the goal of full monetary freedom of the marketplace as that which best advances liberty, prosperity, and peace. The question becomes, how will we achieve it?

We believe that Germany is in a unique position to end the destructive forces of fiat monetary expansion that seem to gain new impetus every day. That is number one. Before we can have the perfect money, we must have a better money, and Germany is in a position to show us the way. All of us who desire liberty, prosperity, and peace should ask Germany to seize this opportunity to stop what surely will destroy free-market capitalism. By reinstating the deutsche mark and tying it to its vast gold holdings, Germany can be the catalyst that creates a cascade of similar virtuous acts that will lead eventually to full monetary freedom and all that that will bring.

Consider the likely consequences of the world's fourth-largest economy establishing a 100 percent gold-backed currency. This currency would dominate world trade, because all trading nations would desire to denominate their exchanges in the soundest money available. For a while at least, that would be the deutsche mark. Demand would drop for the currencies of all other nations unless and until these countries did the same thing. A virtuous cycle would ensue as first one then another country linked its currency to gold. The country with the most to lose would be the United States, whose dollar currently is preferred for international trade. But as demand increased first for the deutsche mark and later for the currencies of other nations who followed Germany's example, demand for the dollar would fall and prices would rise precipitously in the United States as countries no longer found it advantageous to hold dollars abroad. At this point, the United States would be forced to return to gold. In our opinion, nothing less will bring the world's superpower to its senses; i.e., the United States will not voluntarily adopt gold, because it benefits the most from the current inflationary system. However, if the major trading nations of the world adopt gold-backed currencies, even the United States will be forced by the market to do so.

But this is not the end. Once the peoples of the world see the advantages to using gold money, they will begin to understand that central banks are not required to perform the money function at all. Why couldn't Hong Kong Shanghai Bank, Citibank, Barclays, Deutsche Bank, or any of a number of well-respected international private banks do the same? These international banks are more nimble than any ossified government bank to meet the needs of business and finance. Furthermore, these international banks are more trustworthy than national central banks, which tend to operate in great secrecy in order to hide the risk they are taking with our money. Private banks would have to answer to stockholders employing their own independent auditors.

Consider how religious toleration arose in the West, first as an expediency by princes who vied for power with the Catholic Church. Different religions were established and protected by the state. But over time, religious tolerance came to be seen as a good in itself. Today we accept religious tolerance in the West as a universal given, yet it is a relatively recent phenomenon.

It is in this vein that we recommend that Germany end the tyranny of the inflationary euro and adopt a golden deutsche mark. Such a courageous yet self-protective action will lead to a U-turn in monetary policy, away from monetary destruction and toward better and better money everywhere.

The arguments by American critics of a gold standard all rest on this unstated presumption: The economic outcomes of policy decisions made by a committee of 12 salaried bureaucrats, 7 of whom were appointed by the president of the United States, and 5 of whom were appointed by the largest regional banks that own a majority of shares of the 12 regional Federal Reserve banks, are better for the nation than the decisions of millions of owners of gold coins, who seek their own interests.

This is the argument in favor of a salaried bureaucracy in place of the free market. It assumes the superior wisdom and superior public interest of a committee of academics (Board of Governors) and commercial banking agents (regional Fed bank presidents). The mainstream opponents of a gold standard never put it this way, but this is the inescapable implication of their opposition.

The only exceptions within the anti-gold special-interest group are the Greenbackers. They assume the following, and are willing to say so: The economic outcomes of policy decisions made by a congressional committee are superior for the nation to the decisions of millions of owners of gold coins, who seek their own interests.

But the Greenbackers refuse to admit that there is a second presumption: The decisions of this committee will be faithfully implemented under the authority of the Department of the Treasury, which is under the authority of the president, and whose employees are protected by civil-service rules against being fired.

Ultimately, this debate is between the logic of the free market as a social organization versus the logic of central planning. The battlefield is monetary theory and monetary policy.

There is one overwhelming reason why the mainstream media ridicule gold as an investment and also gold as a monetary standard. To buy gold is to vote against the Federal Reserve System.

These days, we read that "gold is too high, so don't buy it." Did even one of these supposed investment experts on gold publicly tell people to buy gold when it was under $300? Of course not. Bill Bonner of Agora Publishing did in 2000. I did in October of 2001, immediately after 9-11.

The mainstream-media experts are experts on when not to own gold: now. It is always now.

They complain that gold bugs are members of a religion. I accept this. Anti-gold bugs are members of a rival religion.

Gold bugs favor the religion of the free market. Anti-gold bugs favor the religion of central planning by means of central banking. The two camps have been at each other's throats for two centuries.

The anti-gold bugs have been dominant in academia for at least a century.

The anti-gold bugs have been dominant in financial journalism ever since 1933, when President Franklin Roosevelt unilaterally made gold illegal for Americans to own. He issued an executive order on April 5, 1933. He gave Americans until May 1 to turn in their gold at $20 an ounce. Anyone who refused and got caught risked a $10,000 fine (at least $170,000 in today's money) and a decade in jail. The text is here.

Then, to complete the heist, the government hiked the price of gold to $35: the Gold Reserve Act of January 30, 1934. The government pocketed the difference: an increase of 75 percent. "Tough luck, suckers!"

Only one man was prosecuted under the executive order. If he had not contested the EO in court, no one would ever have known. So, the fearful and/or trusting citizens who obeyed the EO lost. Everyone who ignored it made 75 percent on his investment. This was consistent with the first law of federal politics: "You play ball with us, and we'll smash you in the teeth with the bat."

That was the end of the gold-coin standard in the world. It had ended for Europe in the weeks after the outbreak of World War I in 1914. Commercial banks began to experience runs by depositors on the gold coins stored in their vaults on behalf of depositors. So, the banks defaulted. The governments allowed this, just as Washington had allowed it in 1861. The central banks then confiscated the commercial banks' gold. Only England restored the gold-coin standard after the War in 1925. Then it reneged again in 1931. That left only the United States. FDR ended that loophole in 1933.

The financial world today regards FDR's action in 1933 as irrelevant, but legitimate. It was neither. It was a violation of contract. It was a concentration of wealth. It was confiscatory. Above all, it was undemocratic in the most fundamental way. His action removed from the general population the authority to impose negative sanctions — gold runs — on the fractional-reserve-banking system and the federal government.

In political democracy, your party can get its way if it gets 50 percent plus one vote, and the counting is not rigged. You get one vote, but it is diluted.

In gold-coin currency democracy, where the government is not in the money business, you get as many votes as you have gold coins on deposit at a commercial bank. You can withdraw your coins or deposit new ones. Your vote counts for you 100 percent. There is no dilution of your vote.

If 10 percent of the depositors vote "no" by withdrawing gold coins, the bank must change its lending policies. It must reduce lending and build up coins in the vault. The process of withdrawing gold coins does not take 50 percent plus one for concerned depositors to get their way. The more fractionally reserved the bank, the fewer withdrawals that it takes to effect a change of lending policy: higher reserves, fewer loans.

The defenders of the Federal Reserve System want highly concentrated voting: a majority on the Federal Open Market Committee. This is 12 people. Seven are appointed by the president and must be confirmed by the Senate. After this, he has no authority over them. Five are members of the 12 regional, privately owned Federal Reserve Banks. One of the five is the president of the New York Fed, whose membership does not rotate.

Compare this arrangement with the US Supreme Court, which has nine members.

In theory, seven FOMC members and five justices run the United States of America. They determine policies. The FOMC determines monetary policy. It has a veto over the US government. The Supreme Court determines politics, justice, and almost everything else. It has a veto over Congress and the president.

The Court operates through the various executive bureaucracies. Its decisions can be resisted, but not overcome in the long run. The Court possesses legitimacy in the eyes of the voters. It will get its way.

The FOMC operates through commercial banks. But, when push comes to shove, seven people set policy. In theory, Congress or the president can tell the FOMC what to do. In practice, neither ever does this.

The independence of the Federal Reserve from the political system is hailed by defenders of democracy as necessary to reliable money. The independence of the Supreme Court from the political system is hailed by defenders of democracy as necessary to reliable laws.

In short, democracy is window dressing for elite control over the United States.

This is why control over the curriculum materials and methodology of a dozen law schools and a dozen business schools is the heart of rule by oligarchy.

In terms of the 6,000 people who shape policies internationally, control over two dozen universities in the world, most of which are in the United States, is basic to shaping the outlook of this elite. Read David Rothkopf's book, Superclass. About one-third of the 6,000 people who run the institutions that run the world attended one of these two dozen universities. If we take the top 40, about 50 percent of the elite attended.

I used Google to search for "independence" and "Federal Reserve System." The first page, which few people ever go beyond, are self-serving puff pieces by Federal Reserve Banks.

The bankers have been successful in persuading the people who discuss the issues of the day to defend the autonomy of the Fed from political interference. Typical is this article from CBS News (2009):

The hope is that an independent Fed can overcome the temptation to use monetary policy to influence elections, and also overcome the temptation to monetize the debt, and that it will do what's best for the economy in the long-run rather than adopting the policy that maximizes the chances of politicians being reelected.

Another example comes from Forbes, a major business magazine:

So before we rush to tampering with the Fed's independence, let's review why it is important. The answer is fairly simple. An independent central bank can focus on monetary policies for the long term; that is, policies targeting low and stable inflation and a monetary climate that promotes long-term economic growth. Political cycles, alas, are considerably shorter. Without independence from the political cycle the central bank would be subject to political pressures, which in turn would impart an inflationary bias to monetary policy. In this area politicians in a democratic society are shortsighted because they are driven by the need to win their next election. This is supported by empirical evidence. A politically insulated central bank is more likely to be concerned with long-run objectives.

A variant of the argument for central bank independence is that control of monetary policy is far too important to be put in the hands of politicians. As a group they have repeatedly demonstrated the lack of political will to make difficult economic decisions. But now they want to assert control over the Fed.

If you were to substitute almost any other special-interest group, conventional opinion would be outraged. Add the group to this sentence: "A variant of the argument for central bank independence is that control of [military, health, business, etc.] policy is far too important to be put in the hands of politicians." The main exceptions: law and education, where the elite control certification.

When the public had access to gold coins prior to 1914, individuals controlled banking policy. They also controlled government fiscal policy. They could take their coins out of commercial banks if they did not approve of government policy. This is why national governments annul or restrict gold-coin redeemability whenever a major war breaks out. They do not want to face the citizens' veto.

With the repudiation of any gold-coin standard since 1914, citizens no longer understand the case for a gold-coin currency. They do not understand that widespread gold ownership was the number one restraining factor on the expansion of state power in the economy. The uncoordinated individual decisions of millions of people could overturn any government policy that required central bank inflation to fund it. The politicians resented this. So did the central bankers.

The politicians were under restraints: golden handcuffs. They decided that it was better to turn the money-creation power over to the bankers. The central bankers promised to buy government bonds at low rates: lender of last resort. This made the central bank the counterfeiter of last resort.

Politicians do not take the step of putting money-creation under the federal government. They could, but they don't. This is the Greenbackers' solution. They have failed to persuade the Congress ever since 1863, when Lincoln allowed the issuing of fiat money by the Treasury, but promised to veto any further rounds of monetary inflation.

Who will hold the hammer? Who will veto decisions by the federal government? The answer used to be twofold: the gold-coin standard and the jury system. The intelligentsia has been successful in undermining the first. It has tried to do the second, with judges instructing juries that they can decide only the violation of a law, not the lawfulness of the law itself. It has been less successful in this than in its war on gold.

The issue that divides the anti-gold bugs from the gold bugs is simple to state. The gold-coin standard places monetary authority in the hands of millions of economic participants who own gold. The gold bugs favor this. The anti-gold bugs oppose it.

The rival camps are divided by rival systems of economic sovereignty. The gold bugs favor the sovereignty of the free market. The anti-gold bugs favor the sovereignty of the banking cartel, which is the joint creation of the federal government (Federal Reserve) and the states (state bank licensing).

This is a replay of the arguments of Adam Smith against the arguments of the mercantilists. It is the logic of widespread, decentralized private ownership and voluntary contract versus the logic of government licensing, barriers to entry, and the legal right to counterfeit money.

The anti-gold bugs do not want to put it this way. This is why gold bugs should always put it this way.

A prerequisite to market acceptance of any gold money would be confidence in the integrity of the sponsoring institution. Not only is the Bundesbank known for its integrity and reverence for stable money; Germany itself has a worldwide reputation for the rule of law, advanced financial architecture, and a stable political system. For these reasons, Germany would prove to the world that a gold-backed money is not only possible but desirable. (emphasis added)

Joe Salerno, in "Gold Standards: True and False," provides some sound guidance on discussion of a return to gold. What is ultimately desired is a return to a market-chosen money, which has historically been a commodity — gold or silver money, not a gold- or silver-"backed" money. Salerno's caution continues to be relevant. He argues,

A significant development in the current controversy over the role of gold in the U.S. monetary system, which has potentially important implications for both monetary theory and policy, has gone largely unnoticed by commentators on both sides of the debate. I am referring to the emergence of a new defense of gold that differs fundamentally from the traditional case for the gold standard. This development has been obscured by the diversity of plans for monetary reform coming out of the pro-gold camp. A close examination of these proposals, however, reveals that they are of two distinct types; they differ not only in the reasons they offer for considering a gold standard desirable, but also in their conception of what monetary arrangements constitute a "gold standard."

First, there are the proposals that embody the traditional "hard money" arguments for the gold standard. These arguments focus on the desirability of a free-market commodity money vis-à-vis a government-monopolized paper fiat money. The basic thrust of the hard money proposals is to render government monetary policy superfluous by restoring a genuine gold standard under which the quantity and value of money is determined solely by market forces. The second group of pro-gold writers, whose proposals have received the most publicity, have eschewed the traditional hard-money case for gold and in its stead constructed a quite novel case purporting to demonstrate that gold can provide government monetary authorities with an effective instrument for managing the money-supply process within the established fiat-money framework. For this group, the raison d'être of a gold-based monetary regime is that it facilitates the achievement of government monetary policy objectives. Needless to say, the gold standard envisioned by these policy-oriented advocates differs quite radically from the ideal of the hard-money group. The gold "price rule," which is the monetary reform favored by most policy-oriented gold advocates, bears only a superficial resemblance to the traditional conception of the gold standard. (emphasis added)

Given Professor Salerno's careful differentiation of proposed gold standards as either true or false standards, one must be careful when evaluating any proposal for a return to gold. Questions of concern:

Will the proposal, in the short run, be a better monetary system with better monetary policy than the current system of nationalized (or "continentalized," in the case of the euro) fiat moneys?

Is the proposal one that will move the system over time to a true gold standard — a gold-coin standard?

Will the proposal become like the interwar gold-exchange standard, a false standard that will likely lead to economic results that will discredit gold (and/or silver) as money?

Salerno's comments are equally applicable to other current discussions concerning gold that have recently appeared in the Wall Street Journal. Seth Lipsky, in "The Gold Standard Goes Mainstream," points out that, as a result of Ron Paul's influence, "In the ferment within today's Republican Party, there's a growing realization that America's system of fiat money is part of the economic problem." He concludes,

It is no small thing that Mr. Romney's platform calls for a gold commission and an audit of the Fed. The last Republican to run on a platform calling for a dollar "on a fully convertible gold basis" was Dwight Eisenhower, who cast the promise aside once in office. That's a strategic misstep for Mr. Romney, should he win in November. (emphasis added)

In a critique of a return to gold, John H. Cochrane of the University of Chicago concludes, "No monetary system can absolve a nation of its fiscal sins."

Ron Paul, in "Why Monetary Freedom Matters," reinforces Salerno's caution on true reform, a market determined money, versus reforms, that while perhaps better than a "false trust in fiat money" will leave too many opportunities for monetary mischief. Paul states, "As far back as the Gold Commission (1982), I've made the case for gold." But he wouldn't close down the central bank: he would legalize competition in currencies, repeal legal-tender laws, and eliminate all taxes on silver or gold purchases, and allow private mints. In essence, his proposal is

similar to what F. A. Hayek (1976, 1978) had talked about. Why don't we denationalize money, legalize competition, allow free markets to work, and allow free-market banking to work?

Armed with Salerno's strong case for a true gold standard, you be the judge. In my judgment, Ron Paul is on the right track; Cochrane is misdirected by false gold standards; and Barron and Bloom's proposal, while attractive in the short run, is (if not accompanied by Paul's suggested reforms in the United States and elsewhere) most likely a step in the wrong direction.

Advocates of sound money should be heartened by the interest currently being generated for monetary reform. Discussion should be guided with a few things in mind:

Gerald P. O'Driscoll Jr.'s concerns about abolishing central banks,See " Central Banks: Abolish or Reform." HT to Kurt Schuler at Free Banking.

Salerno's gold standard: true or false, and

Paul's caveat that

Others are thinking about it [monetary reform], but some of them would like to internationalize something different than the dollar reserve standard. They would like to have another fiat currency and a pretend alliance with gold — and they want to move control over a new global currency into the IMF and the World Bank. I think that would be a disaster. (emphasis added)

Let's hope Lipsky's optimism concerning a gold commission becomes a reality where a "well-conceived and well-staffed gold commission" (preferably one dominated by Austrian-influenced economists) actually sorts out the issues in favor of competition in currency and an evolution toward a gold-coin standard à la the outline provided by Paul.

Recorded on Friday, 14 September 2012, at the Metropolitan Club in New York City.

The European System of Central Banks (ESCB) consists of one central bank, the European Central Bank (ECB), and the national central banks of the EMU, all of which are still extant within their own sovereign nations. Although the ECB is prohibited by treaty from monetizing the debt of its sovereign members via outright purchases of their debt, it has interpreted this limitation on its power not to include lending euros to the national central banks taking the very same sovereign debt as collateral. Of course this is simply a backdoor method to circumvent the very limitation that was insisted on when the more responsible members such as Germany joined the European Monetary Union.

When the ECB was first formed around the turn of the new millennium, the bond markets assumed that it would be operated along the lines of the German central bank, the Bundesbank, which ran probably the least inflationary monetary system in the developed world. However, they also assumed that the EMU would not allow one of its members to default on its sovereign debt. Therefore, the interest rate for many members of the EMU fell to German levels. Unfortunately, many nations in the EMU did not use this lower interest rate as an opportunity to reduce their budgets; rather, many simply borrowed more. Thus was born the euro debt crisis, when it became clear to the bond market that debt repayment by many members of the EMU was questionable. Interest rates for these nations soared.

Over the past few years the European Union itself has established several bailout funds, but the situation has not been resolved. In fact, things are even worse, for it now appears that even larger members of the EMU succumbed to the debt orgy and may need a bailout to avoid default. Thus we have arrived at the point predicted by Dr. Bagus in which the euro has been plundered by multiple parties and the pot is empty. The ECB and many sovereign members of the EMU want unlimited bond buying of sovereign debt by the ECB. Only Germany opposes this plan, but it is the lone voice against this new bout of monetary inflation.

In 1923 Germany experienced one of the world's worst cases of hyperinflation and the worst ever for an industrialized nation. The reichsmark was destroyed by its own central bank, plunging the German people into misery and desperation. Now, after only a dozen years of relative monetary discipline, the euro faces the same fate as country after country demands to be bailed out of its mounting debts by unlimited printing of money by the ECB. Because Germany is part of the EMU, it must accept these newly printed euros. This threatened monetary inflation of unlimited amounts has shaken German bankers to the core. It is the nightmare scenario that they feared when, against their better judgment, the German politicians agreed to give up their beloved deutsche mark and place the economic fate of the nation in the hands of a committee of foreigners not as concerned about monetary inflation. But Germany can put a stop to this destruction and save the world while it saves itself. It can leave the EMU, reinstate the deutsche mark, and tie it to gold.

Despite the haughty pronouncements of EU officials, there is nothing that can stop a sovereign country from leaving the EMU and adopting a different monetary system. The most likely scenario would be a one-for-one redenomination of German banks' euro-denominated accounts for deutsche marks. Thereafter, the DM would float freely in currency markets in the same way as British pounds and American dollars. The Bundesbank would be responsible for monetary policy just as it was before Germany joined the EMU. By leaving the EMU Germany would insulate itself from the consequences of the euro as a tragedy of the commons; i.e., monetary inflation by third parties would end, Germany would not experience higher prices due to the actions of third parties, and the capital-destroying transfers of wealth would end.

Yet Germany should go one step further. It should anchor the DM to gold. Germany is the world's fourth-largest economy, behind only the United States, China, and Japan. Furthermore, Germany owns more of the world's gold than any other entity except the United States, more than either China or Japan and more than any other European country. A prerequisite to market acceptance of any gold money would be confidence in the integrity of the sponsoring institution. Not only is the Bundesbank known for its integrity and reverence for stable money; Germany itself has a worldwide reputation for the rule of law, advanced financial architecture, and a stable political system. For these reasons, Germany would prove to the world that a gold-backed money is not only possible but desirable. Expect a cascade of similar pronouncements once Germany's trading partners realize the importance of settling international financial transactions in the best money available — which initially at least would be a golden DM.

Of course the beneficial consequences of tying money to gold go beyond ending price inflation and capital-destroying wealth transfers. We can expect all the beneficial consequences of a return to limited government, for government could no longer fund itself through the unholy alliance with an inflationary central bank that creates fiat money in order to monetize government's profligate spending. The people would no longer be so subservient to government, pleading and begging for special interests at the expense of the rest of society, for government would be forced to go to the people for approval to increase its budget. The list of benefits goes on and on. Suffice it to say that it all begins with truly sound money, money anchored in gold. Germany can lead the way and earn the just respect of a grateful world. It is in the right place at the right moment in history. It should seize the moment!

I think it would be a useful exercise to go through Mr. Weldon's case against gold. Clearly, he expects people to take it seriously. While I cannot bring myself to do this, having actually read it, I do think some editor at the Guardian took it seriously, even though he also read it.

He begins with a historical statement.

Ever since Richard Nixon ended the convertibility of the US dollar into gold in 1971, there have been calls for a return to some form of gold standard. Proponents of this view, often known as "gold bugs", want to see an end to paper money guaranteed by promises and for currencies to once more be backed by precious metal. In the last few years as central banks around the world have engaged in quantitative easing to try and support their economies these voices have become louder.

This is surely comforting to any gold bug who is old enough to remember Nixon's announcement, made when Mr. Weldon's parents were teenagers. At the time, the number of gold bugs was limited to a handful of Austrian School economists and a few elderly souls who could actually remember the pre-1933 American gold-coin standard.

Over the next decade, the "hard money" newsletter industry blossomed in the United States, but the number of gold bugs who had access to the mainstream media was still not much larger than a few dozen people. I may be exaggerating these numbers. I cannot think of any gold bug in a professorial position in Great Britain.

Having misled the readers regarding the size and influence of the gold standard's acolytes, he gets rolling.

The specific appeal of gold can be hard to rationalise: it might be aesthetically pleasing, but does that make it a sound basis for a monetary system?

I see. Aesthetically pleasing. It's a matter of taste. Nothing substantive, you understand.

Note: as a debater for over 50 years, I recognize this tactic. When a debater indulges in the rhetoric of contempt in his opening arguments, we can be sure of three things: (1) he thinks he has the judges on his side; (2) he has not got a strong substantive case; (3) he thinks his opponent has only recently fallen off the proverbial turnip truck.

Sometimes I wonder if gold bugs just listened to too much Spandau Ballet in the 1980s.

I cannot say that I am familiar with the Spandau Ballet. Wikipedia informs us that it was a popular rock band in Great Britain. What it has to do with gold eludes me. The phrase "too clever by half" comes to mind.

Robert Skidelsky argued that supporters of the gold standard have an almost atavistic belief in its powers, rooted in the age-old worship of sun gods.

I am quite familiar with Skidelsky's work. He is an economist-turned hagiographer. Of his eleven books listed in his Wikipedia entry, five are on Keynes. None is on any aspect of economic theory, including monetary theory.

So far, in his first two paragraphs, Mr. Weldon has used three examples of rhetorical contempt, but no substance.

This strategy plays well in the debate societies at Oxford and Cambridge, but it does not play well across the English Channel, let alone across the Atlantic. Mr. Weldon is clearly uninterested in any audience beyond Oxbridge and the Labor Party.

Here, he identifies the enemy position of all Keynesians.

What they tend to ignore is that the world has tried the gold standard before and it was, in most respects, a disaster.

Here is a statement. It is a conclusion. It is not an argument.

The world tried the international gold standard from 1815 until the outbreak of World War I 1914, which was the greatest period of economic growth in recorded history. The world of 1900 would have been unrecognizable in its wealth for the masses by someone getting out of a time machine activated in 1800.

At present, as the economy grows and produces more goods the central bank can expand the money supply to keep up with output. Under the gold standard, as output increases, the money supply will be fixed and with more goods but the same amount of money, prices will tend to fall.

So, prices tend to fall under the gold standard. The horror! Why, the whole consumer price index would begin to resemble the cost of computing: ever less expensive.

We must understand Mr. Weldon's argument in the light of economic theory and economic history since 1800. Economic theory teaches that economic growth reduces the effects of scarcity. A world without scarcity would be a world where demand and supply balance at zero price. Therefore, when there is economic growth, we should expect to see a world in which consumer prices are falling in the direction of zero prices. The gold standard fostered a world which conforms to the traditional call of economists, who preach the doctrine of salvation by economic growth.

Mr. Weldon is appalled by such a conclusion. Why? Because it points to a very great advantage of the traditional gold standard: reduced consumer prices. So, he invokes falling prices as evidence of the gold-coin standard's disaster. He therefore implicitly invokes the good old days: greater scarcity, greater poverty, and the all-round economic misery, a la 1800.

I am not using the rhetoric of contempt — yet. This really is the logic of his position.

He continues.

Falling prices might sound like a good thing, and in individual cases they often are, but a falling general price level is usually associated with severe economic strains. Why buy anything today if it will be cheaper next week? The end result tends to be falling output, rising unemployment, falling wages and a large increase in the real burden of debt.

When he says "usually," he means usually since the end of World War I, in which the gold-coin standard was abandoned in the West, except in the United States and the United Kingdom, 1925 to 1911, when Winston Churchill unwisely reestablished the gold standard at the prewar price, ignoring a decade of mass inflation. He did this for political reasons. The fake exchange rate maintained the convenient illusion: the fact that the men — he and his colleagues — who had taken the nation into that disastrous war and then had destroyed the prewar pound sterling as an effect of their financing of the War through currency expansion had not in fact ruined the pound.

Most economists now accept that both the Long Depression of 1873 to 1896 and the Great Depression of the 1930s were aggravated by the gold standard. In the 1930s the sooner countries came off gold, the faster they recovered.

The period of 1873 to 1896 was the single most productive economic period of comparable length in mankind's history. In the section of Friedman and Schwartz's book, A Monetary History of the United States (1963), which the Keynesian economics guild never cites, they proved this with respect to the economic statistics of the United States.

As for economic recovery after 1930, the main nation to recover was Nazi Germany, which used monetary inflation, price and wage controls, rationing, and violence against trade unions as the primary policy tools of economic growth. The Nazi state held down nominal prices by the threat of violence, thereby cutting real wages, so the statistics looked like recovery. The story of this "recovery" is found in Adam Tooze's book, The Wages of Destruction.

Here, he raises the issue of democracy.

A gold standard means that monetary policy and interest rates are set to defend the value of a currency against a metal rather than to reflect economic conditions in the country. As professor Dani Rodrik argued last night, this is fundamentally undemocratic.

Here, we get to the political heart of the debate. The traditional gold-coin standard transfers power over monetary policy to the broad mass of citizens, who can start a run on the banks at any time if they suspect that the central bank — highly undemocratic — is turning to inflation as a way to fund the government's debt. It is the democracy of the free market, and the democrats of the ballot box despise this aspect of the free market. They want monetary policy controlled by an alliance of central bankers, commercial bankers, and politicians, who all want to run larger national government deficits without raising interest rates.

The opponents of the gold standard are always defenders of the autonomy of central banks from politics. This argument is correct. These banks are indeed autonomous, or close to it. The central bank is the most undemocratic official government institution in every nation. Calling for the insulation of the central bank from politics is politically comparable to calling for the secret police to be independent from politics, except that the secret police only threaten a few thousand people. The central bank's policies threaten the nation.

Indeed the real reason that the gold standard could not be resurrected in a sustainable manner after its suspension the first world war was the extension of the franchise to incorporate the working class. Once workers had the vote they were unlikely to support politicians who continually put defending the value of money against gold over defending the number of people in work.

The working class, through its ownership of gold coins, and its ability to cause a run on the banks by withdrawing their money in small gold coins, was in fact disenfranchised economically after World War I began. They refused to return to the prewar gold-coin standard in 1918. Politicians and bankers did not want to transfer this power back to the masses. Once the central banks in every nation stole the gold from commercial banks, who had stolen the gold coins of the depositors by breaking the contracts of full gold-coin redemption on demand, the political elite never again let the masses have their coins.

The central bankers have long hired bright young economics graduates of Cambridge and Oxford to persuade the middle classes that fiat money creation by a politically independent central bank was just what the nation needed. The central bankers did the same in every Western nation.

Of course the gold standard had its beneficiaries, most notably in the financial sector. Stable international prices and a very open global capital market in the era of the classical gold standard created a great environment for international bankers.

Here, he reverses historical causation. It was the banking establishment that opposed the reestablishment of a gold-coin standard. Why? Because it reduces the ability of the financial community to make massive profits through fractional reserves. Fractional reserves provide the leverage that makes large commercial bankers rich. This is why there is no such thing as a commercial bank that has publicly promoted the gold standard. The last major economist to be employed by a large commercial bank to write in favor of the gold standard was Benjamin Anderson. Chase let him write its newsletter. He left Chase and returned to teaching before the outbreak of World War II.

Economically, the case for the gold standard simply does not stack up and yet it still finds very vocal supporters. Fundamentally the case is political rather than financial. Gold bugs want to see golden handcuffs restraining the ability of central banks to intervene and states to spend, they want to remove any vestige of political control of the monetary system and fix it an arbitrarily chosen shiny metal in order to let free market forces take over. It is therefore no surprise that most gold bugs are to be found on the libertarian right.

Here, he finally gets to the truth. The issue is indeed deeply political. Gold bugs do indeed want to see golden handcuffs that restrain the ability of central banks to inflate. They want to substitute economic control by the masses who own gold coins for political control by an elite. So, gold bugs are usually found on the libertarian Right.

Mr. Weldon is part of a long and distinguished tradition of economists who spend their lives at the feet of central bankers, doing their ideological work for the bankers in exchange for a few scraps that fall from the table.

If you detect the rhetoric of contempt creeping in, you are pretty observant.

These men have baptized the state and the power of monetary debasement as the way of wealth.

Every political class needs its court prophets. Every banking establishment needs politicians who do their bidding. Young men who are not good in physics or chemistry or engineering see their career opportunities at Oxford and Cambridge. They major in economics. The smart ones become bankers. The less smart ones become economists.

The ones who are not smart enough to major in economics major in politics and become politicians.

The bankers hire the economists to tell the politicians what to think.

The economics graduates who are not good enough to get hired by the big banks go into financial journalism.

This article originally appeared on LewRockwell.com, August 9, 2012.

The Austrian School advocates against price fixing and economic planning, and the Austrian School advocates a gold standard, which can be seen as a way of fixing the rate of change of the size of the money supply through economic planning.

While it's true that many Austrian economists (Mises, Rothbard, Hayek, etc.) write in reference to gold as money and use such definitions in their thought constructs, the context of their writing must first be understood. The majority of the dominant Austrian economic literature today was composed at a time when gold was still considered money in some aspects of the global economy. It was only after 1971 — when Richard Nixon took the United States off the gold standard (not a true gold standard, but bear with me) completely, thus shattering the Bretton Woods agreement — that the transformation of the dollar into a full fiat currency backed only by the "full faith and credit of the United States" was complete. The "full faith and credit" of course refers to the government's ability to pillage its citizens of their earned wealth.

So many times when Mises or Rothbard refer to money as gold, it's because an international gold standard, albeit an incredibly flawed one, was still in operation at the time of most of their writings.

As far as Austrians advocating a return to a gold standard goes, this is an often misinterpreted position. Austrians recognize the efficiencies and wealth-generating ability of the uninhibited market. They are wary of government intervention, which interferes in the process of billions of remunerated individual transactions en masse that encompasses a market economy. Austrians merely wish to extend their laissez-faire views to the creation and sale of a specific commodity: money.

Rothbard, writing in The Case for a Genuine Gold Dollar, summarizes what such a standpoint would mean:

The best known proposal to separate money from the state is that of F.A. Hayek and his followers. Hayek's "denationalization of money" would eliminate legal tender laws, and allow every individual and organization to issue its own currency, as paper tickets with its own names and marks attached. The central government would retain its monopoly over the dollar, or franc, but other institutions would be allowed to compete in the money creation business by offering their own brand name currencies. Thus, Hayek would be able to print Hayeks, the present author to issue Rothbards, and so on. Mixed in with Hayek's suggested legal change is an entrepreneurial scheme by which a Hayek-inspired bank would issue "ducats," which would be issued in such a way as to keep prices in terms' of ducats constant. Hayek is confident that his ducat would easily out- compete the inflated dollar, pound, mark, or whatever.

Market competition vets out the inefficiencies of lackluster firms while improving the quality and lowering the price of whatever good or service is produced. Extending this outcome to the sphere of currency production would generate the same results, because those currencies that are perceived as low in value or purchasing power would fail to garner widespread use. Prices are only ever determined by consumer valuation; this is no different when applied to currency and its purchasing power.

If I were to obtain a printing press and begin producing sheets of "James E. Millers" and then attempted to pass them off as currency, no one outside of a few naïve children would likely accept them as money. The promise of value from a lone seller is normally not sufficient for the universal acceptance of a medium of exchange. Money acts best to facilitate transactions when it holds a few specific qualities: it's recognizable, easily divisible, and durable. This is why gold, which holds all of the listed qualities, was historically used as a currency for thousands of years. When Austrians advocate a return to a gold standard, there is an implicit assumption that if legal-tender laws, capital-gains taxes on alternative currencies, and the requirement that taxes in general be paid in dollars (or whatever country's respective currency) are abolished, gold would most likely make a roaring return as a universally accepted medium of exchange.

Gold's historical use also explains why it acts as a hedge against profligate government spending and currency debasement. See the past ten years alone in the United States:

Austrians are not on the side of government enforcement of a gold standard outside of basic contract enforcement. As Gary North puts it, "whenever governments enter the money business, the public should expect monkey business." The government must relinquish itself from all monetary control as such inevitably leads to indirect public-debt monetization, perpetual inflation, the boom-and-bust business cycle, and banking-sector cartelization. The free market — meaning the decentralized actions of millions — must dictate how currency develops to prevent the mentioned abuses.

In short, the Austrian position is that people can use whatever commodity they desire as money. However, an archaic system of multiple types of money (think chickens, cattle, eggs, butter, grains, cigarettes, pebbles, seashells, etc.) isn't the best way to foster a dynamic and encompassing economy. This is why a universal good, such as gold or silver, ends up emerging as a widely accepted medium. Government interference or acquisition of this process distorts a once-democratic market process in favor of a coercive system that enriches a few at the expense of the general public.

Our hypocrisy-asserting anonymous blogger quotes Warren Buffett:

[Gold] gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.

But what Mr. Buffett must ask himself is if gold really has no utility, why is it dug up in the first place? Are gold miners nothing more than mindless drones infatuated with the metal's shiny luster? I think we can agree that this is not the case, for man acts with purpose — the purpose of gold mining being that gold itself is accepted as valuable.

Opponents of the gold standard fail to understand several things: what money really is, the danger in state control over money, and how the market process is capable of creating a sustainable monetary system. This is why they come up with illogical claims such as Mr. Buffett's. For those who derive a great deal of their income by influencing government policy, they want nothing more than to prevent and marginalize the return of a true gold standard.

All of the above theoretical analysis yields the conclusion that the current monetary and banking system is incompatible with a true free-enterprise economy, that it contains all of the defects identified by the theorem of the impossibility of socialism, and that it is a continual source of financial instability and economic disturbances. Hence, it becomes indispensable to profoundly redesign the world financial and monetary system, to get to the root of the problems that beset us and to solve them. This undertaking should rest on the following three reforms:

the reestablishment of a 100 percent reserve requirement as an essential principle of private-property rights with respect to every demand deposit of money and its equivalents;

the abolition of all central banks (which become unnecessary as lenders of last resort if reform 1 above is implemented, and which as true financial central-planning agencies are a constant source of instability) and the revocation of legal-tender laws and the always-changing tangle of government regulations that derive from them; and

a return to a classic gold standard, as the only world monetary standard that would provide a money supply that public authorities could not manipulate and that could restrict and discipline the inflationary yearnings of the different economic agents.[2]

As we have stated, the above prescriptions would enable us to solve all our problems at the root, while fostering sustainable economic and social development the likes of which have never been seen in history. Furthermore, these measures can both indicate which incremental reforms would be a step in the right direction, and permit a more sound judgment about the different economic-policy alternatives in the real world. It is from this strictly circumstantial and possibilistic perspective alone that the reader should view the Austrian analysis in relative "support" of the euro that we aim to develop in the present paper.

Traditionally, members of the Austrian School of economics have felt that as long as the ideal monetary system is not achieved, many economists, especially those of the Chicago School, commit a grave error of economic theory and political praxis when they defend flexible exchange rates in a context of monetary nationalism, as if both were somehow more suited to a market economy. In contrast, Austrians believe that until central banks are abolished and the classic gold standard is reestablished along with a 100 percent reserve requirement in banking, we must make every attempt to bring the existing monetary system closer to the ideal, both in terms of its operation and its results. This means limiting monetary nationalism as far as possible, eliminating the possibility that each country could develop its own monetary policy, and restricting inflationary policies of credit expansion as much as we can, by creating a monetary framework that disciplines as far as possible economic, political, and social agents, and especially labor unions and other pressure groups, politicians, and central banks.

It is only in this context that we should interpret the position of such eminent Austrian economists (and distinguished members of the Mont Pèlerin Society) as Mises and Hayek. For example, there is the remarkable and devastating analysis against monetary nationalism and flexible exchange rates that Hayek began to develop in 1937 in his particularly outstanding book Monetary Nationalism and International Stability.[3] In this book, Hayek demonstrates that flexible exchange rates preclude an efficient allocation of resources on an international level, as they immediately hinder and distort real flows of consumption and investment. Moreover, they make it inevitable that the necessary real downward adjustments in costs take place via a rise in all other nominal prices, in a chaotic environment of competitive devaluations, credit expansion, and inflation, which also encourages and supports all sorts of irresponsible behaviors from unions by inciting continual wage and labor demands that can only be satisfied without increasing unemployment if inflation is pushed up even further.

Thirty-eight years later, in 1975, Hayek summarized his argument as follows:

It is, I believe, undeniable that the demand for flexible rates of exchange originated wholly from countries such as Great Britain, some of whose economists wanted a wider margin for inflationary expansion (called "full employment policy"). They later received support, unfortunately, from other economists[4] who were not inspired by the desire for inflation, but who seem to have overlooked the strongest argument in favor of fixed rates of exchange, that they constitute the practically irreplaceable curb we need to compel the politicians, and the monetary authorities responsible to them, to maintain a stable currency. (emphasis added)

To clarify his argument yet further, Hayek adds,

The maintenance of the value of money and the avoidance of inflation constantly demand from the politician highly unpopular measures. Only by showing that government is compelled to take these measures can the politician justify them to people adversely affected. So long as the preservation of the external value of the national currency is regarded as an indisputable necessity, as it is with fixed exchange rates, politicians can resist the constant demands for cheaper credits, for avoidance of a rise in interest rates, for more expenditure on "public works," and so on. With fixed exchange rates, a fall in the foreign value of the currency, or an outflow of gold or foreign exchange reserves acts as a signal requiring prompt government action.[5] With flexible exchange rates, the effect of an increase in the quantity of money on the internal price level is much too slow to be generally apparent or to be charged to those ultimately responsible for it. Moreover, the inflation of prices is usually preceded by a welcome increase in employment; it may therefore even be welcomed because its harmful effects are not visible until later.

Hayek concludes,

I do not believe we shall regain a system of international stability without returning to a system of fixed exchange rates, which imposes on the national central banks the restraint essential for successfully resisting the pressure of the advocates of inflation in their countries — usually including ministers of finance. (Hayek 1979 [1975], pp. 9–10)

With respect to Ludwig von Mises, it is well known that he distanced himself from his valued disciple Fritz Machlup when in 1961 Machlup began to defend flexible exchange rates in the Mont Pèlerin Society. In fact, according to R.M. Hartwell, who was the official historian of the Mont Pèlerin Society, "Machlup's support of floating exchange rates led von Mises to not speak to him for something like three years" (Hartwell 1995, 119). Mises could understand how macroeconomists with no academic training in capital theory, like Friedman and his Chicago colleagues, and also Keynesians in general, could defend flexible rates and the inflationism invariably implicit in them, but he was not willing to overlook the error of someone who, like Machlup, had been his disciple and therefore really knew about economics, and yet allowed himself to be carried away by the pragmatism and passing fashions of political correctness. Indeed, Mises even remarked to his wife on the reason he was unable to forgive Machlup: "He was in my seminar in Vienna; he understands everything. He knows more than most of them and he knows exactly what he is doing" (Margit von Mises 1984, 146).

Mises's defense of fixed exchange rates parallels his defense of the gold standard as the ideal monetary system on an international level. For instance, in 1944, in his book Omnipotent Government, Mises wrote,

The gold standard put a check on governmental plans for easy money. It was impossible to indulge in credit expansion and yet cling to the gold parity permanently fixed by law. Governments had to choose between the gold standard and their — in the long run disastrous — policy of credit expansion. The gold standard did not collapse. The governments destroyed it. It was incompatible with etatism as was free trade. The various governments went off the gold standard because they were eager to make domestic prices and wages rise above the world market level, and because they wanted to stimulate exports and to hinder imports. Stability of foreign exchange rates was in their eyes a mischief, not a blessing. Such is the essence of the monetary teachings of Lord Keynes. The Keynesian School passionately advocates instability of foreign exchange rates.[6] (emphasis added)

Furthermore, it comes as no surprise that Mises scorned the Chicago theorists when in this area, as in others, they ended up falling into the trap of the crudest Keynesianism. In addition, Mises maintained that it would be relatively simple to reestablish the gold standard and return to fixed exchange rates: "The only condition required is the abandonment of an easy money policy and of the endeavors to combat imports by devaluation."

Moreover, Mises held that only fixed exchange rates are compatible with a genuine democracy, and that the inflationism behind flexible exchange rates is essentially antidemocratic:

Inflation is essentially antidemocratic. Democratic control is budgetary control. The government has but one source of revenue — taxes. No taxation is legal without parliamentary consent. But if the government has other sources of income it can free itself from their control. (Mises 1969, pp. 251–253)

Only when exchange rates are fixed are governments obliged to tell citizens the truth. Hence, the temptation to rely on inflation and flexible rates to avoid the political cost of unpopular tax increases is so strong and so destructive. So, even if there is not a gold standard, fixed rates restrict and discipline the arbitrariness of politicians:

Even in the absence of a pure gold standard, fixed exchange rates provide some insurance against inflation which is not forthcoming from the flexible system. Under fixity, if one country inflates, it falls victim to a balance of payment crisis. If and when it runs out of foreign exchange holdings, it must devalue, a relatively difficult process, fraught with danger for the political leaders involved. Under flexibility, in contrast, inflation brings about no balance of payment crisis, nor any need for a politically embarrassing devaluation. Instead, there is a relatively painless depreciation of the home (or inflationary) currency against its foreign counterparts. (Block 1999, p. 19, emphasis added)

As we have seen, Austrian economists defend the gold standard because it curbs and limits the arbitrary decisions of politicians and authorities. It disciplines the behavior of all the agents who participate in the democratic process. It promotes moral habits of human behavior. In short, it checks lies and demagoguery; it facilitates and spreads transparency and truth in social relationships. No more and no less. Perhaps Ludwig von Mises said it best:

The gold standard makes the determination of money's purchasing power independent of the changing ambitions and doctrines of political parties and pressure groups. This is not a defect of the gold standard, it is its main excellence. (Mises 1966, p. 474)

The introduction of the euro in 1999 and its culmination beginning in 2002 meant the disappearance of monetary nationalism and flexible exchange rates in most of continental Europe. Later we will consider the errors committed by the European Central Bank (ECB). Now what interests us is to note that the different member states of the monetary union completely relinquished and lost their monetary autonomy, that is, the possibility of manipulating their local currency by placing it at the service of the political needs of the moment. In this sense, at least with respect to the countries in the eurozone, the euro began to act and continues to act very much like the gold standard did in its day. Thus, we must view the euro as a clear, true, even if imperfect, step toward the gold standard.

Moreover, the arrival of the Great Recession of 2008 has even further revealed to everyone the disciplinary nature of the euro: for the first time, the countries of the monetary union have had to face a deep economic recession without monetary-policy autonomy. Up until the adoption of the euro, when a crisis hit, governments and central banks invariably acted in the same way: they injected all the necessary liquidity, allowed the local currency to float downward and depreciated it, and indefinitely postponed the painful structural reforms that where needed and that involve economic liberalization, deregulation, increased flexibility in prices and markets (especially the labor market), a reduction in public spending, and the withdrawal and dismantling of union power and the welfare state. With the euro, despite all the errors, weaknesses, and concessions we will discuss later, this type of irresponsible behavior and forward escape has no longer been possible.

For instance, in Spain, in just one year, two consecutive governments have been forced to take a series of measures that, though still quite insufficient, up to now would have been labeled as politically impossible and utopian, even by the most optimistic observers:

article 135 of the Spanish Constitution has been amended to include the anti-Keynesian principle of budget stability and equilibrium for the central government, the autonomous communities, and the municipalities;

all of the projects that imply increases in public spending, vote purchasing, and subsidies, projects on which politicians regularly based their action and popularity, have been suddenly suspended;

the salaries of all public servants have been reduced by 5 percent and then frozen, while their work schedule has been expanded;

social-security pensions have been frozen de facto;

the standard retirement age has been raised across the board from 65 to 67;

the total budgeted public expenditure has decreased by over 15 percent; and

significant liberalization has occurred in the labor market, business hours, and in general, the tangle of economic regulation.[7]

Furthermore, what has happened in Spain is also taking place in Ireland, Portugal, Italy, and even in countries which, like Greece, until now represented the paradigm of social laxity, the lack of budget rigor, and political demagoguery.[8] What is more, the political leaders of these five countries, now no longer able to manipulate monetary policy to keep citizens in the dark about the true cost of their policies, have been summarily thrown out of their respective governments. And states that, like Belgium and especially France and Holland, until now have appeared unaffected by the drive to reform are also starting to be forced to reconsider the very grounds for the volume of their public spending and for the structure of their bloated welfare state. This is all undeniably due to the new monetary framework introduced with the euro, and thus it should be viewed with excited and hopeful rejoicing by all champions of the free-enterprise economy and the limitation of government powers. For it is hard to conceive of any of these measures being taken in a context of a national currency and flexible exchange rates: whenever they can, politicians eschew unpopular reforms, and citizens everything that involves sacrifice and discipline. Hence, in the absence of the euro, authorities would again have taken what up to now has been the usual path — i.e. a forward escape consisting of more inflation; the depreciation of the currency to recover "full employment" and gain competitiveness in the short term (covering their backs and concealing the grave responsibility of labor unions as true generators of unemployment); and, in short, the indefinite postponement of the necessary structural reforms.

Let us now focus on two significant ways the euro is unique. We will contrast it both with the system of national currencies linked together by fixed exchange rates, and with the gold standard itself, beginning with the latter. We must note that abandoning the euro is much more difficult than going off the gold standard was in its day. In fact, the currencies linked with gold kept their local denomination (the franc, the pound, etc.), and thus it was relatively easy, throughout the 1930s, to unanchor them from gold, insofar as economic agents, as indicated in the monetary-regression theorem Mises formulated in 1912 (Mises 2009 [1912], pp. 111–123), continued without interruption to use the national currency, which was no longer exchangeable for gold, relying on the purchasing power of the currency right before the reform. Today this possibility does not exist for those countries that wish, or are obliged, to abandon the euro.

Because the euro is the only unit of currency shared by all the countries in the monetary union, its abandonment requires the introduction of a new local currency, with unknown and much less purchasing power, and includes the emergence of the immense disturbances that the change would entail for all the economic agents in the market: debtors, creditors, investors, entrepreneurs, and workers.[9] At least in this specific sense, and from the standpoint of Austrian theorists, we must admit that the euro surpasses the gold standard, and that it would have been very useful for mankind if in the 1930s the different countries involved had been obliged to stay on the gold standard, because as is the case today with the euro, any other alternative was nearly impossible to put into practice and would have affected citizens in a much more damaging, painful, and obvious way.

Hence, to a certain extent it is amusing (and also pathetic) to note that the legion of social engineers and interventionist politicians who, led at the time by Jacques Delors, designed the single currency as one more tool for use in their grandiose projects to achieve a European political union, now regard with despair something they never seem to have been able to predict: that the euro has ended up acting de facto as the gold standard, disciplining citizens, politicians, and authorities, tying the hands of demagogues and exposing pressure groups (headed by the unfailingly privileged unions), and even questioning the sustainability and the very foundations of the welfare state.[10]

According to the Austrian School, this is precisely the main comparative advantage of the euro as a monetary standard in general, and against monetary nationalism in particular — this and not the more prosaic arguments, like "the reduction of transaction costs" or "the elimination of exchange risk," which were deployed at the time by the invariably short-sighted social engineers of the moment.

Now let us consider the difference between the euro and a system of fixed exchange rates, with respect to the adjustment process that takes place when different degrees of credit expansion and intervention arise between the different countries. Obviously, in a fixed-rate system, these differences manifest themselves in considerable exchange-rate tensions that eventually culminate in explicit devaluations and the high cost in terms of lost prestige, which, fortunately, these entail for the corresponding political authorities. In the case of a single currency, like the euro, such tensions manifest themselves in a general loss of competitiveness, which can only be recovered with the introduction of the structural reforms necessary to guarantee market flexibility, along with the deregulation of all sectors and the reductions and adjustments necessary in the structure of relative prices.

Moreover, the above ends up affecting the revenues of each public sector, and thus, of its credit rating. In fact, under the present circumstances, in the euro area, the current value in the financial markets of each country's sovereign public debt has come to reflect the tensions that typically revealed themselves in exchange-rate crises, when rates were more or less fixed in an environment of monetary nationalism.

Therefore, at this time, the leading role is not played by foreign-currency speculators but by the rating agencies, and especially by international investors, who, by purchasing sovereign debt or not, are healthily setting the pace of reform while also disciplining and determining the fate of each country. This process may be called "undemocratic," but it is actually the exact opposite. In the past, democracy suffered chronically and was corrupted by irresponsible political actions based on monetary manipulation and inflation, a veritable tax of devastating consequences, that is imposed outside of parliament on all citizens in a gradual, concealed, and devious way.

Today, with the euro, the recourse to an inflationary tax has been blocked, at least at the local level of each country, and politicians have suddenly been exposed and have been obliged to tell the truth and accept the corresponding loss of support. Democracy, if it is to work, requires a framework that disciplines the agents who participate in it. And today in continental Europe that role is being played by the euro. Hence, the successive fall of the governments of Ireland, Greece, Portugal, Italy, Spain, and France, far from revealing a democracy deficit, manifests the increasing degree of rigor, budget transparency, and democratic health that the euro is encouraging in its respective societies.

As it would be interesting and highly illustrative, we should now, if only briefly, comment on the diverse and motley amalgam formed by the euro's enemies. This group includes in its ranks such disparate elements as doctrinaires of the far left and right; nostalgic or unyielding Keynesians like Krugman and Stiglitz; dogmatic monetarists in support of flexible exchange rates, like Barro and others; naive advocates of Mundell's theory of optimum currency areas; terrified dollar (and pound) chauvinists; and, in short, the legion of confused defeatists who "in the face of the imminent disappearance of the euro" propose the "solution" of blowing it up and abolishing it as soon as possible.[11]

Perhaps the clearest illustration (or rather, the most convincing piece of evidence) of the fact that Mises was entirely correct in his analysis of the disciplining effect of fixed exchange rates, and especially of the gold standard, on political and union demagoguery lies in the way in which the leaders of leftist political parties, union members, "progressive" opinion makers, antisystem "indignados," far-right politicians, and, in general, all fans of public spending, state subsidies, and interventionism openly and directly rebel against the discipline the euro imposes, and specifically against the loss of autonomy in each country's monetary policy and what that implies: the much-reviled dependence on markets, speculators, and international investors when it comes to being able (or not) to sell the growing sovereign public debt required to finance continual public deficits.

One need only glance at the editorials in the most leftist newspapers,The editorial line of the defunct Spanish newspaper Público was paradigmatic in this sense. (See also, for example, the case of Estefanía 2011, and of his criticism of the aforementioned reform of article 135 of the Spanish Constitution to establish the "anti-Keynesian" principle of budget stability and equilibrium.) or read the statements of the most demagogic politicians,See, for example, the statements of the socialist candidate for the French presidency, for whom "the path of austerity is ineffective, deadly, and dangerous" (Hollande 2012), or those of the far-right candidate Marine Le Pen, who believes the French "should return to the franc and bring the euro period to a close once and for all" (Martín Ferrand 2012). or of leading unionists, to observe that this is so, and that nowadays, just as in the 1930s with the gold standard, the enemies of the market and the defenders of socialism, the welfare state, and union demagoguery are protesting in unison, both in public and in private, against "the rigid discipline the euro and the financial markets are imposing on us," and they are demanding the immediate monetization of all the public debt necessary, without any countermeasure in the form of budget austerity or reforms that boost competitiveness.

In the more academic sphere, but also with ample coverage in the media, contemporary Keynesian theorists are mounting a major offensive against the euro, again with a belligerence only comparable to that Keynes himself showed against the gold standard in the 1930s. Especially paradigmatic is the case of Krugman,One example among many articles is Krugman 2012; see also Stiglitz 2012. who as a syndicated columnist tells the same old story almost every week about how the euro means a "straitjacket" for employment recovery, and he even goes so far as to criticize the profligate American government for not being expansionary enough and for having fallen short in its (huge) fiscal stimulus packages.The US public deficit has stood at between 8.2 and 10 percent over the last three years, in sharp contrast with German deficit, which stood at only 1 percent in 2011. More intelligent and highbrow, though no less mistaken, is the opinion of Skidelsky, since he at least explains that the Austrian business-cycle theoryAn up-to-date explanation of the Austrian theory of the cycle can be found in Huerta de Soto 2012 [1998], chapter 5. offers the only alternative to his beloved Keynes and clearly recognizes that the current situation actually involves a repeat of the duel between Hayek and Keynes during the 1930s.Skidelsky 2011.

Stranger still is the stance taken on flexible exchange rates by neoclassical theorists in general, and by monetarists and members of the Chicago School in particular.A legion of economists belong to this group, and most of them (surprise, surprise!) come from the dollar-pound area. Among others in the group, I could mention, for example, Robert Barro (2012), Martin Feldstein (2011), and President Barack Obama's adviser, Austan Goolsbee (2011). In Spain, though for different reasons, I should cite such eminent economists as Pedro Schwartz, Francisco Cabrillo, and Alberto Recarte. It appears that this group's interest in flexible exchange rates and monetary nationalism predominates over their (we presume sincere) desire to encourage economic liberalization reforms. Indeed, their primary goal is to maintain monetary-policy autonomy and be able to devalue (or depreciate) the local currency to "recover competitiveness" and absorb unemployment as soon as possible, and only then, eventually, do they focus on trying to foster flexibility and free-market reforms.

Their naïveté is extreme, and we referred to it in our discussion of the reasons for the disagreement between Mises, on the side of the Austrian School, and Friedman, on the side of the Chicago theorists, in the debate on fixed versus flexible exchange rates. Mises always saw very clearly that politicians are not likely to take steps in the right direction if they are not literally obligated to do so, and that flexible rates and monetary nationalism remove practically every incentive capable of disciplining politicians and doing away with "downward rigidity" in wages (which thus becomes a sort of self-fulfilling assumption that monetarists and Keynesians wholeheartedly accept) and with the privileges enjoyed by unions and all other pressure groups. Mises also observed that as a result, in the long run, and even in spite of themselves, monetarists end up becoming fellow travelers of the old Keynesian doctrines: once "competitiveness" has been "recovered," reforms are postponed, and what is even worse, unionists become accustomed to having the destructive effects of their restrictionist policies continually masked by successive devaluations.

This latent contradiction between defending the free market and supporting monetary nationalism and manipulation via "flexible" exchange rates is also evident in many proponents of the most widespread interpretation of Robert A. Mundell's theory of "optimum currency areas."Mundell 1961. Such areas would be those in which, to begin with, all productive factors were highly mobile, because if that is not the case, it would be better to compartmentalize them with currencies of a smaller scope, to permit the use of an autonomous monetary policy in the event of any "external shock." However, we should ask ourselves, Is this reasoning sound? Not at all: the main source of rigidity in labor and factor markets actually lies in, and is sanctioned by, intervention and state regulation of the markets, so it is absurd to think states and their governments are going to commit hara-kiri first, thus relinquishing their power and betraying their political clientele, in order to adopt a common currency afterward.

Instead, the exact opposite is true: only when politicians have joined a common currency (the euro in our case) have they been forced to implement reforms that until very recently it would have been inconceivable for them to adopt. In the words of Walter Block,

government is the main or only source of factor immobility. The state, with its regulations … is the prime reason why factors of production are less mobile than they would otherwise be. In a bygone era the costs of transportation would have been the chief explanation, but with all the technological progress achieved here, this is far less important in our modern "shrinking world." If this were so, then under laissez-faire capitalism, there would be virtually no factor immobility. Given even the approximate truth of these assumptions the Mundellian region then becomes the entire globe — precisely as it would be under the gold standard.Block 1999, 21.

This conclusion of Block's is equally applicable to the euro area, to the extent that the euro acts, as we have already indicated, as a "proxy" for the gold standard, which disciplines and limits the arbitrary power of the politicians of the member states.

We must not fail to stress that Keynesians, monetarists, and Mundellians are all mistaken because they reason exclusively in terms of macroeconomic aggregates, and hence they propose, with slight differences, the same sort of adjustment via monetary and fiscal manipulation, "fine tuning," and flexible exchange rates. They believe that all of the effort it takes to overcome the crisis should therefore be guided by macroeconomic models and social engineering. Thus, they completely disregard the profound microeconomic distortion that monetary (and fiscal) manipulation generates in the structure of relative prices and in the capital-goods structure. A forced devaluation (or depreciation) is "one size fits all," i.e., it entails a sudden linear percentage drop in the price of consumer goods and services and productive factors, a drop that is the same for everyone.

Although in the short term this gives the impression of an intense recovery of economic activity and of a rapid absorption of unemployment, it actually completely distorts the structure of relative prices (because, without monetary manipulation, some prices would have fallen more, others less, and others would not have fallen at all and might even have risen), leads to a widespread poor allocation of productive resources, and causes a major trauma that any economy would take years to process and recover from.See Whyte's (2011) excellent analysis of the serious harm the depreciation of the pound is causing in United Kingdom; and with respect to the United States, see Laperriere 2012. This is the microeconomic analysis centered on relative prices and the productive structure, which Austrian theorists have characteristically developedHuerta de Soto 2012 [1998]. and which, in contrast, is entirely missing from the analytical toolbox of the assortment of economic theorists who oppose the euro.

Finally, outside the purely academic sphere, the tiresome insistence with which Anglo-Saxon economists, investors, and financial analysts attempt to discredit the euro by foretelling the bleakest future for it is to a certain extent suspicious. This impression is reinforced by the hypocritical position of the different US administrations (and also, to a lesser extent, the British government) in wishing (halfheartedly) that the eurozone would "get its economy in order," and yet self-interestedly omitting to mention that the financial crisis originated on the other side of the Atlantic, i.e., in the recklessness and the expansionary policies pursued by the Federal Reserve for years, the effects of which spread to the rest of the world via the dollar, as it is still used as the international reserve currency. Furthermore, there is almost unbearable pressure for the eurozone to introduce monetary policies at least as expansionary and irresponsible ("quantitative easing") as those adopted in the United States, and this pressure is doubly hypocritical, because such an occurrence would undoubtedly deliver the coup de grace to the single European currency.

Might not this stance in the Anglo-Saxon political, economic, and financial world be hiding a buried fear that the dollar's future as the international reserve currency may be threatened if the euro survives and is capable of effectively competing with the dollar in a not-too-distant future? All indications suggest that this question is becoming more and more pertinent, and though today it does not appear very politically correct, it pours salt on the wound that is most painful for analysts and authorities in the Anglo-Saxon world: the euro is emerging as an enormously powerful potential rival to the dollar on an international level."The euro, as the currency of an economic zone that exports more than the United States, has well-developed financial markets, and is supported by a world class central bank, is in many aspects the obvious alternative to the dollar. While currently it is fashionable to couch all discussions of the euro in doom and gloom, the fact is that the euro accounts for 37 percent of all foreign exchange market turn over. It accounts for 31 percent of all international bond issues. It represents 28 percent of the foreign exchange reserves whose currency composition is divulged by central banks" (Eichengreen 2011, 130). Guy Sorman, for his part, has commented on "the ambiguous attitude of US financial experts and actors. They have never liked the euro, because by definition, the euro competes with the dollar: following orders, American so-called experts explained to us that the euro could not survive without a central economic government and a single fiscal system" (Sorman 2011). In short, it is clear that champions of competition between currencies should direct their efforts against the monopoly of the dollar (for example, by supporting the euro), rather than advocate the reintroduction of, and competition between, "little local currencies" of minor importance (the drachma, escudo, peseta, lira, pound, franc, and even the mark).

As we can see, the anti-euro coalition brings together quite varied and powerful interests. Each distrusts the euro for a different reason. However, they all share a common denominator: the arguments that form the basis of their opposition to the euro would be exactly the same, and they might well repeat and word them even more emphatically, if instead of the single European currency they had to come to grips with the classic gold standard as the international monetary system.

In fact, there is a large degree of similarity between the forces that joined in an alliance in the 1930s to compel the abandonment of the gold standard and those that today seek (up to now unsuccessfully) to reintroduce old, outdated monetary nationalism in Europe.

As we have already indicated, technically it was much easier to abandon the gold standard than it would be today for any country to leave the monetary union. In this context, it should come as no surprise that members of the anti-euro coalition often even fall back on the most shameless defeatism: they predict a disaster and the impossibility of maintaining the monetary union, and then right afterward, they propose the "solution" of dismantling it immediately. They even go so far as to hold international contests (in — where else? — the United Kingdom, the home of both Keynes and monetary nationalism) in which hundreds of "experts" and crackpots participate, each with his own proposals for the best and most innocuous way to blow up the European monetary union.Such is the case with, for example, the contest held in the United Kingdom by Lord Wolfson, the owner of Next stores. Up to now, this contest has attracted no fewer than 650 "experts" and crackpots. Were it not for the crass and obvious hypocrisy involved in such initiatives, which are always held outside the euro area (and especially in the Anglo-Saxon world, by those who fear, hate, or scorn the euro), we should commend the great effort and interest shown in the fate of a currency which, after all, is not their own.

No one can deny that the European Union chronically suffers from a number of serious economic and social problems. Nevertheless, the maligned euro is not one of them. Rather, the opposite is true: the euro is acting as a powerful catalyst that reveals the severity of Europe's true problems and hastens or "precipitates" the implementation of the measures necessary to solve them. In fact, today, the euro is helping spread more than ever the awareness that the bloated European welfare state is unsustainable and needs to be substantially reformed.I have already mentioned, for instance, the recent legislative changes that have delayed the retirement age to 67 (and even indexed it with respect to future trends in life expectancy), changes already introduced or on the way in Germany, Italy, Spain, Portugal, and Greece. I could also cite the establishment of a "copayment" and increasing areas of privatization in connection with healthcare. These are small steps in the right direction, which, because of their high political cost, would not have been taken without the euro. They also contrast with the opposite trend indicated by Barack Obama's healthcare reform, and with the obvious resistance to change when it comes to tackling the inevitable reform of the British National Health Service. The same can be said for the all-encompassing aid and subsidy programs, among which the Common Agricultural Policy occupies a key position, both in terms of its very damaging effects and its total lack of economic rationality.O'Caithnia 2011.

Most of all, it can be said for the culture of social engineering and oppressive regulation that, on the pretext of harmonizing the legislation of the different countries, fossilizes the single European market and prevents it from being a genuine free market.Booth 2011. Now more than ever, the true cost of all these structural flaws is becoming apparent in the euro area: without an autonomous monetary policy, the different governments are being forced to reconsider (and when applicable, to reduce) all their public-expenditure items, and to attempt to recover and gain international competitiveness by deregulating and increasing as far as possible the flexibility of their markets (especially the labor market, which has traditionally been very rigid in many countries of the monetary union).

In addition to the above cardinal sins of the European economy, we must add another, which is perhaps even graver, due to its peculiar, devious nature. We are referring to the great ease with which European institutions, many times because of a lack of vision, leadership, or conviction about their own project, allow themselves to become entangled in policies that in the long run are incompatible with the demands of a single currency and of a true free single market.

First, it is surprising to note the increasing regularity with which the burgeoning and stifling new regulatory measures are introduced into Europe from the Anglo-Saxon academic and political world, specifically the United States,See, for example, "United States' Economy: Over-regulated America: The home of laissez-faire is being suffocated by excessive and badly written regulation," The Economist, February 18, 2012, p. 8, and the examples there cited. and often when such measures have already proven ineffective or extremely disruptive. This unhealthy influence is a long-established tradition. (Let us recall that agricultural subsidies, the antitrust legislation, and regulations concerning "corporate social responsibility" have actually originated, like many other failed interventions, in the United States.) Nowadays such regulatory measures crop up repeatedly and are reinforced at every step, for example with respect to the so-called fair market value and the rest of the International Accounting Standards, or to the (until now, fortunately, failed) attempts to implement the so-called agreements of Basel III for the banking sector and Solvency II for the insurance sector, both of which suffer from insurmountable and fundamental theoretical deficiencies as well as serious problems in relation to their practical application.Huerta de Soto 2003 and 2009.

A second example of the unhealthy Anglo-Saxon influence can be found in the European Economic Recovery Plan, which the European Commission launched at the end of 2008 under the auspices of the Washington Summit, with the leadership of Keynesian politicians like Barack Obama and Gordon Brown, and on the advice of economic theorists who are enemies of the euro, like Krugman and others.On the hysterical support for the grandiose fiscal-stimulus packages of this period, see Fernando Ulrich 2011. The plan recommended to member countries an expansion of public spending of around 1.5 percent of GDP (some 200 billion euros on an aggregate level). Though some countries, like Spain, made the error of expanding their budgets, the plan — thank God and the euro, and much to the despair of Keynesians and their acolytesKrugman 2012, Stiglitz 2012. — soon came to nothing, once it became clear that it only served to increase the deficits, preclude the achievement of the Maastricht Treaty objectives, and severely destabilize the sovereign-debt markets of the countries of the eurozone.

Again, the euro provided a disciplinary framework and an early curb on the deficit, in contrast to the budget recklessness of countries that are victims of monetary nationalism, and specifically, the United States and especially the United Kingdom, which closed with a public deficit of 10.1 percent of GDP in 2010 and 8.8 percent in 2011, which on a worldwide scale was only exceeded by Greece and Egypt. Despite such bloated deficits and fiscal-stimulus packages, unemployment in the United Kingdom and the United States remains at record (or very high) levels, and their respective economies are just not getting off the ground.

Third, and above all, there is mounting pressure for a complete European political union, which some suggest as the only "solution" that could enable the survival of the euro in the long term. Apart from the "eurofanatics," who always defend any excuse that might justify greater power and centralism for Brussels, two groups coincide in their support for political union. One group consists, paradoxically, of the euro's enemies, particularly those of Anglo-Saxon origin: there are the Americans, who, dazzled by the centralized power of Washington and aware that it could not possibly be duplicated in Europe, know that with their proposal they are injecting a divisive virus deadly to the euro; and there are the British, who make the euro an (unjustified) scapegoat on which to vent their (totally justified) frustrations in view of the growing interventionism of Brussels. The other group consists of all those theorists and thinkers who believe that only the discipline imposed by a central government agency can guarantee the deficit and public-debt objectives established in Maastricht. This is an erroneous belief. The very mechanism of the monetary union guarantees, just like the gold standard, that those countries that abandon budget rigor and stability will see their solvency at risk and be forced to take urgent measures to reestablish the sustainability of their public finances if they do not wish to suspend payments.

Despite the above, the most serious problem does not lie in the threat of an impossible political union, but in the unquestionable fact that a policy of credit expansion carried out in a sustained manner by the ECB during a period of apparent economic prosperity is capable of canceling, at least temporarily, the disciplinary effect exerted by the euro on the economic agents of each country. Thus, the fatal error of the ECB consists of not having managed to isolate and protect Europe from the great expansion of credit orchestrated on a worldwide scale by the US Federal Reserve beginning in 2001.

Over several years, in a blatant failure to comply with the Maastricht Treaty, the ECB allowed M3 to grow by even more than 9 percent per year, which far exceeds the objective of 4.5 percent growth in the money supply, an aim originally set by the ECB itself.Specifically, the average rise in M3 in the eurozone from 2000 to 2011 exceeded 6.3 percent, and we should highlight the increases that occurred during the bubble years 2005 (from 7 percent to 8 percent), 2006 (from 8 percent to 10 percent), and 2007 (from 10 percent to 12 percent). The above data show that, as has already been indicated, the goal of a zero deficit, though commendable, is merely a necessary, though not a sufficient, condition for stability: during the expansionary phase of a cycle induced by credit expansion, public-spending commitments may be made based on the false tranquility that surpluses generate; yet later, when the inevitable recession hits, these commitments are completely unsustainable. This demonstrates that the objective of a zero deficit also requires an economy that is not subject to the ups and downs of credit expansion, or at least that the budgets be closed out with much larger surpluses during the expansionary years. Furthermore, even though this increase was appreciably less reckless than that brought about by the US Federal Reserve, the money was not distributed uniformly among the countries of the monetary union, and it had a disproportionate impact on the periphery countries (Spain, Portugal, Ireland, and Greece), which saw their monetary aggregates grow at a pace far more rapid, between three and four times more, than France or Germany. Various reasons can be given to explain this phenomenon, from the pressure applied by France and Germany, both of which sought a monetary policy that during those years would not be too restrictive for them, to the extreme short-sightedness of the periphery countries, which did not wish to admit they were in the middle of a speculative bubble, as is the case with Spain, and thus were also unable to give categorical instructions to their representatives in the ECB council to make an important issue of strict compliance with the monetary-growth objectives established by the ECB itself.

In fact, during the years prior to the crisis, all of these countries, except Greece,Therefore, Greece would be the only case to which we could apply the tragedy-of-the-commons argument Bagus (2010) develops concerning the euro. In light of the reasoning I have presented in the text, and as I have already mentioned, I believe a more apt title for Bagus's remarkable book, The Tragedy of the Euro, would have been The Tragedy of the European Central Bank. easily observed the 3 percent deficit limits, and some, like Spain and Ireland, even closed their public accounts with large surpluses.The surpluses in Spain were as follows: 0.96 percent, 2.02 percent, and 1.90 percent in 2005, 2006, and 2007 respectively. Those of Ireland were 0.42 percent, 1.40 percent, 1.64 percent, 2.90 percent, and 0.67 percent in 2003, 2004, 2005, 2006, and 2007 respectively. Hence, though the heart of the European Union was kept out of the American process of irrational exuberance, the process was repeated with intense virulence in the European periphery countries, and no one, or very few people, correctly diagnosed the grave danger in what was happening.The author of these lines could be cited as an exception (Huerta de Soto 2012 [1998], xxxvii).

If academics and political authorities from both the affected countries and the ECB, instead of using macroeconomic and monetarist analytical tools imported from the Anglo-Saxon world, had used those of the Austrian business-cycle theoryIbid. — which after all is a product of the most genuine continental economic thought — they would have managed to detect in time the largely artificial nature of the prosperity of those years, the unsustainability of many of the investments (especially with respect to real estate development) that were being launched due to the great easing of credit, and in short, that the surprising influx of rising public revenue would be of very short duration.

Still, fortunately, though in the most recent cycle the ECB has fallen short of the standards European citizens had a right to expect, and we could even call its policy a "grave tragedy," the logic of the euro as a single currency has prevailed, thus clearly exposing the errors committed and obliging everyone to return to the path of control and austerity. In the next section, we will briefly touch on the specific way the ECB formulated its policy during the crisis and how and on what points this policy differs from that followed by the central banks of the United States and United Kingdom.

One of the most striking characteristics of the last cycle, which has ended in the Great Recession of 2008, has undoubtedly been the differing behavior of the monetary and fiscal policies of the Anglo-Saxon area, based on monetary nationalism, and those pursued by the member countries of the European monetary union. Indeed, from the time the financial crisis and economic recession hit in 2007–2008, both the Federal Reserve and the Bank of England have adopted monetary policies that have consisted of reducing the interest rate to almost zero; injecting huge quantities of money into the economy (euphemistically known as "quantitative easing"); and continuously, directly, and unabashedly monetizing the sovereign public debt on a massive scale.At this time (2011–2012), the Federal Reserve is directly purchasing at least 40 percent of the newly issued American public debt. A similar statement can be made regarding the Bank of England, which is the direct holder of 25 percent of all the sovereign public debt of the United Kingdom. In comparison with these figures, the (direct and indirect) monetization carried out by the European Central Bank seems like innocent "child's play." To this extremely lax monetary policy (in which the recommendations of monetarists and Keynesians concur) is added the strong fiscal stimulus involved in maintaining, both in the United States and in the United Kingdom, budget deficits close to 10 percent of the respective GDPs (which, nevertheless, at least the most recalcitrant Keynesians, like Krugman and others, do not consider anywhere near sufficient).

In contrast with the situation of the dollar and the pound, in the euro area, fortunately, money cannot so easily be injected into the economy, nor can budget recklessness be indefinitely maintained with such impunity. At least in theory, the ECB lacks authority to monetize the European public debt, and though it has accepted it as collateral for its huge loans to the banking system, and beginning in the summer of 2010 even sporadically made direct purchases of the bonds of the most threatened periphery countries (Greece, Portugal, Ireland, Italy, and Spain), there is certainly a fundamental economic difference between the behavior of the United States and United Kingdom, and the policy continental Europe is following: while monetary aggression and budget recklessness are deliberately, unabashedly, and without reservation undertaken in the Anglo-Saxon world, in Europe such policies are carried out reluctantly, and in many cases after numerous, consecutive and endless "summits." They are the result of lengthy and difficult negotiations between many parties, negotiations in which countries with very different interests must reach an agreement.

Furthermore, what is even more important, when money is injected into the economy and support is provided to the debt of countries that are having difficulties, such actions are always balanced with, and taken in exchange for, reforms based on budget austerity (and not on fiscal stimulus packages) and on the introduction of supply-side policies that encourage market liberalization and competitiveness.Luskin and Roche Kelly have even referred to "Europe's Supply-Side Revolution" (Luskin and Roche Kelly 2012). Also highly significant is "A Plan for Growth in Europe," which was urged February 20, 2012, by the leaders of 12 countries in the European Union (including Italy, Spain, the Netherlands, Finland, Ireland, and Poland), a plan that comprises only supply-side policies and does not mention any fiscal-stimulus measure. There is also the manifesto "Initiative for a Free and Prospering Europe" (IFPE) signed in Bratislava in January 2012 by, among others, the author of these lines. In short, a change of models seems a priority in countries that, like Spain, must move from a speculative, "hot" economy based on credit expansion to a "cold" economy based on competitiveness. Indeed, as soon as prices decline ("internal deflation") and the structure of relative prices is readjusted in an environment of economic liberalization and structural reforms, numerous opportunities for entrepreneurial profit will arise in sustainable investments, which in a monetary area as extensive as the euro area are sure to attract financing. This is how to bring about the necessary rehabilitation and ensure the longed-for recovery in our economies, a recovery that again should be cold, sustainable, and based on competitiveness.  Moreover, though it would have been better had it happened much sooner, the de facto suspension of payments by the Greek state, which has given a nearly 75 percent "haircut" to the private investors who mistakenly trusted in Greek sovereign debt holdings, has clearly signaled to markets that the other countries in trouble have no other alternative than to firmly, rigorously, and without delay carry out all necessary reforms. As we have already seen, even states like France, which until now appeared untouchable and comfortably nestled in a bloated welfare state, have lost the highest credit rating on their debt, seen its differential with the German bund rise, and found themselves increasingly doomed to introduce austerity and liberalization reforms to avoid jeopardizing what has always been their indisputable membership among the eurozone hardliners.In this context, and as I explained in the section devoted to the "Motley Anti-euro Coalition," we should not be surprised by the statements of the candidates to the French presidency, which are mentioned in footnote 13.

From the political standpoint, it is quite obvious that Germany (and particularly the chancellor Angela Merkel) has the leading role in urging forward this whole process of rehabilitation and austerity (and opposing all sorts of awkward proposals that, like the issuance of "European bonds," would remove the incentives the different countries now have to act with rigor). Many times Germany must swim upstream. For on the one hand, there is constant international political pressure for fiscal-stimulus measures, especially from the Obama administration, which is using the "crisis of the euro" as a smokescreen to hide the failure of its own policies. And on the other hand, Germany has to contend with rejection and a lack of understanding from all those who wish to remain in the euro solely for the advantages it offers them, while at the same time they violently rebel against the bitter discipline that the European single currency imposes on all of us, and especially on the most demagogic politicians and the most irresponsible privileged interest groups.

In any case, and as an illustration that will understandably exasperate Keynesians and monetarists, we must highlight the very unequal results that until now have been achieved with American fiscal-stimulus policies and monetary "quantitative easing," in comparison with German supply-side policies and fiscal austerity in the monetary environment of the euro: public deficit, in Germany, 1 percent, in the United States, over 8.20 percent; unemployment, in Germany, 5.9 percent, in the United States, close to 9 percent; inflation, in Germany, 2.5 percent, in the United States, over 3.17 percent; growth, in Germany, 3 percent, in the United States, 1.7 percent. (The figures for United Kingdom are even worse than those for the United States.) The clash of paradigms and the contrast in results could not be more striking.Estimated data as of December 31, 2011.

Just as with the gold standard in its day, today a legion of people criticize and despise the euro for what is precisely its main virtue: its capacity to discipline extravagant politicians and pressure groups. Plainly, the euro in no way constitutes the ideal monetary standard, which, as we saw in the first section, could only be found in the classic gold standard, with a 100 percent reserve requirement on demand deposits, and the abolition of the central bank. Hence, it is quite possible that once a certain amount of time has passed and the historical memory of recent monetary and financial events has faded, the ECB may go back to committing the grave errors of the past, and promote and accommodate a new bubble of credit expansion.Elsewhere I have mentioned the incremental reforms that, like the radical separation between commercial and investment banking (as in the Glass-Steagall Act), could improve the euro somewhat. At the same time, it is in United Kingdom where, paradoxically (or not, in light of the devastating social damage that has resulted from its banking crisis), my proposals have aroused the most interest, to the point that a bill was even presented in the British Parliament to complete Peel's Bank Charter Act of 1844 (curiously, still in effect) by extending the 100 percent reserve requirement to demand deposits. The consensus reached there to separate commercial and investment banking should be considered a (very small) step in the right direction (Huerta de Soto 2010 and 2011). However, let us remember that the sins of the Federal Reserve and the Bank of England have been much worse still and that, at least in continental Europe, the euro has ended monetary nationalism, and for the states in the monetary union, it is acting, even if only timidly, as a "proxy" for the gold standard, by encouraging budget rigor and reforms aimed at improving competitiveness, and by putting a stop to the abuses of the welfare state and of political demagoguery.

In any case, we must recognize that we stand at a historic crossroads.My uncle by marriage, the entrepreneur Javier Vidal Sario from Navarre, who remains perfectly lucid and active at the age of 93, assures me that in all his life he had never, not even during the years of the Stabilization Plan of 1959, witnessed in Spain a collective effort at institutional and budget discipline and economic rehabilitation comparable to the current one. Also historically significant is the fact that this effort is not taking place in just one country (for example, Spain), nor in relation to one local currency (for example, the old peseta), but rather is spread throughout all of Europe, and is being made by hundreds of millions of people in the framework of a common monetary unit (the euro). The euro must survive if all of Europe is to internalize and adopt as its own the traditional German monetary stability, which in practice is the only and the essential disciplinary framework from which, in the short and medium term, European Union competitiveness and growth can be further stimulated. On a worldwide scale, the survival and consolidation of the euro will permit, for the first time since World War II, the emergence of a currency capable of effectively competing with the monopoly of the dollar as the international reserve currency, and therefore capable of disciplining the American ability to provoke additional systemic financial crises that, like that of 2007, constantly endanger the world economic order.

Just over 80 years ago, in a historical context very similar to ours, the world was torn between maintaining the gold standard — and with it budget austerity, labor flexibility, and free and peaceful trade — or abandoning the gold standard, and thus everywhere spreading monetary nationalism, inflationary policies, labor rigidity, interventionism, "economic fascism," and trade protectionism.

Hayek, and the Austrian theorists led by Mises, made a titanic intellectual effort to analyze, explain, and defend the advantages of the gold standard and free trade, in opposition to the theorists who, led by Keynes and the monetarists, opted to blow up the monetary and fiscal foundations of the laissez-faire economy, which until then had fueled the Industrial Revolution and the progress of civilization.As early as 1924, the great American economist Benjamin M. Anderson wrote the following: Economical living, prudent financial policy, debt reduction rather than debt creation — all these things are imperative if Europe is to be restored. And all these are consistent with a greatly improved standard of living in Europe, if real activity be set going once more. The gold standard, together with natural discount and interest rates, can supply the most solid possible foundation for such a course of events in Europe. Clearly, once again, history is repeating itself (Anderson 1924). I am grateful to my colleague Antonio Zanella for having called my attention to this excerpt.

On that occasion, economic thought ended up taking a very different route from that favored by Mises and Hayek, and we are all familiar with the economic, political, and social consequences that followed. As a result, today, well into the 21st century, incredibly, the world is still afflicted by financial instability, the lack of budget rigor, and political demagoguery. For all these reasons, but mainly because the world economy urgently needs it, on this new occasion,[45] Moreover, this historic situation is now being revisited in all its severity on China, the economy of which is at this time on the brink of expansionary and inflationary collapse. See "Keynes versus Hayek in China," The Economist, December 30, 2011. Mises and Hayek deserve to finally triumph, and the euro (at least provisionally, and until it is replaced once and for all by the gold standard) deserves to survive.As we have already seen, Mises, the great defender of the gold standard and 100 percent–reserve free banking, in the 1960s collided head-on with theorists who, led by Friedman, supported flexible exchange rates. Mises decried the behavior of his disciple Machlup, when the latter abandoned the defense of fixed exchange rates. Now, 50 years later and on account of the euro, history is also repeating itself. On that occasion, the advocates of monetary nationalism and exchange-rate instability won, with consequences we are all familiar with. This time around let us hope that the lesson has been learned and that Mises's views will prevail. The world needs it and he deserves it.

[1] The main authors and theoretical formulations can be consulted in Huerta de Soto 2012 [1998].

[2] Ibid., chapter 9.

[3] F.A. Hayek 1971 [1937].

[4] Though Hayek does not expressly name them, he is referring to the theorists of the Chicago School, led by Milton Friedman, who in this and other areas shake hands with the Keynesians.

[5] Later we will see how, with a single currency like the euro, the disciplinary role of fixed exchange rates is taken on by the current market value of each country's sovereign and corporate debt.

[6] To underline Mises's argument even more clearly, I should indicate that there is no way to justifiably attribute to the gold standard the error Churchill committed following World War I, when he fixed the gold parity without taking into account the serious inflation of pound sterling banknotes issued to finance the war. This event has nothing to do with the current situation of the euro, which is freely floating in international markets, nor with those problems that affect countries in the eurozone's periphery and that stem from the loss in real competitiveness suffered by their economies during the bubble (Huerta de Soto 2012 [1998], 447, 622–623 in the English edition).

[7] In Spain, different Austrian economists, including me, had for decades been clamoring unsuccessfully for the introduction of these (and many other) reforms that only now have become politically feasible, and have done so suddenly, with surprising urgency, and due to the euro. Two observations: first, the measures that constitute a step in the right direction have been sullied by the increase in taxes, especially on income, movable capital earnings and wealth (see the manifesto against the tax increase that I and 50 other academics signed in February 2012); second, the principles of budget stability and equilibrium are a necessary, but not a sufficient, condition for a return to the path toward a sustainable economy, since in the event of another episode of credit expansion, only a huge surplus during the prosperous years would make it possible, once the inevitable recession hit, to avoid the grave problems that now affect us.

[8] For the first time, and thanks to the euro, Greece is facing up to the challenges that its own future poses. Though blasé monetarists and recalcitrant Keynesians do not wish to recognize it, internal deflation is possible and does not involve any "perverse" cycle if accompanied by major reforms to liberalize the economy and regain competitiveness. It is true that Greece has received and is receiving substantial aid, but it is no less true that it has the historic responsibility to refute the predictions of all those prophets of doom who, for different reasons, are determined to see the failure of the Greek effort so they can retain in their models the very stale (and self-interested) hypothesis that prices (and wages) are downwardly rigid (see also our remarks in footnote 9 about the disastrous effects of Argentina's highly praised devaluation of 2001). For the first time, the traditionally bankrupt and corrupt Greek state has taken a drastic remedy. In two years (2010–2011) the public deficit has dropped 8 percentage points; the salaries of public servants have been cut by 15 percent initially and another 20 percent after that, and their number has been reduced by over 80,000 employees and the number of town councils by almost half; the retirement age has been raised; the minimum wage has been lowered, etc. (Vidal-Folch 2012). This "heroic" reconstruction contrasts with the economic and social decomposition of Argentina, which took the opposite (Keynesian and monetarist) road of monetary nationalism, devaluation, and inflation.

[9] Therefore, fortunately, we are "chained to the euro," to use Cabrillo's apt expression (Cabrillo 2012). Perhaps the most hackneyed contemporary example Keynesians and monetarists offer to illustrate the "merits" of a devaluation and of the abandonment of a fixed rate is the case of Argentina following the bank freeze ("corralito") that took place beginning in December of 2001. This example is seriously erroneous for two reasons. First, at most, the bank freeze is simply an illustration of the fact that a fractional-reserve banking system cannot possibly function without a lender of last resort (Huerta de Soto 2012 [1998], 785–786). Second, following the highly praised devaluation, Argentina's per capita GDP fell from 7,726 dollars in 2000 to 2,767 dollars in 2002, thus losing two-thirds of its value. This 65 percent drop in Argentinian income and wealth should give serious pause to all those who nowadays are clumsily and violently demonstrating, for example in Greece, to protest the relatively much smaller sacrifices and drops in prices involved in the healthy and inevitable internal deflation that the discipline of the euro is requiring. Furthermore, all the patter about Argentina's "impressive" growth rates, of over 8 percent per year beginning in 2003, should impress us very little if at all, when we consider the very low starting point after the devaluation, as well as the poverty, paralysis, and chaotic nature of the Argentinian economy, where one-third of the population has ended up depending on subsidies and government aid; the real rate of inflation exceeds 30 percent; and scarcity, restrictions, regulations, demagoguery, the lack of reforms, and government control (and recklessness) have become a matter of course (Gallo 2012). Along the same lines, Pierpaolo Barbieri states, "I find truly incredible that serious commentators like economist Nouriel Roubini are offering Argentina as a role model for Greece" (Barbieri 2012).

[10] Even the President of the ECB, Mario Draghi, has gone so far as to expressly state that the "continent's social model is 'gone'" (Blackstone, Karnitschnig, and Thomson 2012).

[11] I do not include here the analysis of my esteemed disciple and colleague Philipp Bagus (The Tragedy of the Euro, Ludwig von Mises Institute, Auburn, Alabama, USA 2010), because from Germany's point of view, the manipulation to which the European Central Bank is subjecting the euro threatens the monetary stability Germany traditionally enjoyed with the mark. Nevertheless, his argument that the euro has fostered irresponsible policies via a typical tragedy-of-the-commons effect seems weaker to me, because during the bubble stage, most of the countries that are now having problems, with the only possible exception of Greece, were sporting a surplus in their public accounts (or were very close to one). Thus, I believe Bagus would have been more accurate if he had titled his otherwise excellent book The Tragedy of the European Central Bank (and not of the euro), particularly in light of the grave errors committed by the European Central Bank during the bubble stage, errors we will remark on in a later section of this article (thanks to Juan Ramón Rallo for suggesting this idea to me).

Since I am in fundamental agreement with the thrust of Yeager's argument, I shall utilize one illustration in his discussion to elucidate an especially neglected contribution to monetary theory made by Mises in his consistent application of methodological individualism to the explanation of monetary phenomena. In this connection, I wish to focus attention on Yeager's treatment of the modern monetary approach to the balance of payments. I propose to show, first, that the valid and vitally important insight on which the monetary approach rests forms the basis of Mises's own elaboration of balance-of-payments theory and, second, that Mises's approach is not open to the objection that Yeager raises against the monetary approach, precisely because Mises firmly adheres to the precept of methodological individualism. This enterprise, it may be noted, has important implications for the contemporary formulation of the monetary approach as well as for doctrinal research into its historical antecedents. On the doctrinal side, it is a matter of setting the record straight. Several studies have appeared recently of the doctrinal roots of the monetary approach. With one minor exception,The exception is Thomas M. Humphrey, "Dennis H. Robertson and the Monetary Approach to Exchange Rates," Federal Reserve Bank of Richmond Economic Review 66 (May/June 1980), p. 24, wherein Mises is briefly mentioned as one whose contributions to the monetary approach have been largely overlooked. all of them have completely neglected Mises's contribution. Hopefully, greater familiarity with Mises's approach to the balance of payments, which so strongly anticipates the monetary approach, will spark a rethinking of the latter approach and lead to its reformulation on sounder methodological foundations.

The fundamental insight of the monetary approach is that the balance of payments is essentially a monetary phenomenon. The very concept of a balance of payments implies the existence of money; as one writer puts it, "Indeed, it would be impossible to have a balance-of-payments surplus or deficit in a barter economy."M.A. Akhtar, "Some Common Misconceptions about the Monetary Approach to International Adjustment," in The Monetary Approach to International Adjustment, eds. Bluford H. Putnam and D. Sykes Wilford (New York: Praeger, 1978), p. 121. This being the case, any endeavor to explain balance-of-payments phenomena must naturally focus on the supply of and demand for the money commodity. The monetary approach consists in the rigorous delineation of the implications of this simple yet powerful insight for the analysis of balance-of-payments disequilibrium, adjustment, and policy. As I shall attempt to demonstrate, Mises fully anticipated the modern monetary approach by explicitly recognizing these implications.

Mises grounds his balance-of-payments analysis on the insight that the balance of payments is a monetary concept. He states that, "If no other relations than those of barter exist between the inhabitants of two areas, then balances in favor of one party or the other cannot arise."Ludwig von Mises, The Theory of Money and Credit, new enl. ed., trans. H.E. Batson (Irvington-on-Hudson, N.Y.: Foundation for Economic Education, 1971), p. 182. Mises thus conceives of money as the active element in the balance of payments and not as a residual or accommodating item that passively adjusts to the "real" flows of goods and capital:

The surplus of the balance of payments that is not settled by the consignment of goods and services but by the transmission of money was long regarded as merely a consequence of the state of international trade. It is one of the great achievements of Classical political economy to have exposed the fundamental error in this view. It demonstrated that international movements of money are not consequences of the state of trade; that they constitute not the effect, but the cause, of a favorable or unfavorable trade balance. The precious metals are distributed among individuals and hence among nations according to the extent and intensity of their demand for money.Ibid.

Mises uses his marginal-utility theory of money to explain the "natural" or equilibrium distribution of the world money stock among the various nations. Regarding the case of a 100 percent specie standard, he writes that

the proposition is as true of money as of every other economic good, that its distribution among individual economic agents depends on its marginal utility … all economic goods, including of course money, tend to be distributed in such a way that a position of equilibrium among individuals is reached, when no further act of exchange that any individual could undertake would bring him any gain, any increase of subjective utility. In such a position of equilibrium, the total stock of money, just like the total stocks of commodities, is distributed among individuals according to the intensity with which they are able to express their demand for it in the market. Every displacement of the forces affecting the exchange ratio between money and other economic goods [i.e., the supply and demand for money] brings about a corresponding change in this distribution, until a new position of equilibrium is reached.Ibid., pp. 183–84.

Mises goes on to conclude that the same principles that determine the distribution of money balances among persons also determine the distribution of money stocks among nations, since the national money stock is merely the sum of the money balances of the nation's residents.Ibid., p. 184. In thus building up his explanation of the international distribution of money from his analysis of the interpersonal distribution of money balances, Mises sets the stage for an analysis of balance-of-payments phenomena that conforms to the precept of methodological individualism.

Like the later proponents of the monetary approach, Mises envisages balance-of-payments disequilibrium as an integral phase in the process by which individual and hence national money holdings are adjusted to desired levels. Thus, for example, the development of an excess demand for money in a nation will result in a balance-of-payments surplus as market participants seek to augment their money balances by increasing their sales of goods and securities on the world market. The surplus and the corresponding inflow of the money commodity will automatically terminate when domestic money balances have reached desired levels and the excess demand has been satisfied. Conversely, a balance-of-payments deficit is part of the mechanism by which an excess supply of money is adjusted.

The role played by the balance of payments in the monetary-adjustment process is clearly spelled out by Mises in the following passage.

In a society in which commodity transactions are monetary transactions, every individual enterprise must always take care to have on hand a certain quantity of money. It must not permit its cash holding to fall below the definite sum considered necessary for carrying out its transactions. On the other hand, an enterprise will not permit its cash holding to exceed the necessary amount, for allowing that quantity of money to be idle will lead to loss of interest. If it has too little money, it must reduce purchases or sell some wares. If it has too much money, then it must buy goods.…

In this way, every individual sees to it that he is not without money. Because everyone pursues his own interest in doing this, it is impossible for the free play of market forces to cause a drain of all money out of the city, a province or an entire country.

If we had a pure gold standard, therefore, the government need not be the least concerned about the balance of payments. It could safely let the market take care of maintaining a sufficient quantity of gold within the country. Under the influence of free-trade forces, gold would leave the country only if a surplus of cash balances were on hand. Conversely it would always flow into the country if cash balances were insufficient. Thus, for Mises, the monetary-adjustment process ensures that gold money, like all other commodities, is imported when in short supply and exported when in surplus.Ludwig von Mises, On the Manipulation of Money and Credit, ed. Percy L. Greaves, trans. Bettina Bien Greaves (Dobbs Ferry, N.Y.: Free Market Books, 1978), pp. 53–54.

An implication of this view of the balance of payments as a phase in the monetary adjustment process is that international movements of money that do not reflect changes in the underlying monetary data can only be temporary phenomena. "Thus," writes Mises, "international movements of money, so far as they are not of a transient nature and consequently soon rendered ineffective by movements in the contrary direction, are always called forth by variations in demand for money."Mises, Theory of Money and Credit, p. 185.

Although Mises therefore does regard the long-run causes of balance-of-payments disequilibrium as exclusively monetary in nature, he does not make the error, which Yeager attributes to the more radical, global-monetarist proponents of the monetary approach, of identifying a balance-of-payments surplus with the process of satisfying an excess demand for domestic money or a deficit with the process of working off an excess supply of domestic money. Mises explicitly recognizes that changes occurring on the "real" side of the economy, for example, a decline in the foreign demand for a nation's exports, may well have a disequilibrating impact on the balance of payments, even in the absence of a change in the underlying conditions of monetary supply and demand. However, in Mises's view, such nonmonetary disturbances of balance-of-payments equilibrium are merely short-run phenomena. It is one of the functions of the balance-of-payments adjustment mechanism to reverse the disequilibrating flows of money that attend these disturbances and to restore thereby the equilibrium distribution of the world money stock, which is determined solely by the configuration of individual demands for money holdings.

If the state of the balance of payments is such that movements of money would have to occur from one country to the other, independently of any altered estimation of money on the part of their respective inhabitants, then operations are induced which re-establish equilibrium. Those persons who receive more money than they will need hasten to spend the surplus again as soon as possible, whether they buy production goods or consumption goods. On the other hand, those persons whose stock of money falls below the amount they will need will be obliged to increase their stock of money, either by restricting their purchases or by disposing of commodities in their possession. The price variations, in the markets of the countries in question, that occur for these reasons give rise to transactions which must always re-establish the equilibrium of the balance of payments. A debit or credit balance of payments that is not dependent upon an alteration in the conditions of demand for money can only be transient.Ibid., pp. 184–85.

The foregoing passage illustrates the difference between Mises and the global monetarists, who deny the possibility that international flows of money can proceed from nonmonetary causes. Their denial is tantamount to claiming that all international movements of money are necessarily equilibrating, since they are undertaken solely in response to disequilibrium between national supplies of and demands for money. As Yeager has pointed out, this line of reasoning leads to the outright and fallacious identification of balance-of-payments surpluses and deficits with the process of adjusting national money stocks to desired levels.

It is not difficult to pinpoint the source from which this erroneous line of reasoning stems: it is the tendency of the monetary approach to depart from the sound precept of methodological individualism and to focus on the nation rather than the individual as the basic unit of analysis. In so doing, it has naturally, although quite illegitimately, applied to the nation analytical concepts and constructs that are appropriate only to the analysis of individual action. In particular, the monetary approach attempts to explain balance-of-payments phenomena by conceiving the nation in the manner of a household or firm that is consciously aiming at acquiring and maintaining an optimum level of money balances. The concept of what Ludwig Lachmann has called "the equilibrium of the household and of the firm" is then invoked to describe the actions which the nation-household must and will undertake in the service of this goal.Ludwig M. Lachmann, Capital, Expectations, and the Market Process: Essays on the Theory of the Market Economy, ed. Walter E. Grinder (Kansas City: Sheed Andrews and McMeel, 1977), p. 117. As Lachmann explains, the concept of household-firm equilibrium is implied in the very logic of choice.Ibid., pp. 117, 189. An economic agent will always choose the course of action consistent with his goals and their ranking given his knowledge of available resources and of technology. His actions are, therefore, always equilibrating in the sense that they are always aimed at bringing about a (possibly only momentarily) preferred state of affairs.

In the context of the issues dealt with by the monetary approach, the implication of this analytical concept is that the nation will never alter the level of its stock of money unless it is dissatisfied with it, that is, unless there is an excess supply of or demand for domestic money. A further implication is that all international movements of money will be equilibrating, the result of deliberate steps undertaken by nations to adjust their actual money balances to desired levels. National payments, surpluses and deficits, then, are logically always associated with the adjustment of monetary disequilibrium. To argue that balance-of-payments disequilibria may arise, even temporarily, for reasons unrelated to monetary disequilibrium is to argue that the economic agent, in this case the nation, has taken leave of economic rationality. Why else acquire or rid oneself of money balances, if not as a deliberate act of choice aimed at securing a more preferred position? Thus the global monetarists are prepared to deny, for example, that a shift in relative demands from domestic to foreign products would create even a temporary deficit in the balance of payments in the absence of the development of an excess supply of domestic money.

This clearly illustrates the confusion that results when monetary theorists lapse into methodological holism and apply to hypostasized entities such as the nation concepts whose use is inappropriate outside the realm of individual action. The concept of household-firm equilibrium has meaning only within the framework of the logic of choice. And the logic of choice itself is meaningful only within the context of individual action.

By virtue of his thoroughgoing methodological individualism, Mises maintains a firm grasp on the all-important distinction between the equilibrium of the individual actor and interindividual equilibrium in his balance-of-payments analysis. This difference between Mises's approach and the monetary approach may be seen in their divergent analyses of the effects on the balance of payments of a change emanating from the "real" or "goods" side of the economy. Assuming an international pure specie currency and starting from a situation of monetary and balance-of-payments equilibrium, let us suppose that domestic consumers increase their expenditures on foreign imports and that this increase reflects increased valuations of foreign products relative to domestic products. Let us further assume that the overall demand for money balances remains unchanged and that no other changes in the real or monetary data occur elsewhere in the system.

Under these conditions, those proponents of the monetary approach who are inclined to identify balance-of-payments surpluses and deficits with the process of adjusting monetary disequilibrium would naturally deny any disequilibrating effect on the balance of payments, since the nation, by hypothesis, does not wish to alter its level of money balances but merely its mix of consumers' goods. The adjustment will thus proceed entirely in the goods sphere, with the nation simply increasing its exports of domestic products, which it now demands less urgently, to pay for the increased imports of the now more highly esteemed foreign products, while the level of its money balances remains unchanged.

For Mises, however, things are not simple, since the adjustment process does not consist of the mutually consistent choices and actions of a single macroeconomic agent. Rather, it involves a succession of configurations of mutually inconsistent individual equilibria representing numerous microeconomic agents who are induced by the price system to bring their individual actions into closer and closer coordination until a final interindividual equilibrium is effected.

As a consequence, in Mises's analysis there will indeed emerge an initial balance-of-payments deficit and corresponding outflow of money from the nation as domestic consumers shift their expenditures from domestic products to foreign imports. Now, from the point of view of these individual domestic consumers, this outflow of money is certainly "equilibrating" in the logic-of-choice sense, because it demonstrably facilitates their attainment of a more preferred position. Nevertheless, from the point of view of the economic system as a whole, far from serving to adjust a preexisting monetary disequilibrium, this flow of money disrupts the prevailing equilibrium in the interindividual distribution of money balances and is therefore ultimately self-reversing. Thus, the domestic producers of those goods for which demand has declined experience a shrinkage of their incomes, which threatens to leave them with insufficient money balances. On the other hand, the foreign producers, the demand for whose products have increased, experience an augmentation of their incomes and a consequent buildup of excess money balances. Without going into detail, suffice it to say that the steps undertaken by both groups to readjust their money balances to desired levels will initiate a balance-of-payments adjustment process that will reestablish the original, equilibrium distribution of money holdings among individuals, and hence among nations.

Mises thus arrives at the same long-run, comparative-static conclusion as the proponents of the monetary approach do, to the effect that the change in question will not result in any alteration in national money stocks. However, his focus on the individual economic agent leads him to analyze the dynamic macroeconomic process by which the comparative-static, macroeconomic result emerges.

Before concluding, I wish to briefly note two other important ways in which Mises anticipated the monetary approach. The first involves the global perspective of the monetary approach, which contrasts so sharply with the narrowly national focus of closed-economy macro-models typical of the various Keynesian approaches to the balance of payments. The monetary approach views the world economy as a unitary market with the various national commodity and capital submarkets fully integrated with one another and subject to the rule of the law of one price. As a consequence, arbitrage insures that a particular nation's prices and interest rates are rigidly determined by the forces of supply and demand prevailing on the world market.

The analytical importance of the global perspective, which has revolutionized modern balance-of-payments analysis, was grasped completely by Mises:

The mobility of capital goods, which nowadays is but little restricted by legislative provisions such as customs duties, or by other obstacles, has led to the formation of a homogeneous world capital market. In the loan markets of the countries that take part in international trade, the net rate of interest is no longer determined according to national, but according to international, considerations. Its level is settled, not by the natural rate of interest in the country, but by the natural rate of interest anywhere…. So long and in so far … as a nation participates in international trade, its market is only a part of the world market; prices are determined not nationally but internationally.Mises, Theory of Money and Credit, pp. 374–75.

I might add that Mises's individualist and subjectivist analytical focus enables him to deal more trenchantly than the writers on the monetary approach with the objection that the existence of internationally nontraded goods and services, for example, houses, haircuts, ice cream cones, severely limits the operation of the law of one price and thus undermines the unity of the world price level. The response of the proponents of the monetary approach, such as Jacob Frankel and Harry Johnson, is the empirical assertion that the elasticities of substitution between the classes of traded and nontraded goods approaches infinity in both consumption and production, a condition that places extremely narrow limits on the range of relative price changes between the two classes of goods.Jacob A. Frenkel and Harry G. Johnson, "The Monetary Approach to the Balance of Payments: Essential Concepts and Historical Origins," in The Monetary Approach to the Balance of Payments, eds. Jacob A. Frenkel and Harry G. Johnson (Toronto: University of Toronto, 1976), pp. 27–28.

Mises, on the other hand, disposes of the objection theoretically.Mises, Theory of Money and Credit, pp. 170–78. His argument is based on the important insight that the location of a good in space is a factor conditioning its usefulness and, therefore, its subjective value to the individual economic agent. For this reason, technologically identical goods that occupy different positions in space are, in fact, different goods. To the extent that the overall valuations and demands of market participants for such physically identical goods differ according to their locations, there will naturally be no tendency for their prices to be equalized. Mises is able to conclude logically, therefore, that the existence of so-called nontraded goods whose prices tend to diverge internationally does not constitute a valid objection to the worldwide operation of the law of one price in the case of each and every good and the corollary tendency to complete equalization of the purchasing power of a unit of the world money.

A final respect in which Mises can be considered as a forerunner of the monetary approach is in his analysis of the causes and cures of a persistent balance-of-payments disequilibrium. For Mises and for the monetary approach, a chronic balance-of-payments deficit can only result from an inflationary monetary policy that continuously introduces excess money balances into the domestic economy via bank-credit creation. The deficit and the corresponding efflux of gold reflects the repeated attempts of domestic money holders to rid themselves of these excess balances, which are being re-created over and over again by the inflationary intervention of the monetary authority. The deficits will only be terminated when the inflationary monetary policy is brought to a halt or the stock of gold reserves is exhausted. Tariffs and other protectionist measures will fail to rectify the situation, since they do not address the fundamental cause of monetary disequilibrium.

The connection between inflationist, interventionist monetary policies and chronic balance-of-payments disequilibrium is delineated by Mises in the following passage:

If the government introduces into trade quantities of inconvertible banknotes or government notes, then this must lead to a monetary depreciation. The value of the monetary unit declines. However, this depreciation in value can affect only the inconvertible notes. Gold money retains all, or almost all, of its value internationally. However, since the state — with its power to use the force of the law — declares the lower-valued monetary notes equal in purchasing power to the higher-valued gold money and forbids the gold money from being traded at a higher value than the paper notes, the gold coins must vanish from the market. They may disappear abroad. They may be melted down for use in domestic industry. Or they may be hoarded.…

No special government intervention is needed to retain the precious metals in circulation within a country. It is enough for the state to renounce all attempts to relieve financial distress by resorting to the printing press. To uphold the currency, it need do no more than that. And it need do only that to accomplish this goal. All orders and prohibitions, all measures to limit foreign exchange transactions, etc., are completely useless and purposeless. Mises, Manipulation of Money and Credit, p. 55.

In conclusion, Mises's contribution to balance-of-payments analysis should be hailed not only as a doctrinal milestone in the development of the monetary approach but, much more importantly, as a shining exemplar of methodological individualism in monetary theory.Limitation of space has precluded a discussion of Mises's analysis of the exchange rate. Suffice it to say that Mises anticipated the monetary approach to the exchange rate, both in his pathbreaking explanation of the purchasing-power-parity theory (which predated Cassel) and also in his integration of expectations into the explanation of short-run exchange-rate movements. Moreover, Mises brought his global perspective to bear in his insight that the exchange rate between national currencies is to be explained on the same principles as the exchange rate between parallel currencies circulating in the same nation.

[This article is excerpted from Money, Sound and Unsound, chapter 6: "Ludwig von Mises and the Monetary Approach to the Balance of Payments: Comment on Yeager." This essay originally appeared in Method, Process, and Austrian Economics: Essays in Honor of Ludwig von Mises, ed. Israel M. Kirzner (New York: D.C. Heath and Company, 1982), pp. 247–56.]

Since the gold standard determines the money supply, there's not much scope for the central bank to use monetary policy to stabilize the economy.… Because you had a gold standard which tied the money supply to gold, there was no flexibility for the central bank to lower interest rates in recession or raise interest rates in an inflation.

This is precisely why the gold standard is so good: it prevents the authorities from engaging in reckless money pumping of the sort Bernanke has been engaging in since the end of 2007 by pushing over $2 trillion in new money into the banking system.

The Federal Reserve balance sheet jumped from $0.889 trillion in December 2007 to $2.247 trillion in December 2008. The yearly rate of growth of the balance sheet climbed from 2.6 percent in December 2007 to 152.8 percent by December 2008. Additionally the Fed has aggressively lowered the federal-funds rate target from 5.25 percent in August 2007 to almost nil by December 2008.

Consequently the yearly rate of growth of the AMS measureAustrian Money Supply. of the US money supply climbed from 1.5 percent in April 2008 to 14.3 percent by August 2009.

Contrary to Bernanke and most mainstream thinkers, such pumping has inflicted severe damage to the process of real wealth generation. It has severely impoverished wealth generators and laid the foundation for serious economic troubles ahead.

Allowing the money supply to be determined by the production of gold leads to stability and not chaos as Bernanke suggests. In an environment where money is gold and no one is engaged in the act of money printing, economic swings, i.e., boom-bust cycles, cannot emerge. (Note that money printing sets in motion an exchange of nothing for something, i.e., an act of embezzlement.) Contrary to Bernanke, it is policies that aim at stabilizing the economy that result in instability and economic chaos.

Bernanke holds that another major negative of a gold standard is that it creates a system of fixed exchange rates between the currencies of countries that are on a gold standard. There is no variability as we have it today, he argues:

If there are shocks or changes in the money supply in one country and perhaps even a bad set of policies, other countries that are tied to the currency of that country will also experience some of the effects of that.

It seems that the Fed chairman is arguing in favor of a floating currency system. We suggest that Bernanke has overlooked the fact that in a free market money is a commodity, and a dollar or other similar currency as such is not an independent entity.

Prior to 1933, the name dollar was used to refer to a unit of gold that had a weight of 23.22 grains. Since there are 480 grains in one ounce, this means that the name dollar also stood for 0.048 ounce of gold. This in turn means that one ounce of gold referred to $20.67. Please note that $20.67 is not the price of one ounce of gold in terms of dollars as Bernanke and other experts are saying. "Dollar" was just a name for 0.048 ounce of gold. According to Rothbard,

No one prints dollars on the purely free market because there are, in fact, no dollars; there are only commodities, such as wheat, cars, and gold.Murray N. Rothbard, "The Case for a Genuine Gold Dollar," The Gold Standard: An Austrian Perspective, pp. 1–17.

Likewise, the names of other currencies stood for a fixed amount of gold. The habit of regarding these names as a separate entity from gold emerged with the enforcement of the paper standard. Over time, as paper money assumed a life of its own, it became acceptable to set the price of gold in terms of dollars, francs, pounds, etc. — the absurdity of all this reached new heights with the introduction of the floating currency system.

Contrary to Bernanke, in a free market, currencies do not float against each other. They are exchanged in accordance with a fixed definition. If the British pound stands for 0.25 ounces of gold and the dollar stands for 0.05 ounces of gold, then one British pound will be exchanged for five dollars. This rate of exchange is a result of the fact that 0.25 of an ounce is five times larger than 0.05 of an ounce.

A floating currency system of commodity money is no less absurd than the idea of a fluctuating market price for dollars in terms of cents. How many cents equal one dollar is not something that is subject to fluctuations. It is fixed forever.Ibid.

Once it is realized that in a free market money is a commodity, it is obvious that, in similarity to other goods and services, its exchange value cannot stay still but will vary in accordance with supply and demand.

Now, Bernanke argues that variability in the supply of gold could lead to instability. But why should this be the case? Does a change in the supply-demand conditions of various goods and services produce instability? All that we will have is a change in prices. Obviously, if the supply of gold were to increase strongly this will lead to an increase in prices in terms of gold. This increase in prices however, has nothing to do with inflation. (Inflation, an increase in money "out of thin air," leads to an exchange of nothing for something — an act of embezzlement.) If the increase in the supply of gold were to persist, people would likely abandon gold as the medium of exchange and adopt another commodity.

According to the Fed chairman another problem with the gold standard is that it could trigger a speculative attack:

Now normally, a central bank with a gold standard only keeps a fraction of the gold necessary to back the entire money supply.… The British Central Bank only kept a small amount of gold, and they relied on their credibility to stand by the gold standard under all circumstances — so that nobody ever challenged them about the issue. But if for whatever reason, if markets lose confidence in your willingness and your commitment to maintaining that gold standard relationship, you can get a speculative attack.

A possible speculative attack is not a result of a gold standard but of the central bank abusing the gold standard by issuing paper money unbacked by gold. In short, the authorities were issuing unbacked-by-gold paper money, thereby undermining the gold standard.

Also in his speech Bernanke laments that a shortage of gold could lead to a general fall in prices, which could seriously damage the economy. For the Fed chairman, the fact that money is not growing is a disaster.

What matters is not the amount of money as such but its purchasing power. Hence with an expansion in real wealth the purchasing power of dollars will increase and every holder of dollars will be able to command more real wealth. A general fall in prices, which is labeled deflation, therefore permits more individuals to access an expanding pool of wealth.

Contrary to Bernanke, a gold standard that is not abused by the central bank generates stability. Boom-bust cycles are the outcome of central-bank policies that are aimed at stabilizing the economy. The alleged instability of economies during so-called gold standards in the past took place because the authorities were issuing unbacked-by-gold paper money, thereby undermining the gold standard.

If inflation is just a general rise in prices as the popular thinking has it, then why is it regarded as bad news? What kind of damage does it do?

Mainstream economists maintain that inflation causes speculative buying, which generates waste. Inflation, it is maintained, also erodes the real incomes of pensioners and low-income earners and causes a misallocation of resources. Inflation, it is argued, also undermines real economic growth.

Why should a general rise in prices hurt some groups of people and not others? Or how does inflation lead to the misallocation of resources? Why should a general rise in prices weaken real economic growth? Also, if inflation is triggered by various factors such as unemployment or economic activity then surely it is just a symptom and therefore doesn't cause anything as such.

To ascertain what inflation is all about, we have to establish its definition. Now, to establish the definition of inflation we have to establish how this phenomenon emerged. We have to trace it back to its historical origin.

Inflation originated when a country's ruler, such as a king, would force his citizens to give him all their gold coins under the pretext that a new gold coin was going to replace the old one. In the process, the king would falsify the content of the gold coins by mixing it with some other metal and return diluted gold coins to the citizens. On this Rothbard wrote,

More characteristically, the mint melted and recoined all the coins of the realm, giving the subjects back the same number of "pounds" or "marks," but of a lighter weight. The leftover ounces of gold or silver were pocketed by the King and used to pay his expenses.

Because of the dilution of the gold coins, the ruler could now mint a greater number of coins and pocket for his own use the extra coins minted. What was now passing as a pure gold coin was in fact a diluted gold coin.

The increase in the number of coins brought about by the dilution of gold coins is what inflation is all about. As a result of the increase in the number of coins that masquerade as pure gold coins, prices in terms of coins now go up (more coins are being exchanged for a given amount of goods).

Note that what we have here is an inflation of coins, i.e., an expansion of coins. As a result of inflation, the ruler can engage in an exchange of nothing for something (he can engage in an act of diverting resources from citizens to himself). Also note that the increase in prices in terms of coins comes because of the coin inflation. Observe however that it is the increase in coins brought about by the dilution of gold coins that enables the diversion of resources here to the ruler and not an increase in prices as such.

Under the gold standard, the technique of abusing the medium of exchange became much more advanced through the issuance of paper money unbacked by gold. Inflation therefore means an increase in the number of receipts for gold because of receipts that are not backed by gold yet masquerade as the true representatives of money proper, gold.

The holder of unbacked receipts can now engage in an exchange of nothing for something. As a result of the increase in the number of receipts (inflation of receipts) we now also have a general increase in prices. Observe that the increase in prices develops here because of the increase in paper receipts that are not backed up by gold. Also, what we have is a situation where the issuers of the unbacked paper receipts divert real goods to themselves without making any contribution to the production of goods.

In the modern world, money proper is no longer gold but rather paper money; inflation in this case is an increase in the stock of paper money.

Observe that we don't say, as monetarists are saying, that the increase in the money supply causes inflation. What we are saying is that inflation is the increase in the money supply.

Note that increases in the money supply set in motion an exchange of nothing for something. They divert real funding away from wealth generators toward the holders of the newly created money. This is what sets in motion the misallocation of resources, not price rises as such.

Real incomes of wealth generators fall, not because of general rises in prices, but because of increases in the money supply. When money is expanded, i.e., created "out of thin air," the holders of the newly created money can divert goods to themselves without making any contribution to the production of goods.

As a result, wealth generators who have contributed to the production of goods discover that the purchasing power of their money has fallen, because there are now fewer goods left in the pool — they cannot fully exercise their claims over final goods, because these goods are not there.

Once wealth generators have fewer real resources at their disposal, this is obviously going to hurt the formation of real wealth. As a result, real economic growth is going to come under pressure.

General increases in prices, which follow increases in money supply, only point to an erosion of real wealth. Price increases by themselves however do not cause this erosion.

Likewise it is monetary inflation, and not increases in prices, that erodes the real incomes of pensioners and low-income earners. As a rule, they are the last receivers of money, often called the "fixed-income groups."

According to Rothbard,

Particular sufferers will be those depending on fixed-money contracts — contracts made in the days before the inflationary rise in prices. Life insurance beneficiaries and annuitants, retired persons living off pensions, landlords with long-term leases, bondholders and other creditors, those holding cash, all will bear the brunt of the inflation. They will be the ones who are "taxed."

Now, all other things being equal, if for a given stock of goods an increase in the money supply occurs, this would mean that more money is going to be exchanged for a given stock of goods. Obviously, then, the purchasing power of money is going to fall, i.e., the prices of goods are going to increase (more money per unit of a good). In this case the general increase in prices is associated with inflation, i.e., increases in paper money.

But now consider the following case: the rate of growth in money is in line with the rate of growth in goods. Consequently, the prices of goods on average don't change. Do we have inflation here or don't we? For most economists, if an increase in the money supply is exactly matched by the increase in the production of goods, then this is fine, because no increase in general prices has taken place and therefore no inflation has emerged. We suggest that this way of thinking is false: inflation has taken place, i.e., the money supply has increased. This increase cannot be undone by the corresponding increase in the production of goods and services.

For instance, once a king has created more diluted gold coins that masquerade as pure gold coins he is now able to exchange nothing for something irrespective of the rate of growth of the production of goods. Regardless of what the production of goods is doing, the king is now engaging in an exchange of nothing for something, i.e., diverting resources to himself by paying nothing in return. This diversion is possible because of the increase in the number of coins brought about by the dilution of gold coins, i.e., the inflation of coins.

The same logic can be applied to paper-money inflation. The exchange of nothing for something that the expansion of money out of "thin air" sets in motion cannot be undone by an increase in the production of goods. The increase in money supply — i.e., the increase in inflation — is going to set in motion all the negative side effects that money printing does, including the menace of the boom-bust cycle, regardless of the increase in the production of goods.

According to Rothbard,

The fact that general prices were more or less stable during the 1920s told most economists that there was no inflationary threat, and therefore the events of the great depression caught them completely unaware.

Now, let us say that on a gold standard, because of an increase in the production of gold, the supply of money — i.e., gold — has increased. Subsequently a general increase in the prices of goods has taken place. Should we label this increase as inflation? According to some commentators on the gold standard, an increase in the supply of gold generates similar distortions that money out of thin air does.

Let us start with a barter economy. John the miner produces ten ounces of gold. The reason he mines gold is because he believes there is a market for it. Gold contributes to the well-being of individuals. He exchanges his ten ounces of gold for various goods such as potatoes and tomatoes.

Now people have discovered that gold, apart from being useful in making jewelry, is also useful for some other applications. They now assign a much greater exchange value to gold than before. As a result, John the miner can exchange his ten ounces of gold for more potatoes and tomatoes.

Should we condemn this as bad news because John is now diverting more resources to himself? No, what is happening with John the miner is just what is happening all the time in the market. As time goes by, people assign greater importance to some goods and diminish the importance of other goods. Some goods are now considered as more important than other goods in supporting people's lives and well-being.

Now people have discovered that gold is useful for another use: to serve as the medium of exchange. Consequently they further lift the price of gold in terms of tomatoes and potatoes. Gold is now predominantly demanded as a medium of exchange — the demand for other services of gold, such as ornaments, is now much lower than before.

Note however, that gold is a part of the pool of real wealth and promotes people's lives and well-being. Let us see what happens if John increases the production of gold.

One of the attributes for selecting gold as the medium of exchange is that it is relatively scarce. This means that a producer of a good who has exchanged this good for gold expects the purchasing power of his effort to be preserved over time by holding gold.

If for some reason there is a large increase in the production of gold, and this trend persists, the exchange value of the gold will be subject to a persistent decline versus other goods, all other things being equal. Under such conditions, people are likely to abandon gold as the medium of the exchange and look for other commodity to fulfill this role.

As the supply of gold starts to increase, its role as the medium of exchange diminishes, while the demand for it for some other usages is likely to be retained or increase. So in this sense the increase in the production of gold adds to the pool of real wealth.

When John the miner exchanges gold for goods he is engaged in an exchange of something for something. He is exchanging wealth for wealth. Also note that an increase in the supply of gold didn't occur because of an act of diluting gold but because of an increase in gold production.

Contrast all this with the printing of gold receipts, i.e., receipts that are not backed 100 percent by gold. This sets a platform for consumption without making any contribution to the pool of real wealth. Empty certificates set in motion an exchange of nothing for something, which in turn leads to the misallocation of resources and to boom-bust cycles.

Remember, an increase in the supply of mined gold doesn't lead to the misallocation of resources, i.e., employment of resources contrary to the true free market, which reflects consumers' most urgent preferences. Note again that the number of coins increased here is not because of the dilution of gold coins but as a result of an increase in the production of gold, i.e., real wealth. In contrast to the holder of money out of thin air, the wealth generator — the gold producer — supports his own activities. He is not engaged in the diversion of real resources from other wealth generators by means of empty money. Consequently, any decline in the amount of money out of thin air is not going to hurt him. (Note a decline in the money out of thin air will reduce the diversion of resources to activities that emerged on the back of money out of thin air.)

Contrary to the popular definition, inflation is not about general rises in prices but about increases in money "out of thin air." Inflation is an act of embezzlement. On a gold standard, inflation is about the increase in receipts unbacked by gold money. On a paper standard, inflation is about an increase in the supply of paper money. The general increase in prices, as a rule, develops on account of the increase in money. The harm that most people attribute to rises in prices is in fact due to increases in the money supply out of thin air. Therefore, policies that are aimed at fighting inflation without identifying what it is all about only make things much worse. When inflation is seen as a general increase in prices, then anything that contributes to price increases is called inflationary. It is no longer the central bank and fractional-reserve banking that are the sources of inflation, but rather various other causes. In this framework, not only does the central bank have nothing to do with inflation; on the contrary, the bank is regarded as an inflation fighter.

On this subject Mises wrote,

To avoid being blamed for the nefarious consequences of inflation, the government and its henchmen resort to a semantic trick. They try to change the meaning of the terms. They call "inflation" the inevitable consequence of inflation, namely, the rise in prices. They are anxious to relegate into oblivion the fact that this rise is produced by an increase in the amount of money and money substitutes. They never mention this increase. They put the responsibility for the rising cost of living on business. This is a classical case of the thief crying "catch the thief." The government, which produced the inflation by multiplying the supply of money, incriminates the manufacturers and merchants and glories in the role of being a champion of low prices.

As we have seen, the Constitution forbids the states to make anything but gold and silver coin a tender in payment of debt, nor does it permit the federal government to make anything a legal tender. One of the most important pieces of legislation that could be enacted would be the repeal of all federal legal-tender laws. Such laws, which have the effect of forcing creditors to accept something in payment for the debts due them that they do not wish to accept, are one of the most tyrannical devices of the present monetary authorities.

Not only does the Federal Reserve have a coercive monopoly in issuing "money," but every American is forced to accept it. Each Federal Reserve note bears the words, "This note is legal tender for all debts, public and private." The freedom to conduct business in something else — such as gold and silver coin — cannot exist so long as the government forces everyone to accept its paper notes. Monetary freedom ends where legal-tender laws begin.

The United States had no such laws until 1862, when the Congress — in violation of the Constitution — enacted them in order to ensure the acceptance of the Lincoln greenbacks, the paper notes printed by the US Treasury during the wartime emergency. That "emergency" has now lasted for 120 years; it is time that this unconstitutional action by the Congress be repealed. Freedom of contract — and the right to have such contracts enforced, not abrogated, by the government — is one of the fundamental pillars of a free society.

A second major reform needed is a legal definition of the term "dollar." The Constitution uses the word "dollar" at least twice, and it is quite clear that by it the framers meant the Spanish-milled dollar of 371 ¼ grains of silver. Since 1968, however, there has been no domestic definition of "dollar," for in that year redemption of silver certificates and delivery of silver in exchange for the notes ended, and silver coins were removed from circulation.

In 1971, the international definition of the "dollar" as 1/42 of an ounce of gold was also dropped. The Treasury and Federal Reserve still value gold at $42.22 per ounce, but that is a mere accounting device. In addition, IMF rules now prohibit any member country from externally defining its currency in terms of gold. The word "dollar," quite literally, is legally meaningless, and it has been meaningless for the past decade. Federal Reserve notes are not "dollars"; they are notes denominated in "dollars." But what a "dollar" is, no one knows.

This absurdity at the basis of our monetary system must be corrected. It is of secondary importance whether we define a "dollar" as a weight of gold or as a weight of silver. What is important is that it be defined. The current situation permits the Federal Reserve — and the Internal Revenue Service for that matter — to use the word any way they please, just like the Red Queen in Alice in Wonderland.

No rational economic activity can be conducted when the unit of account is undefined. The use of the meaningless term "dollar" has all but wrecked the capital markets of this country. If the "dollar" changes in meaning from day-to-day, even hour-to-hour, long-term contracts denominated in "dollars" become traps that all wish to avoid. The breakdown of long-term financing and planning in the past decade is a result of the absurd nature of the "dollar." There is very little long-term planning occurring at the present. The only way to restore rationality to the system is to restore a definition for the term "dollar." We suggest defining a "dollar" as a weight of gold of a certain fineness, .999 fine. Such a fixed definition is the only way to restore confidence in the markets and in the "dollar." Capitalism cannot survive the type of irrationality that lies at the basis of our present monetary arrangements.

We are extremely pleased that the Gold Commission has recommended to the Congress a new gold coinage. It has been almost 50 years since the last United States gold coins were struck, and renewing this constitutional function would indeed be a cause for celebration and jubilee.

We believe that the coins should be struck in one-ounce, one-half-ounce, one-quarter-ounce, and one-tenth-ounce weights, using the most beautiful of coin designs, that designed by Augustus Saint Gaudens in 1907. A coinage in such weights would allow Americans to exchange their greenbacks for genuine American coins; there would no longer be any need for purchasing Canadian, Mexican, South African, or other foreign coins. Combined with the removal of capital-gains taxation on the coins and the elimination of all transaction taxes, such as excise and sales taxes, the new American coinage could quickly become an alternative monetary system to our present paper monopoly.

In addition to the new official coinage, private mints should also be permitted to issue their own coins under their own trademarks. Such trademarks should be protected by law, just as other trademarks are. Furthermore, private citizens should once again enjoy the right to bring gold bullion to the Treasury and exchange it for coins of the United States for a nominal minting fee.

In the last six years, Nobel laureate Friedrich Hayek has called attention once again to the economic advantages of a system of competing currencies. In two books, Choice in Currency and Denationalization of Money, Professor Hayek proposes that all legal obstacles be removed and that the people be allowed to choose freely what they wish to use in transactions. Those competing monies might be foreign currencies, private coins, government coins, private bank notes, and so on. Such unrestricted freedom of choice would result in the most reliable currencies or coins winning public acceptance and displacing less reliable competitors. Good money — in the absence of government coercion — drives out bad. The new coinage that the Gold Commission has recommended and which we strongly endorse is a first step in the direction of allowing currencies to compete freely.

By a strict interpretation of the Constitution, one of the most unconstitutional (if there are degrees of unconstitutionality) of federal agencies is the Federal Reserve. The Constitution grants no power to the Congress to set up such an institution, and the Fed is the major cause of our present monetary problems. The alleged constitutional authority stems from a loose and imaginative interpretation of the implied powers clause.

Functioning as the central bank of the United States, the Federal Reserve is an anachronism. It was created at a time when faith in control of the economy by Washington was growing, but since it started operations in 1914, it has caused the greatest depressions (1929-1939), recessions (too numerous to mention), inflations, and unemployment levels in our nation's history. The only useful function it performs, the clearing of checks between banks, could be much better handled through private clearinghouses or eliminated entirely by electronic funds transfer. Given its record, there simply is no good reason for allowing the Federal Reserve a monopoly over the nation's money and banking system. Eliminating the power to conduct market operations must be achieved if we expect to stop inflation and restore monetary freedom.

Such a step may alarm some, however. They might be concerned about what will happen to all the Federal Reserve notes now in circulation and what they will be replaced with. First, the present Federal Reserve notes would be retired and replaced by notes redeemable in gold or silver or some other commodity. Such notes would be similar to traveler's checks now in use which are, at the present time, redeemable only in paper notes. Like traveler's checks, such notes would not be legal tender and no one would be forced to accept them in payment. And since they would be promises to pay, any institution that issued them and then failed to redeem them as promised would be subject to both civil and criminal prosecution, unlike the Federal Reserve, which is subject to neither.

As for the present circulating Federal Reserve notes, they could be made redeemable for gold once a "dollar" is defined as a weight of gold. Anyone who wishes to redeem them could simply do so by exchanging them for gold coins at his bank.

It is important to note that should we institute a gold standard before the Federal Reserve System is ended, that system must function along classical gold standard lines. As Friedman and Schwartz pointed out, it was the failure of the Federal Reserve to abide by the classical gold standard rules that caused the panic of 1929 and the subsequent depression.

In chapters 2 and 3, we demonstrated the disruptive effects fractional-reserve banking has caused in the United States. Since we still suffer with that system, it is imperative that a fundamental reform of it be made. That reform is simply that all promises to pay on demand, whether made in the form of notes or deposits, be backed 100 percent by whatever is promised, be it silver, gold, or watermelons. If there is any failure to carry 100 percent reserves or to make delivery when demanded, such persons or institutions would be subject to severe penalties. The fractional-reserve system has created the business cycle, and if that is to be eliminated, its cause must be also.

One of the areas in which we believe a majority of the Gold Commission erred is in not requiring a thorough and complete assay, inventory, and audit of the gold reserves of the United States on a regular basis. Perhaps there is less of an argument for such a procedure when the gold reserves are essentially stable, but when there is any significant change in them — as will happen when a new coinage is issued — careful scrutiny of the government's gold supplies is necessary.

There have been cases of employee thefts at government bullion depositories, unrecorded shipments of gold from one depository to another, and numerous press reports about millions of dollars worth of gold missing. It seems elementary that the government ought to ascertain accurately its reserves of this precious metal, and that the present ten-year "audit" of the gold inventory is totally inadequate for this purpose. We are quite sure that the Federal Reserve has a much better idea of how many Federal Reserve notes are printed and circulating than the Treasury does of the weight and fineness of its gold assets. This irrational treatment of paper and gold must be corrected immediately.

Finally, there are laws on the books empowering the president to compel delivery, that is, to confiscate privately owned gold bullion, gold coins, and gold certificates in time of war. There can be no monetary freedom when the possibility of such a confiscation exists.

One of the standard objections raised against a gold standard is that while it may have worked in the 19th century, it would not work today, for government has grown much larger in the past 100 years.

There is an element of truth in such an argument, for the gold standard is not compatible with a government that continually incurs deficits and lives beyond its means. Growing governments have always sought to be rid of the discipline of gold; historically they have abandoned gold during wars in order to finance them with paper dollars, and during other periods of massive government growth — the New Deal, for example.

Because gold is honest money, it is disliked by dishonest men. Politicians, prevented from buying votes with their own money, have learned how to buy votes with the people's money. They promise to vote for all sorts of programs, if elected, and they expect to pay for those programs through deficits and through the creation of money out of thin air, not higher taxes. Under a gold standard, such irresponsibility would immediately result in high interest rates (as the government borrowed money) and subsequent unemployment. But through the magic of the Federal Reserve, these effects can be postponed for awhile, allowing the politicians sufficient time to blame everyone else for the economic problems they have caused. The result is, as John Maynard Keynes said many years ago, that not one man in a million understands who is to blame for inflation.

Because the gold standard would be incompatible with deficit financing, a major reform needed would be a balanced budget. Such a balance could easily be achieved by cutting spending — surprising as it may be, no cuts have been made yet — to the level of revenue received by the government.

But beyond that, there should be massive cuts in both spending and taxes, something on the order of what President Truman did following World War II, when 75 percent of the federal budget was eliminated over a period of three years. Honest money and limited government are equally necessary in order to end our present economic crisis.

As part of this budget reform, the government should eventually be required to make all its payments in gold or in gold-denominated accounts. No longer would it be able to spend "money" created out of thin air by the Federal Reserve.

In order to make such gold payments, the government should begin accepting gold as payment for all taxes, duties, and dues. As a tax collector, the government must specify in what form taxes may be paid (or must be paid), and it should specify that taxes must be paid in either gold or silver coins or certificates. Such an action should occur, of course, as one of the last actions in moving toward a sound monetary system. All of the other reforms discussed here should be accomplished first. Such a requirement to pay taxes in gold or silver would yield the necessary flow to put the government on the gold standard and allow it to make all payments in gold.

But long before this is achieved, since gold is money, there should be no taxation of any sort on either gold coins or bullion. The commission has judged rightly in recommending that capital-gains and sales taxes be eliminated from the new American coinage. We would go further, in the interest of monetary freedom, and urge that all taxation of whatever sort be eliminated on all gold and silver coins and bullion. That would mean the elimination of not only capital-gains and sales taxes, but also the discriminatory treatment of gold coins in Individual Retirement Accounts, for example. Persons saving for their retirement should be free to keep their savings in gold coins without incurring a penalty. One reform that might be accomplished immediately would be to direct the Internal Revenue Service to accept all US money at face value for both the assessment and collection of taxes. At the present time, the IRS accepts pre-1965 silver coins at face value in the collection of taxes, but at market value in the assessment of taxes. This policy is grossly unfair, has no basis in law, and should be corrected immediately.

Together with monetary, tax, and budget reforms, a comprehensive plan for a gold standard and monetary freedom requires several improvements in our present regulatory structure.

For example, mining regulations, which make it difficult and expensive to open or operate gold and silver mines, would have to be eliminated. All regulations on the export, import, melting, minting, and hoarding of gold coins would also have to be repealed.

But the major reforms needed are in our banking laws. Under present law, there is no free entry into the banking industry; it is largely cartelized by the Federal Reserve and other federal and state regulatory agencies. Deregulation of banking, including free entry by simply filing the legal documents with the proper government clerk, is a must for monetary freedom. All discretion on the part of the regulators must be ended.

At the same time, there would need to be stricter enforcement of the constitutional prohibition against states "emitting bills of credit." It must be clearly recognized that the states, neither directly nor indirectly through their creatures, state chartered banks, may get into the paper money business.

Although we believe that there is actually nothing in the Constitution that legitimizes our present banking and monetary arrangements, the present system has been with us for so long that a constitutional amendment is probably needed to reaffirm what the Constitution says.

We propose that the following language become the 27th Ammendment to the Constitution:

Neither Congress nor any state shall make anything a tender in payment of private debts, nor shall they charter any bank or note-issuing institution, and states shall make only gold and silver coins as tender in payment of public taxes, duties, and dues.

This article is excerpted from The Case for Gold (1982), chapter 6, "The Transition to Monetary Freedom."

Thus it devolves upon the laws of the country and upon the courts to define what the parties to the contract had in mind when speaking of a sum of money and to establish how the obligation to pay such a sum is to be settled in accordance with the terms agreed upon. They have to determine what is and what is not legal tender. In attending to this task the laws and the courts do not create money. A thing becomes money only by virtue of the fact that those exchanging commodities and services commonly use it as a medium of exchange. In the unhampered market economy the laws and the judges in attributing legal tender quality to a certain thing merely establish what, according to the usages of trade, was intended by the parties when they referred in their deal to a definite kind of money. They interpret the customs of the trade in the same way in which they proceed when called to determine what is the meaning of any other terms used in contracts.

Mintage has long been a prerogative of the rulers of the country. However, this government activity had originally no objective other than the stamping and certifying of weights and measures. The authority's stamp placed upon a piece of metal was supposed to certify its weight and fineness. When later princes resorted to substituting baser and cheaper metals for a part of the precious metals while retaining the customary face and name of the coins, they did it furtively and in full awareness of the fact that they were engaged in a fraudulent attempt to cheat the public. As soon as people found out these artifices, the debased coins were dealt with at a discount as against the old better ones. The governments reacted by resorting to compulsion and coercion. They made it illegal to discriminate in trade and in the settlement of deferred payments between "good" money and "bad" money and decreed maximum prices in terms of "bad" money. However, the result obtained was not that which the governments aimed at. Their decrees failed to stop the process which adjusted commodity prices (in terms of the debased currency) to the actual state of the money relation. Moreover, the effects appeared which Gresham's law describes.

The history of government interference with currency is, however, not merely a record of debasement practices and of abortive attempts to avoid their inescapable catallactic consequences. There were governments that did not look upon their mintage prerogative as a means of cheating that part of the public who placed confidence in their rulers' integrity and who, out of ignorance, were ready to accept the debased coins at their face value. These governments considered the manufacturing of coins not as a source of surreptitious fiscal lucre but as a public service designed to safeguard a smooth functioning of the market. But even these governments — out of ignorance and dilettantism — often resorted to measures which were tantamount to interference with the price structure, although they were not deliberately planned as such. As two precious metals were used side by side as money, the authorities naively believed that it was their task to unify the currency system by decreeing a rigid exchange ratio between gold and silver. The bimetallic system proved a complete failure. It did not bring about bimetallism, but an alternating standard. That metal which, compared with the instantaneous state of the fluctuating market exchange rate between gold and silver, was overvalued in the legally fixed ratio, predominated in domestic circulation, while the other metal disappeared. Finally the governments abandoned their vain attempts and acquiesced to monometallism. The present silver purchase policy of the American government is not seriously a device of monetary policy. It is merely a device for raising the price of silver for the benefit of the owners of silver mines, their employees, and the states within whose boundaries the mines are located. It is a hardly disguised subsidy. Its monetary significance consists exclusively in the fact that it is financed by issuing additional dollar notes whose legal tender quality does not differ essentially from that of the Federal Reserve notes, although they bear the practically meaningless imprint "Silver Certificate."

Yet economic history also provides instances of well-designed and successful monetary policies on the part of governments whose only intention was to equip their countries with a smoothly working currency system. Laissez-faire liberalism did not abolish the traditional government prerogative of mintage. But in the hands of the liberal governments the character of this state monopoly was completely altered. The ideas which considered it an instrument of interventionist policies were discarded. No longer was it used for fiscal purposes or for favoring some groups of the people at the expense of other groups. The government's monetary activities aimed at one objective only: to facilitate and to simplify the use of the medium of exchange which the conduct of the people had made money. A nation's currency system, it was agreed, should be sound. The principle of soundness meant that the standard coins — i.e., those to which unlimited legal tender power was assigned by the laws — should be properly assayed and stamped bars of bullion coined in such a way as to make the detection of clipping, abrasion, and counterfeiting easy. To the government's stamp no function was attributed other than to certify the weight and the fineness of the metal contained. Pieces worn by usage or in any other way reduced in weight beyond the very narrow limits of tolerated allowance lost their legal tender quality; the authorities themselves withdrew such pieces from circulation and reminted them. For the receiver of an undefaced coin there was no need to resort to the scales and to the melting pot in order to know its weight and content. On the other hand, individuals were entitled to bring bullion to the mint and to have it transformed into standard coins either free of charge or against payment of a seigniorage generally not surpassing the actual expenses of the process. Thus the various national currencies became genuine gold currencies. Stability in the exchange ratio between the domestic legal tender and that of all other countries which had adopted the same principles of sound money was thus brought about. The international gold standard came into being without intergovernmental treaties and institutions.

In many countries the emergence of the gold standard was effected by the operation of Gresham's law. The role that government policies played in the process in Great Britain consisted merely in ratifying the results brought about by the operation of Gresham's law; it transformed a de facto state of affairs into a legal state. In other countries the governments deliberately abandoned bimetallism just at the moment when the change in the market ratio between gold and silver would have brought about a substitution of a de facto silver currency for the then prevailing de facto gold currency. With all these nations the formal adoption of the gold standard required no other contribution on the part of the administration and the legislature than the enactment of laws.

It was different in those countries which wanted to substitute the gold standard for a — de facto or de jure — silver or paper currency. When the German Reich in the 1870s wanted to adopt the gold standard, the nation's currency was silver. It could not realize its plan by simply imitating the procedure of those countries in which the enactment of the gold standard was merely a ratification of the actual state of affairs. It had to exchange the silver standard coins in the hands of the public against gold coins. This was a time-absorbing and complicated financial operation involving vast government purchases of gold and sales of silver. Conditions were similar in those countries which aimed at the substitution of gold for credit money or fiat money.

It is important to realize these facts because they illustrate the difference between conditions as they prevailed in the liberal age and those prevailing today in the age of interventionism.

Discussion of gold has gone from nonexistent a decade ago to the question of whether its price is in bubble territory, and now a policy question in the Republican primary. Ron Paul has been stumping for a return to the gold standard for decades, and the populace has finally caught up.

The issue resonates with young people who worry about a dire future with a dollar crash and nationwide poverty. The gold issue is hot enough that Newt Gingrich has promised to appoint a gold commission, with The Case for Gold coauthor Lewis Lehrman and Jim Grant as cochairman.

When Ronald Reagan went through the gold commission charade in 1981 to satisfy a campaign promise of studying the gold standard question, Lehrman cast one of two dissenting votes on the commission that voted in favor of maintaining the fiat money status quo. The other "no" vote came from Ron Paul himself. As Murray Rothbard explained,

The gold standard was the easiest pledge to dispose of. President Reagan appointed an allegedly impartial gold commission to study the problem — a commission overwhelmingly packed with lifelong opponents of gold. The commission presented its predictable report, and gold was quickly interred.

In similar fashion, Norris and the NYT look to explore the worthiness of a gold standard by citing a University of Chicago survey of 37 economists asking if they agreed that "price-stability and employment outcomes would be better for the average American" if the dollar's value were tied to gold.

Norris makes a point that among the 37 were advisers to both Democratic and Republican presidents. As if this insured some sort of impartiality. Like Captain Renault in Casablanca, you will be shocked — shocked! — to know that all 37 of the esteemed economists polled think a gold standard is a terrible idea.

The first statement the 37 economists responded to was

If the US replaced its discretionary monetary policy regime with a gold standard, defining a "dollar" as a specific number of ounces of gold, the price-stability and employment outcomes would be better for the average American.

Those disagreeing were 43 percent and those strongly disagreeing were the other 57 percent.

With their answers, the responders also provided a one to ten degree of confidence in their opinion. Most were highly confident in their positions. The Ivy League is well represented with nearly half the panel coming from Yale, Harvard, or Princeton. Berkeley and Stanford combined for ten on the panel and the supposedly free-market Chicago had five representatives, as did MIT.

Anil K. Kashyap is a professor of economics and finance at Chicago and used the survey to make this snide remark: "A gold standard regime would be a disaster for any large advanced economy. Love of the G.S. implies macroeconomic illiteracy."

According to his webpage Professor Kashyap is currently teaching these two advanced MBA elective classes: "Analyzing Financial Crises" and "Understanding Central Banks." But Kashyap is plenty busy off campus. He's a consultant for the Federal Reserve Bank of Chicago and a member of the Economic Advisory Panel of the Federal Reserve Bank of New York. He does work for the government of Japan and, well, you get the idea.

Former Obama economic advisor Austan Goolsbee, also a professor at Chicago, seems downright annoyed by the gold questions, saying, "eesh. Has it come to this?"

One wonders how MIT's Bengt Holmstöm makes this judgment: "All insights from the past and current crises go against a gold standard."

To the contrary, history shows that with a gold standard there are fewer crises; and when there are crises they are short-lived, as in the case of the panics of 1819, 1873, and 1920. Since the last remnants of the gold standard were cast aside by Nixon in 1971, world economies have been a series of booms, busts, inflations, economic instability, with no real economic growth.

"This proposal makes no sense in the modern world," says Yale's William Nordhaus. "Just look at the Eurozone to see the consequences." Surely the good professor doesn't think Europe is currently on the gold standard. But assuming he equates the fiat euro with a gold-backed euro, Professor Nordhaus should read Philipp Bagus's The Tragedy of the Euro. Bagus points out that member states of the European Union run deficits expecting them to be financed by the ECB. So Europe has a tragedy of the commons at work with its monetary policy that sets up very dangerous incentives for member states, making the system unworkable.

Governments cannot print prosperity, and capital must be saved — it cannot be conjured from the ether.

A number of professors on the panel made comments to the effect that the price of gold is too volatile or unstable to back the dollar. Evidently it doesn't occur to them that it's not the price of gold that's volatile but the value of the dollar. The value of the dollar is volatile downward for the very reason that the Fed can create dollars from nowhere; evidenced by the M2 money supply increasing from $683.7 billion in August 1971 to the current $9,712.8 billion.

Creating paper and digits is cheap and effortless. Mining gold is anything but. It's expensive and the yellow metal is quite hard to find. Grant's Interest Rate Observer points out that, according to the US Geological Survey, the world supply of gold has increased at rate of only 1.7 percent a year from 1900 through 2009.

Granted, it hasn't been a steady 1.7 percent growth. Production boomed in the 1930s, for instance, but since the 2000s, growth has declined to 1.1 percent. However, as Grant points out,

Still, over the long run, the co-commissioners [Grant and Lehrman] agree, the Newmonts and the Barricks of the world are more dependable sources of monetary matter than the Federal Reserves of the world.

Behavioral economist Richard Thaler asks, "Why tie to gold? Why not 1982 Bordeaux?" Assuming Professor Thaler is being serious, wine doesn't make a terribly good money, although it might do better than our present paper system. After all, a number of things have been used as money throughout history: salt, sugar, cattle, iron hoes, tea, cowrie shells, and even cigarettes in prison camps.

Ultimately the commodity that is selected by the marketplace to be money will have these characteristics: generally marketable, divisible, high value per unit weight, fairly stable value, durable, recognizable, and homogeneous.

Thaler's 1982 Bordeaux flunks most of the test. While it's divisible, wine is anything but durable, certainly not homogeneous, and hauling Bordeaux around by the bottle or barrel would not be handy in this (as the professors like to say) modern world.

It's hard to make a case that 1982 Bordeaux is generally marketable, but having a bottle to trade with might serve you well in certain situations. Value would vary widely due to weather and harvests on the supply side and consumer preference on the demand side. This leads us to the problem that, in some parts of the world and for some people, wine — whether it's 1982 Bordeaux or Two Buck Chuck — is not recognized as having any value at all.

Meanwhile, the yellow metal passes the test with flying colors.

The second statement posed to the panel was, "There are many factors besides US inflation risk that influence the current dollar price of gold."

To this question 73 percent strongly agreed and 27 percent simply agreed.

MIT's Daron Acemoglu strongly agreed with this statement and commented, "Gold is intrinsically close to useless, so its price is determined as a 'bubble.'" Gold has been used for thousands of years as a medium of exchange and store of value. It's jaw-dropping to know a professor at MIT believes gold is useless. In fact it is the dollar and US Treasury debt that are the greatest bubbles the world has ever seen.

Professor Nordhaus also strongly agreed and wrote, "There is no discernible connection between gold price and CPI movements in the period since the demonetization of gold in 1971."

Really? This chart plotting the price of gold and CPI portrays a strong connection.

The connection reflected by the chart would be even stronger if John Williams's shadowstats SGS-CPI were used instead of the BLS's hedonically adjusted numbers.

LBJ's guns-and-butter policy of the 1960s combined with Nixon's big-government conservatism, each facilitated by a compliant Fed, led to Nixon's unshackling the dollar from its last faint gold restraint. The resulting stagflation of the 1970s brought on the cry to return the dollar to gold.

Bush and Obama's drones-and-caviar policy makes LBJ and Nixon look like rock-ribbed fiscal conservatives. The money printing has been relentless, and the yellow metal's price merely reflects this quaint old definition of "inflation."

To ask the question if 2012 is 1980 all over again answers the question as to why returning to gold is imperative. The nightmarish economic outcomes caused by being, as Jim Grant says, on a "PhD standard" demand change, and more people realize it each and every day.

Fiat paper, whose use is mandated by the state, is the PhDs' money; while gold, with a value derived from trade, is the people's money.

The people want their money back from the ivory tower — before it's too late.

Also, and not so coincidentally, this was the "War to Make the World Safe for Mass Democracy," a political system which we have all learned by now is the great enemy of freedom in all its social and economic manifestations.

Now, it is true that the gold standard did not disappear overnight, but limped along in weakened form into the early 1930s. But this was not the pre-1914 classical gold standard, in which the actions of private citizens operating on free markets ultimately controlled the supply and value of money and governments had very little influence.

Under this monetary system, if people in one nation demanded more money to carry out more transactions or because they were more uncertain of the future, they would export more goods and financial assets to the rest of the world, while importing less. As a result, additional gold would flow in through a surplus in the balance of payments increasing the nation's money supply.

Sometimes, private banks tried to inflate the money supply by issuing additional bank notes and deposits, called "fiduciary media," promising to pay gold but unbacked by gold reserves. They lent these notes and deposits to either businesses or the government. However, as soon as the borrowers spent these additional fractional-reserve notes and deposits, domestic incomes and prices would begin to rise.

As a result, foreigners would reduce their purchases of the nation's exports, and domestic residents would increase their spending on the relatively cheap foreign imports. Gold would flow out of the coffers of the nation's banks to finance the resulting trade deficit, as the excess paper notes and checks were returned to their issuers for redemption in gold.

To check this outflow of gold reserves, which made their depositors very nervous, the banks would contract the supply of fiduciary media bringing about a monetary deflation and an ensuing depression.

Temporarily chastened by the experience, banks would refrain from again expanding credit for a while. If the Treasury tried to issue convertible notes only partially backed by gold, as it occasionally did, it too would face these consequences and be forced to restrain its note issue within narrow bounds.

Thus, governments and commercial banks under the gold standard did not have much influence over the money supply in the long run. The only sizable inflations that occurred during the 19th century did so during wartime when almost all belligerent nations would "go off the gold standard." They did so in order to conceal the staggering costs of war from their citizens by printing money rather than raising taxes to pay for it.

For example, Great Britain experienced a substantial inflation at the beginning of the 19th century during the period of the Napoleonic Wars, when it had suspended the convertibility of the British pound into gold. Likewise, the United States and the Confederate States of America both suffered a devastating hyperinflation during the War for Southern Independence, because both sides issued inconvertible Treasury notes to finance budget deficits. It is because politicians and their privileged banks were unable to tamper with and inflate a gold money that prices in the United States and in Great Britain at the close of the 19th century were roughly the same as they were at the beginning of the century.

Within weeks of the outbreak of World War I, all belligerent nations departed from the gold standard. Needless to say by the war's end the paper fiat currencies of all these nations were in the throes of inflations of varying degrees of severity, with the German hyperinflation that culminated in 1923 being the worst. To put their currencies back in order and to restore the public's confidence in them, one country after another reinstituted the gold standard during the 1920s.

Unfortunately, the new gold standard of the 1920s was fundamentally different from the classical gold standard. For one thing, under this latter version, gold coin was not used in daily transactions. In Great Britain, for example, the Bank of England would only redeem pounds in large and expensive bars of gold bullion. But gold bullion was mainly useful for financing international trade transactions.

Other countries such as Germany and the smaller countries of Central and Eastern Europe used gold-convertible foreign currencies such as the US dollar or the pound sterling as reserves for their own domestic currencies. This was called the gold-exchange standard.

While the US dollar was technically redeemable in honest-to-goodness gold coin, banks no longer held reserves in gold coin but in Federal Reserve notes. All gold reserves were centralized, by law, in the hands of the Fed and banks were encouraged to use Fed notes to cash checks and pay for checking and savings deposit withdrawals. This meant that very little gold coin circulated among the public in the 1920s, and residents of all nations came increasingly to view the paper IOUs of their central banks as the ultimate embodiment of the dollar, franc, pound, etc.

This state of affairs gave governments and their central banks much greater leeway for manipulating their national money supplies. The Bank of England, for example, could expand the amount of paper claims to gold pounds through the banking system without fearing a run on its gold reserves for two reasons.

Foreign countries on the gold exchange standard would be willing to pile up the paper pounds that flowed out of Great Britain through its balance of payments deficit and not demand immediate conversion into gold. In fact by issuing their own currency to tourists and exporters in exchange for the increasing quantities of inflated paper pounds, foreign central banks were in effect inflating their own money supplies in lock-step with the Bank of England. This drove up prices in their own countries to the inflated level attained by British prices and put an end to the British deficits.

In effect, this system enabled countries such as Great Britain and the United States to export monetary inflation abroad and to run "a deficit without tears" — that is, a balance-of-payments deficit that does not involve a loss of gold.

But even if gold reserves were to drain out of the vaults of the Bank of England or the Fed to foreign nations, British and US citizens would be disinclined, either by law or by custom, to put further pressure on their respective central banks to stop inflating by threatening bank runs to rid themselves of their depreciating notes and retrieve their rightful property left with the banks for safekeeping.

Unfortunately, contemporary economists and economic historians do not grasp the fundamental difference between the hard-money classical gold standard of the 19th century and the inflationary phony gold standard of the 1920s.

Thus, many admit, if somewhat grudgingly, that the gold standard worked exceedingly well in the 19th century. However, at the same time, they maintain that the gold standard suddenly broke down in the 1920s and 1930s and that this breakdown triggered the Great Depression. Monetary freedom in their minds is forever discredited by the tragic events of the 1930s. The gold standard, whatever its merits in an earlier era, is seen by them as a quaint and outmoded monetary system that has proved it cannot survive the rigors and stresses of a modern economy.

Those who implicate the gold standard as the main culprit in precipitating the events of the 1930s generally fall into one of two groups. One group argues that it was an inherent flaw in the gold standard itself that led to a collapse of the financial system, which in turn dragged the real economy down into depression. Writers in the second group maintain that governments, for social and political reasons, stopped adhering to the so-called rules of the gold standard, and that this initiated the downward spiral into the abyss of the Great Depression.

From either perspective, however, it is clear that the gold standard can never again be trusted to serve as the basis of the world's monetary system. On the one hand, if it is true that the gold standard is fundamentally flawed, that in itself is a crushing practical argument against the principle of monetary freedom. On the other hand, if the gold standard is in fact a creature of rules contrived by governments, and it is politically impossible for them to follow those rules, then monetary freedom is simply irrelevant from the outset.

The first argument is the Keynesian argument and the second the monetarist argument against the gold standard.

Two recent books have elaborated these arguments against the gold standard. The economic historian Barry Eichengreen published a book in 1992 entitled Golden Fetters: The Gold Standard and the Great Depression. Eichengreen summarized the argument of this book in the following words:

The gold standard of the 1920s set the stage for the Depression of the 1930s by heightening the fragility of the international financial system. The gold standard was the mechanism transmitting the destabilizing impulse from the United States to the rest of the world. The gold standard magnified that initial destabilizing shock. It was the principle obstacle to offsetting action. It was the binding constraint preventing policymakers from averting the failure of banks and containing the spread of financial panic. For all these reason the international gold standard was a central factor in the worldwide Depression. Recovery proved possible, for these same reasons, only after abandoning the gold standard.

According to Eichengreen, then, not only was the gold standard responsible for initiating and internationally propagating the Great Depression, it was also the primary reason why the recovery was delayed for so long.

It was only after governments one after another in the 1930s severed the link between their national currencies and gold that their national economies finally began to recover. This was because, unbound by the rules of the gold standard, governments were now able to bail out their banking systems and run budget deficits financed by bank credit inflation without the constraining fear of losing their gold reserves.

Thus, the phrase "golden fetters" in the title of Eichengreen's book is a reference to Keynes's statement in 1931, "There are few Englishman who do not rejoice at the breaking of our gold fetters."

Of course, what Keynes and Eichengreen fail to understand is that the end of the classical liberal era in 1914 caused the removal from government central banks of the "golden handcuffs" of the genuine gold standard. Were these "golden handcuffs" still in place in the 1920s, central banks would have been rigidly constrained from inflating their money supplies in the first place and the business cycle that culminated in the Great Depression would not have taken place.

A second book that inculpates the gold standard as a leading cause of the Great Depression was published in 1998 and is entitled The Great Depression: An International Disaster of Perverse Economic Policies. According to the authors, Thomas E. Hall and J. David Ferguson, one of the most perverse and destabilizing economic policies of the 1920s involved the Fed violating the rules of the gold standard by allegedly "sterilizing" the inflow of gold from Great Britain.

This means that the Fed refused to pyramid inflated paper dollars on top of these newly acquired gold reserves in quantities sufficient to drive US prices up to the inflated level of British prices. This policy would have made US products more expensive relative to British products on world markets and would have helped mitigate Great Britain's ongoing loss of gold reserves through its balance-of-payments deficits.

These deficits were the result of the fact that Great Britain had returned to the gold standard after its wartime inflation at the prewar gold parity, which, given the inflated level of domestic prices, significantly overvalued the British pound in terms of the dollar.

These deficits could have been avoided if the British government had either deflated its price level sufficiently or chosen to return to gold at a devalued exchange rate reflecting the true extent of its previous inflation.

Hall and Ferguson, however, ignore these considerations, arguing that when the United States sterilizes gold,

The impact on the system is that Britain bears the brunt of the adjustment. Since the money supply in the United States did not rise, neither did U.S. incomes and prices as they were supposed to, which would have helped Britain eliminate their payments deficit. Since Britain was not aided by rising exports to the United States, Britain must experience a more severe decline in incomes and prices than would have been the case if the U.S. money supply had gone up. In this way Britain would bear the brunt of the adjustment in the form of a more severe recession than would have occurred if the United States had been playing by the rules. Thus it was critical that each country play fair.

Thus, in Hall and Ferguson's view, the rules of the gold standard dictate that when one central bank irresponsibly engages in monetary inflation and subsequently attempts to maintain an overvalued exchange rate, less inflationary central banks must rush to its aid and expand their own nations' money supplies in order to prevent it from losing its gold reserves.

But if a nation losing gold due to inept or irresponsible monetary policy can always count on those gaining gold to share "the brunt of the adjustment" by expanding their own money supplies, this is surely a recipe for worldwide inflation.

Now, this line of argument indicates that Hall and Ferguson completely misunderstand the true purpose and function of the gold standard. To begin with, a gold standard functions much better without a central bank, because these institutions, as creatures of politics, are inherently inflationary and tend to promote rather than restrain the inflationary propensities of the fractional-reserve commercial banks.

But, second, under a genuine gold coin standard, the choices of private households and firms effectively control the money supply. As I explained above, if the residents of one nation demand to hold more money for whatever reason, they can obtain the precise quantity of gold coin they require through the balance of payments by temporarily selling more exports and buying fewer imports.

This implies that, if a central bank does exist and it wishes to act in accordance with a genuine gold standard, it should always "sterilize" gold inflows by issuing additional notes and deposits only on the basis of 100 percent gold reserves and insisting that the commercial banks do the same. It should not permit these gold reserves to be used as the basis of a multiple credit expansion by the banking system.

In this way, a nation's money supply would be completely subject to market forces. By the way, this is precisely how the distribution of the supply of dollars between the different states of the United States is determined today. There is no government agency charged with monitoring and controlling New Jersey's or Alabama's money supply.

Hall and Ferguson reveal their uneasiness with and lack of insight into the operation of the money supply process under a genuine gold standard with the following example:

Suppose a fad had swept the nation in 1927 because Calvin Coolidge appeared in public wearing one gold earring. Then every teenager in America wanted to wear a gold earring "just like silent Cal".… The result would be an [increase] in the commercial demand for gold. Since more gold would be used in earrings less would be available for money.… It would be beyond the power of government to do anything about this fact. What a scary thought, the teenagers of America would have caused the U.S. money supply to decline.

While it is true that the commercial demand for gold does play a role in determining the supply and value of money under a gold standard, it is hardly cause for alarm. Rather, it highlights the important fact that the gold standard evolved on the market from a useful commodity with a preexisting supply and demand and was not the product of a set of arbitrary rules promulgated by governments.

Now, Hall and Ferguson conclude that by breaking the rules of the game and persisting in sterilizing the gold inflows from 1929 to 1933, the Fed caused a monetary deflation in Great Britain and throughout Europe. The nations losing gold were forced to contract their money supplies and this contributed to a financial collapse and a precipitous decline in real economic activity that marked the onset of the Great Depression.

Thus while the authors blame the initiation of the Great Depression on Fed sterilization policies, they attribute its length and severity to the gold standard. According to the authors, as long as European countries remained on the gold standard and US sterilization continued, there could be no end of the Depression in sight. The US gold stock would become a huge pile of sterilized and useless gold. Starting with the British in 1931, our trading partners began to recognize this fact, and one by one they left the gold standard. The Germans and ironically the United States were among the last to leave gold and so were hurt the worst, experiencing the longest and deepest forms of the Depression.

So although Eichengreen emphasizes the gold standard as a restraint on government monetary policy and Hall and Ferguson the failure of governments to play by its rules, in effect, they reach the same conclusion: the gold standard, and with it monetary freedom, stands indicted as a primary cause of the greatest economic catastrophe in history.

In the face of the historical evidence they adduce, can any defense be mounted in favor of the gold standard? The answer is a resounding "yes," and the defense is as simple as it is impregnable. As I have tried to indicate above, the case against the gold standard is from beginning to end a case of mistaken identity. The genuine gold standard did not fail in the 1920s, because it had already been destroyed by government policies after 1914.

The monetary system that sowed the seeds of the Great Depression in the 1920s was a central-bank-manipulated and inflationary pseudogold standard. It was central banking that failed in the 1920s and stands discredited to this day as the cause of the Great Depression.

A detailed case in support of this view can be found in the works of Murray N. Rothbard, particularly in his book America's Great Depression and in A History of Money and Banking in the United States: The Colonial Era to World War II.

In these works you will read that the US money supply, properly defined, increased from 1921 to 1928 at the annual rate of 7 percent per year, a rate of monetary inflation that was unseen under the classical gold standard. You will also learn that during the 1920s the Fed, far from operating as the deflationary force on the money supply portrayed by some monetarists, increased the categories of bank reserves within its control at the annual rate of 18 percent per year.

Finally you will read that from 1929 to 1932, the Fed continued to exercise a highly inflationary impact on the money supply, as it feverishly pumped new reserves into the banking system in a vain attempt to ward off the cyclical downturn entailed by its own earlier inflation of the money supply. The Fed was defeated in this endeavor to pump up the money supply and "reflate" prices in the early 1930s by domestic and foreign depositors who reclaimed their rightful property from an inherently bankrupt US banking system. They had suddenly lost confidence in the Fed-controlled monetary system masquerading as a gold standard, when they perceived at last the dwindling prospect of ever redeeming the rapidly expanding mountain of inflated paper claims for their gold dollars.

[This talk was delivered at the Mises Institute conference The History of Liberty, January 29, 2000.]

Carl Menger, founder of the Austrian School of economics, started to unravel the mystery of money in the late 19th century. Ludwig von Mises finally cut the Gordian knot with his first magnum opus, The Theory of Money and Credit (1912), the most important single advance in monetary theory in the history of economic thought.

In that treatise, Mises erected a theory of money of astounding originality that was complete and internally integrated: as well as externally integrated with modern, subjectivist economics in general. With this book, Mises completed the victory of the "marginal revolution" by extending its conquest to the monetary realm. In doing so, Mises finally made economics whole. In his later treatise, Human Action, Mises developed his theory further, making it even more rigorous.

While Mises's monetary writings should be required reading for any educated citizen, it can be challenging to parse some of the technical language. That is where Gary North comes in. In Mises on Money, Dr. North lucidly explains all the essential tenets of Mises's monetary theory, with his inimitable incisiveness and style. He methodically walks the reader through such topics as the origin of money, Mises's "regression theorem," fractional reserve banking, and the Austrian business cycle theory. He explains why money is not "neutral," and why price stabilization is a chimera. After reading this short work, you will have a firm understanding of Austrian monetary theory, and will be in prime condition to tackle Mises's own writings on the subject.

Dr. North writes:

In summarizing Mises's theory of money, I cover five themes: the definition of money; the optimum quantity of money and its corolary, stable prices; fractional reserve banking, and how to inhibit it; and the monetary theory of the business cycle. They are closely interrelated. Mises's system was a system.

Yet over the last two years a dramatic shift in gold purchases has occurred. In the third quarter of this year alone, net gold purchases by central banks amounted to 150 tons — more than double the amount of the whole yearly total of 2010. For the first time in over 20 years, central banks of the world are buying more gold than they are divesting themselves of.

Yet if central banks deal exclusively in nonconvertible (and fiat) money, what explains the sudden change of heart?

Convertibility may bring costs for a central bank, but it also has its benefits. In particular, it solved two problems:

Without convertibility, these two issues get significantly more complicated. In this short essay, we will focus on only the first of these problems.

Independence for a central bank comes from the government that grants it the monopoly rights to money production in its jurisdiction. Congress provides oversight for the Fed, but no government agent specifically determines the day-to-day operations of the central bank. (This is debatable, of course, but that is a separate issue.)

This independence is coveted, and for good reason. A government in charge of its printing press has an incentive to pay for its expenditures not through taxes, or even by debt, but through the relatively painless act of printing the necessary money. The problem with this is the ensuing inflationary bias that a government-controlled printing press has.

An independent central bank issues currency, which is recorded as a liability on its balance sheet. In an offsetting transaction, an asset is purchased that balances the accounting statement. Though this asset can be anything, it has become the norm that it is a relatively safe interest-bearing government bond. Gold still comprises a portion of most central banks' balance sheets, but because it has its own costs and returns no interest, it is a relatively unattractive option.

If a central bank wants to directly increase the money supply, it increases its liabilities (sells cash) and correspondingly increases its assets (buys bonds). If it wants to decrease the money supply, it decreases its assets (sells bonds), which then decreases its liabilities (by decreasing the amount of cash outstanding).

As a thought experiment, imagine what would happen if a central bank didn't sell any assets but instead had them lose value. As an extreme example, imagine that the bonds it holds default due to the insolvency of their issuer. Cash does not automatically have to adjust by decreasing by an equivalent amount. To maintain the accounting equality, the relevant liability that changes is the central bank's equity. Accounting insolvency is defined as being that moment when your equity turns negative.

It is difficult to imagine a central bank turning insolvent. Indeed, by and large this doesn't happen, though as Philipp Bagus and I outline in our book, Deep Freeze: Iceland's Economic Collapse, recent examples do exist (see also here). A central bank that holds bonds as its assets only maintains its solvency as long as the issuer of its bonds maintains its own solvency.

The problem that develops is what to do if equity turns negative. Recapitalization must result, but by whom? In an extreme scenario, the government can directly recapitalize the central bank. This action is not without consequences. Central banks enjoy, at least in some countries, high degrees of independence because they do not rely on their governments for funding. Indeed, as they remit profits back to the government at year's end, they are revenue generators for the government.

But a government supporting a central bank is also increasingly interested in how that bank is run. Increased oversight of the monetary authority might be welcomed by some, but it also opens Pandora's box: perhaps with the increased oversight the government will also start influencing the central bank's operating mandates, or even its daily operations.

Gold purchases by central banks are completely rational responses given this independence dilemma. With the solvency of some large governments being increasingly questioned each day, investors and central banks alike are also questioning the value of their debts. Greece just gave private holders of its debt a 50 percent haircut; could the same for governments and other organizations be far off? The solvency of a growing list of countries gets longer by the week — Ireland, Portugal, Italy, Spain — not even the United States is immune to this possibility, as its own debt crisis illustrates.

Holding gold does not eliminate the possibility of negative equity for the central bank (indeed, it might even increase the odds). But given the recent past it makes for an attractive option. As countries demonstrate their difficulties in getting their debts and deficits in order and thus improving their solvency outlooks, the value of their debt becomes questionable as well.

While holding any real asset serves no direct use for a central bank, it does act as an insurance policy of sorts. The solvency of a central bank holding government debt is subordinate to the solvency of the countries whose debt it holds. For a central bank worried about the value of its assets, diversification of its assets into gold makes for a rational alternative.

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The sound-money principle has two aspects. It is affirmative in approving the market's choice of a commonly used medium of exchange. It is negative in obstructing the government's propensity to meddle with the currency system.Mises, L. v. (1953), The Theory of Money and Credit, New Haven, Yale University Press, p. 414 (Part Four, Monetary Reconstruction).

And further,

It is impossible to grasp the meaning of the idea of sound money if one does not realize that it was devised as an instrument for the protection of civil liberties against despotic inroads on the part of governments. Ideologically it belongs in the same class with political constitutions and bills of right.Ibid.

To Mises, the sound-money principle thus meant

In what follows I will try to show that it can be logically concluded that if money does not comply with the sound-money principle, that is if it is unsound money, it will erode and eventually destroy civil liberties by (and here I may add, ever greater) despotic inroads on the part of government.

Such a statement can be shown to be irrefutably true, as it is derived from the sound-money principle, and the sound-money principle can be traced back to the irrefutably true axiom of human action, which is at the heart of praxeology: the logic of human action, as Mises termed it.

One of Mises's pathbreaking achievements is that he reconstructed the science of economics along the lines of praxeology.On the praxeological method see Rothbard (1997), "Praxeology: The Methodology of Austrian Economics." For a detailed explanation, seem, for instance, Hoppe (2007), "Praxeology and Economics Science," Economic Science and the Austrian Method, pp. 7–48. At the heart of praxeology is the axiom of human action.

The axiom of human action is of a rather special quality: it meets the requirements of an a priori synthetic judgment, as the German-Prussian philosopher Immanuel Kant (1724–1804) called it.Immanuel Kant developed his epistemology most completely in his Critique of Pure Reason (1781).

To explain, a priori here means knowledge that comes to us before, or irrespective of, sensory experience. A priori knowledge is within our minds, so to speak. It is knowledge about the real world (reality), and for obtaining it one does not have to take recourse to observation.

Consider the following two examples:

These statements strike one as necessarily a priori true; one wouldn't have to test them for proving their validity.

Synthetic means that one adds to a concept (say, body) a predicate (say, heavy) that is not thought in the concept before. The example is this:

All bodies are heavy.

One would have to learn from experience that bodies are heavy; one wouldn't know this a priori. Synthetic judgments are a posteriori.

Kant maintained that there is the possibility of so-called a priori synthetic judgments: judgments that neither repeat the meaning of concepts tautologically nor express new information about the subject term on the basis of experience.

According to Kant, a priori synthetic judgments must meet two requirements.

Mises's axiom of human action meets both of these requirements.In this context see Hoppe, H.-H. (2007 [1995]), "Praxeology and Economics Science," Economic Science and the Austrian Method, pp. 7–48, esp. pp. 17–24. The axiom of human action is not derived from sensory observation. To understand that humans act stems from a reflective understanding, not from observation.

And, it is self-evident. The truth value of the axiom of human action cannot be denied, as such a denial would be a form of action and thus contradict the very statement that there cannot be such a thing as human action.

Praxeology, therefore, provides us with true knowledge about the outer world, and the truth of knowledge derived from praxeology is valid independent of sensory experience. It is in this sense that we can speak of praxeology as a priori theory.

An a priori economic proposition informs us about the relationships between observable events and the counterfactual alternatives to these events; it does not concern relationships between various observable events.See, for instance, Hülsmann, J. G. (2003), "Facts and Counterfactuals in Economic Law," Journal of Libertarian Studies, volume 17, no. 1, Winter 2003, pp. 57–102.

An aprioristic proposition allows us to name the outcome of a certain action with certainty. For instance, if the stock of money is increased, we know for sure that it will lower the exchange value of a money unit.

We know that the law of diminishing marginal utility is implied in the axiom of human action. This law says that the marginal utility of a unit (that is the utility of an additional unit of the good) declines if the supply of the good increases (other things equal).

An additional money unit in one's possession can only be employed as a means for removing an uneasiness that is deemed less urgent than the least urgent one that has so far been satisfied by the unchanged size of money units in one's possession.

We can therefore say with certainty that a rise in the money stock necessarily reduces the exchange value of a money unit (when compared to a situation in which the money stock had remained unchanged).

This, of course, is not to say that aprioristic propositions allow us to make exact forecasts in a quantitative sense. For instance, we do not know when and by how much the exchange value of a money unit declines if and when the money stock rises.

However, a priori theory tells us in advance (that is, without having to run a social experiment) whether or not a given action — or policy measure, for that matter — can or cannot bring about the promised effects.

For instance, we know with certainty that a rise in the money stock will never be "neutral" in the sense of leaving market agents' income and wealth positions unaffected. A rise in the money stock will always benefit some at the expense of others. It is impossible to think otherwise.

As action requires time — with time being a category of human action — a rise in the money supply benefits the early receivers of the newly created money at the expense of the later receivers of the new money or those who don't receive any of the new money (known as the "Cantillon effect").

In what follows it will be shown that the sound-money principle can be traced back to the axiom of human action. To do so, one has to start with stating some true propositions that can be logically derived from this axiom.

From the irrefutably true axiom of human action we know that human action is purposeful action: means are employed to achieve certain ends.

We also know that means are scarce with regard to the services for which man wants to use them. Where man is not restrained by the insufficient quantity of things available, there is no need for any action — and this is impossible to think.

And because of the scarcity of means, we also know that man prefers more goods over fewer goods.

Assuming that people realize that the division of labor yields a higher productivity than self-sufficient production (which is, it should be stressed, an assumption), they will engage in specialization and trade.

Trading becomes most efficient if people make use of an indirect means of exchange. Exchanging goods against a good that has a higher marketability expands actors' markets, allowing them to take full advantage of the productivity gains provided by the division of labor.

The commodity with the highest marketability will be chosen as money. Mises described the process as follows:

There would be an inevitable tendency for the less marketable of the series of goods used as media of exchange to be one by one rejected until at last only a single commodity remained, which was universally employed as a medium of exchange; in a word, money.Mises, L. v. (1953), The Theory of Money and Credit, New Haven, Yale University Press, pp. 32–33.

Why, however, is money chosen by the unhampered market necessarily commodity money, as Mises maintains (as did Carl Menger before him)? Already in 1912, Mises had shown with his regression theorem that money must have emerged, for aprioristic considerations, from a commodity.

People demand money because there is uncertainty (which, in turn, is a category of human action), and money helps to deal with uncertainty: It can be exchanged against other vendible items most conveniently, as it has purchasing power.

The purchasing power of money is determined by the supply of and the demand for money. But isn't such an explanation circular? If the purchasing power of money is determined by the supply of and demand for money, how can this explain the demand for money, which is, in turn, determined by the purchasing power of money?

Mises with his regression theorem found the answer to this question. He explained that the demand for money in the present is explained by money's purchasing power experienced in the (immediate) past.

He saw that the purchasing power of money can be regressively traced back to the point in time when a commodity, which had previously been used only for nonmonetary purposes, is used for monetary purposes for the first time.

From a praxeological viewpoint we can therefore conclude that in a free market — where people are assumed to be governed by self-interest and have the ability to appreciate the higher productivity resulting from a division of labor — money must emerge in the form of commodity money, and that free-market money means sound money.

Against this backdrop the following questions arise: How can it be that today's moneys — the US dollar, the euro, the Chinese renminbi, the British pound or the Swiss franc — are no longer commodity moneys? How can it be that they are not produced freely (in the sense of complying with free-market principles)?

Today's moneys are so-called fiat moneys: moneys that represent intrinsically valueless paper tickets or "bits and bytes" on computer hard disks; they are not redeemable into anything. These fiat moneys are produced by government-sponsored central banks, which hold the money production monopoly.

We know from history that the gold standard was, in an admittedly prolonged process, replaced by fiat money. Mainstream economists typically maintain that this happened because the gold standard failed — as it didn't allow for a flexible, or politically motivated, increase in the money supply.

However, a priori theory offers a rather different explanation of why the gold standard (sound money) was replaced by a fiat-money standard (unsound money). The central element in this a priori theoretical explanation is the concept of the state.

Murray N. Rothbard developed a new Austrian theory of the state, defining it as follows:

The State is that organization in society which attempts to maintain a monopoly of the use of force and violence in a given territorial area; in particular, it is the only organization in society that obtains its revenue not by voluntary contribution or payment for services rendered but by coercion.Rothbard (2009), Anatomy of the State, Ludwig von Mises Institute, p. 11.

Rothbard not only explained that the state is incompatible with the free-market society; he also outlined in What Has Government Done to Our Money? how and why commodity money was replaced by fiat money — namely, because of the continual expansion of the state.

Hans-Hermann Hoppe has explored in great detail the logical-ethical-economic implications of public ownership of government — as represented by democracy-republicanism — showing that once public ownership of government is put into place, ever-greater violations of individual property rights will be the logical consequence.See in this context Hoppe, H. H. (2006), Democracy — The God That Failed: The Economics and Politics of Monarchy, Democracy, and Natural Order, Transaction Publishers, New Brunswick (US) and London (UK).

Three interrelated factors explain this.

Under public ownership of government there will be temporary caretakers of government power (so-called politicians, or the ruling class). Assuming self-interest on their part, the caretakers of government will use their temporary government power to their own advantage.

The caretakers of government will maximize their current income rather than the present value of all future government revenues. For what the temporary caretaker of government doesn't consume when he holds government power, he won't be able to consume in the future.

Public ownership of government means that those who want to be among the class of the rulers need the support from the majority of the people. The latter, also assumed to be driven by self-interest, will support those who will provide them with the desired (monetary and nonmonetary) benefits.

The caretakers of government will have to win over as many voters as possible to get into and stay in power. This can only be achieved by promising, and providing, potential voters with benefits they otherwise wouldn't, or couldn't, obtain. These benefits will have to be expropriated, and necessarily so, from others.

Assuming that voters prefer more over fewer goods — which is a logical implication of the axiom of human action — it becomes obvious why public ownership of government will necessarily result in progressive violations of individuals' property rights.

Some forms of private-property violations are more advantageous for bringing about a coercive redistribution of income and wealth than others, both from the viewpoint of the rulers and the ruled.

In particular, using fiat money is, politically speaking, more attractive than other forms of expropriation (such as raising taxes). Having recourse to fiat money, Rothbard noted, government "can then appropriate resources slyly and almost unnoticed, without rousing the hostility touched off by taxation."Rothbard, M. N. (2008 [1963]), What Has Government Done To Our Money?, Ludwig von Mises Institute, p. 52.

Rothbard described the various steps through which commodity money is replaced by fiat money (including, for instance, monopolizing the minting business, giving money a name rather than defining it as a weight of the commodity it represents, etc.).

The final step in replacing commodity money by fiat money is allowing banks to suspend the redemption of outstanding bank notes and demand deposits in money proper (which was, in practice, gold).

This is actually what happened on August 15, 1971, when Richard Nixon, president of the United States of America, closed the "gold window." In his television address, President Nixon said,

I have directed Secretary Connally to suspend temporarily the convertibility of the American dollar except in amounts and conditions determined to be in the interest of monetary stability and in the best interests of the United States.… The effect of this action, in other words, will be to stabilize the dollar."

President Nixon's order meant that the US dollar was no longer redeemable in gold. The measure was not temporary; it is still in place. And it did not stabilize the US dollar: between August 1971 and July 2011, the greenback lost 82 percent of its purchasing power (on the basis of consumer prices).

Under the Bretton Woods system, all major currencies — the British pound, the French franc, the Japanese yen, to name just a few — were linked to the US dollar. With the suspension of the redeemability of the greenback in gold, all these currencies were also cut loose from gold. Commodity moneys became fiat moneys.

That said, replacing commodity money by fiat money (that is, replacing the sound-money principle by the unsound-money principle) is, from a praxeological viewpoint, a logical consequence of public ownership of government.

What has a priori theory to say about the question of whether fiat money can last, or whether it will have to collapse? The answer can be found within Austrian trade-cycle theory, or with two important implications, which may all too easily escape our attention:

Ongoing injections of fiat money produced through bank-circulation credit to "fight" the crisis caused by fiat-money expansion in the first place prevent unprofitable investments from being liquidated, as they can be refinanced at lower interest rates and appear to be profitable.

Artificially suppressed interest rates — brought about by an expansion of bank-circulation credit — encourage investment projects that would not have been undertaken if the market interest hadn't been pushed down by central-bank policy.

The consequence of these two aspects is that the economy's overall debt load keeps growing at a faster rate over time than real incomes, leading (sooner or later) to a situation of overindebtedness, in particular if and when government is in the hands of temporary caretakers.

A fiat-money regime will therefore end up, and logically so, in a situation in which borrowers will no longer be in a position (or willing, for that matter) to service their debt, and lenders will no longer be willing to rollover maturing debt. It is at this stage when the printing of ever-greater amounts of fiat money will be seen as the policy of the least evil.

This, too, is a praxeological inference. To explain, public ownership of government reduces the economic incentive to limit aggression against individuals' property rights. It reduces peoples' encompassing interest in the market economy by increasing their interest in transfer incomes.See in this Olson, M. (2000), Power and Prosperity, Outgrowing Communist and Capitalist Dictatorships, Basic Books, esp. pp. 1–24. It increases the societal time preference, thereby lowering savings and investment and thus economic progress.

Government beneficiaries (such as those employed by government or firms receiving orders from the public sector) will increasingly be in favor of an expanding government — as big government will give them (at least the chance of) bigger business and higher (monetary and nonmonetary) income — setting into motion a process in which ever-greater numbers of people team up with government. Frederic Bastiat put the underlying logic succinctly: "Government is that great fiction, through which everybody endeavors to live at the expense of everybody else."Bastiat, C. F. (2007), The Bastiat Collection, Volume I, Ludwig von Mises Institute, p. 99.

It was actually in accordance with praxeology when Mises concluded as early as 1923 — well before he put forward praxeology — that under public ownership of government, fiat money will be progressively debased, or even completely destroyed:

If a government is not in a position to negotiate loans and does not dare levy additional taxation for fear that the financial and general economic effects will be revealed too clearly too soon, so that it will lose support for its program, it always considers it necessary to undertake inflationary measures. Thus inflation becomes one of the most important psychological aids to an economic policy which tries to camouflage its effects.… By deceiving public opinion, it permits a system of government to continue which would have no hope of receiving the approval of the people if conditions were frankly explained to them.Mises, L. v. (2006, 1923), "Stabilization of the Monetary Unit — From the Viewpoint of Theory," The Causes of the Economic Crisis, p. 38.

To sum up, Mises's sound-money principle can be logically deduced from the axiom of human action, which is at the heart of praxeology; the sound-money principle is axiomatic in nature.

This is all the more important as we find that the sound-money principle has been replaced by the unsound-money principle the world over:

It is in this way that fiat money — with all its corruptive consequences — is instrumental in eroding the fundament of the free-market order, increasingly transforming it into a socialist order.

The way back to the sound-money principle is theory dependent. Mises wrote,

The belief that a sound monetary system can once again be attained without making substantial changes in economic policy is a serious error. What is needed first and foremost is to renounce all inflationist fallacies. This renunciation cannot last, however, if it is not firmly grounded on a full and complete divorce of ideology from all imperialist, militarist, protectionist, statist, and socialist ideas.Ibid, p. 44.

To Mises, a return to the sound-money principle must start with unmasking false theories. This is because theories are at the heart of human action:

Action is preceded by thinking.… He who thinks a causal relation thinks a theorem. Action without thinking, practice without theory are unimaginable. Mises, L. v. (1996), Human Action, 4th ed., Fox & Wilkes, San Francisco, p. 177.

A priori theory is a powerful intellectual tool for classifying theories as true or false. In fact, apriorism puts us in a position to unmask false economic theories ex ante, theories that make false promises, resulting in detrimental (even disastrous) consequences if put into practice.

Making use of a priori theory shows us that free-market money is sound money, and that deviating from the sound-money principle leads to disastrous economic, social, and political damage.

To return to sound money, one has to understand the aprioristic nature of the sound-money principle. And so Mises's work on the methodology of the science of economics deserves the highest attention.

As the Austrian business-cycle theory teaches, artificially cheap credit, not backed by real savings, creates intertemporal discoordination in production involving scarce resources that ultimately results in malivestment. As Roger Garrison explains,

An artificial boom is an instance in which the change in the interest-rate signal and the change in resource availabilities are at odds with one another. If the central bank pads the supply of loanable funds with newly created money, the interest rate is lowered just as it is with an increase in saving. But in the absence of an actual change in time preferences, no additional resources for sustaining the policy-induced boom are freed up. In fact, facing a lower interest rate, people will save less and spend more on current consumables. The central bank's credit expansion, then, results in an incompatible mix of market forces.

Increased investment in longer-term projects is consistent with the underlying economic realities in a genuine saving-induced boom but not in a policy-induced artificial boom. The artificial boom is characterized by "malinvestment and overconsumption."

The type of boom-and-bust cycle caused by cheap credit and overinvestment was reflected in the recent housing bubble as well as the dot-com bubble just over a decade ago. As former Fed chairman Alan Greenspan cut interest rates (to deal with his previous bubbles) he provided the credit and incentive to invest in such ventures as housing and Internet start-ups. Once these investments were not as profitable as they were originally, well, you know the outcome.

So what is gold's role in all this? In light of credit and monetary expansion by governments, gold has historically kept its value over time. Investors looking for a safe asset that maintains its value can always look to gold. In a recent article in the Telegraph, Emma Simon elaborates on this historical case:

Recent research from the World Gold Council shows how gold has held its value over the long term when compared with other commodities. The relative price of gold and oil has remained almost constant over the past 50 years. So although the price of both (in either pounds or dollars) has risen during this period, if you were buying a barrel of oil with bullion you would hand over roughly the same weight of gold as you would have done in 1950.

More startling is that gold has retained this purchasing power over even longer periods. It is thought that an ounce of gold bought 350 loaves in the time of Nebuchadnezzar, the king of Babylon who died in 562BC. An ounce of gold still buys roughly 350 ordinary sliced loaves today, showing that over 2,500 years gold has proved a very effective hedge against inflation, at least when it comes to everyday essentials.

So if gold holds its value in the face of inflation, what does this tell us about the latest drop in its price following Bernanke's "Twist" announcement?

At the onset of "Quantitative Easing 2," Bernanke's last big monetary-base expansion, it was speculated that the Fed may be creating a commodities bubble. Indeed, commodities enjoyed a bull run while Bernanke added $600 billion to the Fed's balance sheet:

Source: SeekingAlpha.com

Once QE2 ended, commodities at the consumer level continued to increase in price until the "Operation Twist" announcement. There are a few conclusions to draw from this. First, we are experiencing the bursting of a commodity bubble caused by interest rates being kept artificially low by central banks around the world. These low interest rates entice large investors such as university endowments and pension funds to seek higher returns elsewhere. For example, the University of Texas endowment took the unprecedented move of purchasing $1 billion in gold bullion last April. Bernanke even boasted at the onset of QE2 last November that stock prices were up as more investors were willing to risk their money for better returns. Like commodities, stock-market gains have been heavily correlated to increases in the Fed's balance sheet. As Henry Hazlitt acknowledged, "no actual inflation happens by a simultaneous or proportional increase in everybody's money supply or money income." New money hits the economy in stages and flows into different sectors. The effect isn't felt all at once. This is just one of the consequences of artificially low interest rates. 

Second, the market was expecting Bernanke and the other leaders at the Federal Reserve to do a lot more at the recent Federal Open Market Committee meeting than replicate a failed monetary trick from the 1960s. Even Goldman Sachs was surprised by the market effects of the "Twist." Judging by the plunge commodity prices took following the Fed's announcement, the market has become accustomed to expecting further monetary "easing" — especially given Bernanke's record of meeting any economic slowdown with more money printing. It should also be pointed out that China's recent attempt at slowing down its inflation-driven economy has also lowered demand for commodities; yet another case of fiat boom and subsequent bust.

While gold may be down in price now, there is great reason to assume it will continue to rise in the long term. As investor Brandon Smith explains,

In reality, there is no QE1, QE2, TARP, etc. These are not separate stimulus efforts that actually started and concluded independent of one another. They are all a part of one long fiat injection into our economy that never ended.

The Fed is ALWAYS creating fiat. Some of it is reported, most of it is not. Ask yourself this: Are interest rates still at near zero? If the answer is yes, then the fiat still flows.

Indeed, in order to keep interest rates low, the Fed must suppress by continued "easing." There is no reason to believe that central banks around the world will suddenly have a change of heart and stop injecting money into their economies to avoid a much needed correction. This is especially so in the United States; as Doug Casey points out, "interest accounts for roughly 2% of $15 trillion official national debt, or $300 billion per year. As interest rates inevitably rise, that interest amount will grow." 

The Fed will, if it ever plans to, have to raise interest rates slowly if the US government doesn't plan on continuing its spending spree of buying votes. Considering both central banks of Sweden and Japan started devaluing their perspective currencies last August and what becomes of the eurozone will most likely be the massive printing of either the drachma, escudo, lira, deutschemark, or even the euro itself, gold doesn't appear to be in a bubble in the long run as governments around the world continue to spend like drunken sailors to prop up commercial banks and provide entitlements. Having your cake and eating it too is a good strategy when the money is cheap (basically free in the case of the printing press), but the party won't last forever.

We have just witnessed another boom and bust caused by the Federal Reserve's keeping interest rates too low. The erratic volatility of gold and other commodities is the direct result of further intervention into the market through central banking. A former boss and mentor of mine once conveyed to me his worry that the actions of just a few people are having a profound effect on the world's financial system.

My response was that we haven't seen anything yet.

The period between 1873 and 1894 remains one of the most misunderstood and debated in all of American economic history. To some, this era represents the greatest phase of industrial growth in the country's history.Murray N. Rothbard, A History of Money and Banking in the United States (Auburn, Alabama: Ludwig von Mises Institute, 2002), pp. 147–169; Jonathan M. Finegold Catalán, "The Austrian History of US Money and Banking." But others interpret the data as evidence of one of the United States' longest depressions.Paul Krugman, "The Third Depression." Krugman writes, "As far as I can tell, there were only two eras in economic history that were widely described as 'depressions' at the time: the years of deflation and instability that followed the Panic of 1873 and the years of mass unemployment that followed the financial crisis of 1929–31." A few scholars have even had to revise their beliefs in the face of the evidence.See, most famously, Milton Friedman and Anna J. Schwartz, A Monetary History of the United States, 1867–1960 (Princeton: Princeton University Press, 1963), p. 15. Given such a broad spread of opinion, one may be amazed to realize just how much research has been conducted on the topic. It is not as if historical knowledge is lacking here.

What makes this particular subject so pertinent and controversial is the general price deflationI will use "price deflation," "deflation," and "a [general] fall in prices" interchangeably throughout. Nowhere do I mean a reduction in the supply of money. In all three cases, I am referring to the general movement of prices. that characterized the period.F.W. Taussig, "Prices from 1873 to 1884," Science 6, no. 142 (1885). This trend of falling prices — coupled with certain problems that allegedly impacted the country's agricultural sector — leads many economists to categorize this era as a depression. On the other hand, some economists see the deflation as evidence that a fall in prices does not necessarily imply a loss in wealth and productivity.The topic of deflation is more complex than this. I purposefully avoid the subject for the sake of simplicity. The complexity stems from the fact that a fall in the general price level can be caused by different factors, and it is this causal factor that decides whether deflation is harmful. See Steven Horwitz, "Deflation: The Good, the Bad, and the Ugly," The Freeman 60, no. 1 (2010).

How can so many economists disagree about a time period that is so abundantly documented? The topic is not complicated. It concerns only whether the American economy grew or shrank between 1873 and 1894. Simple enough, no? But the economics profession cannot find consensus! Perhaps what is to blame is a lack of concern for the details.

If there is one economist with a penchant for detail and with a willingness to uncover the facts, it is Robert Higgs. We have seen it in his work on the Great Depression, the Second World War, and the Cold War.Robert Higgs, Depression, War, and Cold War (Oakland, California: The Independent Institute, 2006); Robert Higgs, Arms, Politics, and the Economy: Historical and Contemporary Perspectives (Oakland, California: The Independent Institute, 1990); Robert Higgs, Resurgence of the Warfare State: The Crisis Since 9/11 (Oakland, California: The Independent Institute, 2005). The more radical among us will also appreciate the immense effort put into his most well-known work, Crisis and Leviathan.Robert Higgs, Crisis and Leviathan: Critical Episodes in the Growth of American Government (Oxford, United Kingdom: Oxford University Press, 1987). Higgs, an economist who underwent a sharp ideological and methodological shift during his career, is no slacker. And it should come as no surprise that he is also the author of one of the best studies of the American economy between 1865 and 1914 — his very first book, The Transformation of the American Economy.

Written when Higgs was still a methodological positivist, Transformation of the American Economy is an interpretation of a vast pool of collected empirical evidence.Robert Higgs, "Nonsense about Deflation"; he writes, "even if you are a confirmed positivist in your methodological bent (as I was in 1971)" Also, on pp. 67 of The Transformation of the American Economy, Higgs describes the methodology he used. But praxeological purists should not be dissuaded from engaging the book. The most questionable aspect of Higgs's methodology (borrowed largely from Milton Friedman and Karl PopperMilton Friedman, Essays in Positive Economics (Chicago, Illinois: University of Chicago, 1953); Karl R. Popper, The Logic of Scientific Discovery (New York City: Harper Torchbooks, 1965).) is probably his judging of a theory's "usefulness" in accordance to how well it fits the facts.Writes Higgs, "To determine which of the competing theories is the most useful, we must consider questions for which they predict differently"; Higgs 1971, p. 7. But Mises would agree with Higgs that historians should use theory to interpret history (rather than using history as a means of developing theory).Ludwig von Mises, <a href="http://mises.org/resources/3250/Human-Action"><em>Human Action</em></a> (Auburn, Alabama: Ludwig von Mises Institute, 1998), pp. 38–41. And while the "usefulness" of a theory cannot be determined by how well it fits the facts, certainly Mises would agree that the assumptions of the theory must fit the details of history.If a theory says that if A then B, an application to reality could only be useful if A actually occurred in reality. In short, Higgs's history should be satisfactory for methodologists of all kinds.

While by Higgs's own admission his book is not a comprehensive explanation of the entire period between 1865 and 1914,Robert Higgs 1971, p. viii. it certainly remains one of the most complete accounts since Walt Rostow's 1938 journal article on the 1873–96 "depression."W.W. Rostow, "Investment and the Great Depression," Economic History Review 8, 2 (1938). One would be hard pressed to find a better alternative.

Before getting ahead of ourselves, it should be made clear that the period between 1873 and 1896 did witness a number of fluctuations. The United States' banking industry suffered a crash in September 1873, causing a slight fall in productivity.Samuel Rezneck, "Distress, Relief, and Discontent in the United States during the Depression of 1873–1878," Journal of Political Economy 58, no. 6 1950; Rothbard, History of Money and Banking in the United States. (Auburn: Ludwig von Mises Institute, 2002) p. 153.

The extent of the damage, however, is up for debate. In Rothbard's words, "What sort of 'depression' is it which saw an extraordinarily large expansion of industry, of railroads, of physical output, of net national product, or real per capita income?"Rothbard 2002, pp. 153–156. Rothbard interprets the panic of 1873 as a necessary period of bankruptcy to cleanse the financial system, giving way to the great growth which took place over the following two decades. The evidence certainly runs in Rothbard's favor. According to Friedman and Schwartz,

Whichever estimate of net national product one accepts, the major conclusion is the same: [a] usually rapid rise in output converted an unusually slow rate of rise in the stock of money into a rapid decline in prices.Friedman and Schwartz 1963, p. 41.

Data on industrial production shows a minor decline between 1873 and 1874 from 29 to 28 on Frickley's index (1900 acting as the index year), but a rise to 32 and 36 by 1878 and 1879, respectively.Christina D. Romer, "Is the Stabilization of the Postwar Economy a Figment of the Data?", The American Economic Review 76, no. 3 (1986), p. 318; Edwin Frickley, Production in the United States, 1860–1914. Harvard Economic Studies (Cambridge: Harvard University Press, 1947).

Another financial panic occurred in 1884, but industrial output remained unchanged at 47 between 1884 and 1885; and by 1886 output had risen to 57.Rothbard 2002, pp. 161–162; Romer 1986, p. 318.

Between 1873 and 1892, industrial production rose from 30 to 79.Ibid. This represents a revolutionary, and perhaps historically unsurpassed, growth in American productivity. The period of vigorous growth ended in 1893, which saw the beginnings of a dramatic depression caused, in large part, by the political gold-and-silver-standards agitation and the inability of banks to satisfy an increase in the demand for money.The political explanation, Rothbard 2002, pp. 168–169; a monetary explanation, Friedman and Schwartz 1963, pp. 108–113; a banking explanation, George Selgin, The Theory of Free Banking (Totowa, New Jersey: Rowman & Littlefield, 1988), pp. 13–15.

Now that we have a broad understanding of the nature and direction of the American economy during this period of time, we can begin our foray into Higgs's Transformation of the American Economy. Higgs's book is much more than a history of depressions and growth. It chronicles the structural change that took place in the United States over the nearly 50 years between the American Civil War and the First World War. Higgs explores four major themes: the causes and nature of industrial growth, urbanization, the impact of the changes on agriculture and farmers, and the influence of industrialization on worker and racial inequality.

Higgs explains that the great industrial growth of the last three decades of the 19th century was not an isolated and sudden phenomenon. The roots of America's industrial revolution are found in the prewar economy of the 1840s and 1850s. What allowed for the great postwar rise in output with a steady fall in prices was a slowing in the pace of monetary expansion, which, following the greenback period, was mainly tied to gold production.The greenback dollar was a fiat paper currency issued by the United States as a means of paying expenses during the American Civil War. It was used as an alternative to the issuance of debt and taxation. See Fred Perry Powers, "The Greenback in War," Political Science Quarterly 2, no. 1 (1887).

What made possible this dramatic economic growth? Changes in the American population provide a partial explanation. Between 1865 and 1915, the American population almost tripled, thanks to falling mortality rates and a substantial increase in immigration. An important byproduct of greater productivity, of course, was new technologies that allowed medical science to combat disease that had previously plagued dense populations. The great economic impact of all this was an increase in the labor force — the more workers, the greater the work that can be done.

There was also an important increase in agricultural productivity, caused by mechanization and the acquisition of more productive, and largely uninhabited, land (between 1845 and 1848 the United States expanded territorially by almost 70 percent). Greater agricultural productivity freed labor for industrial purposes.

There was also an accumulation of human capital, including a rise in literacy rates (literacy among whites rose from 90 percent in 1870 to 95 percent in 1915, and literacy among nonwhites increased from 20 percent in 1870 to 70 percent by 1910), despite fluctuation in public-school attendance.Workers oftentimes went on their own to learn certain intellectual skills required for different jobs, and it is important to remember that gains in productivity allow for increased leisure time, which includes providing parents the opportunity to teach their children (whereas earlier the opportunity cost of taking the time to teach your child how to read included the loss of necessary wages). There was also a lot of on-the-job training, where employers were more than willing to provide workers the tools necessary for employment.

Increases in investment were made possible only by greater capital accumulation, as consumers put aside savings, which were then invested into the production of an even greater quantity of wealth. The enlargement of the market, along with technological innovation, made possible an increase in economies of scale. This is illustrated by the rise of corporations and large business firms, which made use of mass-production techniques to deliver quality products to the consumer. In a certain sense, the productivity of the period fed on itself — a benefit of the unfettered market.

Enhanced agricultural productivity made possible a larger population with a relatively smaller pool of producers. This gave many people the opportunity to leave the countryside and flock to the cities. Unsurprisingly, city size swelled during the postwar period; this also factored into the creation of large, city-based industrial centers.

Health problems related to increasing population density were slowly solved through medical and technological breakthroughs, as mentioned earlier. This not only included medical technologies, such as vaccines and antibacterial medicines, but also less obvious products, such as water filters and better sewage systems.

Higgs also postulates that an increase in population density made innovation easier. It allowed people to share ideas and become aware of them more quickly, and thus build on these new ideas faster and more efficiently. In other words, there were fewer barriers to intellectual development.

Industrial productivity and urban growth aside, the 1873–96 era is oftentimes considered a period of great poverty for the farmer. Surely, an increase in agricultural output led to a fall in the prices of agricultural products, and a rise in productivity made fewer farmers necessary. Those who could not keep up with the changing nature of the market were sure to suffer, but this is no different from changes in any other industry.

It's true that farm output prices oftentimes fell by greater magnitudes than transportation costs, which made cost of production relatively higher than before. But, even this simply suggested the necessity to change business models.

There were, of course, the common grievances against moneylenders. During this time, farmers were likely to mortgage their land as a means of collecting the necessary capital to invest in mechanization and other things to increase the productivity of their land.

Rising savings led to a fall in interest rates, which led to the creation of a vast loan industry in the western United States. Interest rates also fell due to price deflation, which increased the real value of interest over time.

in regard to the impact of deflation on farmers, Higgs concludes that farmers with low debt were not susceptible to changes in the ratio between the value of their debt and the value of their output. Interestingly, many moneylenders included the option for a dynamic interest rate, allowing the rate on loans to fall with deflation.

In short, the agricultural sector experienced the consequences of a structural shift in favor of industrialization. Farming was no longer the dominant industry, and this forced many individuals to change their business plans or even line of work.

Should the horse-and-buggy industry have been saved against the aggression of the automobile? The problems suffered by those victims of the growing irrelevance of their jobs were temporary. While this was perhaps inconvenient for some individuals, none of this suggests that there was any general poverty or depression in agriculture. Perhaps this poverty was unique to those who simply refused to change with the times. The great productive growth made employment possible for all those able and willing to do adapt.

Did industrialization lead to greater inequality? Workers' real wages grew between 1880 and 1894 at a very fast pace, meaning that the average American was markedly wealthier at the end of this period than at the beginning. This undoubtedly was caused by a combination of rising nominal wages and falling price levels — the purchasing power of the dollar was increasing, and it was the consumer who benefited the most. While there was inequality between workers of different geographic regions, Higgs shows that wages were rising just as fast in the South as elsewhere. Any general poverty that may have existed in the South was a consequence, not of industrial stagnation, but of the American Civil War and the massive destruction it wrought on southern property.

Regarding inequality between workers of different races, especially between native white Americans and European immigrants, Higgs shows that even in the event of discrimination, this was oftentimes offset by the competition created by industrial expansion. Simply put, if one employer offered an immigrant lower wages, a competitor would often use this as an opportunity to take that worker himself by offering higher wages. On discrimination against black workers, Higgs is largely inconclusive; but he presents no evidence that would suggest the market rewarded discrimination. Instead, he points to inequality of treatment under the law and public discrimination against blacks in their efforts to obtain skills and education. Higgs continues his work on this topic in a later book.Robert Higgs, Competition and Coercion: Blacks in the American Economy, 1865-1914 (Cambridge: Cambridge University Press, 2008).

The research in Robert Higgs's Transformation of the American Economy is much more nuanced than this review might lead one to believe. Higgs pores over the minutiae of economic history of the period. The detail in which he explains the general concepts outlined here is amazing. Most histories have focused on the monetary aspects of the deflation between 1873 and 1894, but Higgs's history is much more encompassing and much more human. It is a story of a major structural shift in the American economy and how it impacted different people. Higgs leaves little to the imagination, and he explicitly acknowledges what he does not know.

Transformation of the American Economy is a book every economist and economic historian should read. If more of these professionals took the time to review Robert Higgs's book, there would be much less confusion and disagreement. Higgs demonstrates that the period between the American Civil War and the First World War was largely an era of radical productivity and a vast increase in wealth. True, some suffered, as is to be expected in such changes, but society as a whole benefited to a degree never experienced before or witnessed since.A possible exception is the period between 1980 and 2001, although I have not seen a comparison of the data. Even then, the two periods are incomparable in regard to just how fundamentally the American economy changed.

So, here's the deal: You've got thirty seconds. You'll have a big audience. What would you say?

I knew immediately what my message would be, though not exactly how I would say it. I thought about what my message implied about my life and the world, and came away satisfied with my decision.

Then I considered what others might say. I could easily imagine any number of people issuing a message of love. Stop hating and love. Make love, not war. They might even recite the popular Biblical passage, 1 Corinthians 13: "If I speak in the tongues of men or of angels, but do not have love, I am only a resounding gong or a clanging cymbal."

I recalled Mel Gibson's final message as Sir William Wallace in the movie Braveheart. For leading a revolt against the treacherous King Edward I of England, Wallace has been brought to the Tower of London for public torture and execution. Eager to see a traitor get his just punishment, the crowd watches as he's half-hanged, racked, and disemboweled. Before the final deathblow he's given one last chance to confess his treason. By this time the crowd is calling for mercy. Already near death, Wallace summons the last of his strength and shouts "Freedom!" before the ax comes down on his neck.

Perhaps you would secure the rights to play Gibson's final word as the core of your parting message. You could do much worse.

I thought of what certain others might say — Obama, Hillary, Krugman, Bernanke. What would be the Fed chairman's parting words? Would he decline the offer? He probably would, but if he didn't, I can't imagine him shouting "Inflate!" or "Accommodate!" And yet this is what the man does for a living. Shouldn't he choose to die supporting the values he has lived by? Can you imagine Obama shouting "Change!" or Hillary shouting "It takes a village!"? Didn't think so. Or how about Krugman calling for perpetual bubbles so we don't have to fake a space invasion?

Others might take the opportunity to tell a joke, on the grounds that the world needs more laughter. The danger there is that no one would think it's funny. Some would encourage people to care better for their children, as they are the future. Those soured by the whole human race might tell the world off. A few might smile pleasantly at the camera and say nothing, as they did throughout their lives. Smiles shouldn't be dismissed lightly. We couldn't go through our days without them.

The possibilities are endless.

The world has seen gold soar in price for over a decade because people grew increasingly distrustful of the appointed money printers, especially the ones at the Federal Reserve. For many investors, I suspect, gold has been little more than a safe port in a storm. When the storm passes, it's on to something else. I wonder if they've ever considered what it would be like if they didn't need an "inflation hedge" or a "safe haven."

That would be my point. In my thirty seconds of fame I would tell people they need to be using a market-based money. Facing the camera with an American gold eagle in one hand, I might say, "See this? Can't print it. But this — " I would add while holding a Fed dollar in my other hand, "can be printed to send your loved ones off to unnecessary wars, bail out politically connected corporations, and drain your savings. You need a monetary system that works for you, not them. Fight for it!"

Print: $10 $6

Audio: $7 $5

The Mises Institute offers an extensive library of literature explaining the economics behind an autonomous commodity-coin system. But you don't need to be an Austrian to appreciate the value of gold. In 1914 Europe went to war. Three years later it was officially a world war. For this to happen the belligerents (with the exception of the late-entry United States) had to go off the gold standard. It wasn't the men doing the fighting who made the decision. It was the politicians who sent them to fight — and die in the millions. And what did they die for? The rest of the bloody century, and now the new century with the world still at war and teetering on financial collapse. The killing had to be funded, and that meant gold had to be abandoned.

Isn't it ironic that gold and the gold standard have been dubbed the barbarous relic when it's the paper systems that are forced on us that are reducing the world to barbarism?

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In the summer of 1896, anticipating the defeat of the gold forces at the Democratic convention, the Morgans, previously dominant in the Democratic Party, approached the McKinley–Mark Hanna–Rockefeller forces through their rising young satrap, Congressman Henry Cabot Lodge of Massachusetts. Lodge offered the Rockefeller forces a deal: The Morgans would support McKinley for president and neither sit home nor back a third, Gold Democrat party, provided that McKinley pledged himself to a gold standard. The deal was struck, and many previously hard-money Democrats shifted to the Republicans. The nature of the American political party system was now drastically changed: previously a tightly fought struggle between hard-money, free-trade, laissez-faire Democrats on the one hand, and protectionist, inflationist, and statist Republicans on the other, with the Democrats slowly but surely gaining ascendancy by the early 1890s, was now a party system that would be dominated by the Republicans until the depression election of 1932.

The Morgans were strongly opposed to Bryanism, which was not only Populist and inflationist, but also anti–Wall Street bank; the Bryanites, much like Populists of the present day, preferred congressional, greenback inflationism to the more subtle, and more privileged, big-bank-controlled variety. The Morgans, in contrast, favored a gold standard. But, once gold was secured by the McKinley victory of 1896, they wanted to press on to use the gold standard as a hard-money camouflage behind which they could change the system into one less nakedly inflationist than populism but far more effectively controlled by the big-banker elites. In the long run, a controlled Morgan-Rockefeller gold standard was far more pernicious to the cause of genuine hard money than a candid free-silver or greenback Bryanism.

As soon as McKinley was safely elected, the Morgan-Rockefeller forces began to organize a "reform" movement to cure the "inelasticity" of money in the existing gold standard and to move slowly toward the establishment of a central bank. To do so, they decided to use the techniques they had successfully employed in establishing a pro-gold standard movement during 1895 and 1896. The crucial point was to avoid the public suspicion of Wall Street and banker control by acquiring the patina of a broad-based grassroots movement. To do so, the movement was deliberately focused in the Middle West, the heartland of America, and organizations developed that included not only bankers, but also businessmen, economists, and other academics, who supplied respectability, persuasiveness, and technical expertise to the reform cause.

Accordingly, the reform drive began just after the 1896 elections in authentic Midwest country. Hugh Henry Hanna, president of the Atlas Engine Works of Indianapolis, who had learned organizing tactics during the year with the pro-gold standard Union for Sound Money, sent a memorandum, in November, to the Indianapolis Board of Trade, urging a grassroots Midwestern state like Indiana to take the lead in currency reform.For the memorandum, see James Livingston, Origins of the Federal Reserve System: Money, Class, and Corporate Capitalism, 1890–1913 (Ithaca, N.Y.: Cornell University Press, 1986), pp. 104–05.

In response, the reformers moved fast. Answering the call of the Indianapolis Board of Trade, delegates from boards of trade from 12 Midwestern cities met in Indianapolis on December 1, 1896. The conference called for a large monetary convention of businessmen, which accordingly met in Indianapolis on January 12, 1897. Representatives from 26 states and the District of Columbia were present. The monetary-reform movement was now officially under way. The influential Yale Review commended the convention for averting the danger of arousing popular hostility to bankers. It reported that "the conference was a gathering of businessmen in general rather than bankers in particular."Yale Review 5 (1897): 343–45, quoted in ibid., p. 105.

The conventioneers may have been businessmen, but they were certainly not very grassrootsy. Presiding at the Indianapolis Monetary Convention of 1897 was C. Stuart Patterson, dean of the University of Pennsylvania Law School and a member of the finance committee of the powerful, Morgan-oriented Pennsylvania Railroad. The day after the convention opened, Hugh Hanna was named chairman of an executive committee which he would appoint. The committee was empowered to act for the convention after it adjourned. The executive committee consisted of the following influential corporate and financial leaders:

John J. Mitchell of Chicago, president of the Illinois Trust and Savings Bank, and a director of the Chicago and Alton Railroad; the Pittsburgh, Fort Wayne and Chicago Railroad; and the Pullman Company. Mitchell was named treasurer of the executive committee.

H.H. Kohlsaat, editor and publisher of the Chicago Times-Herald and the Chicago Ocean Herald, trustee of the Chicago Art Institute, and a friend and adviser of Rockefeller's main man in politics, President William McKinley.

Charles Custis Harrison, provost of the University of Pennsylvania, who had made a fortune as a sugar refiner in partnership with the powerful Havemeyer ("Sugar Trust") interests.

Alexander E. Orr, New York City banker in the Morgan ambit, who was a director of the Morgan-run Erie and Chicago, Rock Island, and Pacific Railroads; of the National Bank of Commerce; and of the influential publishing house, Harper Brothers. Orr was also a partner in the country's largest grain-merchandising firm and a director of several life insurance companies.

Edwin O. Stanard, St. Louis grain merchant, former governor of Missouri, and former vice president of the National Board of Trade and Transportation.

E.B. Stahlman, owner of the Nashville Banner, commissioner of the cartelist Southern Railway and Steamship Association, and former vice president of the Louisville, New Albany, and Chicago Railroad.

A.E. Willson, influential attorney from Louisville and a future governor of Kentucky.

But the two most interesting and powerful executive committee members of the Indianapolis Monetary Convention were Henry C. Payne and George Foster Peabody. Henry Payne was a Republican Party leader from Milwaukee and president of the Morgan-dominated Wisconsin Telephone Company, long associated with the railroad-oriented Spooner-Sawyer Republican machine in Wisconsin politics. Payne was also heavily involved in Milwaukee utility and banking interests, in particular as a longtime director of the North American Company, a large public-utility-holding company headed by New York City financier Charles W. Wetmore.

So close was North American to the Morgan interests that its board included two top Morgan financiers. One was Edmund C. Converse, president of Morgan-run Liberty National Bank of New York City, and soon-to-be founding president of Morgan's Bankers Trust Company. The other was Robert Bacon, a partner in J.P. Morgan and Company, and one of Theodore Roosevelt's closest friends, whom Roosevelt would make assistant secretary of state. Furthermore, when Theodore Roosevelt became president as the result of the assassination of William McKinley, he replaced Rockefeller's top political operative, Mark Hanna of Ohio, with Henry C. Payne as postmaster general of the United States. Payne, a leading Morgan lieutenant, was reportedly appointed to what was then the major political post in the Cabinet, specifically to break Hanna's hold over the national Republican Party. It seems clear that replacing Hanna with Payne was part of the savage assault that Theodore Roosevelt would soon launch against Standard Oil as part of the open warfare about to break out between the Rockefeller-Harriman–Kuhn, Loeb camp and the Morgan camp.See Philip H. Burch, Jr., Elites in American History, vol. 2, The Civil War to the New Deal (New York:Holmes and Meier, 1981), p. 189, n. 55.

Even more powerful in the Morgan ambit was the secretary of the Indianapolis Monetary Convention's executive committee, George Foster Peabody. The entire Peabody family of Boston Brahmins had long been personally and financially closely associated with the Morgans. A member of the Peabody clan had even served as best man at J.P. Morgan's wedding in 1865. George Peabody had long ago established an international banking firm of which J.P. Morgan's father, Junius, had been one of the senior partners. George Foster Peabody was an eminent New York investment banker with extensive holdings in Mexico, who was to help reorganize General Electric for the Morgans, and was later offered the job of secretary of the Treasury during the Wilson administration. He would function throughout that administration as a "statesman without portfolio."Ibid., pp. 231, 233. See also Louise Ware, George Foster Peabody (Athens: University of Georgia Press, 1951), pp. 161–67.

Let the masses be hoodwinked into regarding the Indianapolis Monetary Convention as a spontaneous grassroots outpouring of small Midwestern businessmen. To the cognoscenti, any organization featuring Henry Payne, Alexander Orr, and especially George Foster Peabody meant but one thing: J.P. Morgan.

The Indianapolis Monetary Convention quickly resolved to urge President McKinley to (1) continue the gold standard, and (2) create a new system of "elastic" bank credit. To that end, the convention urged the president to appoint a new monetary commission to prepare legislation for a new revised monetary system. McKinley was very much in favor of the proposal, signaling Rockefeller agreement, and on July 24 he sent a message to Congress urging the creation of a special monetary commission. The bill for a national monetary commission passed the House of Representatives but died in the Senate.See Kolko, Triumph, pp. 147–48.

Disappointed but intrepid, the executive committee, failing a presidentially appointed commission, decided in August 1897 to go ahead and select its own. The leading role in appointing this commission was played by George Foster Peabody, who served as liaison between the Indianapolis members and the New York financial community. To select the commission members, Peabody arranged for the executive committee to meet in the Saratoga Springs summer home of his investment-banking partner, Spencer Trask. By September, the executive committee had selected the members of the Indianapolis Monetary Commission.

The members of the new Indianapolis Monetary Commission were as follows:See Livingston, Origins, pp. 106–07.

Chairman was former Senator George F. Edmunds, Republican of Vermont, attorney, and former director of several railroads.

C. Stuart Patterson, dean of University of Pennsylvania Law School, and a top official of the Morgan-controlled Pennsylvania Railroad.

Charles S. Fairchild, a leading New York banker, president of the New York Security and Trust Company, former partner in the Boston Brahmin investment-banking firm of Lee, Higginson and Company, and executive and director of two major railroads. Fairchild, a leader in New York state politics, had been secretary of the Treasury in the first Cleveland administration. In addition, Fairchild's father, Sidney T. Fairchild, had been a leading attorney for the Morgan controlled New York Central Railroad.

Stuyvesant Fish, scion of two longtime aristocratic New York families, was a partner of the Morgan-dominated New York investment bank of Morton, Bliss and Company, and then president of Illinois Central Railroad and a trustee of Mutual Life. Fish's father had been a senator, governor, and secretary of state.

Louis A. Garnett was a leading San Francisco businessman.

Thomas G. Bush of Alabama was a director of the Mobile and Birmingham Railroad.

J.W. Fries was a leading cotton manufacturer from North Carolina.

William B. Dean was a merchant from St. Paul, Minnesota, and a director of the St. Paul–based transcontinental Great Northern Railroad, owned by James J. Hill, ally with Morgan in the titanic struggle over the Northern Pacific Railroad with Harriman, Rockefeller, and Kuhn, Loeb.

George Leighton of St. Louis was an attorney for the Missouri Pacific Railroad.

Robert S. Taylor was an Indiana patent attorney for the Morgan-controlled General Electric Company.

The single most important working member of the commission was James Laurence Laughlin, head professor of political economy at the new Rockefeller-founded University of Chicago and editor of its prestigious Journal of Political Economy. It was Laughlin who supervised the operations of the commission's staff and the writing of the reports. Indeed, the two staff assistants to the commission who wrote reports were both students of Laughlin's at Chicago: former student L. Carroll Root, and his current graduate student Henry Parker Willis.

The impressive sum of $50,000 was raised throughout the nation's banking and corporate community to finance the work of the Indianapolis Monetary Commission. New York City's large quota was raised by Morgan bankers Peabody and Orr, and heavy contributions to fill the quota came promptly from mining magnate William E. Dodge; cotton and coffee trader Henry Hentz, a director of the Mechanics National Bank; and J.P. Morgan himself.

With the money in hand, the executive committee rented office space in Washington, DC, in mid-September, and set the staff to sending out and collating the replies to a detailed monetary questionnaire, sent to several hundred selected experts. The monetary commission sat from late September into December 1897, sifting through the replies to the questionnaire collated by Root and Willis. The purpose of the questionnaire was to mobilize a broad base of support for the commission's recommendations, which they could claim represented hundreds of expert views. Second, the questionnaire served as an important public-relations device, making the commission and its work highly visible to the public, to the business community throughout the country, and to members of Congress. Furthermore, through this device, the commission could be seen as speaking for the business community throughout the country.

To this end, the original idea was to publish the Indianapolis Monetary Commission's preliminary report, adopted in mid-December, as well as the questionnaire replies in a companion volume. Plans for the questionnaire volume fell through, although it was later published as part of a series of publications on political economy and public law by the University of Pennsylvania.See Livingston, Origins, pp. 107–08.

Undaunted by the slight setback, the executive committee developed new methods of molding public opinion using the questionnaire replies as an organizing tool. In November, Hugh Hanna hired as his Washington assistant financial journalist Charles A. Conant, whose task was to propagandize and organize public opinion for the recommendations of the commission. The campaign to beat the drums for the forthcoming commission report was launched when Conant published an article in the December 1 issue of Sound Currency magazine, taking an advanced line on the report, and bolstering the conclusions not only with his own knowledge of monetary and banking history, but also with frequent statements from the as-yet-unpublished replies to the staff questionnaire.

Over the next several months, Conant worked closely with Jules Guthridge, the general secretary of the commission; they first induced newspapers throughout the country to print abstracts of the questionnaire replies. As Guthridge wrote some commission members, he thereby stimulated "public curiosity" about the forthcoming report, and he boasted that by "careful manipulation" he was able to get the preliminary report "printed in whole or in part — principally in part — in nearly 7,500 newspapers, large and small." In the meanwhile, Guthridge and Conant orchestrated letters of support from prominent men across the country, when the preliminary report was published on January 3, 1898. As soon as the report was published, Guthridge and Conant made these letters available to the daily newspapers. Quickly, the two built up a distribution system to spread the gospel of the report, organizing nearly 100,000 correspondents "dedicated to the enactment of the commission's plan for banking and currency reform."Ibid., pp. 109–10.

The prime and immediate emphasis of the preliminary report of the Indianapolis Monetary Commission was to complete the promise of the McKinley victory by codifying and enacting what was already in place de facto: a single gold standard, with silver reduced to the status of subsidiary token currency. Completing the victory over Bryanism and free silver, however, was just a mopping-up operation; more important in the long run was the call raised by the report for banking reform to allow greater elasticity. Bank credit could then be increased in recessions and whenever seasonal pressure for redemption by agricultural country banks forced the large central reserve banks to contract their loans. The actual measures called for by the commission were of marginal importance. (More important was that the question of banking reform had been raised at all.)

The public having been aroused by the preliminary report, the executive committee decided to organize a second and final meeting of the Indianapolis Monetary Convention, which duly met at Indianapolis on January 25, 1898. The second convention was a far grander affair than the first, bringing together 496 delegates from 31 states. Furthermore, the gathering was a cross-section of America's top corporate leaders. While the state of Indiana naturally had the largest delegation, of 85 representatives of boards of trade and chambers of commerce, New York sent 74 delegates, including many from the Board of Trade and Transportation, the Merchants' Association, and the Chamber of Commerce in New York City.

Such corporate leaders attended as Cleveland iron manufacturer Alfred A. Pope, president of the National Malleable Castings Company; Virgil P. Cline, legal counsel to Rockefeller's Standard Oil Company of Ohio; and C.A. Pillsbury of Minneapolis–St. Paul, organizer of the world's largest flour mills. From Chicago came such business notables as Marshall Field and Albert A. Sprague, a director of the Chicago Telephone Company, subsidiary of the Morgan-controlled telephone monopoly, American Telephone and Telegraph Company. Not to be overlooked was delegate Franklin MacVeagh, a wholesale grocer from Chicago, and an uncle of a senior partner in the Wall Street law firm of Bangs, Stetson, Tracy and MacVeagh, counsel to J.P. Morgan and Company. MacVeagh, who was later to become secretary of the Treasury in the Taft administration, was wholly in the Morgan ambit. His father-in-law, Henry F. Eames, was the founder of the Commercial National Bank of Chicago, and his brother Wayne was soon to become a trustee of the Morgan-dominated Mutual Life Insurance Company.

The purpose of the second convention, as former Secretary of the Treasury Charles S. Fairchild candidly explained in his address to the gathering, was to mobilize the nation's leading businessmen into a mighty and influential reform movement. As he put it, "If men of business give serious attention and study to these subjects, they will substantially agree upon legislation, and thus agreeing, their influence will be prevailing." He concluded, "My word to you is, pull all together." Presiding officer of the convention, Iowa Governor Leslie M. Shaw, was, however, a bit disingenuous when he told the gathering, "You represent today not the banks, for there are few bankers on this floor. You represent the business industries and the financial interests of the country."

There were plenty of bankers there, too.Ibid., pp. 113–15. Shaw himself, later to be secretary of the Treasury under Theodore Roosevelt, was a small-town banker in Iowa, and president of the Bank of Denison who continued as bank president throughout his term as convention governor. More important in Shaw's outlook and career was the fact that he was a longtime close friend and loyal supporter of the Des Moines Regency, the Iowa Republican machine headed by the powerful Senator William Boyd Allison. Allison, who was to obtain the Treasury post for his friend, was in turn tied closely to Charles E. Perkins, a close Morgan ally, president of the Chicago, Burlington and Quincy Railroad, and kinsman of the powerful Forbes financial group of Boston, long tied in with the Morgan interests.See Rothbard, "Federal Reserve," pp. 95–96.

Also serving as delegates to the second convention were several eminent economists, each of whom, however, came not as academic observers but as representatives of elements of the business community. Professor Jeremiah W. Jenks of Cornell, a proponent of trust cartelization by government and soon to become a friend and adviser of Theodore Roosevelt as governor, came as delegate from the Ithaca Business Men's Association. Frank W. Taussig of Harvard University represented the Cambridge Merchants' Association. Yale's Arthur Twining Hadley, soon to be the president of Yale, represented the New Haven Chamber of Commerce, and Frank M. Taylor of the University of Michigan came as representative of the Ann Arbor Business Men's Association. Each of these men held powerful posts in the organized economics profession, Jenkins, Taussig, and Taylor serving on the currency committee of the American Economic Association. Hadley, a leading railroad economist, also served on the boards of directors of Morgan's New York, New Haven and Hartford and Atchison, Topeka and Santa Fe Railroads.On Hadley, Jenks, and especially Conant, see Carl P. Parrini and Martin J. Sklar, "New Thinking about the Market, 1896–1904: Some American Economists on Investment and the Theory of Surplus Capital," Journal of Economic History 43 (September 1983): 559–78. The authors point out that Conant's and Hadley's major works of 1896 were both published by G.P. Putnam's Sons of New York. President of Putnam's was George Haven Putnam, a leader in the new banking-reform movement. Ibid., p. 561, n. 2.

Both Taussig and Taylor were monetary theorists who, while committed to a gold standard, urged reform that would make the money supply more elastic. Taussig called for an expansion of national-bank notes, which would inflate in response to the "needs of business." As TaussigFrank W. Taussig, "What Should Congress Do About Money?" Review of Reviews (August 1893): 151, quoted in Joseph Dorfman, The Economic Mind in American Civilization (New York: Viking Press, 1949), 3, p. xxxvii. See also ibid., p. 269. put it, the currency would then "grow without trammels as the needs of the community spontaneously call for increase." Taylor, too, as one historian puts it, wanted the gold standard to be modified by "a conscious control of the movement of money" by government "in order to maintain the stability of the credit system." Taylor justified governmental suspensions of specie payment to "protect the gold reserve."Ibid., pp. 392–93.

On January 26, the convention delegates duly endorsed the preliminary report with virtual unanimity, after which Professor J. Laurence Laughlin was assigned the task of drawing up a more elaborate final report, which was published and distributed a few months later. Laughlin's — and the convention's — final report not only came out in favor of a broadened asset base for a greatly increased amount of national bank notes, but also called explicitly for a central bank that would enjoy a monopoly of the issue of bank notes.The final report, including its recommendations for a central bank, was hailed by F.M. Taylor, in his "The Final Report of the Indianapolis Monetary Commission," Journal of Political Economy 6 (June 1898): 293–322. Taylor also exulted that the convention had been "one of the most notable movements of our time — the first thoroughly organized movement of the business classes in the whole country directed to the bringing about of a radical change in national legislation." Ibid., p. 322.

The convention delegates took the gospel of banking reform to the length and breadth of the corporate and financial communities. In April 1898, for example, A. Barton Hepburn, president of the Chase National Bank of New York — at that time a flagship commercial bank for the Morgan interests — and a man who would play a large role in the drive to establish a central bank, invited Indianapolis Monetary Commissioner Robert S. Taylor to address the New York State Bankers Association on the currency question, since "bankers, like other people, need instruction upon this subject." All the monetary commissioners, especially Taylor, were active during the first half of 1898 in exhorting groups of businessmen throughout the nation for monetary reform.

Meanwhile, in Washington, the lobbying team of Hanna and Conant was extremely active. A bill embodying the suggestions of the monetary commission was introduced by Indiana Congressman Jesse Overstreet in January, and was reported out by the House Banking and Currency Committee in May. In the meantime, Conant met almost continuously with the banking committee members. At each stage of the legislative process, Hanna sent letters to the convention delegates and to the public, urging a letter-writing campaign in support of the bill.

In this agitation, McKinley Secretary of the Treasury Lyman J. Gage worked closely with Hanna and his staff. Gage sponsored similar bills, and several bills along the same lines were introduced in the House in 1898 and 1899. Gage, a friend of several of the monetary commissioners, was one of the top leaders of the Rockefeller interests in the banking field. His appointment as Treasury secretary had been gained for him by Ohio's Mark Hanna, political mastermind and financial backer of President McKinley, and old friend, high-school classmate, and business associate of John D. Rockefeller, Sr. Before his appointment to the cabinet, Gage was president of the powerful First National Bank of Chicago, one of the major commercial banks in the Rockefeller ambit.

During his term in office, Gage tried to operate the Treasury as a central bank, pumping in money during recessions by purchasing government bonds on the open market, and depositing large funds with pet commercial banks. In 1900, Gage called vainly for the establishment of regional central banks.

Finally, in his last annual report as secretary of the Treasury in 1901, Lyman Gage let the cat completely out of the bag, calling outright for a government central bank. Without such a central bank, he declared in alarm, "individual banks stand isolated and apart, separated units, with no tie of mutuality between them." Unless a central bank established such ties, Gage warned, the panic of 1893 would be repeated.Livingston, Origins, p. 153. When he left office early the next year, Lyman Gage took up his post as president of the Rockefeller-controlled US Trust Company in New York City.Rothbard, "Federal Reserve," pp. 94–95.

[Originally published as "The Origins of the Federal Reserve System," Quarterly Journal of Economics 2, no. 3 (Fall 1999): pp. 3–51, this article has been republished by the Mises Institute in The Origins of the Federal Reserve, as chapter 3, "The Beginnings of the 'Reform' Movement: The Indianapolis Monetary Convention" (2009).]

The Fed has recently acquired quite a taste for correcting market prices. Remember that the goal of the first round of debt monetization — euphemistically called "quantitative easing" — was to free bank balance sheets from the toxic waste accumulated during the boom and thus prevent banks from unloading unwanted mortgage securities in the marketplace at distressed prices, which would not only have burned a considerable hole into their capital but would also have revealed the lack of true demand for these securities. This required the printing by the Fed of a brand new $1 trillion — give or take a few hundred billion — and provided a nice subsidy to the hard-pressed American financial system. The second round of debt monetization — QE2 — was squarely aimed at manipulating the prices of Treasury securities. Treasury yields were simply not in line with what the committee deemed appropriate for the planned recovery and had thus to be massaged to lower levels. Another $600 billion had to be printed for this initiative.

For the benefit of those Americans who were beginning by now to feel that monetary policy in the United States was acquiring a whiff of Weimar Germany, and who were still beholden to the quaint idea that the setting of asset prices and yields, just as any other price, should best be left to the market, Fed chairman Ben Bernanke, in an op-ed in the Washington Post in November 2010, spelled out the advantages of clever price manipulation by the central bank (I know, I know, you readers of the Schlichter files have read this quote already a few times. But it is simply too delicious to miss any opportunity to quote it again):

Easier financial conditions will promote economic growth. For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.

Well, the virtuous circle has not arrived yet. Defenders of this policy will argue that things would look even worse without it, and that for a while "quantitative easing" boosted equity markets and other risk assets. Hooray for that. Although it has to be said that the idea that we, the public, can easily be cajoled into feeling confident and behaving in more expansionary modes economically via the open manipulation of market prices strikes me as somewhat condescending and hubristic. But we are talking about a state agency here, so we shouldn't be surprised.

The Fed's entire policy program suffers from the same defect that all market interventions suffer from. The moment you stop intervening, the underlying problems come to the surface again. Just look at the short-lived results of QE2. Administrative price setting does not change economic reality, at least not for the better. The interventionist has to keep intervening and do so at an accelerating pace.

Surprisingly few people seem willing to ask what exactly the underlying economic problem is. As long as we avoid that question and simply talk superficially about slow growth, the risk of a "double dip" and the need for "stimulus," I guess the Fed will continue to get away with portraying an image of, at worst, innocent bystander or, at best, a well-meaning and public-service-minded bureaucracy that just keeps trying to fight the recession, diligently exploring all available policy tools. According to this popular view, our economic difficulties seem to have come over us like a bad harvest or an alien invasion. They appear to be entirely exogenous, and the Fed is our friend and partner helping us to get out of this mess.

The reality is different. Like all state bureaucracies, the Fed is in fact struggling with problems that are predominantly of its own making. The Fed is the reason we are in this crisis. Or, more specifically, the present economic crisis is the inevitable consequence of the political decision to adopt a system of unconstrained, constantly expanding fiat money, in which the central bank, in its role as lender of last resort, systematically encourages bank lending and thereby the extension of credit on the basis of money printing rather than true savings. This system came into full bloom only in 1971, when Nixon severed the last link to gold and thus initiated, for the first time in history, a global system of unrestricted fiat-money creation.

Our present problems are excessive levels of debt, now mainly public-sector debt, weak financial institutions, and distorted asset markets. On their present scale these problems would be inconceivable without a system of fully elastic fiat money and persistent periods of artificially low interest rates. Abandoning the gold anchor allowed the Fed, and other central banks, to cheapen credit and encourage borrowing for periods of unprecedented length. Today the Fed is promising us a way out of the crisis by providing monetary-policy accommodation. This is hardly original. The Fed has practically always provided policy accommodation. Policy accommodation was the raison d'être for the Fed. The Fed was founded in 1913 to support the banks' money and credit creation and to avoid credit corrections. Hard and inflexible commodity money has now everywhere been replaced with elastic fiat money under central-bank control so that the level of interest rates and the availability of credit in the economy are no longer constrained by the extent of voluntary saving but can be determined administratively by the central bank for the purpose of extra growth.

When Nixon took the dollar off gold internationally, the monetary base and bank reserves in the United States, that is, the part of the overall money supply that the Fed controls directly, was $69.8 billion. Ten years later it was $147 billion, another ten years later it was $319.7 billion, another ten years later it was $645.1 billion, and last month, exactly 40 years after the dollar was "freed" from gold, it was $2,679.5 billion. Like all interventionists, the Fed has to run ever faster to prevent the laws of economics from catching up with the unintended consequences of its interventions.

"Operation Twist" is another attempt to keep interest rates low and to encourage borrowing when the present crisis is in fact the result of low interest rates and excessive borrowing. The only solution to our problems is to stop printing ever-larger quantities of money and to finally allow the market to set interest rates and to cleanse the economy of its accumulated dislocations.

However, even if we restrict ourselves to movements in the prices that average households face in the marketplace, there is still widespread disagreement. Although the overlap isn't perfect, typically the Keynesians warn that with high unemployment, the US runs the risk of a Japanese "lost decade" of flat consumer prices and stagnant economic growth. Many Austrians, in contrast, warn of a different decade: namely the United States during the 1970s, when Americans suffered high unemployment and price inflation.

To bolster their position, the Keynesians confidently point at the low yields on various government bonds, signaling that "the market" expects modest price increases over the coming years. In contrast, soaring gold and silver prices have been the trump cards for those Austrians predicting skyrocketing prices in general.

For a while the Keynesians had no adequate response to this. They suggested that commodity prices were volatile, and that emerging market demand — coupled with production shortages — could explain the meteoric rise in gold and silver over the past few years. In a particular act of desperation, Paul Krugman recently suggested that gold was simply in a bubble pumped up by Glenn Beck.

Yet now the Keynesians (and others who think the world is in a deflationary liquidity trap) seem to have settled on a secure new theory: gold prices allegedly jump in response to a low real rate of interest. If this theory is correct, the Keynesians can explain the high gold prices of both the 1970s and today, and can confidently maintain that Bernanke needs to open the monetary spigots to help the economic recovery.

The theory linking gold prices to (real) interest rates isn't new, but lately it has become chic because of its relevance to the policy debate over Fed policy. Last October Eddy Elfenbein spelled out the basics and did some quick calibrations to derive a rule of thumb: "Whenever the dollar's real short-term interest rate is below 2%, gold rallies. Whenever the real short-term rate is above 2%, the price of gold falls."

Much more recently, Paul Krugman literally couldn't get to sleep worrying about the issue, so at 4:30 in the morning he wrote up a blog post using formal economic modeling to explain why gold prices should adjust upward whenever real interest rates fall. After reaching his result, Krugman declared,

[S]uppose this is the right story, or at least a good part of the story, of gold prices. If so, just about everything you read about what gold prices mean is wrong.

For this is essentially a "real" story about gold, in which the price has risen because expected returns on other investments have fallen; it is not, repeat not, a story about inflation expectations. Not only are surging gold prices not a sign of severe inflation just around the corner, they're actually the result of a persistently depressed economy stuck in a liquidity trap — an economy that basically faces the threat of Japanese-style deflation, not Weimar-style inflation. So people who bought gold because they believed that inflation was around the corner were right for the wrong reasons.

For completeness, we can also link to Brad DeLong, who elaborates on Krugman's stance. DeLong graphs the price of gold against (a proxy for) real interest rates, and generally speaking they move in opposite directions. In particular, when real interest rates were arguably negative in the late 1970s and early 1980s — because annual price hikes were greater than nominal interest rates — the price of gold was high. But in our current crisis, we also have low real rates of interest, because nominal interest rates are so low. DeLong gives the intuition for this outcome:

On this interpretation gold is and always has been a super Treasury bond: a very long duration asset that is or at least is perceived to be "safe" in the sense that its price does not trade at a discount (due to risk and default premia) from a Treasury bond of the same duration but instead trades at a premium.

What is the Austrian economist to make of these claims? Is it really true that the meteoric rise in gold can be chalked up primarily to a collapse in the real interest rate? Is the fear of dollar debasement truly just a figment of Glenn Beck's imagination?

Although many in the deflationist camp think they've plugged the last chink in their armor, let's not rush to judgment. Far from providing a theoretically sound and empirically confirmed explanation, Krugman and DeLong have really just explained the two huge gold price spikes of the late 1970s and in the last few years. But there are other falsifiable implications of Krugman's model; let's see if it passes those tests too.

First, let's reproduce the chart of daily yields on 20-year Treasury Inflation-Protected Securities (TIPS) that Krugman used in his own post:

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If we study the dynamics of Krugman's model, we see that it implies that sudden and large changes in the real interest rate should lead to one-shot adjustments in the price of gold in the opposite direction. This is the mechanism, after all, by which Krugman thinks he has adequately explained the sharp rise in gold prices over the last few years.

Yet there are large stretches in the above chart that do not fit this story. For example, the real interest rate (as measured by 20-year TIPS yields) rose quite sharply from 2.06 percent on January 3, 2006, to 2.58 percent by July 3 of that year. That's a very strong move for such a short time period.

It's unclear how much this shift should have moved the price of gold, since Krugman's model is qualitative. To actually calculate the new equilibrium spot price, we'd need to plug in a number for what he calls the "choke price" of gold, at which nobody would buy gold for industrial or commercial applications.

Yet regardless of the size of the move, the direction is perfectly clear: if Krugman's basic story is right, then this large increase in the "real rate of interest" over a six-month period should clearly have reduced the real price of gold.

So how well does Krugman's theory hold up? Eyeballing the charts at Kitco, the spot price of gold in early January 2006 was $530. By early July the spot price had risen to $623. After adjusting for the change in official CPI, that's still a 15 percent increase in the "real" price of gold, during a short stretch when Krugman's theory says gold prices should have gone down, and probably sharply. Oops.

Krugman's model has other implications, too. For example, if the real interest rate holds steady for an extended stretch, then the real price of gold should rise (on an annualized basis) by the same rate during that period. Unfortunately, the yield on the 20-year TIPS bounces all over the place, so it's hard to test this implication. Even so, as the chart above indicates, the yield is relatively calm during the year 2005, and hovers around 2 percent. Sometimes it's lower, sometimes it's higher, but it doesn't stray too far from 2 percent during the year, at least compared to how volatile it is on the rest of the graph.

So if Krugman's model were the whole story, then the real price of gold should have increased only about 2 percent during the year 2005. In fact, the spot price increased from $428 to $512; after adjusting for the change in CPI, the real price increased about 16 percent.

To sum up, whether we're looking at large moves in the real interest rate over shorter periods, or fairly steady real interest rates over longer periods, there are patches using Krugman's own data set that are at complete odds with his model. Krugman and DeLong think they solved their pesky problem of rising gold prices, but they really haven't. They came up with a qualitative model in which sudden drops in the real interest rate lead to instantaneous upward shifts in the price of gold. Seeing this result, they declared, "Mission accomplished!" and cracked open some beers. But there are several other implications of their model that fail to match the data.

Now it's true, Eddy Elfenbein's model for gold prices seems pretty good:

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But the problem is, Elfenbein is just curve fitting. The elegant theoretical apparatus that Krugman et al., deploy requires gold to respond to long-term interest rates, yet Elfenbein admits that he instead used short-term rates to generate the above graph. What's more revealing, Elfenbein says of his above chart,

The relationship isn't perfect but it's held up fairly well over the past 15 years or so. The same dynamic seems at work in the 15 years before that, but I think the ratios are different.

That's fine as far as it goes, and perhaps short-term traders in the markets will find Elfenbein's model useful. However, he clearly hasn't given us "the" model of gold, since he himself admits that (a) it doesn't dovetail with any theoretical explanation and (b) it really only "works" when he restricts the data to a certain period and then plays with parameters to get the best fit. With such a procedure, one might "explain" gold prices by reference to all sorts of things.

In fairness to Elfenbein, he is quite transparent about the limits of his accomplishment. (Alas, no one ever accused Paul Krugman of comparable modesty.) Elfenbein writes,

Let me make this clear that this is just a model and I'm not trying to explain 100% of gold's movement. Gold is subject to a high degree of volatility and speculation. Geopolitical events, for example, can impact the price of gold.

This is an excellent point, and should give pause to those who think Krugman et al., have solved the alleged mystery of soaring gold prices. It is well known that geopolitical events can cause sharp movements in the price of gold. It is interesting to note that these do not necessarily coincide with the required movements in the TIPS yields. For example, after President Obama told the world that US forces had killed Osama bin Laden on May 2, gold prices tumbled about $55 per ounce over the next few days. But the 20-year TIPS yield slightly fell too. (For Krugman's story to work, TIPS yields should have risen on the "expansionary" news, in order to knock down gold prices.)

In the section above I showed the shortcomings of the real-interest-rate theory in terms that even mainstream economists can appreciate. But now I want to point out the fundamental problem with the approach of Krugman et al.: they are trying to explain the price of gold while ignoring its historical function as the market's money.

For example, let's look under the hood of Krugman's model. If you can wade through the jargon, this is what he's doing: Krugman first assumes that there is a fixed stock of gold (already mined) in the possession of various owners. Then, that fixed stockpile slowly disappears as it flows into commercial and industrial applications. But the crucial thing is, in Krugman's model the only reason to hold gold is that you expect the price paid by dentists (for gold fillings) to go up in the future. Here's Krugman in his own words:

Here's how it works. Imagine that there's a fixed stock of gold available right now, and that over time this stock gradually disappears into real-world uses like dentistry. (Yes, gold gets mined, and there's a more or less perpetual demand for gold that just sits there; never mind for now). The rate at which gold disappears into teeth — the flow demand for gold, in tons per year — depends on its real price … (emphasis added)

Notice the part I emphasized: Krugman is quite consciously ignoring the fact that there are some people out there who hold gold "that just sits there." He says, "never mind for now," but he never comes back to this crucial point.

As we should expect by now, Eddy Elfenbein's introduction to his own analysis is refreshingly candid:

But the question is, "How can anyone reasonably calculate what the price of gold is?" For stocks, we have all sorts of ratios. Sure, those ratios can be off … but at least they're something. With gold, we have nothing. After all, gold is just a rock (ok ok, an element).

How the heck can we even begin to analyze gold's value? There's an old joke that the price of gold is understood by exactly two people in the entire world. They both work for the Bank of England and they disagree.

It is clear that neither Krugman nor Elfenbein has any appreciation for the historical role of gold (and silver) as a medium of exchange. Ludwig von Mises, in his classic work The Theory of Money and Credit, explained systematically how gold can begin as a normal commodity, with its relative price determined by its use as a factor of production.

Yet because of the process I summarize in this article, traders begin holding gold (or other media of exchange) not because they want to use it to make necklaces or tooth fillings but because it is a very liquid asset. When this process snowballs, gold (or other media of exchange) becomes commonly accepted, and at that point the market has spontaneously given birth to a money. (See a recent challenge to this view.)

Once we understand gold's historical role as the world's market-based commodity money, we can see why it is the inflation hedge par excellence, and also why people rush into gold when they are fearful. The equilibrium relationships described by Krugman et al., need to be true, other things equal, but they have by no means demonstrated that Bernanke needs to inflate more.

I submit that Krugman, DeLong, et al., will have a hard time really understanding the market's embrace of gold (and silver), if they try to explain its price with a model that ignores gold's historical role as a medium of exchange. (To his credit, the deflationist Mish has always emphasized gold's special place as the market's money.)

When bad news from Greece causes Treasury prices to rise, everybody accepts the commonsense explanation that, "Investors are fleeing the euro into the dollar." So why should it be such a mystery that Bernanke's incredible dollar pumping would send worried investors into safe-haven currencies (gold and silver) that cannot be debased?

There are plenty of investors — including small potatoes as well as big guns such as Jim Rogers and Marc Faber — who are quite clear about why Bernanke's policies have pushed up commodities in general, and the precious metals in particular. We don't need to draw up fancy models to get inside their heads; these people are screaming their motivations at us every day.

Now perhaps these high-profile investors are wrong, and we really are in store for stable consumer prices as far as the eye can see. But I don't think so, and neither do the millions of other people rushing into gold.

In the present article I'll focus on Mises's intriguing proposal for returning a country to a gold-backed currency. (This proposal is in the last section of the book, consisting of material written after World War II.)

Before quoting Mises's proposal, let me set up the problem. The classical-liberal goal of "sound money" tied currencies to the precious metals. Just as a constitution was intended to restrain the arbitrary exercise of government power, the gold standard (or some other commodity standard) strictly limited the ability of a government to engage in inflation. The advocates of sound money had seen all too well the destructive consequences of the runaway printing press.

Now, purists can rightfully argue that no government scheme involving money will end well. It is certainly true that the optimal arrangement returns money and banking completely to the private sector, where there isn't even such a thing as a national currency, just as we don't have "national" computers or novels.

Unfortunately, even though the proponents of sound money can all agree that FDR's actions in 1933 and Richard Nixon's actions in 1971 were despicable, they can't all agree on the best way to reverse those catastrophes. For example, suppose the government does indeed link the US dollar back to gold. What price should it use? The current market price? The Bretton Woods-era price of $35 per ounce? The pre-Roosevelt price of $20.67 an ounce?

To illustrate some of the problems, consider my own proposal from earlier this year. I suggested that Bernanke (and other Fed policymakers) could "go back on gold" immediately by switching from targeting the federal-funds rate to targeting the price of gold. I recommended that as the Fed's holdings of Treasury debt and other assets matured, it should replace them with physical gold. (This would reassure investors that the Fed would be able to maintain the peg.)

When it came to the crucial question of what price to set as the target, I decided quite arbitrarily on $2,000 per ounce. My reasoning went like this: When the Fed begins buying massive amounts of gold, the market value of gold relative to other goods and services will rise because there is a huge new buyer in the market for gold. Consequently, if the Fed locked in the current market price (which was around $1,400 when I first wrote the article), it would require price deflation for most other goods and services.

Not wanting to repeat the mistake of the British government when it went back to gold in 1925 at the pre–World War I parity — and thereby caused wrenching adjustment problems in British labor markets — I thought it wise for Bernanke to set the gold target price well above the market price on the day of the announcement. That way, the brunt of the adjustment (when the value of gold relative to everything else had to rise) would occur with just the price of gold rising (up to $2,000 per ounce).

Needless to say, there are a few problems with my idea. The most obvious one is that I just picked $2,000 out of the air. Another problem was that there was no definite proportion of gold backing the outstanding quantity of dollars; I was simply recommending that Bernanke & Co. buy or sell assets in order to maintain the target price of gold.

As we'll see, Mises's own proposal — written more than a half a century ago — is far superior to mine.

In chapter 23, "The Return to Sound Money," Mises lays out his plan to return a fictitious country (Ruritania), with its currency (the rur), to the gold standard. The reader must remember that when Mises wrote this, the US dollar was still redeemable for gold at the rate of $35 per ounce. In the interest of accuracy, I have retained his original wording below, but in our times we can drop the references to the dollar and just focus on tying the rur back to gold:

From the point of view of monetary technique the stabilization of a national currency's exchange ratio as against foreign, less-inflated currencies or against gold is a simple matter. The preliminary step is to abstain from any further increase in the quantity of domestic currency. This will at the outset stop the further rise in foreign-exchange rates and the price of gold. After some oscillations a somewhat stable exchange rate will appear, the height of which depends on the purchasing-power parity. At this rate it no longer makes any difference whether one buys or sells against currency A or currency B.

But this stability cannot last indefinitely. While an increase in the production of gold or an increase in the issuance of dollars continues abroad, Ruritania now has a currency the quantity of which is rigidly limited. Under these conditions there can no longer prevail full correspondence between the movements of commodity prices on the Ruritanian markets and those on foreign markets. If prices in terms of gold or dollars are rising, those in terms of rurs will lag behind them or even drop. This means that the purchasing-power parity is changing. A tendency will emerge toward an enhancement of the price of the rur as expressed in gold or dollars. When this trend becomes manifest, the propitious moment for the completion of the monetary reform has arrived. The exchange rate that prevails on the market at this juncture is to be promulgated as the new legal parity between the rur and either gold or the dollar. Unconditional convertibility at this legal rate of every paper rur against gold or dollars and vice versa is henceforward to be the fundamental principle.

The reform thus consists of two measures. The first is to end inflation by setting an insurmountable barrier to any further increase in the supply of domestic money. The second is to prevent the relative deflation that the first measure will, after a certain time, bring about in terms of other currencies the supply of which is not rigidly limited in the same way. As soon as the second step has been taken, any amount of rurs can be converted into gold or dollars without any delay and any amount of gold or dollars into rurs. The agency, whatever its appellation may be, that the reform law entrusts with the performance of these exchange operations needs for technical reasons a certain small reserve of gold or dollars. But its main concern is, at least in the initial stage of its functioning, how to provide the rurs necessary for the exchange of gold or foreign currency against rurs. To enable the agency to perform this task, it has to be entitled to issue additional rurs against a full — 100 percent — coverage by gold or foreign exchange bought from the public.

In this brief passage Mises offers a proposal that avoids the problems we discussed in the previous section. There is no arbitrary selection of a gold price; Mises lets the market do that.

Recall that I had initially thought that pegging the existing market price of gold might lead to trouble because the extra demand to acquire gold by the central bank (or the government's treasury) would cause the relative price of gold to rise. However, under Mises's proposal the government isn't entering the market to bid gold away from others. Rather, the government initially makes no effort to bulk up on its gold holdings. Instead, it passively accepts gold deposits from outsiders who wish to obtain newly issued currency (in exchange for gold) at the official peg.

But what about the gold backing of the currency? The reason I had thought the central bank needed to change the composition of its assets from bonds into gold was to reassure investors that the new peg would indeed be maintained. Here too Mises has an elegant answer: from the moment the new policy goes into effect, any new issue of currency must be backed 100 percent by gold held by the monetary authority.

It is true that the total quantity of money will not be backed 100 percent by gold in the government's vaults, but nonetheless investors would know that from the date of the reform, all additions were fully backed. This is a very nonarbitrary and sensible approach, yielding two desirable outcomes. First, the government wouldn't need to absorb a large fraction of the stock of gold from the private sector early on. Second, as the quantity of domestic currency expanded over time, a larger and larger fraction of the currency would be backed by gold.

When it comes to "second-best" policy recommendations in a world of government intervention, we can never find perfection (by definition). But if we are going to have the government providing a monopoly of domestic currency, Ludwig von Mises's proposal for a return to a gold standard is theoretically elegant and eminently practical.

In the simplest terms, money is a commonly used medium of exchange — one that is widely accepted and that serves as an intermediary for trade. As I explained in a previous article,

If you are a plumber, you don't really need money to live (you can't eat money); money just makes it possible for you to indirectly exchange your plumbing services for groceries. If money weren't there, each time you needed food you would have to find a grocer that was in need of plumbing services so that you could barter your services for food.

If gold is not our commonly used medium of exchange (and most of us do not think in terms of gold for our day-to-day calculations), then — as amazing as this may seem, given all of his prior inaccurate predictions and statements — Ben Bernanke gave the right answer. I hate to admit it.

It is said that a gold or silver coin will have value and be recognized all over the world; but, frankly, so will a dozen eggs or a beautiful diamond.

Having said that, the only reason Bernanke is right is that there is a difference between free-market money (for example, gold) and legal tender, which is forcibly imposed upon us by the government (for example, all paper currencies). As Ron Paul mentioned, gold has been used as money for more than 6,000 years, so the only reason that the average citizen has never held a gold coin in his hands is that the governments of the entire world have basically outlawed gold as medium of payment for debts, public charges, taxes, and government dues.

You see, without a central bank imposing a legal tender, a barter economy tends to select a certain commodity as money. A strange example of this can be found in our prison system, where paper money is not allowed. There cigarettes have emerged as money, or as a common medium of exchange. I say "strange" because a prison is far from being a free environment, but it is also pretty much the only place today where legal tender does not circulate.

The prisoners probably have few goods available to them, and without any knowledge of economics or formal agreement, they chose a good that was very liquid, meaning that most people want it, so it is easily exchanged. In prison, cigarettes are also scarce, which gives them value. They are also relatively nonperishable and homogeneous, which are all characteristics of good money. They are not perfectly divisible, but I guess you can't have it all in that environment. It seems that our prisoners are far wiser in their choice of money than politicians, central bankers, and mainstream economists all over the world.

Using the same mechanism as our savvy prisoners, civilizations all over the world — when left to make their own decisions — have repeatedly chosen gold and silver as forms of money. Well before our time, in a world where a different language might be spoken every 50 miles, somehow gold and silver coordinated all kinds of local and international transactions.

So what's wrong with government-issued paper money? Well, the big danger when you have a printing press is that you will probably keep on printing money for yourself and for your friends. In theory this doesn't have to happen, but in practice it happens every time. (In our "developed" democracies the money printing is not as overt; it is hidden behind all kinds of accounting tricks, confusing terms, and secrecy, but it happens nonetheless.) As much fun as money printing is for the ruling class, its consequences for the population at large are devastating.

One of the other questions Congressman Paul asked Ben Bernanke was why central banks use gold rather than diamonds as a reserve, for example. Chairman Bernanke replied that holding gold was "tradition." Aside from not being aware of the above-mentioned natural-selection process that made gold money in the past, the chairman failed to know that gold is perfectly divisible and completely homogenous.

Perfect divisibility means that you can break up a piece of gold and each little piece will have the same value by weight as it had when it was a big piece. You can also melt it back together. With many other goods (and especially with diamonds), a substantial amount of their value is lost as they are divided, and often you can't piece them back together.

$8 $5

Homogeneity means that an ounce of gold produced in Africa is the same as an ounce of gold produced in America or anywhere else. Ounces of gold are all alike, unlike diamonds, which exist in an infinite variety of colors and grades, making them unsuitable as money.

So why is gold so important to sound economists like Congressman Paul? Because a free-market commodity money such as gold would put an end to — or at least expose — the thefts and power grabs perpetrated by the government. Physical ounces of gold cannot be printed — they are either in the vault or they aren't — and this is the kind of transparency and honesty governments loathe.

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I realize I am betraying my naïvete by admitting this, but I was very surprised at the depth of falsehood in the LA Times article mentioned above. Here is the blurb below the title, "Pushing for a Return to the Gold Standard":

The idea to make the precious metal legal tender has gained currency in more than a dozen state capitals, aided by Tea Party support and other efforts to rein in federal power. Economists say the plan would be disastrous.

I suppose the final sentence is technically true, but it's very misleading. It's a bit like saying, "Baskin-Robbins offers 31 flavors, but customers buy chocolate." Yes, some economists say a return to the gold standard would be disastrous, and I'd grant that perhaps even a large majority do. But the blurb above makes it sound as if virtually all economists oppose the move, which isn't true.

The writer, Nathaniel Popper, reinforces this misconception in two other places. He quite clearly tries to pit the rube businessmen and tea-party politicians against the professional economists. First he writes,

The ultimate goal is to return the nation to the gold standard, in which every dollar would be backed by a fixed amount of the precious metal. Economists of all stripes say the plan would be ruinous, but that view is of scant concern to Pitts [a South Carolina state representative].

"Quite frankly, I think that economists from universities are thinking within the confines of their own little world," Pitts said. "They don't deal with the real issues." (emphasis added)

Just to make sure the reader gets the point, Popper writes later in the article:

The United States and most of the rest of the world operated on a full gold standard until the Great Depression. Economists generally agree that the policy helped cause the depression and earlier severe downturns by limiting the amount of money the government could create, constraining its ability to stimulate the economy.

Scholars say moving to a gold standard now would be likely to slow the economy's already meager growth.

"At some point someone may be crazy enough to try it, but they won't stay with it anymore than they did in the past," said Allan Meltzer, a Carnegie Mellon University economics professor and a critic of the Fed's current monetary policy.

Given the lack of support from mainstream economists, activists have turned a few texts written by outsiders into their bibles, such as "Pieces of Eight," an out-of-print book by [constitutional lawyer] Vieira.

In the entire article, Popper doesn't quote a single economist who is in favor of the gold standard, or even paraphrase his or her views. This might be acceptable, except for the fact that Popper quotes or makes reference to businessmen, politicians, and the lawyer Vieira. (I am not familiar with Vieira's work, and it should go without saying that I'm not criticizing him.)

Now, it would be easy for me to accuse Popper of lying, but for all I know he was so sure of the stupidity of the gold standard that he didn't even try to find actual PhD economists currently teaching at colleges (some even at top-20 graduate schools) who would have nice things to say about the gold standard. I personally know at least 20 such people, so believe me, they're out there if Popper or other journalists actually want to give the case for gold a fighting chance.

As far as books touting the advantages of the gold standard, yes indeed there are volumes written by people with PhDs in economics. A classic text is Ludwig von Mises's The Theory of Money and Credit, while a newer, much more reader-friendly selection is Murray Rothbard's What Has Government Done to Our Money? My own book on the Great Depression exploded the myth that the gold standard had something to do with it.

Before moving on, let me quickly address that particular claim. I've written a longer response here, but for now we have to wonder: If the gold standard caused the Great Depression, what else was going on? After all, the gold standard wasn't implemented in the 1920s. Although there had been plenty of industrial crises or financial panics in the previous hundred years, there had been no prolonged global depression approaching the experience of the 1930s — even as more and more countries joined the growing worldwide market of gold-based economies. So clearly it's not enough to point to the "golden fetters" of the monetary system to explain what happened in the Great Depression.

As a final point, let's not forget that FDR abandoned the gold standard in 1933. The Great Depression thus lingered on — after leaving the allegedly awful gold standard — for at least another 8 years (and I would say 13 years, because I don't think World War II "fixed" the economy), in what was still the worst economic period in US history. It's odd that the gold standard could wreak so much havoc in the early 1930s — even though it had never done anything comparable earlier in US history — and then could continue to "cause" the Great Depression, from 8 to 13 years after abandoning it. It starts to make you wonder whether the "economists of all stripes" know what they're talking about.

One of the most absurd objections to returning to a gold standard is that "You can't eat gold." I am not making this up; Dave Leonhardt of the New York Times actually said that to Ron Paul when he defended the idea on the Colbert Report.

Dr. Paul didn't really get a chance to answer (Colbert instead made a funny joke about idolatry), but it would have been delicious had he quickly asked the cynic, "Oh, so you make sandwiches out of Federal Reserve notes?" (We also would have accepted, "Oh, so I take it you are proposing a hamburger standard for the dollar?")

The utter absurdity of the objection — namely that you "can't eat gold" — is that gold actually is a useful commodity even for nonmonetary purposes. It's true, you can't eat gold, but you can wear it, you can fill cavities with it, and you can treat arthritis with it. In contrast, all you can do with fiat paper currency is use it in exchange, and you'd better not keep a large fraction of your wealth in actual paper dollars, since their purchasing power constantly erodes with the passage of time.

Ironically, in addition to ill-informed critiques such as those emanating from the LA Times, the gold standard has critics from the purist libertarian camp. Such critics often ask, "What's so special about gold? Why do Ron Paul and so many other alleged fans of the free market favor the federal government telling us what the money should be?"

Of course Murray Rothbard — and as far as I know, every living Austrian economist — would prefer that money and banking were returned to the private sector, receiving neither special regulations nor privileges distinguishing them from any other industry. That means banks would be free to issue their own paper notes (backed by gold reserves) if they wanted, but if they issued too many and got caught in a "run," the government wouldn't declare a "bank holiday" and relieve the irresponsible institution of its contractual obligations.

In the meantime, given that there is a Federal Reserve (and other central banks), many Austrians (though here the agreement is not universal) believe that restoring the convertibility of the dollar to a fixed weight of gold would be a move in the right direction, even though it would still not be perfect.

The purpose of repegging the dollar to gold would be to remove what is euphemistically called "monetary policy" (a more sinister description would be "legalized counterfeiting") from politics and special-interest corruption as much as possible. People laud the current Fed as being "independent," but of course that is absurd. The Fed as it currently operates is clearly a cartelization device that shoves new money into the pockets of rich bankers, and that allows the government to finance massive deficits much more cheaply than would otherwise be possible.

Related to the above criticism, some purists also ask, "Why don't you favor a market-driven price for the dollar and for gold? Just let supply and demand determine prices, not some rigid number picked out of a hat by the politicians."

This objection sounds plausible at first, but it too misses the mark. If the Fed were to say, "We are now announcing a new policy objective of maintaining the price of gold at $2,000 per ounce, from now until the end of time, and we will begin accumulating stockpiles of gold to reassure investors that we will be able to maintain the target," this would not be analogous to the federal government saying, "We are establishing a minimum price of labor at $7.25 per hour."

Under a genuine gold standard, when the Fed "sets" the dollar price of gold it isn't threatening people with fines or jail time if they want to trade gold at a different price. Rather, the Fed (or the government in general, if there were no central bank) would adjust the quantity of dollars in existence to maintain the target. If the forces of supply and demand were such that the market price of gold had drifted upward to, say, $2,025 per ounce, then the Fed (assuming a $2,000 target) would need to sell off some of its gold holdings,The operation would be automatic if the system were set up along the lines of the classical gold standard. People all over the world would have the guarantee that they could always turn over $2,000 in Federal Reserve notes in exchange for a physical ounce of gold. If the market price of gold ever went above $2,000, therefore, speculators could earn arbitrage profits by buying from Uncle Sam at $2,000 and reselling gold in the market for more. which would (1) flood the market with more gold and (2) shrink the amount of dollars in the financial system. This contractionary policy would push down the price of gold toward the peg of $2,000.

On the other hand, nobody would be so foolish as to sell his gold for less than $2,000 per ounce, if the Fed (or the Treasury) had a standing invitation for anyone to trade in an ounce of gold in exchange for $2,000 in Federal Reserve notes. Why sell your gold to another private citizen for (say) $1,950 an ounce, when the US government stands prepared to buy unlimited quantities of gold at a fixed price of $2,000 per ounce?

Finally, a critic could (and actually did, on my blog) ask how this arrangement differs from the current one? After all, right now Bernanke "sets" interest rates, but not through literal price controls. Instead, the Fed adjusts the quantity of reserves in the banking sector such that the "market-determined" federal funds rate is close enough to the Fed's target for this interest rate. So isn't this basically the same thing as the gold standard, with a different "good" serving as the monetary commodity?

There are two problems with this sophisticated objection. First, in the current system the Fed has a moving federal-funds target. At best, then, it would be analogous only if the Federal Open Market Committee said after each meeting, "We are now setting the target price of gold at such-and-such dollars. However, if unemployment begins rising and core CPI is under 2 percent, we will begin raising the target price of gold in $10 increments over the next few meetings." That system would be nothing like the classical gold standard.

Yet the deeper problem with the analogy is that on a classical gold standard, the government is (imperfectly) mimicking what would happen if the money were actually gold, with people walking around with gold coins in their pockets, and merchants quoting prices not in dollars but in grains or ounces of gold. The classical gold standard, by fixing the dollar as convertible into a definite and constant weight of gold, doesn't introduce another price: the dollar is supposed to be a claim-ticket to gold. This isn't really "price fixing," any more than defining a foot as 12 inches is "central planning."

In contrast, what would be the free-market analog of the Fed's current strategy of targeting short-term interest rates? The only thing I can think of is if the money commodity in a community weren't something tangible like gold, silver, or tobacco, but rather overnight bonds issued by banks. Yet what is a bond but a promise to deliver money? So how could the money itself be a short-term bond? At this point I am dropping the analogy, lest I become permanently cross-eyed.

As the Fed's debasement of the currency reaches literally unprecedented levels, more and more regular Americans are waking up to the merits of commodity money. Yet this isn't some populist fad; there is a whole tradition of excellent academic scholarship touting the virtues of the gold standard. If he returns to the subject, I hope critics like the LA Times's Popper will give gold a fairer hearing.

This country had the chance to avoid the disastrous meltdown of 2008 and following, the one that has led to the nationalization of industries, the creation of oceans of paper money, and the destruction of so many American dreams. The answer that might have been is the one you hold in your hands: the minority report of the US Gold Commission of 1982, written by Ron Paul and signed by Lewis E. Lehrman. It provides an outstanding history, wonderful theoretical analytics, and a proposal for the return of sound money, which is gold.

Alas, it was the minority report and therefore killed by political forces. Of course, the fix was in from the beginning. The commission only came to exist in the first place as payoff to certain "goldbugs" in the Republican Party in the those years. Ronald Reagan was one of them. So his influence was part of the reason the Commission was created. But it wasn't created to institute a gold standard. It was created to bury the idea once and for all.

Ron Paul wouldn't let it happen. The result was this book, which remains a mighty case for sound money and the blessings that change would bring to this country. A gold currency would restore economic stability and growth. It would eliminate unemployment. It would force government to spend only what it can collect in taxes. It would rein in the welfare state and the warfare state. It would give the people control of money again. It would restore what we used to call freedom, which is a core of social and civic life that is impenetrable and inaccessible to government planners.

With a gold standard, the Fed could disappear. The banking industry would become an industry like any other, subject to the profit and loss test and given no guaranteed bailouts at taxpayer expense. The financial industry would be forced to surrender its love of socialism (for losses, not gains) and become honest again. We would all start living within our means and thriving off private wealth rather than depending on the public sector to save us.

Trade with other nations would benefit. Protectionist wars rooted in currency manipulation would cease. Policy options in Washington would be mercifully restricted to only what Washington could afford to do and afford to enforce. Vast swaths of the public sector as we know it would have to just pack up and go home. This would be the greatest blessing visited on this country in a century. But can you see why Washington isn't interested? It has nothing to do with disagreements over economic theory. It is all about who has power in society. Paper money gives power to tyrants. Sound money — that is gold — gives power to the people and the free markets they control.

So, yes, we should have listened to Ron in 1982. The thing is that he — wisely and bravely — never stopped talking about this issue. It turns out that this book, this minority report, is the work of a prophet. It tells the truth and shows the way. It should be our manifesto again. This timeless statement on behalf of economic truth can be our guide.

They didn't listen then. But maybe they'll listen now. We need monetary freedom more than anything else. The way digital markets are advancing, it might come about with or without Washington's permission. As Ron has always known, paper money cannot last. Either it has to go, or the American dream has to go. They cannot forever live side by side.

This article is the foreword to the second edition of Ron Paul's The Case for Gold (2011).

Hateful money! Hateful money!" cried F——, the economist, despairingly, as he came from the Committee of Finance, where a project of paper money had just been discussed.

"What's the matter?" I said. "What is the meaning of this sudden dislike to the most extolled of all the divinities of this world?"

F—— Hateful money! Hateful money!

Bastiat You alarm me. I hear peace, liberty, and life cried down, and Brutus went so far even as to say, "Virtue! Thou art but a name!" But what can have happened?

F. Hateful money! Hateful money!

B. Come, come, exercise a little philosophy. What has happened to you? Has Croesus been affecting you? Has Jones been playing you false? Or has Smith been libeling you in the papers?

F. I have nothing to do with Croesus; my character, by its insignificance, is safe from any slanders of Smith; and as to Jones —

B. Ah! Now I have it. How could I be so blind? You, too, are the inventor of a social reorganization — of the F—— system. In fact, your society is to be more perfect than that of Sparta, and, therefore all money is to be strictly banished from it. And the thing that troubles you is how to persuade your people to throw away the contents of their purses. What would you have? This is the rock on which all reorganizers split. Anyone could do wonders if he could contrive to overcome all resisting influences, and if all mankind would consent to become soft wax in his fingers; but men are resolved not to be soft wax; they listen, applaud, or reject and — go on as before.

F. Thank heaven I am still free from this fashionable mania. Instead of inventing social laws, I am studying those which it has pleased Providence to invent, and I am delighted to find them admirable in their progressive development. This is why I exclaim, "Hateful money! Hateful money!"

B. You are a disciple of Proudhon, then? Well, there is a very simple way for you to satisfy yourself. Throw your purse into the river, only reserving a small draft on the Bank of Exchange.

F. If I cry out against money, is it likely I should tolerate its deceitful substitute?

B. Then I have only one more guess to make. You are a new Diogenes, and are going to belabor me with a discourse on the contempt of riches.

F. Heaven preserve me from that! For riches, don't you see, are not a little more or a little less money. They are bread for the hungry, clothes for the naked, fuel to warm you, oil to lengthen the day, a career open to your son, a certain portion for your daughter, a day of rest after fatigue, a cordial for the faint, a little assistance slipped into the hand of a poor man, a shelter from the storm, a diversion for a brain worn by thought, the incomparable pleasure of making those happy who are dear to us. Riches are education, independence, dignity, confidence, charity; they are progress and civilization. Riches are the admirable civilizing result of two admirable agents, more civilizing even than riches themselves — labor and exchange.

B. Well! Now you seem to be singing the praises of riches, when, a moment ago, you were loading them with imprecations!

F. Why, don't you see that it was only the whim of an economist? I cry out against money, just because everybody confounds it, as you did just now, with riches, and that this confusion is the cause of errors and calamities without number. I cry out against it because its function in society is not understood, and very difficult to explain. I cry out against it because it jumbles all ideas, causes the means to be taken for the end, the obstacle for the cause, the alpha for the omega; because its presence in the world, though in itself beneficial, has nevertheless introduced a fatal notion, a perversion of principles, a contradictory theory which in a multitude of forms, has impoverished mankind and deluged the earth with blood. I cry out against it, because I feel that I am incapable of contending against the error to which it has given birth, otherwise than by a long and fastidious dissertation to which no one would listen. Oh! if I could only find a patient and right-thinking listener!

B. Well, it shall not be said that for want of a victim you remain in the state of irritation in which you now are. I am listening; speak, lecture, do not restrain yourself in any way.

F. You promise to take an interest?

B. I promise to have patience.

F. That is not much.

B. It is all that I can give. Begin, and explain to me, at first, how a mistake on the subject of money, if mistake there be, is to be found at the root of all economical errors?

F. Well, now, is it possible that you can conscientiously assure me that you have never happened to confound wealth with money?

B. I don't know; but, after all, what would be the consequence of such a confusion?

F. Nothing very important. An error in your brain, which would have no influence over your actions; for you see that, with respect to labor and exchange, although there are as many opinions as there are heads, we all act in the same way.

B. Just as we walk based on the same principle, although we are not agreed upon the theory of equilibrium and gravitation.

F. Precisely. A person who argued himself into the opinion that during the night our heads and feet changed places, might write very fine books upon the subject, but still he would walk about like everybody else.

B. So I think. Nevertheless, he would soon suffer the penalty of being too much of a logician.

F. In the same way, a man would die of hunger who, having decided that money is real wealth, should carry out the idea to the end. That is the reason that this theory is false, for there is no true theory but such as results from facts themselves, as manifested at all times and in all places.

B. I can understand that practically, and under the influence of personal interest, the injurious effects of the erroneous action would tend to correct an error. But if that of which you speak has so little influence, why does it disturb you so much?

F. Because, when a man, instead of acting for himself, decides for others, personal interest, that ever watchful and sensible sentinel, is no longer present to cry out, "Stop! The responsibility is misplaced." It is Peter who is deceived, and John suffers; the false system of the legislator necessarily becomes the rule of action of whole populations. And observe the difference. When you have money, and are very hungry, whatever your theory about money may be, what do you do?

B. I go to a baker's and buy some bread.

F. You do not hesitate about using your money?

B. The only use of money is to buy what one wants.

F. And if the baker should happen to be thirsty, what does he do?

B. He goes to the wine merchant's, and buys wine with the money I have given him.

F. What! Is he not afraid he shall ruin himself?

B. The real ruin would be to go without eating or drinking.

F. And everybody in the world, if he is free, acts in the same manner?

B. Without a doubt. Would you have them die of hunger for the sake of saving up pennies?

F. So far from it, that I consider they act wisely, and I only wish that the theory was nothing but the faithful image of this universal practice. But, suppose now, that you were the legislator, the absolute king of a vast empire, where there were no gold mines.

B. Sounds good to me.

F. Suppose, again, that you were perfectly convinced of this, — that wealth consists solely and exclusively of money; to what conclusion would you come?

B. I should conclude that there was no other means for me to enrich my people, or for them to enrich themselves, but to draw away the money from other nations.

F. That is to say, to impoverish them. The first conclusion, then, to which you would arrive would be this — a nation can only gain when another loses.

B. This axiom has the authority of Bacon and Montaigne.

F. It is not the less sorrowful for that, for it implies that progress is impossible. Two nations, no more than two men, cannot prosper side by side.

B. It would seem that such is the result of this principle.

F. And as all men are ambitious to enrich themselves, it follows that all are desirous, according to a law of Providence, of ruining their fellow-creatures.

B. This is not Christianity, but it is political economy.

F. Such a doctrine is detestable. But, to continue, I have made you an absolute king. You must not be satisfied with reasoning; you must act. There is no limit to your power. How would you treat this doctrine — wealth is money?

B. It would be my endeavor to increase, incessantly, among my people the quantity of money.

F. But there are no mines in your kingdom. How would you set about it? What would you do?

B. I should do nothing: I should merely forbid, on pain of death, that a single dollar should leave the country.

F. And if your people should happen to be hungry as well as rich?

B. Never mind. In the system we are discussing, to allow them to export dollars would be to allow them to impoverish themselves.

F. So that, by your own confession, you would force them to act upon a principle equally opposite to that upon which you would yourself act under similar circumstances. Why so?

B. Because only my own hunger touches me, and the hunger of a nation does not touch legislators.

F. Well, I can tell you that your plan would fail, and that no superintendence would be sufficiently vigilant, when the people were hungry, to prevent the dollars from going out and the grain from coming in.

B. If so, this plan, whether erroneous or not, would effect nothing; it would do neither good nor harm, and therefore requires no further consideration.

F. You forget that you are a legislator. A legislator must not be disheartened at trifles, when he is making experiments on others. The first measure not having succeeded, you ought to take some other means of attaining your end.

B. What end?

F. You must have a bad memory. Why, that of increasing, in the midst of your people, the quantity of money, which is presumed to be true wealth.

B. Ah! To be sure; I beg your pardon. But then you see, as they say of music, a little is enough; and this may be said, I think, with still more reason, of political economy. I must consider. But really I don't know how to contrive —

F. Ponder it well. First, I would have you observe that your first plan solved the problem only negatively. To prevent the dollars from going out of the country is the way to prevent the wealth from diminishing, but it is not the way to increase it.

B. Ah! Now I am beginning to see … the grain which is allowed to come in … a bright idea strikes me … the contrivance is ingenious, the means infallible; I am coming to it now.

F. Now, I, in turn, must ask you — to what?

B. Why, to a means of increasing the quantity of money.

F. How would you set about it, if you please?

B. Is it not evident that if the heap of money is to be constantly increasing, the first condition is that none must be taken from it?

F. Certainly.

B. And the second, that additions must constantly be made to it?

F. To be sure.

B. Then the problem will be solved, either negatively or positively; if on the one hand I prevent the foreigner from taking from it, and on the other I oblige him to add to it.

F. Better and better.

B. And for this there must be two simple laws made, in which money will not even be mentioned. By the one, my subjects will be forbidden to buy anything abroad; and by the other, they will be required to sell a great deal.

F. A well-advised plan.

B. Is it new? I must take out a patent for the invention.

F. You need do no such thing; someone has beaten you to it. But you must take care of one thing.

B. What is that?

F. I have made you an absolute king. I understand that you are going to prevent your subjects from buying foreign productions. It will be enough if you prevent them from entering the country. Thirty or forty thousand custom-house officers will do the trick.

B. It would be rather expensive. But what does that signify? The money they receive will not go out of the country.

F. True; and in this system it is the grand point. But to insure a sale abroad, how would you proceed?

B. I should encourage it by bounties, obtained by means of some good taxes laid upon my people.

F. In this case, the exporters, constrained by competition among themselves, would lower their prices in proportion, and it would be like making a present to the foreigner of the prizes or of the taxes.

B. Still, the money would not go out of the country.

F. Of course. That is understood. But if your system is beneficial, the governments of other countries will adopt it. They will make similar plans to yours; they will have their custom-house officers, and reject your products; so that with them, as with you, the heap of money may not be diminished.

B. I shall have an army and force down their barriers.

F. They will have an army and force down yours.

B. I shall arm vessels, make conquests, acquire colonies, and create consumers for my people, who will be obliged to eat our corn and drink our wine.

F. The other governments will do the same. They will dispute your conquests, your colonies, and your consumers; then on all sides there will be war, and all will be uproar.

B. I shall raise my taxes, and increase my custom-house officers, my army, and my navy.

F. The others will do the same.

B. I shall redouble my exertions.

F. The others will redouble theirs. In the meantime, we have no proof that you would succeed in selling to a great extent.

B. It is but too true. It would be well if the commercial efforts would neutralize each other.

F. And the military efforts also. And, tell me, are not these custom-house officers, soldiers, and vessels, these oppressive taxes, this perpetual struggle toward an impossible result, this permanent state of open or secret war with the whole world, are they not the logical and inevitable consequence of the legislators having adopted an idea that you admit is acted upon by no man who is his own master, that "wealth is money; and to increase the amount of money is to increase wealth?"

B. I grant it. Either the axiom is true, and then the legislator ought to act as I have described, although universal war should be the consequence; or it is false; and in this case men, in destroying each other, only ruin themselves.

F. And, remember, that before you became a king, this same axiom had led you by a logical process to the following maxims — That which one gains, another loses. The profit of one is the loss of the other — which maxims imply an intractable antagonism amongst all men.

B. It is only too certain. Whether I am a philosopher or a legislator, whether I reason or act upon the principle that money is wealth, I always arrive at one conclusion, or one result: universal war. It is well that you pointed out the consequences before beginning a discussion upon it; otherwise, I should never have had the courage to follow you to the end of your economical dissertation, for, to tell you the truth, it is not much to my taste.

F. What do you mean? I was just thinking of it when you heard me grumbling against money! I was lamenting that my countrymen have not the fortitude to study what it is so important that they should know.

B. And yet the consequences are frightful.

F. The consequences! As yet I have only mentioned one. I might have told you of others still more fatal.

B. You make my hair stand on end! What other evils can have been caused to mankind by this confusion between money and wealth?

F. It would take me a long time to enumerate them. This doctrine is one of a very numerous family. The eldest, whose acquaintance we have just made, is called the prohibitive system; the next, the colonial system; the third, hatred of capital; the last and worst, paper money.

B. What! Does paper money proceed from the same error?

F. Yes, directly. When legislators, after having ruined men by war and taxes, persevere in their idea, they say to themselves, "If the people suffer, it is because there is not money enough. We must make some." And as it is not easy to multiply the precious metals, especially when the pretended resources of prohibition have been exhausted, they add, "We will make fictitious money, nothing is more easy, and then every citizen will have his pocketbook full of it, and they will all be rich."

B. In fact, this proceeding is more expeditious than the other, and then it does not lead to foreign war.

F. No, but it leads to domestic disaster.

B. You are a grumbler. Make haste and dive to the bottom of the question. I am quite impatient, for the first time, to know if money (or its sign) is wealth.

F. You will grant that men do not satisfy any of their wants immediately with coined dollars, or dollar bills. If they are hungry, they want bread; if naked, clothing; if they are ill, they must have remedies; if they are cold, they want shelter and fuel; if they would learn, they must have books; if they would travel, they must have conveyances — and so on. The riches of a country consist in the abundance and proper distribution of all these things. Hence you may perceive and rejoice at the falseness of this gloomy maxim of Bacon's, "What one people gains, another necessarily loses" — a maxim expressed in a still more discouraging manner by Montaigne, in these words: "The profit of one is the loss of another." When Shem, Ham, and Japhet divided amongst themselves the vast solitudes of this earth, they surely might each of them build, drain, sow, reap, and obtain improved lodging, food and clothing, and better education, perfect and enrich themselves — in short, increase their enjoyments, without causing a necessary diminution in the corresponding enjoyments of their brothers. It is the same with two nations.

B. There is no doubt that two nations, the same as two men, unconnected with each other, may, by working more, and working better, prosper at the same time, without injuring each other. It is not this that is denied by the axioms of Montaigne and Bacon. They only mean to say, that in the transactions that take place between two nations or two men, if one gains, the other must lose. And this is self-evident, as exchange adds nothing by itself to the mass of those useful things of which you were speaking; for if, after the exchange, one of the parties is found to have gained something, the other will, of course, be found to have lost something.

F. You have formed a very incomplete, nay, a false idea of exchange. If Shem is located upon a plain that is fertile in corn, Japhet upon a slope adapted for growing the vine, Ham upon a rich pasturage — the distinction of their occupations, far from hurting any of them, might cause all three to prosper more. It must be so, in fact, for the distribution of labor, introduced by exchange, will have the effect of increasing the mass of corn, wine, and meat that is produced, and that is to be shared. How can it be otherwise, if you allow liberty in these transactions? From the moment that any one of the brothers should perceive that labor in company, as it were, was a permanent loss, compared to solitary labor, he would cease to exchange. Exchange brings with it its claim to our gratitude. The fact of its being accomplished proves that it is a good thing.

B. But Bacon's axiom is true in the case of gold and silver. If we admit that at a certain moment there exists in the world a given quantity, it is perfectly clear that one purse cannot be filled without another being emptied.

F. And if gold is considered to be riches, the natural conclusion is that displacements of fortune take place among men, but no general progress. It is just what I said when I began. If, on the contrary, you look upon an abundance of useful things, fit for satisfying our wants and our tastes, as true riches, you will see that simultaneous prosperity is possible. Money serves only to facilitate the transmission of these useful things from one to another, which may be done equally well with an ounce of rare metal like gold, with a pound of more abundant material as silver, or with a hundredweight of still more abundant metal, as copper. According to that, if a country like the United States had at its disposal as much again of all these useful things, its people would be twice as rich, although the quantity of money remained the same; but it would not be the same if there were double the money, for in that case the amount of useful things would not increase.

B. The question to be decided is whether the presence of a greater number of dollars has not the effect, precisely, of augmenting the sum of useful things?

F. What connection can there be between these two terms? Food, clothing, houses, fuel, all come from nature and from labor, from more or less skillful labor exerted upon a more or less liberal nature.

B. You are forgetting one great force, which is exchange. If you acknowledge that this is a force, as you have admitted that dollars facilitate it, you must also allow that they have an indirect power of production.

F. But I have added that a small quantity of rare metal facilitates transactions as much as a large quantity of abundant metal; from which it follows that a people is not enriched by being forced to give up useful things for the sake of having more money.

B. Thus, it is your opinion that the treasures discovered in California will not increase the wealth of the world?

F. I do not believe that, on the whole, they will add much to the enjoyments, to the real satisfactions of mankind. If the Californian gold merely replaces in the world that which has been lost and destroyed, it may have its use. If it increases the amount of money, it will depreciate it. The gold diggers will be richer than they would have been without it. But those who possess the gold at the moment of its depreciation, will obtain a smaller gratification for the same amount. I cannot look upon this as an increase, but as a reallocation of true riches, as I have defined them.

B. All that is very plausible. But you will not easily convince me that I am not richer (all other things being equal) if I have two dollars, than if I had only one.

F. I do not deny it.

B. And what is true of me is true of my neighbor, and of the neighbor of my neighbor, and so on, from one to another, all over the country. Therefore, if every citizen of the United States has more dollars, the United States must be more rich.

F. And here you fall into the common mistake of concluding that what affects one affects all, and thus confusing the individual with the general interest.

B. Why, what can be more conclusive? What is true of one, must be so of all. What are all, but a collection of individuals? You might as well tell me that every American could suddenly grow an inch taller without the average height of all the Americans being increased.

F. Your reasoning is apparently sound, I grant you, and that is why the illusion it conceals is so common. However, let us examine it a little. Ten persons were gambling. For greater ease, they had adopted the plan of each taking ten chips, and against these they each placed a 100 dollars under a candlestick, so that each chip corresponded to ten dollars. After the game the winnings were adjusted, and the players drew from under the candlestick as many dollars as would represent the number of chips. Seeing this, one of them, a great arithmetician perhaps, but an indifferent reasoner, said: "Gentlemen, experience invariably teaches me that, at the end of the game, I find myself a gainer in proportion to the number of my chips. Have you not observed the same with regard to yourselves? Thus, what is true of me must be true of each of you, and what is true of each must be true of all. We should, therefore, all of us gain more, at the end of the game, if we all had more chips. Now, nothing can be easier; we have only to distribute twice the number of chips." This was done; but when the game was finished, and they came to adjust the winnings, it was found that the money under the candlestick had not been miraculously multiplied, according to the general expectation. They had to be divided accordingly, and the only result obtained (chimerical enough) was this: every one had, it is true, his double number of chips, but every chip, instead of corresponding to ten dollars, only represented five. Thus it was clearly shown that what is true of each is not always true of all.

B. I see; you are supposing a general increase of chips, without a corresponding increase of the sum placed under the candlestick.

F. And you are supposing a general increase of dollars, without a corresponding increase of things, the exchange of which is facilitated by these dollars.

B. Do you compare the dollars to chips?

F. In any other point of view, certainly not; but in the case you place before me, and which I have to argue against, I do. Consider one thing. In order that there be a general increase of dollars in a country, this country must have mines, or its commerce must be such as to give useful things in exchange for money. Apart from these two circumstances, a universal increase is impossible, the dollars only changing hands; and in this case, although it may be very true that each one, taken individually, is richer in proportion to the number of dollars that he has, we cannot draw the inference that you drew just now, because a dollar more in one purse implies necessarily a dollar less in some other. It is the same as with your comparison of the average height. If each of us grew only at the expense of others, it would be very true of each, taken individually, that he would be a taller man if he had the chance, but this would never be true of the whole taken collectively.

B. Be it so: but, in the two suppositions that you have made, the increase is real, and you must allow that I am right.

F. To a certain point, gold and silver have a value. To obtain this value, men consent to give other useful things that have a value also. When, therefore, there are mines in a country, if that country obtains from them sufficient gold to purchase a useful thing from abroad — a locomotive, for instance — it enriches itself with all the enjoyments that a locomotive can procure, exactly as if the machine had been made at home. The question is whether it spends more efforts in the former proceeding than in the latter? For if it did not export this gold, it would depreciate, and something worse would happen than what did sometimes happen in California and in Australia, for there, at least, the precious metals are used to buy useful things made elsewhere. Nevertheless, there is still a danger that they may starve on heaps of gold; as it would be if the law prohibited the exportation of gold. As to the second supposition — that of the gold that we obtain by trade — it is an advantage, or the reverse, according as the country stands more or less in need of it, compared to its wants of the useful things that must be given up in order to obtain it. It is not for the law to judge of this, but for those who are concerned in it; for if the law should start upon this principle, that gold is preferable to useful things, whatever may be their value, and if it should act effectually in this sense, it would tend to put every country adopting the law in the curious position of having a great deal of cash to spend, and nothing to buy. It is the very same system that is represented by Midas, who turned everything he touched into gold, and was in consequence in danger of dying of starvation.

B. The gold that is imported implies that a useful thing is exported, and in this respect there is a satisfaction withdrawn from the country. But is there not a corresponding benefit? And will not this gold be the source of a number of new satisfactions, by circulating from hand to hand, and stimulating labor and industry, until at length it leaves the country in its turn, and causes the importation of some useful thing?

F. Now you have come to the heart of the question. Is it true that a dollar is the principal that causes the production of all the objects whose exchange it facilitates? It is very clear that a piece of coined gold or silver stamped as a dollar is only worth a dollar; but we are led to believe that this value has a particular character: that it is not consumed like other things, or that it is exhausted very gradually; that it renews itself, as it were, in each transaction; and that, finally this particular dollar has been worth a dollar as many times as it has accomplished transactions — that it is of itself worth all the things for which it has been successively exchanged; and this is believed because it is supposed that without this dollar these things would never have been produced. It is said the shoemaker would have sold fewer shoes, and consequently he would have bought less of the butcher; the butcher would not have gone so often to the grocer, the grocer to the doctor, the doctor to the lawyer, and so on.

B. No one can dispute that.

F. This is the time, then, to analyze the true function of money, independently of mines and importations. You have a dollar. What does it imply in your hands? It is, as it were, the witness and proof that you have, at some time or other, performed some labor, which, instead of turning to your advantage, you have bestowed upon society as represented by your client (employer or debtor). This coin testifies that you have performed a service for society, and moreover it shows the value of it. It bears witness, besides, that you have not yet obtained from society a real equivalent service, to which you have a right. To place you in a condition to exercise this right, at the time and in the manner you please, society, as represented by your client, has given you an acknowledgment, a title, a privilege from the republic, a token, a title to a dollar's worth of property in fact, which only differs from executive titles by bearing its value in itself; and if you are able to read with your mind's eye the inscriptions stamped upon it you will distinctly decipher these words: "Pay the bearer a service equivalent to what he has rendered to society, the value received being shown, proved, and measured by that which is represented by me." Now, you give up your dollar to me. Either my title to it is gratuitous, or it is a claim. If you give it to me as payment for a service, the following is the result: your account with society for real satisfactions is enumerated, balanced, and closed. You had rendered it a service for a dollar, you now restore the dollar for a service; as far as you are concerned you are clear. As for me, I am now in the position in which you were previously. It is I who am now in advance to society for the service which I have just rendered it in your person. I have become its creditor for the value of the labor that I have performed for you, and that I might have devoted to myself. It is into my hands then, that the title of this credit — the proof of this social debt — ought to pass. You cannot say that I am any richer; if I am entitled to receive, it is because I have given. Still less can you say that society is a dollar richer because one of its members has a dollar more and another has one less. For if you let me have this dollar gratis, it is certain that I shall be so much the richer, but you will be so much the poorer for it; and the social fortune, taken in a mass, will have undergone no change, because as I have already said, this fortune consists in real services, in effective satisfactions, in useful things. You were a creditor to society; you made me a substitute to your rights, and it signifies little to society, which owes a service, whether it pays the debt to you or to me. This is discharged as soon as the bearer of the claim is paid.

B. But if we all had a great number of dollars we should obtain from society many services. Would not that be very desirable?

F. You forget that in the process that I have described, and that is a picture of the reality, we only obtain services from society because we have bestowed some upon it. Whoever speaks of a service speaks at the same time of a service received and returned, for these two terms imply each other, so that the one must always be balanced by the other. It is impossible for society to render more services than it receives, and yet a belief to the contrary is the chimera which is being pursued by means of the multiplication of coins, of paper money, etc.

B. All that appears very reasonable in theory, but in practice I cannot help thinking, when I see how things go, that if by some fortunate circumstance the number of dollars could be multiplied in such a way that each of us could see his little property doubled, we should all be more at our ease; we should all make more purchases, and trade would receive a powerful stimulus.

F. More purchases! And what should we buy? Doubtless, useful articles — things likely to procure for us substantial gratification — such as food, clothing, houses, books, pictures. You should begin, then, by proving that all these things create themselves; you must suppose the Mint melting ingots of gold that have fallen from the moon; or that the printing presses be put in action at the Treasury Department; for you cannot reasonably think that if the quantity of corn, cloth, ships, hats, and shoes remains the same, the share of each of us can be greater because we each go to market with a greater amount of real or fictitious money. Remember the players. In the social order the useful things are what the players place under the candlestick, and the dollars that circulate from hand to hand are the chips. If you multiply the dollars without multiplying the useful things, the only result will be that more dollars will be required for each exchange, just as the players required more chips for each deposit. You have the proof of this in what passes for gold, silver, and copper. Why does the same exchange require more copper than silver, more silver than gold? Is it not because these metals are distributed in the world in different proportions? What reason have you to suppose that if gold were suddenly to become as abundant as silver, it would not require as much of one as of the other to buy a house?

B. You may be right, but I should prefer your being wrong. In the midst of the sufferings that surround us, so distressing in themselves, and so dangerous in their consequences, I have found some consolation in thinking that there was an easy method of making all the members of the community happy.

F. Even if gold and silver were true riches, it would be no easy matter to increase the amount of them in a country where there are no mines.

B. No, but it is easy to substitute something else. I agree with you that gold and silver can do but little service, except as a mere means of exchange. It is the same with paper money, bank notes, etc. Then, if we had all of us plenty of the latter, which it is so easy to create, we might all buy a great deal, and should lack nothing. Your cruel theory dissipates hopes, illusions, if you will, whose principle is assuredly very philanthropic.

F. Yes, like all other barren dreams formed to promote universal felicity. The extreme facility of the means that you recommend is quite sufficient to expose its hollowness. Do you believe that if it were merely needful to print bank notes in order to satisfy all our wants, our tastes, and desires, that mankind would have been contented to go on till now without having recourse to this plan? I agree with you that the discovery is tempting. It would immediately banish from the world not only plunder, in its diverse and deplorable forms, but even labor itself, except in the National Printing Bureau. But we have yet to learn how greenbacks are to purchase houses, that no one would have built; corn, that no one would have raised; textiles that no one would have taken the trouble to weave.

B. One thing strikes me in your argument. You say yourself that if there is no gain, at any rate there is no loss in multiplying the instrument of exchange, as is seen by the instance of the players, who were entirely unaffected by a very mild deception. Why, then, refuse the philosopher's stone, which would teach us the secret of changing base material into gold, or what is the same thing, converting paper into money? Are you so blindly wedded to logic that you would refuse to try an experiment where there can be no risk? If you are mistaken, you are depriving the nation, as your numerous adversaries believe, of an immense advantage. If the error is on their side, no harm can result, as you yourself say, beyond the failure of a hope. The measure, excellent in their opinion, in yours is merely negative. Let it be tried, then, since the worst that can happen is not the realization of an evil, but the nonrealization of a benefit.

F. In the first place, the failure of a hope is a very great misfortune to any people. It is also very undesirable that the government should announce the abolition of several taxes on the faith of a resource that must infallibly fail. Nevertheless, your remark would deserve some consideration, if after the issue of paper money and its depreciation, the equilibrium of values should instantly and simultaneously take place in all things and in every part of the country. The measure would tend, as in my example of the players, to a universal mystification, in respect to which the best thing we could do would be to look at one another and laugh. But this is not in the course of events. The experiment has been made, and every time a government — be it king or congress — has altered the money —

B. Who says anything about altering the money?

F. Why, to force people to take in payment scraps of paper that have been officially baptized dollars, or to force them to receive, as weighing an ounce, a piece of silver that weighs only half an ounce but that has been officially named a dollar, is the same thing, if not worse; and all the reasoning that can be made in favor of paper money has been made in favor of legal false-coined money. Certainly, looking at it as you did just now, and as you appear to be doing still, if it is believed that to multiply the instruments of exchange is to multiply the exchanges themselves as well as the things exchanged, it might very reasonably be thought that the most simple means was to mechanically divide the coined dollar, and to cause the law to give to the half the name and value of the whole. Well, in both cases, depreciation is inevitable. I think I have told you the cause. I must also inform you that this depreciation which, with paper might go on till it came to nothing, is effected by continually making dupes; and of these, poor people, simple persons, workmen and farmers are the chief.

B. I see; but stop a little. This dose of political economy is rather too strong for once.

F. Be it so. We are agreed, then, upon this point — that wealth is the mass of useful things we produce by labor; or, still better, the result of all the efforts we make for the satisfaction of our wants and tastes. These useful things are exchanged for each other according to the convenience of those to whom they belong. There are two forms in these transactions; one is called barter: in this case a service is rendered for the sake of receiving an equivalent service immediately. In this form transactions would be exceedingly limited. In order that they may be multiplied, and accomplished independently of time and space amongst persons unknown to each other, and by infinite fractions, an intermediate agent has been necessary — this is money. It gives occasion for exchange, which is nothing else but a complicated bargain. This is what has to be noted and understood. Exchange decomposes itself into two bargains, into two departments, sale and purchase — the reunion of which is needed to complete it. You sell a service, and receive a dollar — then, with this dollar you buy a service. Then only is the bargain complete; it is not till then that your effort has been followed by a real satisfaction. Evidently you only work to satisfy the wants of others, that others may work to satisfy yours. So long as you have only the dollar that has been given you for your work, you are only entitled to claim the work of another person. When you have done so, the economical evolution will be accomplished as far as you are concerned, since you will only then have obtained, by a real satisfaction, the true reward for your trouble. The idea of a bargain implies a service rendered, and a service received. Why should it not be the same with exchange, which is merely a bargain in two parts? And here there are two observations to be made. First: It is a very unimportant circumstance whether there be much or little money in the world. If there is much, much is required; if there is little, little is wanted, for each transaction: that is all. The second observation is this: because it is seen that money always reappears in every exchange, it has come to be regarded as the sign and the measure of the things exchanged.

B. Will you still deny that money is the sign of the useful things of which you speak?

F. A gold eagle is no more the sign of a barrel of flour, than a barrel of flour is the sign of a gold eagle.

B. What harm is there in looking at money as the sign of wealth?

F. The inconvenience is this: it leads to the idea that we have only to increase the sign, in order to increase the things signified; and we are in danger of adopting all the false measures that you took when I made you an absolute king. We should go still further. Just as in money we see the sign of wealth, we see also in paper money the sign of money; and thence conclude that there is a very easy and simple method of procuring for everybody the pleasures of fortune.

B. But you will not go so far as to dispute that money is the measure of values?

F. Yes, certainly, I do go as far as that, for that is precisely where the illusion lies. It has become customary to refer the value of everything to that of money. It is said, this is worth 5, 10, or 20 dollars, as we say this weighs 5, 10, or 20 grains; this measures 5, 10, or 20 yards; this ground contains 5, 10, or 20 acres; and hence it has been concluded that money is the measure of values.

B. Well, it appears as if it was so.

F. Yes, it appears so, and it is this appearance I complain of, and not of the reality. A measure of length, size, surface, is a quantity agreed upon, and unchangeable. It is not so with the value of gold and silver. This varies as much as that of corn, wine, cloth, or labor, and from the same causes, for it has the same source and obeys the same laws. Gold is brought within our reach, just like iron, by the labor of miners, the investments of capitalists, and the combination of merchants and seamen. It costs more or less, according to the expense of its production, according to whether there is much or little in the market, and whether it is much or little in request; in a word, it undergoes the fluctuations of all other human productions. But one circumstance is singular, and gives rise to many mistakes. When the value of money varies, the variation is attributed by language to the other products for which it is exchanged. Thus, let us suppose that all the circumstances relative to gold remain the same, and that the wheat harvest has failed. The price of wheat will rise. It will be said, "The barrel of flour that was worth five dollars is now worth eight;" and this will be correct, for it is the value of the flour that has varied, and language agrees with the fact. But let us reverse the supposition: let us suppose that all the circumstances relative to flour remain the same, and that half of all the gold in existence is swallowed up; this time it is the price of gold that will rise. It would seem that we ought to say, "This gold eagle that was worth 10 dollars is now worth 20." Now, do you know how this is expressed? Just as if it was the other objects of comparison which had fallen in price, it is said: "Flour that was worth ten dollars is now only worth five."

B. It all comes to the same thing in the end.

F. No doubt; but only think what disturbances, what cheatings are produced in exchanges when the value of the medium varies without our becoming aware of it by a change in the name. Coins or notes are issued bearing the name of five dollars, and which will bear that name through every subsequent depreciation. The value will be reduced a quarter, a half, but they will still be called coins or notes of five dollars. Clever persons will take care not to part with their goods unless for a larger number of notes — in other words, they will ask ten dollars for what they would formerly have sold for five; but simple persons will be taken in. Many years must pass before all the values will find their proper level. Under the influence of ignorance and custom, the day's pay of a country laborer will remain for a long time at a dollar while the salable price of all the articles of consumption around him will be rising. He will sink into destitution without being able to discover the cause. In short, since you wish me to finish, I must beg you, before we separate, to fix your whole attention upon this essential point: Once false money (under whatever form it may take) is put into circulation, depreciation will ensue, and manifest itself by the universal rise of everything that is capable of being sold. But this rise in prices is not instantaneous and equal for all things. Sharp men, brokers, and men of business, will not suffer by it; for it is their trade to watch the fluctuations of prices, to observe the cause, and even to speculate upon it. But little tradesmen, farm workers, and workmen will bear the whole weight of it. The rich man is not any the richer for it, but the poor man becomes poorer by it. Therefore, expedients of this kind have the effect of increasing the distance that separates wealth from poverty, of paralyzing the social tendencies that are incessantly bringing men to the same level, and it will require centuries for the suffering classes to regain the ground they have lost in their advance toward equality of condition.

B. Well, I've got to go. I will meditate on the lecture you have been giving me.

F. Have you finished your own dissertation? As for me, I have scarcely begun mine. I have not yet spoken of the popular hatred of capital, of gratuitous credit (loans without interest) — a most unfortunate notion, a deplorable mistake, which takes its rise from the same source.

B. What! Does this frightful commotion of the populace against capitalists arise from money being confounded with wealth?

F. It is the result of different causes. Unfortunately, certain capitalists have arrogated to themselves monopolies and privileges that are quite sufficient to account for this feeling. But when the theorists of democracy have wished to justify it, to systematize it, to give it the appearance of a reasonable opinion, and to turn it against the very nature of capital, they have had recourse to that false political economy at whose root the same confusion is always to be found. They have said to the people: "Take a dollar; put it under a glass; forget it for a year; then go and look at it, and you will be convinced that it has not produced ten cents, nor five cents, nor any fraction of a cent. Therefore, money produces no interest." Then, substituting for the word money, its pretended sign, capital, they have made it by their logic undergo this modification: "Then capital produces no interest." Then follows this series of consequences: "Therefore he who lends capital ought to obtain nothing from it; therefore he who lends you capital, if he gains something by it, is robbing you; therefore all capitalists are robbers; therefore wealth, which ought to serve gratuitously those who borrow it, belongs in reality to those to whom it does not belong; therefore there is no such thing as property, therefore everything belongs to everybody; therefore … "

B. This is very serious; the more so from the syllogism being so admirably formed. I should very much like to be enlightened on the subject. But, alas! I can no longer command my attention. There is such a confusion in my head of the words coin, money, services, capital, interest, that really I hardly know where I am. We will, if you please, resume the conversation another day.

F. In the meantime here is a little work entitled Capital and Rent. It may perhaps remove some of your doubts. Just look at it when you are in want of a little amusement.

B. To amuse me?

F. Who knows? One nail drives in another; one wearisome thing drives away another.

B. I have not yet made up my mind that your views on money and political economy in general are correct. But, from your conversation, this is what I have gathered: That these questions are of the highest importance; for peace or war, order or anarchy, the union or the antagonism of citizens, are at the root of the answer to them. How is it that in France and most other countries that regard themselves as highly civilized, a science that concerns us all so nearly, and the diffusion of which would have so decisive an influence upon the fate of mankind, is so little known? Is it that the state does not teach it sufficiently?

F. Not exactly. For, without knowing it, the state applies itself to loading everybody's brain with prejudices, and everybody's heart with sentiments favorable to the spirit of disorder, war, and hatred; so that, when a doctrine of order, peace, and comity presents itself, it is in vain that it has clearness and truth on its side; it cannot gain admittance.

B. Decidedly you are a frightful grumbler. What interest can the state have in mystifying people's intellects in favor of revolutions, and civil and foreign wars? There must certainly be a great deal of exaggeration in what you say.

F. Consider. At the period when our intellectual faculties begin to develop themselves, at the age when impressions are liveliest, when habits of mind are formed with the greatest ease — when we might look at society and understand it — in a word, as soon as we are seven or eight years old, what does the state do? It puts a blindfold over our eyes, takes us gently from the midst of the social circle that surrounds us, to plunge us, with our susceptible faculties, our impressible hearts, into the midst of Roman society. It keeps us there for ten years at least, long enough to make an indelible impression on the brain. Now observe, that Roman society is directly opposed to what our society ought to be. There they lived upon war; here we ought to hate war; there they hated labor; here we ought to live upon labor. There the means of subsistence were founded upon slavery and plunder; here they should be drawn from free industry. Roman society was organized in consequence of its principle. It necessarily admired what made it prosper. There they considered as virtue what we look upon as vice. Its poets and historians had to exalt what we ought to despise. The very words liberty, order, justice, people, honor, influence, etc., could not have the same signification at Rome as they have, or ought to have, at Paris. How can you expect that all these youths who have been at university or conventual schools with Livy and Quintus Curtius for their catechism, will not understand liberty like the Gracchi, virtue like Cato, patriotism like Caesar? How can you expect them not to be factious and warlike? How can you expect them to take the slightest interest in the mechanism of our social order? Do you think that their minds have been prepared to understand it? Do you not see that in order to do so they must get rid of their present impressions, and receive others entirely opposed to them?

B. What do you conclude from that?

F. I will tell you. The most urgent necessity is not that the state should teach, but that it should allow education. All monopolies are detestable, but the worst of all is the monopoly of education.

First published in 1849, this essay is included in The Bastiat Collection (2011). An MP3 audio file of this article, narrated by Holly Hinton and Joel Sams, is available for download.

America's history and political ethos are all about liberty. The Declaration of Independence declares that life, liberty, and the pursuit of happiness are unalienable rights — but notice how both life and the pursuit of happiness also depend on liberty as a fundamental bedrock of our country. We use the word almost as a cliché. But do we know what it means? Can we recognize it when we see it? More importantly, can we recognize the opposite of liberty when it is sold to us as a form of freedom?

Liberty means to exercise human rights in any manner a person chooses so long as it does not interfere with the exercise of the rights of others. This means, above all else, keeping government out of our lives. Only this path leads to the unleashing of human energies that build civilization, provide security, generate wealth, and protect the people from systematic rights violations. In this sense, only liberty can truly ward off tyranny, the great and eternal foe of mankind.

The definition of liberty I use is the same one that was accepted by Thomas Jefferson and his generation. It is the understanding derived from the great freedom tradition, for Jefferson himself took his understanding from John Locke (1632–1704). I use the term "liberal" without irony or contempt, for the liberal tradition in the true sense, dating from the late Middle Ages until the early part of the 20th century, liberty was devoted to freeing society from the shackles of the state. This is an agenda I embrace — and one that I believe all Americans should embrace.

To believe in liberty is not to believe in any particular social and economic outcome. It is to trust in the spontaneous order that emerges when the state does not intervene in human volition and human cooperation. It permits people to work out their problems for themselves, build lives for themselves, take risks and accept responsibility for the results, and make their own decisions.

Do our leaders in Washington believe in liberty? They sometimes say they do. I don't think they are telling the truth. The existence of the wealth-extracting leviathan state in Washington, DC, a cartoonishly massive machinery that no one can control and yet few ever seriously challenge, a monster that is a constant presence in every aspect of our lives, is proof enough that our leaders do not believe. Neither party is truly dedicated to the classical, fundamental ideals that gave rise to the American Revolution.

Of course, the costs of this leviathan are incalculably large. The 20th century endured two world wars, a worldwide depression, and a 45-year "Cold War" with two superpowers facing off with tens of thousands of intercontinental missiles armed with nuclear warheads. And yet the threat of government today, all over the world, may well present a greater danger than anything that occurred in the 20th century. We are policed everywhere we go: work, shopping, home, and church. Nothing is private anymore: not property, not family, not even our houses of worship.

We are encouraged to spy on each other and to stand passively as government agents scan us, harass us, and put us in our place day after day. If you object, you are put on a hit list. If you fight to reveal the truth, as WikiLeaks or other websites have done, you are targeted and can be crushed. Sometimes it seems like we are living in a dystopian novel like Nineteen Eighty-Four or Brave New World, complete with ever-less economic freedom. Some will say that this is hyperbole; others will understand exactly what I'm talking about.

What is at stake is the American dream itself, which in turn is wrapped up with our standard of living. Too often, we underestimate what the phrase "standard of living" really means. In my mind, it deals directly with all issues that affect our material well-being, and therefore affects our outlook on life itself: whether we are hopeful or despairing, whether we expect progression or regression, whether we think our children will be better off or worse off than we are. All of these considerations go to the heart of the idea of happiness. The phrase "standard of living" comprises nearly all we expect out of life on this earth. It is, simply, how we are able to define our lives.

Our standards of living are made possible by the blessed institution of liberty. When liberty is under attack, everything we hold dear is under attack. Governments, by their very nature, notoriously compete with liberty — even when the stated purpose for establishing a particular government is to protect liberty.

Take the United States, for example. Our country was established with the greatest ideals and respect for individual freedom ever known. Yet look at where we are today: runaway spending and uncontrollable debt; a monstrous bureaucracy regulating our every move; total disregard for private property, free markets, sound money, and personal privacy; and a foreign policy of military expansionism. The restraints placed on our government in the Constitution by the Founders did not work.

Powerful special interests rule, and there seems to be no way to fight against them. While the middle class is being destroyed, the poor suffer, the justly rich are being looted, and the unjustly rich are getting richer. The wealth of the country has fallen into the hands of a few at the expense of the many. Some say this is because of a lack of regulations on Wall Street, but that is not right. The root of this issue reaches far deeper than that.

The threat to liberty is not limited to the United States. Dollar hegemony has globalized the crisis. Nothing like this has ever happened before. All economies are interrelated and dependent on the dollar's maintaining its value, while at the same time the endless expansion of the dollar money supply is expected to bail out everyone.

This dollar globalization is made more dangerous by nearly all governments acting irresponsibly by expanding their powers and living beyond their means. Worldwide debt is a problem that will continue to grow if we continue on this path. Yet all governments, and especially ours, do not hesitate to further expand their powers at the expense of liberty in a futile effort to force an outcome of their design on us. They simply expand and plummet further into debt.

Understanding how governments always compete with liberty and destroy progress, creativity, and prosperity is crucial to our effort to reverse the course on which we find ourselves. The contest between abusive government power and individual freedom is an age-old problem. The concept of liberty, recognized as a natural right, has required thousands of years to be understood by the masses in reaction to the tyranny imposed by those whose only desire is to rule over others and live off their enslavement.

This conflict was understood by the defenders of the Roman Republic, the Israelites of the Old Testament, the rebellious barons of 1215 who demanded the right of habeas corpus, and certainly by the Founders of this country, who imagined the possibility of a society without kings and despots and thereby established a framework that has inspired liberation movements ever since. It is understood by growing numbers of Americans who are crying out for answers and demanding an end to Washington's hegemony over the country and the world.

And yet even among the friends of liberty, many people are deceived into believing that government can make them safe from all harm, provide fairly distributed economic security, and improve individual moral behavior. If the government is granted a monopoly on the use of force to achieve these goals, history shows that that power is always abused. Every single time.

Over the centuries, progress has been made in understanding the concept of individual liberty and the need to constantly remain vigilant in order to limit government's abuse of its powers. Though steady progress has been made, periodic setbacks and stagnations have occurred. For the past one hundred years, the United States and most of the world have witnessed a setback for the cause of liberty. Despite all the advances in technology, despite a more refined understanding of the rights of minorities, despite all the economic advances, the individual has far less protection against the state than a century ago.

Since the beginning of the last century, many seeds of destruction have been planted that are now maturing into a systematic assault on our freedoms. With a horrendous financial and currency crisis both upon us and looming into the future as far as the eye can see, it has become quite apparent that the national debt is unsustainable, liberty is threatened, and the people's anger and fears are growing. Most importantly, it is now clear that government promises and panaceas are worthless. Government has once again failed, and the demand for change is growing louder by the day. Just witness the dramatic back-and-forth swings of the parties in power.

The only thing that the promises of government did was to delude the people into a false sense of security. Complacency and mistrust generated a tremendous moral hazard, causing dangerous behavior by a large number of people. Self-reliance and individual responsibility were replaced by organized thugs who weaseled their way into achieving control over the process whereby the looted wealth of the country was distributed.

The choice we now face: further steps toward authoritarianism, or a renewed effort in promoting the cause of liberty. There is no third option. This course must incorporate a modern and more sophisticated understanding of the magnificence of the market economy, especially the moral and practical urgency of monetary reform. The abysmal shortcomings of a government power that undermines the creative genius of free minds and private property must be fully understood.

This conflict between government and liberty, brought to a boiling point by the world's biggest bankruptcy in history, has generated the angry protests that have spontaneously broken out around the country — and the world. The producers are rebelling and the recipients of largess are angry and restless.

The crisis demands an intellectual revolution. Fortunately, this revolution is under way, and if one earnestly looks for it, it can be found. Participation in it is open to everyone. Not only have our ideas of liberty developed over centuries, they are currently being eagerly debated; and a modern, advanced understanding of the concept is on the horizon. The Revolution is alive and well.

The idea of this book is not to provide a blueprint for the future or an all-encompassing defense of a libertarian program. What I offer here are thoughts on a series of controversial topics that tend to confuse people, and these are interpreted in light of my own experience and my thinking. I present, not final answers, but rather guideposts for thinking seriously about these topics. I certainly do not expect every reader to agree with my beliefs, but I do hope that I can inspire serious, fundamental, and independent-minded thinking and debate on them.

Above all, the theme is liberty. The goal is liberty. The results of liberty are all the things we love, none of which can be finally provided by government. We must have the opportunity to provide them for ourselves, as individuals, as families, as a society, and as a country. Off we go: A to Z.

This article is the introduction to Liberty Defined: 50 Essential Issues That Affect Our Freedom (New York: Grand Central Publishing, 2011).

The Utah law, in a particular way, protects the holders of coins issued by the US Mint. But the problem is general. Why should the state of Utah favor the holders of certain coins over holders of any other form of property? Indeed, of the many different forms of property to be protected from inflation, why should the state of Utah favor coins issued by an agency of the federal government, which is the very perpetrator of that inflation?

Perhaps the reason is because the US Constitution — which is kept in the National Archives in case anybody is curious as to what it says — gives Congress the power to coin money and regulate the value thereof. Therefore, it might be said, the US Congress, in authorizing the minting of coins made out of gold and inscribed with the value "$20," has regulated the value of these coins, regardless of their real market value.

But were we, for entertainment purposes only, to consider at length what the Constitution says, it says that states are prohibited from making anything other than gold or silver into legal tender. I may be a little naïve about this, but it seems to me that this kind of implies that states can make gold and silver legal tender. The scheme, then, is one involving Congress in coining money and in regulating the value of coins (whether of its mint, a foreign government's mint, or potentially a private mint); and this scheme has the states enforcing debts recognizing only gold and silver as legal tender.

The Supreme Court has furthermore decided that the Congress has the power to regulate or outright prohibit any other form of money. In other words, the power to coin money is interpreted to be an exclusive grant of power, removing it from the states and the people thereof. Thus, during the 1930s, the Congress prohibited us from denominating debts in gold or in a foreign currency and prohibited us from using any form of indexation.

Indeed, during the 1930s, Congress made gold into a controlled substance and prohibited us from owning it except under certain conditions. It then started making other things into controlled substances, such as marijuana in 1937. Prior to the 1930s, the only substance that Congress tried to prohibit us from owning was alcohol — and that required a Constitutional amendment.

Fast-forward to the 1970s, when a now-departed US senator from North Carolina named Jesse Helms and an upstart young Congressman from Texas named Ron Paul persuaded Congress to lift the bans on indexation and on the ownership of gold and, furthermore, to authorize the US Mint to emit legal-tender gold coins, albeit at a nominal value. Thus, the coins that the state of Utah is recognizing as money are the true Ron Paul Dollars.

Speaking of the Ron Paul Dollar, I should perhaps comment on the recently concluded trial concerning the self-described "architect" of the privately issued silver Ron Paul Dollar (along with other token coins and warehouse certificates for the same).

The person was found guilty of fraud and of issuing counterfeits of US coinage. While some facts — such as the shape of the Ron Paul Dollar being generally the same as the shape of US coins (which is to say round) — point in the direction of counterfeit, one basic fact seems to have been very badly decided by the jury: there can be no criminal intent in issuing precious-metal coins as imitations of the trash that constitutes US coinage.

Look at the little pieces of junk that constitute the US Coinage. Aside from the penny, they're mostly pieces of zinc polished to look like silver (with the penny being a piece of zinc electro-coated in copper). There can be no criminal intent to pass off real silver coins as zinc coins polished to look like silver.

With regard to the fraud conviction, if the man had been acquitted (and the legality of issuing privately minted coins confirmed) then new companies would enter the business. Then, if the Ron Paul Dollar was being sold at an exorbitant markup, the new companies would drive the price down to a competitive level. But, because the risk of entering this business is that you will go to jail, competition cannot be counted upon to do its job in regulating markups.

But what if this law in the state of Utah catches on? What if people started regularly to price goods and services on the basis that $20 equals an ounce of gold (just as embodied in the original Ron Paul Dollar) and, in so doing, free themselves from the usually unseen tax called inflation? How long would it be before Congress acted to prevent the fact from being admitted that the emperor has no clothes?

Since the expansive Federal Reserve program of quantitative easing began in late 2008, oil prices have almost tripled; gasoline prices have almost doubled. Basic world food prices such as sugar, corn, soybean, and wheat have almost doubled.

Commodity and equity inflation, financed in part by the Fed's flood of excess dollars going abroad, has profound effects on the emerging markets. In many emerging countries, food and fuel make up 25–50 percent of disposable income. Families in these countries can go from subsistence to starvation during such a Fed-fueled commodity boom.

The Fed credit expansion, from late 2008 through March 2011 — creating almost 2 trillion new dollars on the Fed balance sheet — triggered the commodity and stock boom, because the new credit could not at first be fully absorbed by the US economy in recession. Indeed, Chairman Bernanke recently wrote that "quantitative easing" aimed to inflate US equities and bonds directly, thus commodities indirectly. But some of the excess dollars sought foreign markets, causing a fall in the dollar on foreign exchanges.

With quantitative easing the Fed seems to aim at depreciating the dollar. In foreign countries, such as China, financial authorities frantically purchase the depreciating dollars, adding to their official reserves, issuing in exchange their undervalued currencies. The new money is promptly put to work creating speculative bull markets and booming economies.

The emerging market equity and economic boom of 2009 and 2010 was the counterpart of sluggish growth in the US economy during the same period. But the years 2011 and 2012 will witness a Fed-fueled economic expansion in the United States. Growth for 2011, in the United States, will, I believe, be above the new consensus of 3.5 percent — unless there is an oil spike combined with even greater catastrophe in Japan. The Consumer Price Index (CPI) will be suppressed because unemployment keeps wage rates from rising rapidly; the underutilization of industrial capacity keeps finished prices from rising rapidly. Inflation has shown up first in commodity and stock rises.

For Congress the irony could be that euphoria — always caused by renewed, gradual inflation — may set in once again, disarming potential budget and monetary reforms.

But commodity and stock inflation inevitably engenders social effects, not only financial effects. Inflationary monetary and fiscal policies have been a primary cause of the increasing inequality of wealth in American society. Bankers and speculators have been, and still are, the first in line, along with the Treasury, to get the zero-interest credit of the Fed. They were also the first to get bailed out.

Then, with new money, the banks financed stocks, bonds, and commodities, anticipating, as in the past, a Fed-created boom. The near-zero interest rates of the Fed continue to subsidize the large banks and their speculator clients. A nimble financial class in possession of cheap credit is able at the same time to enrich themselves and to protect their wealth against inflation.

But middle-income professionals and workers, on salaries and wages, and those on fixed income and pensions, are impoverished by the very same inflation that subsidizes speculators and bankers. Those on fixed incomes earn little, or negative returns, on their savings. Thus, they save less. New investment then depends increasingly on bank debt, leverage, and speculation.

Inequality of wealth and privilege in American society is intensified by the Fed-induced inflationary process. The subsidized banking and financial community, combined with an overvalued dollar — underwritten by China — have also submerged the manufacturing sector, dependent as it is on goods traded in a competitive world market. In a word, the government deficit and the Federal Reserve work hand in hand, perhaps unintentionally, to undermine the essential equity and comity necessary in a constitutional republic. Equal opportunity and the harmony of the American community cannot survive perennial inflation.

If the defect is inflation and an unstable dollar, what is the remedy?

A dollar convertible to gold would provide the necessary Federal Reserve discipline to secure the long-term value of middle income savings and to backstop the drive for a balanced budget. The gold standard would terminate the world dollar standard by prohibiting official dollar reserves and the special access of the government and the financial class to limitless cheap Fed and foreign credit.

The world trading community would benefit from such a common currency — a nonnational, neutral, monetary standard — that cannot be manipulated and created at will by the government of any one country. Thus, dollar convertibility to gold must be restored. But dollar convertibility to gold must also become a cooperative project of the major powers.

Gold, the historic common currency of civilization, was during the Industrial Revolution and until recent times the indispensable guarantor of stable purchasing power, necessary for both long-term savings and long-term investment, not to mention its utility for preserving the long-term purchasing power of working people and pensioners. The gold standard puts control of the supply of money into the hands of the American people, as it should in a constitutional republic.

Because excess creation of credit and paper money can be redeemed by the people for gold at the fixed statutory price, the monetary authorities are thus required to limit the creation of new credit in order to preserve the legally guaranteed value of the currency. As President Reagan said, "Trust the people."

To accomplish this monetary reform, the United States can lead, first, by announcing future convertibility, on a certain date, of the US dollar, the dollar itself to be defined in statute as a weight unit of gold, as the Constitution suggests; second, by convening a new Bretton Woods conference to establish mutual gold convertibility of the currencies of the major powers — at a level that would not pressure nominal wages; third, to prohibit by treaty the use of any currency but gold as official reserves.

A dollar as good as gold is the way out. It is the way to restore American savings and competitiveness. It is the way to restore economic growth and full employment without inflation. Gold convertibility is the way to restore America's financial self-respect, and to regain its needful role as the equitable leader of the world.

As a soldier of France, no one knew better than Professor Jacques Rueff, the famous French central banker and economist, that World War I had brought to an end the preeminence of the classical European states system; that it had decimated the flower of European youth; that it had destroyed the European continent's industrial primacy. No less ominously, on the eve of the Great War, the gold standard — the gyroscope of the Industrial Revolution, the proven guarantor of 100 years of price stability, the common currency of the world trading system, the monetary standard of commercial civilization — was suspended by the belligerents.

The overthrow of the historic gold standard led, during the next decade, to the great inflations in France, Germany, and Russia. The ensuing inflationary convulsions of the social order, the rise of the speculator class, and the obliteration of the savings of the laboring and middle classes led directly to the rise of Bolshevism, Fascism, and Nazism — linked, as they were, to floating European currencies, perennial budgetary and balance-of-payments deficits, central-bank money printing, and currency wars and the neomercantilism they engendered.

Today, one observes — at home and abroad — the fluctuations of the floating dollar, the unpredictable effects of its variations, the new mercantilism it has engendered, and the abject failure to rehabilitate the dollar's declining reputation. Strange it is that an unhinged token, the paper dollar, is now the monetary standard of the most scientifically advanced global economy the world has ever known.

The insidious destruction of the historic gold dollar — born with the American republic — got underway gradually, in the 1920s, during the interwar experiment with the gold-exchange standard and the dollar's new official reserve-currency role. It must be remembered that World War I had caused the price level almost to double. But after the war, Britain and America tried to maintain the prewar dollar–gold and sterling–gold parities. Designed at the Genoa Convention of 1922, the official reserve-currency roles of the convertible pound and dollar collapsed after 1929 in the Great Depression — a collapse that helped to cause and to intensify the worldwide deflation and depression. Then, Franklin Roosevelt in 1934 reduced the value of the dollar by raising the price of gold from $20 to $35 per ounce.

But it must be emphasized that it was in 1922, at the little-known but pivotal monetary Conference of Genoa, that the unstable gold-exchange standard had been officially embraced by the academic and political elites of Europe. It was here that the dollar and the pound were confirmed as official reserve currencies to supplement what was said to be a scarcity of gold. But there was no true scarcity, only overvalued currencies after World War I.

Professor Rueff warned in the 1920s of the dangers of this flawed gold-exchange system designed "to economize gold." He predicted again in 1960–1961 that the Bretton Woods system, a post–World War II gold-exchange standard, flawed as it was by the same official-reserve-currency contagion of the 1920s, would soon groan under the flood weight of excess American dollars going abroad. Rueff in the 1950s and 1960s forecast permanent US balance-of-payments deficits and the tendency to constant budget deficits — and ultimately the suspension of dollar convertibility to gold. His predictions were borne out by the facts.

After World War II, Professor Rueff saw that, because the United States was the undisputed hegemonic military and economic power of the free world, foreign governments and central banks, in exchange for these military services and other subsidies rendered, would for a while continue to purchase (sometimes to protect their export industries) excess dollars on the foreign exchanges against the creation of their own monies. But these foreign official dollars, originating in the US balance-of-payments and budget deficits, were then redeposited by foreign governments in the New York dollar market, which led to inflation and excess consumption in the United States. This same process engendered inflation in its European and Asian protectorates that purchased excess dollars against the issuance of their own currencies.

In a word, official reserve currencies jam the indispensable international settlements-and-adjustment mechanism. Moreover, these purchases of dollars by foreign central banks have the simultaneous effect of creating inflation in these foreign countries and undervaluing their currencies relative to the dollar. Incipient mercantilism was only one pernicious result of the dollar's overvalued, official reserve-currency status. The decline of the great US manufacturing center was another.

Incredibly, during this same period of the 1960s, the International Monetary Fund authorities had the audacity to advocate the creation of Special Drawing Rights (SDRs), so-called paper gold, invented, as International Monetary Fund officials said, to avoid a "potential liquidity shortage." At that very moment, the world was awash in dollars, in the midst of perennial dollar and exchange-rate crises. Professor Rueff remarked that the fabrication of these SDRs by the International Monetary Fund would be "irrigation plans implemented during the flood."

The post–World War II gold-exchange standard (Bretton Woods) came to an end on the ides of March, in 1968, when President Johnson suspended the London Gold Pool. After a few more crippled years, Bretton Woods expired on August 15, 1971. The truth is that monetarists and Keynesians sought not to reform Bretton Woods, as the true gold-standard reform of Jacques Rueff intended, but rather to demolish it. The true gold standard had become passé among the intellectual, economic, and political elites because of their confusion over the difference between the gold standard and the gold-exchange standard — the collapse of the latter, not the former having intensified the depression.

I shall give you just one example of the obtuseness of the political class of the 1960s and 1970s, which happened at the height of one major dollar crisis. A friend of Professor Rueff, the American banker and policy intellectual, Henry Reuss, chairman of the Banking and Currency Committee of the United States House of Representatives, went so far as to predict, with great confidence and even greater fanfare, that when gold was demonetized, it would fall from $35 to $6 per ounce. (I am not sure whether Congressman Reuss ever covered his short at $800 per ounce in 1980.)

Thus, it was no accident that the exchange-rate crises continued, because the underlying cause, inflation, continued. On August 15, 1971, after one more violent dollar crisis, Nixon defaulted at the gold window of the Western world, declaring that "we are all Keynesians now." In 1972, Nixon, a Republican, a so-called free-market president, imposed the first peacetime wage and price controls in American history — encouraged by some of the famous "conservative" advisers of the era.

In President Nixon's decision of August 1971, the last vestige of dollar convertibility to gold, the final trace of an international common currency, binding together the civilized trading nations of the West, had been unilaterally abrogated by the military leader of the free world.

Ten years later, at the peak of a double-digit inflation crisis, the gold price touched $850. At the time, Paul Volcker, chairman of the Federal Reserve, declared that the gold market was going its own way and had little to do with the Fed's monetary policies. Volcker then engineered a draconian credit contraction leading to nearly 11 percent unemployment and a decline in inflation. At that time, Professor Wallich declared that the gold market is but "a sideshow." Secretary of the Treasury William Miller, a short-lived Fed chairman, who had been selling US gold at about $200 in 1978, announced solemnly that the Treasury would now no longer sell American gold. Presumably Secretary Miller, an aerospace executive, meant that whereas more than one-half the vast American gold stock had been a clever sale, liquidated at prices ranging between $35 and $250 per ounce — now, in the manner of the trend follower, Secretary of the Treasury Miller earnestly suggested that gold was a "strong hold" at $800 per ounce.

On January 18, 1980, Fed Governor Henry Wallich, a former Yale economics professor, explained Federal Reserve Monetarist policies in an article appearing in the Journal of Commerce: "The core of Federal Reserve … measures," basing "control upon the supply of bank reserves," he said, "gives the Federal Reserve a firmer grip on the growth of monetary aggregates."

As subsequent events showed, the Federal Reserve promptly lost control of the monetary aggregates. The bank prime rate rose to 21 percent, inflation to double digits.

Professor Rueff's experience as a central banker had taught him from hard experience what his five volumes of monetary theory and econometrics demonstrated. That is, no central bank, not even the mighty Federal Reserve, can determine the quantity of bank reserves or the quantity of money in circulation — all conceits to the contrary notwithstanding.

During the past 40 years, the important links between central-bank policies, the rate of inflation, and the variations in the money stock have caused much debate among the experts. It is still generally thought by neo-Keynesian — and some monetarist — economists and central bankers, that the quantity of money in circulation, economic growth, and the rate of inflation can be directly coordinated by central-bank credit policy. May I now firmly say that, to the best of my knowledge, no one who believes this hypothesis, and, as an investor, has systemically acted on it in the market, is any longer solvent.

But I do confess that the neo-Keynesian and monetarist quantity theories of money still hang on — even if their practitioners in the market cannot. In the end, neo-Keynesian and monetarist economists at the Federal Reserve were ultimately required to accommodate to a reality in which, for example during 1978, the quantity of money in Switzerland grew approximately 30 percent while the price level rose only 1 percent. The quantity of money, M1, grew in 1979 about 5 percent in the United States while the inflation rate rose 13 percent. The Fed learned that the CPI inflation rate cannot be precisely associated with the quantity of money in circulation.

If, then, a central bank cannot determine the quantity of money in circulation, what, in Rueffian monetary policy, can a central bank realistically do? To conduct operations of the central bank, there must be a target. If the target is both price stability and the quantity of money in circulation, one must know, among other things, not only the magnitude of the desired supply of money, but also the precise volume of the future demand for money in the market — such that the twain shall meet.

It is true that commercial banks supply cash balances, but individuals and businesses — the users of money — generate the decisions to hold and spend these cash balances. Thus, the Federal Reserve must have providential omniscience to calculate correctly, on a daily or weekly basis, the total demand for money — assuming the Fed can gather totally reliable statistical information, which it cannot, and that the Fed's definitions of the monetary aggregates are constant, which they are not.

But if the true goal of the central bank were long-run stability of the general price level, the operating target of monetary policy at the central bank must be simply to influence the supply of cash balances in the market, such that they tend to equal the level of desired cash balances in the market. To attain this goal, the central bank must abandon open-market operations and simply hold the discount rate, or the rediscount rate, above the market rate — when, for example, the price level is rising — providing money and credit only at an interest rate which is not an incentive to create new credit and money.

Indeed, if the target of monetary policy is long-run price stability, the central bank must supply bank reserves and currency only in the amount that is approximately equal to the desire to hold them in the market. For if the supply of cash balances is approximately equal to the desire to hold them, the price level must tend toward stability. If there are no excess cash balances, there can be no excess demand, and thus there can be no sustained inflation. There also can be no sustained deflation, caused by scarcity of cash balances, because the target of monetary policy is a stable price level and, in these circumstances, the central bank supplies the desired cash balances.

An effective central-bank policy, therefore, must reject open-market operations. Professor Rueff shows further that, in order to rule out inflation and unlimited government spending, the government treasury must be required by law to finance its cash needs in the market for savings, away from the banks. That is, a government treasury, in deficit, must be denied the privilege of access to new money and credit at the central bank and commercial banks, in order also to deny the government the pernicious privilege of making a demand in the market without making a supply — the ultimate cause of inflation.

Because the Federal Reserve creates new money and credit to finance the Treasury deficit, but the Treasury creates no new goods and services, total money demand will exceed supply at prevailing prices. Prices must rise. At first, commodity and equity prices advance. Then the general price level rises gradually. This exorbitant US government financing privilege, a function of total Fed discretion and of the dollar's reserve-currency status, is a necessary cause of the balance-of-payments deficit and persistent inflation. It is also a fundamental cause of unlimited budget deficits and bloated big government. So long as new bank credit is available to the government, so long will the budget deficit persist and grow.

One can see that the monetary theory and policy of Jacques Rueff finally does come to grips with, indeed it modifies, the famous law of markets of Jean Baptiste Say, building of course on Say's insights but perfecting the flawed quantity theory of money. Jacques Rueff reformulated the quantity theory of money, definitively, in the following proposition: aggregate demand is equal to the value of aggregate supply, augmented (+/−) by the difference between the variations, during the same market period, in the quantity of money in circulation and the aggregate cash balances desired. This is a central theorem of Rueffian monetary economics.

Rueff demonstrated that Say's law does work, namely, that supply tends to equal demand, provided, however, that the market for cash balances must tend toward equilibrium. Any monetary system, any central bank, that does not reinforce this tendency toward equilibrium in the market for cash balances destroys the first law of stable markets, namely, overall balance between supply and demand — a necessary condition for limiting inflation and deflation.

It is conventional wisdom that Milton Friedman and the monetarists try to regulate the growth of the total quantity of money and inflation through a so-called money-stock rule designed to constrain the central-bank monopoly over the currency issue. In practice, the Federal Reserve has failed, and will fail, to succeed with such a flawed, academic, and impractical rule. Professor Friedman himself humbly admitted failure in a remarkable 2003 interview.

The much simpler, more reliable, market-based technique — proven in the laboratory of history — as Professor Rueff demonstrated, would be to make the value of a unit of money equal to a weight unit of gold, in order to regulate, according to market rules, the same central-bank monopoly. But academics have argued for a century that a monetary "regulator," such as gold money, absorbs too much real resources — by virtue of the process of gold production — and is therefore, in economic terms, too costly.

Whatever the minor incremental mining cost of a gold-convertible currency, it is a superior currency stabilizer, as history shows. The empirical data also show that it is a more efficient regulator of price stability in the long run. The gold standard was no mere symbol. It was an elegantly designed monetary mechanism, carefully orchestrated over centuries by wise men of great purpose, who developed convertibility into a supple and subtle set of integrated financial and credit institutions organized to facilitate rapid growth, quality job creation, a stable price level, above all, social stability amidst free economic institutions.

Thus did the free price mechanism and the international gold standard become the balance wheel of rapid economic growth during the long-lasting Industrial Revolution. Who can deny that two generations of floating exchange rates, pegged and undervalued currencies like the Chinese yuan, and discretionary central banking have burdened the world with booms, panics, and busts, producing immense inflation and uncertainty costs much greater than the comparatively modest cost of mining gold?

At the end of the first decade of the new millennium, the world requires a real monetary standard, a common, nonnational monetary standard, to deal with the monetary disorder of undervalued, pegged currencies and manipulated, floating exchange rates — the diabolical agents of an invisible, predatory mercantilism. Despite all denials, the currency depreciations of today are, without a doubt, designed to transfer unemployment to one's neighbor and, by means of an undervalued currency, to gain share of market in manufactured, labor-intensive, value-added, world-traded goods. If these depreciations and undervaluations are sustained, floating exchange rates combined with the twin budget and trade deficits will, at regular intervals, blow up the world trading system. Great booms and busts, inflation and deflation, and social instability must ensue.

To head off the mercantilism of present floating exchange rates, and the consequences of exchange-rate disorders caused by official dollar reserves, an international monetary conference is indispensable. The present high rates of unemployment and perverse trade effects, associated with floating exchange rates, require an efficient and stable international monetary reform — not least because floating exchange rates reprice entire national production systems at unpredictable intervals. Such monetary perversity cannot be sustained. A European monetary union may be necessary; but it is not sufficient.

Now we see clearly what before we saw in a glass darkly — the dollar's official reserve-currency status still gives an exorbitant credit privilege to the United States. Professor Rueff spoke of American "deficits without tears," because the American budget deficit and balance-of-payments deficits were — they still are — almost automatically financed by the Federal Reserve and the world dollar-reserve-currency system, through the voluntary (or coerced) buildup of dollar balances in the official reserves of foreign governments.

These official dollar reserves were, and still are, immediately invested by foreign authorities, directly or indirectly, in the dollar market for US securities, thus giving back to the United States, at subsidized rates, the dollars previously sent abroad as a result of the persistent US balance-of-payments deficit and budget deficits. This is the subtle mechanism by which excess American domestic consumption and budget deficits are financed. To describe this awesome absurdity, Professor Rueff invoked the metaphor of the king's overworked tailor, yoked permanently to fictitious credit payments by His Majesty's unrequited promissory notes. Despite his purchases, His Majesty's cash balances and euphoria kept rising, blinded as he was to his ultimate, debt-induced insolvency.

There is not sufficient time to dwell on all the intricacies of the superior efficacy of the balance-of-payments adjustment mechanism grounded in domestic and international convertibility to gold. But it can, I think, be shown that, in all cases, currency convertibility to gold, without official reserve currencies, is the least imperfect monetary mechanism, both in theory and in practice, by which to rule out currency wars, to maintain global trade and financial balance, a reasonably stable price level, and economic growth — while ensuring budgetary equilibrium. This proposition has been proven in the only laboratory by which to test monetary theory — namely, the general history of monetary policy under paper and metallic regimes, and, in particular, the history of the international gold standard. (See chart in appendix.)

Between March 10, 2010 and March 9, 2011, foreign governments monetized $415 billion dollars in the form of US securities held in custody at the Fed. This is only a fraction of the $3.5 trillion of official dollar reserves, held in custody at the Fed, accumulated by March 2011, over two generations. This accumulation of foreign dollar reserves is a gigantic mortgage on America. It is the infernal mechanism by which the government-budget deficit and balance-of-payments deficits are financed. Along with the Fed, foreign dollar reserves are sufficient today to finance domestic overconsumption in the United States at below-market interest rates.

It is essential to understand the nature of this ongoing process of currency degradation — because the dollar's reserve-currency role in financing the US budget and balance-of-payments deficits certainly did not end with the breakdown of Bretton Woods in 1971. The perennial and extraordinary US budget and balance-of-payments deficits still persist because there is, today, no efficient international monetary mechanism to forestall the American deficits. Indeed, Professor Rueff argued that if the official reserve role of the dollar (i.e., the world dollar standard) were abolished, and convertibility restored, the immense US budget and current account deficits must end — a blessing not only for the United States, but for the whole world. This is so because the Fed and the Treasury would be bound by statute and treaty to maintain the gold convertibility of the dollar. It is true that both law and international treaty may be violated, but they do create the only barriers to the license of rogues.

The reality behind the "twin deficits" is simply this: the greater and more permanent the Federal Reserve and foreign-reserve facilities for financing the United States budget and trade deficits are, the greater will be the twin deficits and the growth of the US federal government. All congressional, administrative, and statutory attempts to end US deficits have proved futile, and will prove futile, until the crucial underlying flaw — namely, the absence of an efficient international settlements-and-adjustment mechanism — is remedied by international monetary reform inaugurating a new international gold standard and the prohibition of official reserve currencies.

Broadly speaking, at least three essential steps toward convertibility could be taken by America and other great powers:

The US president should request the Federal Reserve System to cooperate with, say, a Group of Ten to stabilize the value of key currencies at levels consistent with balanced international trade among national currency areas. That is to say, exchange rates should be stabilized at approximately their purchasing-power parities, based largely upon comparative unit labor costs of standardized world-traded goods. To do this, indexes of purchasing power can be agreed upon within the Group of Ten and, thus, an optimum and fair value determined for mutual convertibility of national currencies.

But how should the value of the gold monetary standard be determined? The optimum value of the gold parity should reflect a gold price correctly positioned within the hierarchy of all prices; that is, a price proportional to its underlying cost of production. This dollar price of gold, or, more properly, the defined gold weight of the monetary standard, must be set above the average of the marginal costs of production of gold mines operating throughout the world.

This price would provide for steady output of the gold monetary base (about an average of 1.5 percent to 2 percent increase per year over a long run, as centuries of available monetary statistics show). Such a gold price would also prevent any decline in the average level of nominal wages — avoiding, for example, the British problem of underemployment in the 1920s caused by an overvalued pound. Under existing conditions, during the present market period, I have estimated, based on empirical data, that the optimum convertibility price of gold is not less than $2,000 per ounce (as of March 2011).

The president should recommend to the Group of Ten that convertibility regimes take effect at a fixed date in the future, subsequent to the international monetary conferences and agreements made there, perhaps an interval of three to four years. Gold-convertible currencies should become the monetary standards of Europe, of the United States, of the world, just as the gold standard should become the common money of world trade and finance in Asia and elsewhere.

In a constitutional republic such as the United States, the sovereign people should control the supply of money through the limiting mechanism of gold convertibility of the dollar.

As President Reagan said, "Trust the people." Moreover, domestic monetary reform in the United States, and elsewhere, would also mean that only gold and domestic, nongovernment, secured, self-liquidating securities, convertible at maturity to gold, could serve as collateral or backing for new currency issues such as, for example, Federal Reserve notes. Standard gold coins, minted according to the statutory standard, should be generally circulated in the market to be held by all working people, so as to guarantee that neither the monetary standard nor the wages and savings of working people will be arbitrarily abridged by inflationary governments. Such a regime, among other purposes, eliminates the advantage of nimble speculators over middle-income people and those on fixed incomes.

The new international monetary system would rule out, by enforceable treaty obligations, the official reserve currencies that so plagued the entire financial history of the 20th century and the first decade of the 21st. Existing official dollar reserves could be consolidated, refunded, and then gradually amortized over the long term (even to a certain extent refunded through the rise of the official value of gold above the last official revaluation, $42.22 per ounce). This is not unlike the consolidation plan deployed by the first United States secretary of the treasury, Alexander Hamilton, to refund the national and state debts after the Revolutionary War.

This was and is the Rueff plan, brought up to date to deal with the exigencies of the present facts and circumstances. May I say it is an intellectual scandal that such a solution is today regarded as impractical. For if we and our former adversary, Russia, can share capsules in space, why can the United States and its trading partners not agree to restore monetary convertibility, the indispensable condition for stable currencies, world economic growth, and free trade?

By pinning down the future price level by gold convertibility, the immediate effect of international monetary reform will be to end currency speculation in floating currencies, and to terminate the immense costs of inflation hedging. Gold convertibility eliminates the very costly exchange of currencies at the profit-seeking banks. Thus, new savings will be channeled out of financial arbitrage and speculation into long-term financial markets.

Naturally, the investment capital available at long term will mushroom, inspired by restored confidence in convertibility, because the long-run stability of the price level will be pinned down by gold convertibility — as history shows to be the case in previous, well-executed monetary reforms of the past 200 years. Along with increased capital investment will come sustained demand for unemployed labor, at quality wages, to work the new plants and equipment.

The world now awaits a far-seeing leader to carry out the international monetary reform proposed by the great monetary statesman of the 20th century, Professor Jacques Rueff.

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This article is Lewis Lehrman's statement and testimony before the Subcommittee on Domestic Monetary Policy and Technology on March 17, 2011.

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A price steadily holding over $1,400 per ounce (until the Japanese quake) has put gold on the cover of a few magazines, along with constant hawking of the yellow metal on daytime Fox News.

But there seems to be more talk about owning gold than the actual owning of it. Chris Blasi's work indicates that precious metals only made up 2 percent of investment assets at the end of last year after a decade-long bull market. At the same time, investment in real estate has remained constant despite the huge downdraft in property prices, meaning that investors continue to pile into this overbuilt sector.

In its "Wealth Adviser" section, The Wall Street Journal recently featured a striking above-the-fold, half-page image of gold bars stacked in a pyramid, with short gold facts etched on the ends of the bars — tidbits like "Site of world's largest accumulation of gold: New York Fed," and "Value of 2010 world gold sales: $150 billion."

Being editor of the "Wealth Adviser" section, Lawrence Rout enlisted the services of a couple financial experts to debate "The Case For and Against Gold." This is the sort of splashy attention that normally gives gold bulls pause. Editor Rout explains that the combatants were to defend every argument and that "they offer a deep dive for any investors thinking about taking the plunge themselves."

However, the debate was anything but a backyard brawl. Certified financial planner Janet Briaud carried the baton for the buy-side argument, making the usual tired points about crisis investing, uncertain times, and "black-swan" events.

Her insight that "we could very well see deliberate weakening of currencies in many developed countries" is not exactly a news flash. And then she goes on to contemplate gold as a reserve currency with central banks buying the metal, which is already happening. Ms. Briaud does make the point that gold has been recognized to have value for thousands of years by various cultures and that while investment in GLD (the gold exchange traded fund) has gown mightily, it makes up a infinitesimal percentage of financial assets held by households and nonfinancial businesses.

So, how much gold as a percentage of one's portfolio does CFP Briaud think the responsible investor should have? Five to 10 percent.

Five percent is the same allocation that Lew Altfest recommends for investors to hold provided "they promise to hold it rain or shine" (Altfest's emphasis). Mr. Altfest, enlisted to argue against owning the yellow metal, has his own wealth management firm and is a finance professor at Pace University.

Gold has no use other than being pretty, the Pace professor says. It's not a real investment like stocks, bonds, real estate, or private businesses. If the world were falling apart, maybe it would make sense to own some gold he says, but, writes the money maven,

Economies are generally improving world-wide, and inflation, while of some difficulty in a few countries, is not currently a problem in the biggest one, the U.S., nor should it become a really serious problem in the future. No need to call in the gold troops here.

Later on in his gold attack, the professor throws out this laugher: "I don't believe any major nations will seriously pursue a consistent decline of their currencies over an extended period of time." What does he suppose these nations have been doing already? Remember, Mr. Altfest manages money for a living in one of the world's financial capitals and teaches students about finance.

He then questions the ethics of gold mining (at the WSJ's suggestion, I assume, since Ms. Briaud also mentioned ethics). The benefits are few, he writes and, "Very little of the production takes place in the U.S. or is owned by U.S. companies, and this doesn't help our unemployment problem." Since when is the question of whether an investment helps or hurts US employment a valid consideration in portfolio management?

Mr. Altfest must exclude any foreign companies from investment consideration. And, while there is no mining going on in Manhattan (other than money from investors' pockets), plenty of people in Nevada and Alaska make a good living working in the gold-mining industry.

The yellow metal is often mentioned as the commodity to trade with for one's freedom. When asked what he thought about gold as an investment, financial talking head Ron Insana snidely told talk-show host Laura Ingraham, "Sure, everybody should keep some gold on hand to bribe border guards." Insana wasn't intentionally making the best case to own gold. But what's more valuable than something that is, and has been for centuries, universally recognized for its value? When your life depends on making a trade, gold is what you trade with. "It is the last refuge of the desperate," writes value investor Jeremy Grantham, who says he hates gold.

Mr. Altfest doesn't get it, and neither does Ms. Briaud for that matter. Whether you're negotiating with an uneducated thug guarding a border that must be crossed in the middle of nowhere, or sitting across the table from the most sophisticated investor in the world, gold is the universal language and has been for eons. Sure, gold does nothing but sit pretty, failing to generate earnings or pay dividends. But it's portable, durable, and divisible, with a highly recognizable value; it's highly marketable and homogeneous, and its supply is stable: the perfect money.

The WSJ feature provides a wonderful timeline. In 4600 BC, civilizations began using gold as jewelry. Squares of gold were used as money in China in 1091 BC. The first gold coins were minted in what is now Turkey in 560 BC. And so on. That's a track record.

Concluding his case against gold, Altfest writes that if he "were a border guard today who received a 'gift' of gold, I would cash it in and buy stocks." There may be a day when the professor/money manager needs to buy his way out of New York. I hope he seriously doesn't think he can get the job done by slipping a stock certificate to the border guard.

Who knew that the Bible had so much to say about the issues of money and banking? The issue is a serious one because of the important history here and also because the Bible is such a foundational part of public understanding of every issue of public life and morality.

You can search the libraries for weeks and not find a guide as good as Gary North's detailed account of every mention of money and banking in both the Hebrew and Christian Scriptures.

What he finds underscores what the hard-money tradition has long said. Governments engage in evil when they change the definition of money. Inflation is a danger to the individual and society. Governments that monopolize the monetary system are abusing their power. Governments cannot be trusted with money. That's the lesson.

The first example comes from Genesis:

North explains what the passage means by "the money has failed." It had become worthless due to government inflation. The social effects were profound. North marches through the history of Egypt to fill in the gaps.

As part of the exposition, North provides a tutorial on the Austrian theory of money's origins, functions, and workings in society.

He explains this well-known passage: "Your silver has become dross, your wine mixed with water. (Isaiah 1:22)"

And also this one: "Diverse weights are an abomination to the Lord, and a false balance is not good. (Proverbs 20:23)"

He offers an entire chapter that carefully refutes the canard that the Bible forbids the charging of interest, and further explains what is meant by the condemnation of "usury."

It is all written in very clear language that is designed for teaching. There are also study questions at the end of each chapter. In this way, this book would make an excellent money and banking text for a private religious school - or for anyone who is concerned about what the Bible says about this critical subject.

Joking aside, this is one of the most important questions one can ask when dealing with many economic problems.

In recent times, with gold reaching all-time highs, we have seen people question the valuation of assets in dollars. Basically, the yardstick used to measure your assets — your house, car, or stock portfolio — is a steadily shrinking one. This makes you wonder whether your savings are really growing in value. In other words, if the value of your savings has doubled, but the price of milk and everything else has roughly doubled, you are not getting ahead. If anything, you will likely have to pay taxes on your supposed "gain," which is no gain at all.

The way the dollar yardstick is being shrunk is by increasing the stock of money, which means that there are more dollars in circulation. Governments do this.

Why would governments want to decrease the value of our money? Well, there are many reasons why this is very advantageous to our masters.

First, creating more dollars is an easy way to pay for government expenditures. If the government wants to pay for wars, bailouts, or their own cushy salaries and perks, they can print the money instead of taking it away from us by force through taxation.

Second, we all know that scarce, desirable goods are more expensive than abundant ones. On the other hand, some goods are so abundant that they are free in spite of their desirability, such as the air we breathe. So by increasing the number of dollars — by inflating the stock of money — the state reduces its exchange value. This is very bad if you are saving money, but it's great for governments because they are usually big debtors.

Unfortunately for us, this process of devaluation can be done until money is completely worthless. It happens easier than you might think, and not only to banana republics but also to mighty countries.

Usually, cheap goods are a good thing. If you increase the amount of wheat available, we will have cheaper bread. The progress of humanity is based on making economic goods more abundant and affordable. The difference with money is that you cannot consume it in the same way you eat bread. Money is there for the sole purpose of exchange, especially when talking about our modern paper currencies. Given this fact, the cheapening of money does not bring about any well-being.

But wouldn't more money make us richer? Not really.

You see, if you were thrown in the middle of the desert, a pile of money wouldn't do you any good. Money only facilitates the exchange of goods and services, but underneath it all, it is the goods and services themselves that are being exchanged. Think of it as a highly efficient and improved barter. If you are a plumber, you don't really need money to live (you can't eat money); money just makes it possible for you to indirectly exchange your plumbing services for groceries. If money weren't there, each time you needed food you would have to find a grocer that was in need of plumbing services so that you could barter your services for food.

So if the amount of money does not determine how rich a society is — if that's determined instead by the actual goods it produces and possesses — why should we object to the government's creation of money? What does it matter to me if milk is $1 per gallon and I make $10 per hour, or if milk is $10 and I make $100 per hour?

The answer to that question is that the creation of money does not affect all prices and wages simultaneously. Analogies are never perfect, but imagine that you have a pool of water (representing the money already in circulation), and that you add additional water to it (representing new money), but to keep track of the new money you add red dye to it. Obviously the red dye will not affect the pool all at once. At first you will have a very visible spot of concentrated red color in the area where the water was added, and it will take awhile for the entire pool to have a uniform color. If the amount of red dye is not huge and the pool is big enough, the final color of the water may not even be very red.

This is basically how new money makes its way into the economy. The initial recipients of the new money — the government and its friends — get to spend it first with the old, more concentrated purchasing power, and as the money makes its way into the economy it gradually dilutes the purchasing power of the entire pool of money. So, in effect, because of this uneven readjustment of prices, in some segments of the population the price of goods will go up before wages do, making these people much poorer.

This creates a shift of capital from some segments of the population to others, while not increasing the total amount of capital.

But, don't we need to make our exports cheaper? No, we don't.

By making exports cheaper through a weakened currency we subsidize our exports. The buyer of our goods in the importing country gets a good deal, the producer of exports sells more products, but this is all paid for by the population at large. Once again, the policy itself produces no increase in capital but only a transfer of it.

But if it creates export-based jobs, it must be good, right?

The problem is that you are subsidizing those jobs, not creating real productive jobs. To pay for those jobs you had to take resources from someone else. That other person was going to consume, save, or invest that money anyway. Shifting resources does not lead to increased capital, which is what ultimately leads to higher real wages.

Until the population realizes what is really taking place, politicians and the mainstream media will get away with rejoicing every time real-estate prices rise, or when the Dow Jones Industrial Average reaches a new milestone. Now, this graph shows the Dow priced in US dollars, our shrinking yardstick. It sure looks good.

How about changing the yardstick for a more stable one? You could use milk, paper clips, or anything you like. Let's use ounces of gold.

The picture is very different indeed. For one thing it shows that the rise in stock prices or any other good denominated in paper currency may not say much about the real value of your investments. You may have invested your money — in any venture — and be thinking that you are making a nice profit when in fact you might be suffering huge losses. This is one of the dangerous consequences of inflation: by distorting prices it increases the amount of entrepreneurial mistakes. Inflation can mask huge losses.

The other important thing that can be learned from this graph is that gold itself varied in its purchasing power. These variations are greatly amplified by the government-created boom-and-bust cycle.

Let's look at gold priced in ounces of silver; this is a historical chart. Look at how erratic the price of gold becomes in the 20th century with the appearance of central banking.

It is commonly said that gold is a stable yardstick, that its purchasing power has not changed since Roman times. It is said that back then an ounce of gold bought you a full outfit with sandals, and that today an ounce of gold will buy you a full suit, shirt, and shoes. It is claimed by many that gold's purchasing power does not change at all, that paper currencies depreciate against it.

While I agree that gold is much more stable than any modern paper currency, I cannot agree that it has stable exchange value. It is true that paper currencies depreciate against gold, but so does any other good whose supply increases.

At times in history, gold itself has seen its supply increase dramatically, as during the Spanish conquest of the Americas. And silver has at times been more valuable than gold, as in ancient Egypt.

The other claim regarding the value of gold is that it has what is called "intrinsic value," which basically means that the essence of gold itself, its nature, gives it value. It is also claimed that because it is hard and costly to mine, this makes it expensive and gives it a "price floor."

Nothing could be further from the truth. All prices are a product of subjective valuations. If nobody wants it, regardless of how much work it takes to produce, or how amazing its properties are, the good will have no value. It is actually the other way around. Because people are willing to pay a high price for gold, it is economically viable to embark in costly mining and production schemes.

The opposite is also true: regardless of how useless a good is, if people want it, its price will be high. Take jewelry-grade diamonds as an example.

The point that is being missed is that gold is a commodity as well as a monetary metal. There is a market for gold outside the monetary realm, and this is an additional component to its value that modern paper currencies do not have. In that sense one could say that gold's value as a commodity gives it that "price floor," or downside protection.

But above all, gold has value because people want it and because it is scarce. It is that simple.

The generic gold standard may be briefly defined as a monetary system where the unit of value — in terms of which prices, wages, and debts are customarily expressed and paid — consists of the value of a fixed quantity of gold in a large international market that is substantially free.[1]

This definition calls for some explanation. It contains no mention of gold coin or of free coinage of gold. Both of these may be of great convenience and may facilitate the efficient operation of a gold standard, but neither is necessary to the existence of a gold standard. The gold-bullion standard, and the gold-exchange standard, does not ordinarily make any provision for the minting and circulation of gold coins, but both of these standards are clearly forms of the gold standard.

The definition makes no mention of legal tender, a useful quality for standard money to possess but not a necessary one. Legal tender is a purely legal concept of late historical development, usually relating only to debt-paying rights, and a gold standard can exist and perform all of its necessary functions without any legal-tender laws whatsoever. On the other hand, full legal-tender money has at times been driven out of circulation through the force of Gresham's law[2] or of custom by non-legal-tender money.

There is no mention in the definition of redeemability in gold (or its equivalent) of paper money and of fiduciary coins, which is a privilege in most successful gold-standard systems. This privilege is highly desirable, but it is not necessary, provided that sufficient other effective means are used for maintaining the parity of the different kinds of money with the gold unit, such as limiting their supply and receiving them without limit in payment of taxes and other public dues.

All the above-mentioned qualities are useful devices for maintaining the gold standard, but not one of them is absolutely necessary. Furthermore, a currency system might conceivably have any or even all of them and still not be a true gold standard.

A good illustration of the principle here discussed is found in the experience of the Union of South Africa in 1919 and 1920.[3] At that time gold sovereigns, which were unlimited legal tender in the Union, and which enjoyed the free-coinage privilege in England — there was no mint in the Union of South Africa — circulated freely in the Union, and the bank notes there were redeemable at their respective banks of issue in gold sovereigns on demand at parity. However, the exportation of gold bullion from the Union was rigidly controlled by the government. South African gold coins could not be legally exported to what would otherwise have been their best market, but were extensively smuggled out of the country and sold for more than the foreign-currency equivalent of a South African pound.

A sovereign in South Africa, and likewise the gold-bullion content of a sovereign, were worth there less than in the outside free-gold markets of the world. In order to get the sovereigns with which to redeem their notes on demand, as required by law, the South African banks of issue were compelled to buy raw gold in London at a premium, to get it coined in London in the usual way at the British mint, and then to bring it to South Africa. At times they had to pay as much as 26 or 28 shillings of South African bank notes to obtain a sovereign in England. The sovereign was then paid out in South Africa by the bank of issue in redemption at par of a 10-shilling bank note.

Monetary history offers many instances of gold coins dammed up in a country and circulating there at a discount from their bullion value in outside free markets.[4]

On the other hand, a governmental prohibition on the importation of gold in a supposedly gold-standard country, by restricting the supply within the country, might force up the value of gold bullion and gold coin within the country above their values in the free international markets and thereby give them an artificial scarcity or monopoly value.

Whenever the gold value of the monetary unit of a country is divorced from the market value of gold in the free markets of the world, the country cannot be said to be on a true gold standard.

Regardless, therefore, of which of the many common means may be adopted by a nation to maintain the value of its money — such as convertibility, legal tender, and free coinage — the supreme test of the existence of the gold standard is the answer to the question whether or not the money of the country is actually kept at a parity with the value of the gold monetary unit comprising it, in the outside free international gold market, assuming, of course, that such a market of reasonable size actually exists. It is not a question of the means adopted to obtain a particular result, but rather, one of the results itself. The gold standard exists then in any country whenever the value of a fixed quantity of gold in a large and substantially free international market is actually maintained as the standard unit of value.

Under a gold standard (as well as under any other metallic-money standard), it is the weight of the metallic content of the monetary unit that is fixed and not the value, which is an expression of purchasing power. In this respect the unit of value differs from all other units of measurement. For example, the pound as a unit of weight is a fixed weight, the yard as a unit of length is a fixed length, and the gallon as a unit of volume is a fixed volume.[5]

The gold dollar, however, which is our American unit of value, is whatever value is attached at a particular moment to a fixed weight of pure gold, now, one thirty-fifth of an ounce Troy. This value, like the value of anything else, is a continually changing thing — a fact that gives rise to our most difficult monetary problems.

From the monetary standpoint, gold possesses certain well-known physical qualities, which have never been better described than by W. Stanley Jevons in his classic little book, Money and the Mechanism of Exchange, from which much of the material in this section is taken. Largely by reason of its beauty and its scarcity, gold has been a commodity of universal demand for countless generations, being prized highly by the most primitive peoples as well as by the most advanced.

Possessing a large value in a small bulk, it is easily transported. Pure gold is homogeneous, i.e., uniform throughout the mass, so that equal weights will always have exactly the same value. Like other metals, but unlike skins, precious stones, and most other commodities, gold has the quality of divisibility without loss. A nugget of gold can be cut into pieces without loss and the pieces in turn may be readily restored to the original form, likewise without loss. Gold is very durable, being

remarkable for its freedom from corrosion or solution [and] being quite unaffected and untarnished after· exposure of any length of time to dry, or moist, or impure air, and being also insoluble in all the simple acids. … In almost all respects gold is perfectly suited for coining. When quite pure, indeed, it is almost as soft as tin, but when alloyed with one tenth or one twelfth part of copper, becomes sufficiently hard to resist wear and tear, and to give a good metallic ring; yet it remains perfectly malleable and takes a fine impression.[6]

Because of its high value it is carefully guarded by its owners. This fact and the great durability of gold largely explain its high degree of stability in value. There is gold in the world today that men extracted from nature thousands of years before Christ. Our present supply is the "accumulation of the ages," and most of it can readily be made marketable, since it is largely in relatively unspecialized forms, such as coins and bars. The world's annual production of gold, which, for a number of years prior to the Second World War, was approximately equivalent to only about 4 percent of the world's known stock of monetary gold, acts very slowly in affecting the value of such a large marketable supply.

Gold is a commodity of highly elastic demand; in fact, it probably has the most elastic demand of all commodities on the market in a gold-standard country. All three of the principal kinds of demand for gold are highly elastic; they are (1) the monetary demand; (2) the demand for the purpose of ornamentation, including jewelry and utensils; and (3) the hoarding demand.

The demand for gold for monetary uses is obviously highly elastic when the principal countries of the world are on a gold standard and when these countries are offering to buy at fixed prices in unlimited amounts all the gold offered to them for monetary purposes.

The demand for gold to use in ornamentation is likewise highly elastic. Primitive man's first form of clothing was probably some form of paint or mud on his skin — in other words, ornament. Clothing for protection came later. The desire for ornamentation from that day to this has been universal and practically unlimited. Gold is the most widely treasured material for articles of beauty. Most people in the world would like to have more gold ornaments than they do possess and would buy more if such articles were to become cheaper. Reductions in the value of gold ornaments and utensils as compared with other goods, therefore, stimulate an increased demand, and this demand acts as a buffer to gold depreciation.

The demand for gold for the purpose of hoarding is, again, highly elastic. The practice of hoarding gold, common to all countries of the world, is resorted to increasingly in times of unsettlement and fear. It is especially prevalent in India and China. Gold, to the Oriental peoples who hoard it, is a symbol of wealth in general. A given quantity of gold jewelry is not only a commodity that gives direct enjoyment to the Hindu farmer, but it is also a blank check, which he can fill out at any time with the name of any commodity he may want at its market price, a check that can be cashed on demand. His gold trinkets and jewelry serve as his savings-bank deposit and his insurance policy against famine and other misfortune.

The capacity of India and China to absorb gold and silver in hoards is well known. For many generations India was known as the "sink" of the precious metals. From 1931, however, when India went off the gold standard and the price of gold in terms of Indian rupees, instead of continuing stable, advanced greatly through 1940, India's hoarded gold was poured onto the world's markets at rates even greater than those at which it was previously accumulated.[7]

This high degree of elasticity of demand is an important factor in maintaining the high stability of value that gold possesses.

Gold in its relation to the gold standard has three important characteristics.[8] Although they are not entirely distinct, they are best considered separately. These characteristics are (1) a fixed price, (2) an unlimited market, and (3) the fact that normally the production of gold from year to year is controlled chiefly by changing costs in its production and not by changing prices of the product itself.

When a government adopts a gold standard, it fixes the gold content of the monetary unit. Prior to 1933, for example, the unit of value in the United States was defined as the dollar consisting of 25.8 grains of gold 0.900 fine,[9] which means 90 percent was pure gold and 10 percent was copper alloy, making the fine-gold content of the dollar 23.22 grains. Since there are 480 grains in a troy ounce, an ounce of gold was equivalent to as many dollars as 480/23.22 or $20.67, and could always be coined into that amount of gold coin. To say that the dollar was 23.22 grains of pure gold and to say that the mint price of gold was $20.67 were identical propositions. It was like saying that a foot is 12 inches and that an inch is one-twelfth of a foot.[10] Gold coin, on the other hand, at any time could be melted down and reconverted into gold bars. Except for a brief period at the time of the First World War, there were from 1879 to 1933 no restrictions or tariff charges on the importation and exportation of gold.

Not only was the price of gold always the same at the mint and assay offices, but these concerns were under obligation to buy all gold presented to them in proper form, no matter whether it was produced within the United States or abroad or whether it was new gold or gold obtained from the melting down of foreign coins or from jewelry, ornaments, or other sources.[11]

The third characteristic of gold in its relation to the gold standard is the peculiar relationship of its market price to the volume of its current production.

In the case of other commodities, production normally increases as their market prices advance and production decreases as their market prices fall. This, however, is not true for gold in a gold-standard country. Here, as has been previously pointed out, the price of gold does not change.

For example, between 1879 and 1916, inclusive, in the United States, no matter how much gold was being produced in the world's markets or how little, the price of pure gold at the mint was always $20.67 an ounce; and, although during these 38 years the world's annual production of gold increased fourfold and the value or purchasing power of an ounce of gold varied continually and at some times substantially, the price of gold never changed. The reason was that our gold-standard system itself fixed the price of gold, while it did not and could not fix the value of gold.

Although gold producers always received the same price for their gold at the mint and assay offices, the costs of producing this gold were continually changing, as the value of the purchasing power of the gold changed. An increase in the production of gold relative to the demand tends to increase the supply of monetary gold and of the other money and deposit-currency circulation that is based upon it, and thereby, through increasing commodity prices, tends to make gold less valuable.

The commodities whose prices are thus increased include, among others, all those that are elements in the cost of mining gold itself, such as explosives and other chemicals, mining machinery, and labor; also, taxes. It is these rising costs pressing against a fixed gold price that tend to reduce gold production by cutting into the mine owners' profits when the value of gold is declining.

On the other hand, when the value of gold is increasing, i.e., when commodity prices are falling, the prices of the things that comprise mining costs tend to fall with the prices of other commodities. This reduces the cost of mining and, since the mine owner continues to sell all of his gold at the same mint price as before, his profits are increased and gold production is stimulated. Therefore, the production of gold tends to increase when the value of gold rises and to decrease when that value falls.

It should be noted, parenthetically, that gold is produced under widely varying conditions in different parts of the world, that considerable gold is produced as a byproduct of other metals, and that much is still obtained in backward places by primitive methods of panning; while large amounts of labor are continually being spent in more or less futile efforts to find pay dirt. All this means that at any one time it is difficult to ascertain just what is the cost of producing gold. The significant cost, the economist would say, is the marginal cost in the gold mines of substantial gold-producing areas like those of the Transvaal and Russia. This marginal cost, however, is not easily located.

When the value of gold falls and the commodity price level rises, the price of the gold used in manufacturing jewelry, utensils, etc., does not rise, although the costs of other materials and of labor involved in their manufacture and marketing will advance. This means that the prices of articles made largely of gold do not advance in times of rising price levels as much as do wages and the prices of most other commodities.

Gold jewelry and other gold articles, therefore, at such times appear cheap as compared with most other goods, and this situation stimulates demand for them, thereby increasing the flow of newly mined gold into the arts and diverting old gold into the arts from monetary uses.

The hoarding of gold, ornaments, trinkets, and bullion is also stimulated, particularly in countries like India and China, where there is usually an enormous demand for such commodities. All this tends to hold back the upward movement of general prices and the reduction in gold-mining profits that results from them.

When, on the other hand, commodity prices are falling and the value of gold is rising, we have the opposite situation. Then the prices of jewelry, ornaments, and other gold manufactures do not fall as much as the prices of most other things and as wages, because the price of gold itself does not fall. This makes gold products appear dear to the consumer and, therefore, lessens the demand for them.

It drives into the money uses gold that would otherwise have gone into the arts, and causes the melting down of gold jewelry and ornaments in India and China, and the flow of the gold bullion obtained therefrom into the money uses. Gold in the money uses is thereby made more plentiful, and this fact tends to check the declining commodity prices and the rising gold-mining profits.

This article is excerpted from chapter 5 of Gold and the Gold Standard, published in 1944

[1] Obviously, for the gold standard to function, the international market must be more than a very narrow one, and obviously, also, it is unrealistic to expect a market that is 100-percent free.

[2] The monetary principle known as Gresham's law, although Sir Thomas Gresham had little to do with its discovery, is merely an application to money of the economic law of demand and supply. This is the law that says an economic good tends to go to the best market. The law superficially appears to operate somewhat differently for money than for other economic goods, because money is unique in the fact that one of its principal functions is that of passing from hand to hand as a commonly accepted medium of exchange. A precise formulation of Gresham's law within a few words is impossible. With minor qualifications, however, the law may be briefly stated as follows: when two or more kinds of money are in circulation in the same market, all enjoying essentially the same privileges under the law, custom, and public opinion, the poorest money will drive the better money or moneys out of circulation; provided that the total supply of all kinds of money in circulation is sufficiently large to make money so cheap that the better money is worth more outside of active circulation for hoards, merchandise, or export than in such circulation; and provided further, that a dual or other multiple currency system does not develop, under which there are different commodity prices for payments made in the different currencies.

[3] C.S. Richards, Currency in South Africa before Union, reprinted in E.W. Kemmerer and G. Vissering, Report on the Resumption of Gold Payments by the Union of South Africa (1925), p. 537.

[4] See Edwin Walter Kemmerer, "Mexico's Monetary Experience in 1917," American Economic Review (March 1918), pp. 261–62; also, the experiences of the Scandinavian countries and of Spain, 1916–1919, in the Federal Reserve Bulletin (1919), pp. 1039–42 and (1920), pp. 35–46.

[5] These units of measurement in advanced countries are determined meticulously by law. For example, the British Imperial standard yard is defined by law as the distance at 62°F. between two fine lines engraved on gold studs, sunk in a bronze bar, which is in the possession of the government.

[6] W. Stanley Jevons, Money and the Mechanism of Exchange, pp. 46–47.

[7] See Federal Reserve Bulletin (1935), p. 822 and (1943), p. 1201.

[8] These three characteristics would apply also to silver, under a silver standard and to both gold and silver under a system of successful bimetallism.

[9] Act of March 14, 1900, section 1.

[10] Our mint and assay offices (after January 14, 1873) made no charges to anyone for the process of coining gold brought to them, but did charge depositors of gold bullion small fees to cover such costs as those for melting, refining, and alloy.

[11] A like free-coinage privilege would apply to silver in a silver-standard country and to both gold and silver in a. bimetallic country.

Among a number of mainstream-economics arguments leveled against the desirability and feasibility of the gold standard, Mr. Wolf puts forth a line of reasoning that can serve particularly well as a starting point for debating his position. Mr. Wolf writes,

Economists of the Austrian school wish to abolish fractional reserve banking. But we know that this is a natural consequence of market forces. It is wasteful to hold a 100 per cent reserve in a bank, if depositors do not need their money almost all of the time. Banks have a strong incentive to lend some of the money deposited with them, so expanding the aggregate supply of money and credit.

To get the ball rolling, Austrian economists (in particular those in the Misesian-Rothbardian tradition) uncompromisingly call for replacing fiat money with free-market money — money that is produced by the free interplay of the supply of and demand for money.

Such a recommendation has a firm economical-ethical footing: free-market money is the only monetary order that is compatible with private-property rights, the governing principle of the free-market society.

The focus on private-property rights does not only follow from natural-rights theory (in the Lockean tradition), but it can be ultimately justified on the basis of the self-evident, irrefutable axiom of human action, as Hans-Hermann Hoppe has shown.Hans-Hermann Hoppe, "On the Ultimate Justification of the Ethics of Private Property," in The Economics and Ethics of Private Property: Studies in Political Economy and Philosophy, 2nd ed. (Auburn, Alabama: Ludwig von Mises Institute, 2006), pp. 339–45.

Austrians therefore argue for privatizing money production, shutting down central banks, and letting the market decide what kind of money people want to use. Government wouldn't have to play any active role in the workings of a free-market monetary system.

One may hold the view that precious metals — in particular gold and silver, and to some extent copper — would be the freely chosen, universally accepted means of exchange. In other words, they could become money once people have a free choice in monetary matters.

However, Austrian economists wouldn't call for establishing a gold standard, let alone a gold standard with (government-sponsored) central banking: they would argue for free-market money, under which, presumably, gold would become the freely chosen money.Murray N. Rothbard called for a return to a 100% gold dollar. However, this doesn't contradict the statement given above, as Rothbard's recommendation rests on the precondition that "if people love and will cling to their dollars or francs, then there is only one way to separate money from the state, to truly denationalize a nation's money. And that is to denationalize the dollar (or the mark or franc) itself. Only privatization of the dollar can end the government's inflationary dominance of the nation's money supply." See Murray N. Rothbard, "The Case for a Genuine Gold Dollar," in The Gold Standard: Perspectives in the Austrian School, Llewellyn H. Rockwell, Jr., ed. (Auburn, Alabama: Ludwig von Mises Institute, 1992), p. 5. Rothbard's recommendation for defining the dollar once again as a weight of a market commodity, namely gold, rests (i) on the suitability of using precious metals, especially gold, as money and, even more important, (ii) the fact that the US government confiscated gold in 1933 — so that a re-defining of the dollar in gold would be the natural choice.

Now let us turn to fractional-reserve banking. It means that a bank lends out money that clients have deposited with it. Fractional-reserve banking thus leads to a situation in which two individuals are made owners of the same thing.For a thorough discussion see Jesús Huerta de Soto, Money, Bank Credit, and Economic Cycles (Auburn, Alabama: Ludwig von Mises Institute, 2006), esp. chapter 3, "Attempts to Legally Justify Fractional-Reserve Banking," pp. 115–65.

Fractional-reserve banking thus creates a legal impossibility: through bank lending, the borrower and the depositor become owners of the same money. Fractional-reserve banking leads to contractual obligations that cannot be fulfilled from the outset.

As Hoppe, Block, and Hülsmann note, "any contractual agreement that involves presenting two different individuals as simultaneous owners of the same thing (or alternatively, the same thing as simultaneously owned by more than one person) is objectively false and thus fraudulent."Hans-Hermann Hoppe, with Jörg Guido Hülsmann and Walter Block, "Against Fiduciary Media," in the Quarterly Journal of Austrian Economics, vol. 1, no. 1, pp. 21–22. A "fractional reserve banking agreement implies no lesser an impossibility and fraud than that involved in the trade of flying elephants or squared circles."Ibid, p. 26.

The truth is that fractional-reserve banking amounts to violating the nature of the law of property rights. And so the argument that fractional-reserve banking represents sensible money economizing — an argument that Mr. Wolf brings up against a gold standard — doesn't hold water.

Arguing in favor of fractional-reserve banking would in fact be tantamount to saying that it is legal (or rightful or even lawful) that Mr. A does whatever he wishes with Mr. B's property — without requiring Mr. B's consent.

What, however, if the bank and the depositor both agree voluntarily that money deposits should be used for credit transactions via the issuance of fiduciary media? Even such a voluntary agreement would be in violation of the law of property rights.

While bank and depositor benefit from such a trade (or expect to), what about those who receive fiduciary media? They would be falsely lured into exchanging goods and service against an item (fiduciary media) that is already claimed as property by others — something the seller presumably wouldn't agree to if he had only known the very nature of the trade.

What if all market agents voluntarily agreed to engage in fractional-reserve banking? The conclusion above wouldn't change: voluntarily accepted fractional-reserve banking would represent a monetary system that is, by its very nature, in violation of the nature of the law of private-property rights. It would produce economic chaos on the grandest scale.

To be sure, fractional-reserve banking is not, as Mr. Wolf notes, "a natural consequence of market forces." It is a result of, and has been upheld by, government law.

In a free-market system, the practice of fractional-reserve banking would be illegal by its very nature. And so fractional-reserve banking would be ended (sooner rather than later) under the auspices of a functioning law of private-property rights.

The reason that fractional-reserve banking has been around for quite some time is due to government law — which, of course, must be distinguished from the natural law of property rights. Of course, government can make fractional-reserve banking legal in a formal sense. However, even government law does not change the nature of things. As Murray N. Rothbard puts it succinctly,

fractional reserve banks … create money out of thin air. Essentially they do it in the same way as counterfeiters. Counterfeiters, too, create money out of thin air by printing something masquerading as money or as a warehouse receipt for money. In this way, they fraudulently extract resources from the public, from the people who have genuinely earned their money. In the same way, fractional reserve banks counterfeit warehouse receipts for money, which then circulate as equivalent to money among the public. There is one exception to the equivalence: The law fails to treat the receipts as counterfeit.Murray N. Rothbard, The Mystery of Banking, 2nd ed. (Auburn, Alabama: Ludwig von Mises Institute, 2008), p. 98.

In a commodity-money regime — such as the gold standard — fractional-reserve banking is, as Austrian economists show, in effect a form of counterfeiting. However, what about fractional-reserve banking under a system of fiat money?

Under fiat money, banks' liabilities vis-à-vis clients (as far as demand deposits are concerned) are payable in the form of base money, or central-bank money — a type of money that can only be produced by (government-sponsored) central banks.

Central banks hold the monopoly over the production of base money. They can increase the base-money supply at any one time at any amount deemed politically desirable. It is the central bank that eventually determines whether or not banks can meet their payment obligations.

It may well be that the central bank decides, once a bank is called upon by its clients to pay out demand deposits in cash, to provide sufficient amounts of notes — by loaning them to the bank and/or by purchasing part of the bank's assets.

The essential point is, however, that banks that engage in fractional-reserve banking in a fiat-money regime create contractual obligations they cannot fulfill from the outset. Rothbard notes that

it doesn't make any difference what is considered money or cash in the society, whether it be gold, tobacco, or even government fiat paper money. The technique of pyramiding by the banks remains the same.Ibid, p. 100.

Austrian economists, and Ludwig von Mises in particular, have shown that fractional-reserve banking under commodity money necessarily causes economic problems on a grand scale. This is because banks then engage in circulation-credit expansion — that is, they issue money through lending that is not backed by real savings.Circulation credit (or Zirkulationskredit) means that banks, when extending a loan to a consumer or firm, increase the money stock. In contrast, commodity credit (or Sachkredit) means that a bank extends a loan to a consumer or firm by merely transferring already existing money from the saver to the investor. For a more detailed explanation, see Ludwig von Mises, The Theory of Money and Credit (Indianapolis: Liberty Fund, 1981), pp. 296–310.

Circulation bank credit is inflationary, and it causes economic disequilibria and overindebtedness of the private sector — in particular on the part of governments. It is also the very cause of the "boom-and-bust" cycle.

The latter, in turn, opens the door for ever-greater doses of government interventionism — regulations, nationalizations, price controls, etc. — that, over time, erodes and even destroys the very principles on which the free-market society rests.

This conclusion doesn't change when there is fractional-reserve banking under fiat money. Fiat money — or, to be more precise, its production — is already a violation of the free-market principle; and fractional-reserve banking amounts to leveraging the economic consequences of fiat money.

For the sake of preserving prosperous and peaceful societal cooperation, the very opposite of Mr. Wolf's conclusion must hold true: namely that we can and will return to sound money, and the gold standard is one particular form that is fully acceptable from an economical-ethical perspective — if and when it is freely chosen by the people.

But while Rule and the likes of David Einhorn aren't alone keeping some, or a lot of, money in gold, the Wall Street Journal ran a profile of a more typical investment guide who claims, "There's no utility of gold." Investment advisor Tim Medley says people only trade their dollars for gold when they're afraid, and they won't be afraid much longer.

Medley is old enough to remember overflow crowds at financial conferences in the early 1980s listening to presentations about gold, only to have the metal's price plunge and go nowhere for two decades. He's figuring the same will happen again. "Given a choice between first-rate common stocks and gold over the next five to ten years, I feel strongly that stocks will do much better," says Medley.

Unless his clients specifically tell him to buy some gold or gold stocks for their accounts, Medley won't touch the stuff. "There's no organic growth" in gold, he says.

For sure, gold coins and bars silently gather dust. Gold has no staff, makes no product, earns no profit, and incurs no loss. The yellow metal owes no one, but at the same time it collects no interest either.

However, to say gold has no utility? Time and history would say otherwise. Murray Rothbard listed seven necessary qualities for money during a History of Economic Thought lecture at UNLV back in the fall of 1990. For a substance to be used as money it must be (1) generally marketable, (2) divisible, (3) durable, (4) recognizable, (5) homogeneous, and have a (6) high value per unit weight and (7) fairly stable supply.

Gold happens to meet the test of all seven attributes. However, investment advisor Medley seems to be equating the macroeconomic landscape today with that of 1980, when gold hit $850 per ounce, thinking that it's all downhill from here for the price of the yellow metal, just as it was 30 years ago.

But he turns a blind eye to the fact that M2 was just short of $1.5 trillion in January 1980, while this past October it was $8.7 trillion. Gross debt in 1980 was $909 billion, on November 2 of this year, $13.7 trillion. As a percentage of GDP, the debt was 33.4 percent in 1980; today it's 93.2 percent.

On February 15, 1980, the discount rate was goosed up to 13 percent and federal funds were yielding 14.5 percent to 15 percent (on the way to 20 percent a year later) Today, the discount rate is all of 75 basis points and federal funds fetch a yield of zero to a quarter percent.

And while Volcker's policies spurred widespread protests due to the effects of the high interest rates on the construction and farming sectors, causing irate, bankrupt farmers to drive their tractors onto C Street NW, blockading the Eccles Building, Ben Bernanke invited 60 Minutes into the Fed's chambers to go on camera assuring people he will keep rates near zero for as long as it takes.

Bernanke assured the national audience that the Fed was not printing money; however, he didn't explain where the Fed was going to get the funds to buy $600 billion worth of treasuries.

Rick Rule already knows the answer; and it's not just the Fed that's creating money out of nowhere to buy government bonds. "The decision by the European Central Bank to emulate their American peers to print money to buy existent European bonds is tantamount to government counterfeiting," says Rule.

And while central-bank bureaucrats come up with fancy names for this counterfeiting, like "quantitative easing," the owner of Global Resource Investments differs with that characterization. He says, "I disagree; I think it's a form of fraud. I think they are printing money to buy bonds that they couldn't otherwise sell."

Tim Medley believes stocks are selling at good prices and have the potential to reward investors with significant gains, while he believes the gains in gold prices are likely short-lived. Rule also remembers the late 1970s gold bull market, and he contends this market hasn't yet become the "echo market" that that one was:

In an echo market, the market might be kicked off by fear buying like we're seeing in gold now, and the momentum established by the fear buyers attracts the greed buyers. The momentum associated with the greed buyers sparks more fear buying and backwards and forwards.

Based on what Bernanke said on 60 Minutes, it is hard to imagine that it's really too late to be afraid.

However, as Garrison eloquently argues,

Both theory and evidence would seem to suggest that economic stability lies in the direction of monetary decentralization.

The decentralization of money, as proposed by Hayek and explored by Selgin and White has an increasingly strong claim on our attention.See Hayek (1976) Choice in Currency. London: Institute of Economic Affairs. And Selgin, G. A., and White, L. H. (1994) "How Would the Invisible Hand Handle Money?" Journal of Economic Literature 32 (4): pp. 1718–49. — John P. Cochran Concerns with political feasibility should be separated from the more fundamental reconsideration of a market-based money supply. In the light of our continuing experience with a bubble-prone central bank, we might well anticipate that a comparative-institutions analysis would favor a market solution to our money and credit problems. At the very least, a better understanding of the workings of a decentralized monetary system would help identify the perils and pitfalls of continued centralization.Garrison, Roger W. "Interest-Rate Targeting During the Great Moderation." Cato Journal, vol. 29, no. 1 (Winter) 2009, pp. 187–200.

I have made a similar argument in a forthcoming paper,Cochran, John P. (2010 Forthcoming). "Capital in Disequilibrium: Understanding the "Great Recession' and Potential for Recovery." The Quarterly Journal of Austrian Economics, vol. 13, no. 3.

A lesson that should be learned is that money and credit creation is ultimately a major destructive power which misdirects production and falsifies calculation even in a period of relatively stable prices. An economy with a complex financial system like the present banking system, which in turn depends on the government monopoly of the supply of money, will be prone to cycles and crisis even with the best of management. Without a foundation of sound money, cycles are inevitable and destructive not only of short-term economic well being but potentially destructive of long-term of freedom and prosperity if the crisis is used as an excuse to bring back the dead hand of collectivist policies. In the midst of the current crisis, it is more urgent than ever that we follow Hayek in his proposal for drastic monetary reform. He was driven "into proposing the denationalization of money" and a return to a market-determined money.Pizano, Conservations with Great Economists: Friedrich A. Hayek, John Hicks, Nicholas Kaldor, Leonid V. Kantorovich, Joan Robinson, Paul A. Samuelson, Jan Tinbergen. Jorge Pinto Books Inc., 2009) p. 10.

Some in mainstream journalism are recognizing the threat to return to prosperity posed by current monetary institutions that, in addition to the above-mentioned problems, facilitate budgetary malfeasance by unrestrained political leaders. Some journalists are now advocates for more drastic monetary reform. In the Thursday, May 27, Wall Street Journal, Judy Shelton's op-ed is titled "The Recovery Starts with Sound Money." She argues that "the transition to a firmer monetary footing to support entrepreneurial capitalism could be initiated by linking major global-reserve currencies to gold and silver — commodities long associated with monetary functions. It would logically begin with the dollar." And "by linking the dollar to gold, Americans would establish a vital beachhead for sound money and provide a model that other nations could emulate."

While a "beachhead for sound money" would be an improvement over current monetary arrangements, reform, if it is to succeed in freeing us from the threats to our economy and liberty embedded in a government monopoly of the control of the money supply, should be based not only on an understanding of the importance of sound money but also on a strong theoretical understanding that clearly delineates sound from unsound money.See Cochran, John P. (2004). "Capital, Monetary Calculation, and the Trade Cycle: The Importance of Sound Money." The Quarterly Journal of Austrian Economics, vol. 7, no. 1, 17-25. Hence, the timing could not be better for the Mises Institute's release of Money, Sound and Unsound by Joe Salerno, today's leading monetary scholar in the tradition of Mises and Rothbard.

The tome covers nearly 30 years of important contributions by Professor Salerno, defining and defending sound money from its critics and pseudo friends. The volume is a must have for anyone — whether scholar, pundit, policy wonk, or educated layman — who truly wants to understand our current crisis and participate in a meaningful way in a program for a return to sound money.

Joseph Salerno, my friend and colleague at the Mises Institute, published a book this year entitled Money: Sound and Unsound. The book consists of 26 chapters, which were based on articles he wrote in publications around the globe. The common purpose of all the articles is to explain the principle of sound money to an audience of nonspecialists.

The principle of sound money consists of two things: The first is the affirmation of the market's ability to choose and maintain money and all the enormous benefits this has provided to society. The second is the opposition to government meddling in money and all the negative consequences it has on society.

The book does a marvelous job of presenting all the important theoretical debates on money. There are of course some complex historical episodes that are beautifully disentangled, particularly with regard to the Great Depression. The book is filled with analysis of policy, including some of the very best discussions of inflation and deflation. Finally, in terms of moving forward, the book contains several important essays on the gold standard and how to implement it.

I highly and enthusiastically recommend this book to you. Money: Sound and Unsound is a great accomplishment and it contains the very information that we need to move the world in the right direction. I dedicate my lecture today to Joe's accomplishment and to his goal of restoring the principle of sound money.

The principle of sound money acknowledges that money is a vastly important contribution that the market has given to society. Money starts as a commodity used as an intermediary in exchange. For example, I accept tobacco in payment for a labor service, even though I have no desire to consume tobacco, because I know that I can use the tobacco to purchase some tomatoes down at the vegetable stand.

Initially, many goods such as tobacco may serve the purpose of an exchange intermediary. However, there is a natural tendency for particular goods to emerge as the best intermediaries for exchange. Eventually, only a small number of goods endure as the very best commodities to serve as intermediaries.

These goods will naturally have the qualities that allow them to best serve as intermediaries. Those qualities will include being durable, because you would not want an intermediary that might spoil or deteriorate between the time you accepted it and the time you wanted to use it in exchange. Another important quality is that the commodity be divisible, so that you could parcel out the amount of the commodity to be offered in exchange. Tobacco, for example, can be measured by weight to a precise amount. Tomatoes are less divisible and less durable than tobacco. The best intermediaries will also be easy to transport and will thus represent a large value relative to size and weight. They should also be difficult to forge or imitate and easy to store. The commodities that emerge from the market process as the best intermediaries are called money, or the general medium of exchange, because they have the widest salability in the market.

It is important to note that this is not some mysterious process unguided by human choice. Rather, it is an entrepreneurial process whereby certain individuals discover those particular commodities that have the properties required in a particular economy. These individuals benefit from their discoveries — they profit from them. The best entrepreneurial discoveries are eventually emulated and the market is driven in the direction of certain commodities and away from others.

Long ago, people discovered that the best intermediaries for exchange were metals — specifically bronze, tin, copper, silver, and gold. These commodities were extremely durable, highly divisible, easily transported, and difficult to counterfeit. To enhance divisibility, blacksmiths would cut the metals into equal-sized pieces and add their marks to certify the weight and indicate who produced them. In this manner the business of minting coins came into being.

In order to enhance the ability to store and transport money, banks and bank notes came into being. Initially, goldsmiths and silversmiths — who already had a safe place to store their own metals — served as a repository or storage facility for money. In order to enhance the portability of money, paper banknotes emerged as a way of reducing the cost of transport and the risk of theft. Instead of transporting 100 pounds of silver for a trip from London to Paris, I would simply ask my London banker for a banknote for 100 pounds of silver, which I could then cash or redeposit at his corresponding bank in Paris.

"The complex process whereby money and banking developed could never have been imagined prior to it actually happening."

This might all seem simple and obvious today, but it is far from that. The complex process whereby money and banking developed could never have been imagined prior to it actually happening. Cigarettes did quickly emerge as money in World War II prisoner-of-war camps in Germany, but only because everyone was already familiar with the use of money. No one would be capable of discovering money in its modern form during prehistoric times. Governments would also be incapable of creating such a system. Governments merely monopolized existing systems of money.

Everyone acknowledges that money is important, but few people realize how important money really is. Without money, the ability to exchange would be extremely limited. Bartering goods is a costly and cumbersome process in which you have to find someone who wants something you have and has something you want. It also requires two people who can come to terms regarding how much they have to relinquish in order to make the exchange. People would have to supply themselves with most of the goods they consumed and would therefore have far less to consume. Specialization and division of labor would be extremely limited. Economies of scale would be extremely limited. Complex goods could not be produced.

You could not circumvent the difficulties of barter simply by going on Craigslist, because Craigslist would not exist. Neither would computers, the Internet, or cell phones.

In other words, the long-term development of our standard of living is based on and coincides with the development of money. There are still societies in Africa, Asia, and the Americas that do not use money, but these are primitive societies in which people live in crude structures with primitive clothing and an uncertain food supply. They have none of the things that we take for granted, such as indoor plumbing, refrigeration, soap, clean underwear, etc. Their lives can be satisfying, but the point is that their social existence is very different from a society based on money, and they have a much lower standard of living.

The principle of sound money is therefore based on commodity monies that emerged in the market, guided by the principles of property, commerce, and entrepreneurship. The system of money did cause various shocks as it developed and spread, and as the economies of isolated cultures became integrated into the system. Such integration is always a messy process, but ultimately monetary integration itself was wholly beneficial.

Any step away from the principle of sound money will have negative consequences for society. Here I am speaking specifically about government intervention into money and banking. The first type of intervention is the monopolization of minting coins. This may have had the initial appearance of being beneficial, as money became homogenous and counterfeiters were punished with the power of government. However, any government monopoly of money leads to the second type of interference, which is debasement or what we call monetary inflation. Governments and counterfeiters shave or clip coins and reduce the size of coins over time in order to have more money to spend. Today, the process of inflation is done electronically with mere bookkeeping entries.

Even if the state did not debase the supply of money, it would still have monopolized money and destroyed the market process. Only with competing money suppliers would it be possible to have certain types of innovation and product development. These changes improve money and better adapt it to changing economic conditions and thereby enhance economic development throughout the economy over time. George Selgin's new book, Good Money, presents a great historical case study where the government partially relinquished its authority over coins, and the market entered the void and provided an improved product.

The types of innovation that have occurred under state monopoly of money have all been negative. They include fractional-reserve banking, bimetallism, the gold-exchange standard, central banking, fiat paper money, the Bretton Woods system, the World Bank and the International Monetary Fund, the current dollar hegemony, and now quantitative easing. Time limitations prevent me from describing the problems with all of these "developments," but rest assured they are amply covered in the Austrian economics literature and on Mises.org.

Needless to say, we have drifted far away from the principle of sound money. We now have a system of fiat paper money with no commodity backing whatsoever. We have a fractional-reserve-banking system that until recently held almost no reserves to back up deposits. And finally, we have a central bank that has embarked upon a series of extreme and unconventional policies. The government's budget deficit, the raison d'être for inflation, is exploding, and we now have future unfunded liabilities — a "fiscal gap" — that have been estimated to be as high as $200 trillion.

With a second round of quantitative easing (QE2) looming, and with the price of gold shooting past $1,400 per ounce, things have gotten so bad that the gold standard is back in the news. On the one hand you have Robert Zoellick, head of the World Bank, who has suggested that gold-price targeting be used as a guide for monetary policy. On the other hand you have New York University economist Nouriel Roubini, who recently attacked gold because it would limit the policy flexibility of the Federal Reserve — i.e., the Fed could not stimulate growth, the Fed could not manage the price level, the Fed could not serve as the lender of last resort, and the Fed could not have bailed out the big banks. Of course, these are precisely the reasons why Austrians do not want a central bank.

The economics profession was long composed of various schools of economic thought, with the Austrian School consisting of a small but highly innovative group of economists who worked within many of the leading institutions of higher learning. More recently, the Austrian School has grown significantly both inside and outside academia. However, instead of there being a continuum of thought among the various schools, it now feels more like there is one camp of Austrians and another camp of the various types of Keynesians.

The Austrian camp supports what I have labeled and discussed as the positive principles of sound money (commodity money, competitive currencies, free banking, 100 percent reserves on demand deposits). The Keynesian camp supports what I have labeled as the negative principles of sound money, which involve various forms of government intervention. My view is that the Keynesian camp does not really understand how the economy works as a social system that involves the entrepreneurial actions of millions of people. They seem to view the economy as a machine or a single being that they can manipulate with fiscal and monetary stimulus to achieve various results.

I would now like to discuss some examples of the differences between the Austrians and Keynesians. These examples include the Great Depression, deflation, and the proper way out of this economic crisis. These examples are just three of the many things you will find discussed in the Salerno book, which in my opinion is the single best source of information and knowledge about these and many other economic issues related to money.

The Great Depression, which began in 1929 and lasted throughout the 1930s, has been studied by a number of economists. The Keynesian camp has offered several explanations, including the standard answer that the economy suffered from insufficient aggregate demand. However, insufficient aggregate demand is merely a description of the phenomena; it is not an explanation for the phenomena. Milton Friedman said the Great Depression was caused by a fall in the money supply in the early 1930s. Ben Bernanke said the Great Depression was a result of bank failures, which led to a restriction of credit in the early 1930s. These too are descriptions of recessions and depressions; they are not explanations for why they happen. Other economists have even blamed the gold standard for the Great Depression, because it prevented authorities from expanding the money supply.

In contrast, Salerno shows in his book that the Federal Reserve was highly inflationary during the 1920s, setting off a bubble in the stock market and malinvestments throughout the economy. Rather than being deflationary in the 1930s, the Federal Reserve tried and generally succeeded in inflating the money supply. Salerno also points out that we had left the real gold standard in 1914, substituting the Federal Reserve bureaucracy and the gold-exchange standard for the real one. The reason the Depression was "Great" was that Hoover and Roosevelt enacted policies to prevent the market from working and specifically to prevent wages and prices from falling.

This leads to the second example, which is deflation as defined by falling prices. Mainstream economists suffer from a great fear of deflation. Paul Krugman and Ben Bernanke, who were once colleagues at Princeton University before they took on their current high-profile jobs, are both afraid of deflation to the point of being phobic. Austrians like Salerno, on the other hand, think falling prices are a good and natural thing. If production in the economy is increasing and costs are falling, then with a stable money supply prices will fall and paychecks will go further. Deflation is great for the average working person. Entrepreneurs in many industries plan their businesses to anticipate falling prices for their products.

The Keynesians associate deflation with depression, but Salerno explains that the historical association between deflation and depression is weak. Keynesians fear that a little deflation will cause consumers to delay spending and force businesses into bankruptcy, and that this process will cycle out of control into a deflationary spiral. Of course deflation can coincide with depressions; but the depression is caused not by deflation but by the previous inflation that led entrepreneurs to make bad investments.

The reality of deflation is quite the opposite of what Keynesians fear. When an economy goes into recession there is a tendency for prices to fall. The price of capital goods and land fall the most, followed by labor, with consumer goods — especially necessities and nondiscretionary goods — falling the least. As entrepreneurs see the prices of capital goods, land, buildings, and labor falling relative to the price of consumer goods some of them get the idea that they can combine those resources with relatively low prices in order to produce consumer goods with relatively high prices. Rather than causing the economy to cycle out of control into depression, deflation is actually a natural shock absorber that stabilizes the economy.

My final example of the differences between the two schools is the prescription for restoring prosperity. The Keynesians believe that you need to increase the money supply, and now it appears there is no limit on the amount of money to be created. They also believe that there should be stimulus spending by the government, and that too seems now to be unlimited. As part of the stimulus, this spending should be financed by borrowing to increase the deficit and national debt, and this too now seems to be unlimited — whatever is necessary to get the job done.

Austrians view all of these so-called remedies as harmful impediments to the process of economic readjustment. This readjustment is necessary to correct for the malinvestments that occurred during the prior boom (i.e., the housing bubble). The Great Depression, the stagflation of the 1970s, the longstanding weakness of the Japanese economy, and the current crisis all stand as testament to the correctness of our view. The correct view is that government should get out of the way, cut taxes and the size of its own agencies and regulatory bureaucracies, restore a good environment for entrepreneurs, and allow markets to work. Most importantly, government should adopt the principles of sound money. We need to restore the gold standard — which Salerno has written about at great length — close down the Federal Reserve, and return the operation of money and banking back to the marketplace.

It didn't work out as they thought. The 1970s was a time of monetary chaos. What was worth a buck in 1973 is worth only 20 cents today. Stated another way: a dime is worth 2 cents, a nickel is worth a penny, and a penny is worth … nothing at all. It is an accounting fiction that takes up physical space for no reason.

Welcome to the age of paper money, where governments and central banks can manufacture as much money as they want without limit. Gold was the last limit. Its banishment as a standard unleashed the inflation monster and Leviathan itself, which has swelled beyond comprehension.

But guess what? Gold actually hasn't gone anywhere. It is still the hedge of choice, the thing that every investor embraces in time of trouble. It remains the most liquid, most stable, most fungible, most marketable, and most reliable store of wealth on the planet. It has a more dependable buy-sell spread than any other commodity in existence, given its value per unit of weight.

But is it dead as a monetary tool? Maybe not. Whenever the failures of paper become more than obvious, someone mentions gold and then look out for the hysteria. This is precisely what happened recently when Robert Zoellick, head of the World Bank, made some vague noises in the direction of gold. He merely suggested that its price might be used as a metric for evaluating the quality of monetary policy.

What happened? The roof fell in. Brad DeLong of Keynesian fame called Zoellick "the stupidest man alive" and the New York Times trotted out a legion of experts to assure us that the gold standard would not fix things, would hamstring monetary policy, would bring more instability rather than less, would bring back the Great Depression, and lead to mass human suffering of all sorts.

One thing this little explosion proved: newspapers, governments, and their favored academic economists all hate the gold standard. I can understand this. The absence of the gold standard has made possible the paper world they all love, one ruled by the state and its managers, a world of huge debt and endless opportunities for mischief to be made from the top down.

One of the funniest explosions came from Nouriel Roubini, who listed a series of merits of gold without recognizing them as such: gold limits the flexibility and range of actions of central banks (check!); under gold, a central bank can't "stimulate growth and manage price stability" (check!); under gold, central banks can't provide a lender-of-last-resort support (check!); under gold, banks go belly up rather than get bailed out (check!).

His only truly negative point was that under gold, we get more business cycles, but here he is completely wrong, as a quick look at the data demonstrates. And how can anyone say such a thing in the immediate wake of one of history's biggest bubbles and its explosion, which brought the world to the brink of calamity (and which still isn't over)?

Newsflash: it wasn't the gold standard that gave us this disaster.

As Murray Rothbard emphasized, the essence of the gold standard is that it puts power in the hands of the people. They are no longer dependent on the whims of central bankers, treasury officials, and high rollers in money centers. Money becomes not merely an accounting device but a real form of property like any other. It is secure, portable, universally valued, and, rather than falling in value, it maintains or rises in value over time. Under a real gold standard, there is no need for a central bank, and banks themselves become like any other business, not some gigantic socialistic operation sustained by trillions in public money.

Imagine holding money and watching it grow rather than shrink in its purchasing power in terms of goods and services. That's what life is like under gold. Savers are rewarded rather than punished. No one uses the monetary system to rob anyone else. The government can only spend what it has and no more. Trade across borders is not thrown into constant upheaval because of a change in currency valuations.

Of course the World Bank head was not actually talking about a real gold standard. At most he was talking about some kind of rule to rein in central banks that attempt what the Fed is attempting now: the inflating of the money supply to drive down the exchange-rate value of the currency to subsidize exports.

Still, it's good that he raised the topic. The Mises Institute has been pushing scholarship and writing about gold since its founding. To be sure, the issue of the gold standard is largely historical but no less important for that reason. The people who hate the gold standard of the past have no desire for serious monetary reform today.

We should be thrilled should the day ever come when monetary authorities really make paper money directly convertible into gold (or silver or something else). I doubt we can look forward to that day anytime soon. But there is one thing they could let happen right away: free the market to create its own gold standard by permitting true innovation and choice in currency. It's a fair guess that opponents of the gold standard would oppose that too, because, as Alan Greenspan himself once admitted, the people who oppose gold are ultimately opposed to human freedom.

This debate isn't really about monetary policy, much less the technical aspects of the transition. It is about political philosophy: what kind of society do we want to live in? One ruled by an ever-growing, all-controlling state or one in which people have freedom guaranteed and protected?

For instance, argues Roubini, an economy that is growing quickly would tend to overheat and this in turn is likely to lead to a higher inflation and asset bubbles.

In contrast, an economy that is growing more slowly would have a tendency toward deflationary pressure and recession.

On a gold standard, argues Roubini, the central bank will not be able to successfully counterbalance these tendencies. An economy on a gold standard would continue to reinforce the existing negative trends in the business cycle, he maintains.

In a nutshell, according to Roubini the gold standard limits the range of actions that central banks can introduce in order to improve economic growth and employment and manage price stability.

For most economists, another major problem with having a gold standard is that the supply of gold will not grow fast enough to accommodate the rate of increase in the supply of goods and services generated by modern economies. It is held that this can only suffocate economies.

Let us start with a barter economy. John the miner produces ten ounces of gold. The reason why he mines gold is that he believes there is a market for it. Gold contributes to the well-being of individuals. He exchanges his ten ounces of gold for various goods such as potatoes and tomatoes.

People have discovered that gold, apart from being useful in making jewelry, is also useful for some other applications. They now assign a much greater exchange value to gold than before. As a result John the miner can exchange his ten ounces of gold for more potatoes and tomatoes.

Note that as time goes by people assign greater importance to some goods and diminish the importance of some other goods. Some goods are now considered as more important than other goods in supporting people's lives and well-being.

Now people have also discovered that gold is useful to serve as the medium of exchange. Consequently they further lift the price of gold in terms of tomatoes and potatoes. Gold is now predominantly demanded as a medium of exchange — the demand for the other services of gold such as ornaments is now much lower than before.

One of the reasons for selecting gold as the medium of exchange is that it is relatively scarce. This means that a producer of a good who has exchanged this good for gold expects the purchasing power of his effort to be preserved over time by holding gold.

If for some reason there were a large increase in the production of gold and this trend were to persist, the exchange value of gold would be subject to a persistent decline versus other goods, all other things being equal.

Within such conditions people are likely to abandon gold as the medium of the exchange and look for other commodities to fulfill this role.

As the supply of gold starts to increase, its role as the medium of exchange diminishes while the demand for it for some other usages is likely to be retained or increase.

When John the miner exchanges gold for goods, he is engaged in an exchange of something for something. He is exchanging wealth for wealth.

Contrast all this with the printing of gold receipts, i.e., receipts that are not backed 100 percent by gold. This is an act of fraud — that is what inflation is all about — which is another way of saying that it sets a platform for consumption without making any contribution to the pool of real wealth.

Empty certificates set in motion an exchange of nothing for something, which in turn leads to boom-bust cycles.

The printing of certificates unbacked by gold diverts real savings from wealth-generating activities to the holders of the unbacked certificates. This leads to a so-called economic boom.

The diversion of real savings is done by means of unbacked certificates, i.e., unbacked money. Once the printing of unbacked money slows down or stops altogether, this stops the flow of real savings to various activities that emerged on the back of unbacked money.

As a result these activities fall apart — an economic bust emerges. (Note that these activities do not produce real wealth; they only consume.)

Obviously then, without the unbacked money, which diverts real savings to them, they are in trouble. These activities didn't produce any wealth, hence without money given to them they cannot secure the goods they want.

In the case of the increase in the supply of gold no fraud is committed here. The supplier of gold — the gold mine — has increased the production of a useful commodity. So in this sense we don't have an exchange of nothing for something.

Consequently we also don't have the emergence of bubble activities. Again the wealth producer, because he has produced something useful, can exchange it for other goods. He doesn't require empty money to divert real wealth to him.

Note that a major factor for the emergence of a boom is the injections of money "out of thin air" into the economy. The disappearance of money out of thin air is the major cause of an economic bust.

The injection of money out of thin air generates bubble activities, while the disappearance of money out of thin air destroys these bubble activities.

On a gold standard this cannot take place. On a pure gold standard without the central bank, money is gold. Consequently, on the gold standard money cannot disappear, because gold cannot disappear.

We can thus conclude that the gold standard, if not abused, is not conducive to boom-bust cycles.

We have seen that it is the creation of money out of thin air that sets in motion boom-bust cycles. Hence the key supplier of such money — the central bank — cannot be an agent of economic stability as suggested by most mainstream economists.

In a free unhampered market economy (without the central bank) we could envisage that the economy would be subject to various shocks, but it is difficult to envisage a phenomenon of recurrent boom-bust cycles.

According to Rothbard,

Before the Industrial Revolution in approximately the late 18th century, there were no regularly recurring booms and depressions. There would be a sudden economic crisis whenever some king made war or confiscated the property of his subjects; but there was no sign of the peculiarly modern phenomena of general and fairly regular swings in business fortunes, of expansions and contractions.Murray N. Rothbard, "Economic Depressions: Their Cause and Cure," in The Austrian Theory of the Trade Cycle, And Other Essays, (Auburn, AL: Ludwig von Mises Institute, 1983) pp. 61.

In short, the boom-bust-cycle phenomenon is somehow linked to the modern world. But what is the link?

Careful examination reveals that the link is in fact the modern banking system, which is coordinated by the central bank.

The source of recessions turns out to be the alleged "protector" of the economy: the central bank itself.

Now, contrary to Roubini and most mainstream economists, we can ask, why should strong economic growth lead to higher inflation and so-called overheating, while slow economic growth must lead to deflation and economic slump?

Observe that inflation is not about a general increase in the prices of goods and services but about increases in money supply.

As a rule, increases in money supply, i.e., inflation, result in general increases in prices. (Note that a price is the amount of money paid per unit of a good.)

This, however, need not always be the case if the pace of increase in the production of goods exceeds the rate of increase in money supply.

Now, if for a given money supply there is an increase in the production of goods — strong economic growth — obviously this will lead to a fall in general prices and not increases in prices as suggested by Roubini.

Only if the rate of growth of the money supply exceeds the rate of growth of production will a general increase in prices ensue.

Likewise, a fall in economic activity as such doesn't cause deflation and economic slump as suggested by Roubini and mainstream economists. As long as the money supply is not shrinking there is no way one can have deflation.

We have seen that on a gold standard, money, which is gold, cannot disappear. Only on the paper standard and in the framework of the fractional-reserve lending can money disappear.

Note that the disappearance of money on the paper standard is always in response to the previous monetary inflation of the central bank, which undermines the pool of real savings — the bottom line of the economy.

It is the fall in the pool of real savings that leads to the weakening in the real economy, which in turn causes banks to curtail the expansion of credit out of thin air.

Most economists believe that a growing economy requires a growing money stock, on the grounds that growth gives rise to a greater demand for money, which must be accommodated.

Failing to do so, it is maintained, will lead to a decline in the prices of goods and services, which in turn will destabilize the economy and lead to an economic recession, or even worse, depression.

Now on a gold standard if one takes into account that a large portion of gold mined is used for jewelry, this leaves the stock of money almost unchanged over time.

It is held then that the free market, by failing to provide enough gold, can cause money-supply shortages. This in turn, runs the risk of destabilizing the economy.

The whole idea that money must grow in order to sustain economic growth gives the impression that money somehow sustains economic activity.

If this were the case, then most third-world economies would have eliminated poverty by now through printing large quantities of money.

According to Rothbard,

Money, per se, cannot be consumed and cannot be used directly as a producers' good in the productive process. Money per se is therefore unproductive; it is dead stock and produces nothing.Murray N. Rothbard, Man, Economy and State, (Los Angeles: Nash Publishing, 1970) p. 670.

Money's main job is simply to fulfill the role of the medium of exchange. Money doesn't sustain or fund real economic activity.

The means of sustenance, or funding, is provided by saved real goods and services. In fulfilling its role as the medium of exchange, money just facilitates the flow of goods and services.

In a free market the price of money is determined by supply and demand, just like the price of other goods. Consequently, if there is less money, its exchange value will increase. Conversely, the exchange value will fall when there is more money.

Hence within the framework of a free market, there cannot be such thing as "too little" or "too much" money. As long as the market is allowed to clear, no shortage of money can emerge.

Consequently, once the market has chosen a particular commodity as money, the given stock of this commodity will always be sufficient to secure the services that money provides.

According to Mises,

As the operation of the market tends to determine the final state of money's purchasing power at a height at which the supply of and the demand for money coincide, there can never be an excess or deficiency of money. Each individual and all individuals together always enjoy fully the advantages which they can derive from indirect exchange and the use of money, no matter whether the total quantity of money is great, or small. … The services which money renders can be neither improved nor repaired by changing the supply of money. … The quantity of money available in the whole economy is always sufficient to secure for everybody all that money does and can do.Ludwig von Mises, Human Action: Scholar's Edition, (Auburn, AL: Ludwig von Mises Institute, 1998) pp. 418.

We have shown that a pure gold standard is not conducive to business cycles. Contrary to mainstream economists, we suggest that it is the attempts of the central banks to bring about price stability and full employment that set in motion the menace of boom-bust cycles.

The mainstream view that during an economic slump it is OK for the central bank to pump money in order to revive the economy confuses money with funding.

Printing more money cannot generate more goods and services; it can only redistribute the existing wealth from wealth generators to the holders of newly printed money.

In the process this undermines the pool of real funding and weakens wealth generators' ability to grow the economy.

Suppose an economist is convinced that the most appropriate international monetary system in a civilized age is one in which the measuring rod of money in every country has a common, defined value; and, further, that the ideal money unit in such a system will have a value consistent with stability in a price index weighted, as far as practicable, so as to give equal proportionate importance to all components of real income (the flow of productive services). He could at the same time hold that, governments and politics being as we know them to be in the present century, the old-fashioned gold standard would be a more expedient system solely because, under the kind of convertibility obligation that standard requires, politicians in office could be subjected to a simple understandable monetary discipline.

In thus recommending, he would be candidly admitting the inferiority of the gold standard for an imaginary or predictable future era, in which the propensities of governments to manipulate the value of the money unit in the interests of election winning had been constitutionally overcome. He would be saying, in effect,

Because we have not yet reached such high standards of electoral wisdom or of integrity in government, we have to be content with the second-best solution. Given current realities, the practical way to achieve greater order in international monetary relations would be a return to the pre-1914 gold-standard system. That would, at any rate, render "politically impossible" the creeping, crawling, chronic inflation that has plagued mankind since the 1930s.

It is important to emphasize that, in taking such a line, the economist would not allow his readers to accept the current myth that inflation is a scourge that governments try, with varying success, to keep in check. Yet this very myth, accepted by the critics of governments as well as by governments themselves, is one of the consequences of economists generally failing to make explicit their assumptions about the vote-acquisition process.

Let us now imagine the economist going further and contending that, because the world's governments have not yet re-embraced those standards of responsibility and integrity that caused the gold standard of pre-World War I to operate with such fantastic success, he cannot recommend any return to it. He might then argue,

The best that can be hoped for is something like the present system of an International Monetary Fund with Special Drawing Rights [SDRs]; for this does not call upon governments to abandon the use of monetary policy in election winning, and they are not likely to renounce that. Indeed, no government in power could dare do so because the opposition could make too much political capital out of the unpopularity of noninflationary coordination of economic systems during threatened recession.

Analysis of monetary policy, as a branch of an economics in which governmental activity is viewed realistically as interwoven with market activity, must explicitly and repeatedly stress the connection between the value of the money unit and the vote-acquisition process.

But we can now imagine the economist going still further and arguing,

Even the present IMF system with SDRs is not adequately adjusted to the vote-acquisition realities of this age. The yield in votes to creeping inflation tends to decline as public skepticism grows about a government's commitment to a doughty endeavor to fight off the inflationary dragon. Inflation loses its coordinative power in proportion to the extent to which it is expected; when it is expected, the depreciation of the money unit, however expertly engineered, fails to prevent layoffs and unemployment; the rentier fails to be specially exploited because interest on bonds rises, perhaps to twice the yield on equities, providing thereby as good a hedge against inflation as is available to the investor in shares; while under fixed exchange rates, declining activity causes external pressures for deflation or forces unpopular steps to bring about price-cost adjustments, due to a worsening in the balance of payments.

The situation eventually compels resort to a proliferating bunch of "controls" applied to the remnants of the free-market system. The "controls" all tend to repress productivity and all have a regressive incidence. We can, for instance, expect exchange controls, import controls, such abominations as the United States "interest equalization" law,Under "interest equalization," Americans investing outside the United States are taxed heavily, e.g., 15 percent of the capital in the case of investment in equities. and eventually "incomes policies" with extra-legal governmental coercions or "persuasions" and the imposition of legally enacted wage-rates and prices on the coordinative mechanism of the market.

This way of keeping prices down will normally be preferred by governments to neutral restraints via noninflationary monetary policy; for the particular prices or wage rates to be repressed can be selected in such a manner as to minimize the prospective loss of votes. The propensity of governments to act in these ways, especially when balance-of-payments pressures grow, can be lightened by resort to floating exchange rates. Governments can then follow "a policy of benign neglect" of parity considerations and save themselves a host of worries about inflation consequences. This solution is certainly a lesser evil when compared to such evils as exchange control, import quotas, and all the other paraphernalia for the collective overruling of remaining free-market values. In itself, it enables a continuous market valuation of currencies influenced by the independent inflations which national monetary autonomy permits.

The chief obstacle that makes floating exchange rates appear "politically impossible" is the pigheadedness of certain officials and bankers who are today acting as unreasonably as the officials and bankers who resisted currency debasement in the 1930s. But they were at last overruled then and they can be overruled again. Let the value of currencies be determined in a surviving free market, with no governments having to be shackled by monetary contracts with the world in their essential vote-acquisition function.

Of course, floating exchange rates involve the sacrifice of the benefits of better-coordinated international economic activity. The abandonment of contractual relationships between national currencies has to be deplored in itself. But every "politically palatable" alternative is even worse.

If economists who have advocated a return to the gold-standard system, or adoption of the SDRs under the IMF, or floating exchange rates, had throughout put their case in these realistic terms, continually reminding the opinion-making agencies of the underlying vote-gaining assumptions, the consequences upon policy of that form of exposition could have been profound.

Solutions explicitly stated but rejected on political grounds would not for that reason have remained impotent. The creators of public opinion would have begun to perceive more clearly that the interests of the small group of private people who form governments, or of those conspiring to replace them, or of those who finance their election campaigns, have unduly dominated policy.The incentives that actuate politicians are no less difficult to discipline in the social interest even if they are frequently nonpecuniary and public spirited. In his study of 14 Canadian prime ministers, Mr. Bruce Hutchison remarks that, "with two exceptions," all "were animated by … an insatiable appetite for power," yet "none profited financially from his office" (from the introduction of MacDonald to Pearson: The Prime Ministers of Canada, Don Mills, Ontario: Longmans Canada Ltd., 1967). Even so, Mr. Hutchison has to show that corrupt motives were endemic among Canadian legislators. Thus, although Prime Minister Wilfrid Laurier "remained a poor man, the Liberal machine" he headed "was demonstrably corrupt"(ibid., p. 69), and Prime Minister William Lyon Mackenzie King also "led a party convicted of graft" (ibid., p. 133). That is, if tacit assumptions about political considerations had been replaced by explicit assumptions, the ultimate reaction on voting conduct could have been diametrically different.

The usual suspects immediately denounced him, with Keynesian Brad DeLong anointing Zoellick the "Stupidest Man Alive."

In the present article I'll explain the resurging interest in the yellow metal.

I'll also explain the dangers of Zoellick's proposal, and why fans of the classical gold standard should be wary.

In order to make sense of our current situation — and why Zoellick would timidly call for a return to a pseudo-gold standard — we need to first think through the logic of fiat money. Fiat money is not "backed up" by anything; it is intrinsically useless paper (or nowadays, mere electronic bookkeeping entries) that is valuable only because of its anticipated purchasing power. In contrast, a market-based commodity money, such as gold or silver, is a useful good in its own right, serving industrial and consumer purposes.

The critical difference between fiat and commodity money is that fiat money can be produced in virtually unlimited quantities at very low cost. In this respect, the person who controls the printing press of a fiat currency is in a much stronger position than the person who owns a gold mine. With just some ink and paper, the printing press can create a million new dollars quite easily, whereas the owner of the gold mine would need to hire workers to operate expensive equipment in order to bring forth new amounts of gold having the same market value.

Yet we shouldn't conclude that the owner of a printing press has unlimited power. For one thing, prices would eventually rise in response to large amounts of new money creation. So printing off, say, $1 million in fresh new currency would buy fewer and fewer goods and services with each successive round of inflation.

Even more problematic, the people in the community would abandon the currency if the inflation became too excessive. For example, if a brilliant counterfeiter developed a machine to produce perfect $100 bills in his basement, he wouldn't be able to literally buy the whole world. Long before that point — even if the authorities didn't track him down — people would have ditched the dollar and switched to the use of other currencies.

Although our scenario sounds farfetched, it's actually very close to the real world, right now. The only difference is that instead of our hypothetical, brilliant counterfeiter in the basement, we have our actual, less-than-brilliant economist in the Federal Reserve. His name, of course, is Ben Bernanke.

The original Bretton Woods system — so named because of the location of the meetings that established it in 1944 — governed international monetary arrangements in the postwar era until Richard Nixon's fateful decision to close the gold window in 1971.

Under the Bretton Woods agreement, other nations would use US dollars as their "reserves." The Bank of England, Bank of France, etc., would issue their own domestic currencies, but would maintain stockpiles of US dollars with which they could regulate the value of their own currencies. If the British pound sterling began to depreciate against the US dollar, for example, then the Bank of England could enter the foreign-exchange market and use some of its dollar holdings to "buy pounds," thus bringing the value of the pound back within target. In this way, investors across the globe could feel comfortable with their British financial holdings, because the pound was tied to the dollar.

Note the tremendously advantageous position that the Bretton Woods system assigned to the United States. As issuer of the world's reserve currency, the United States had a very captive market. If the Bank of England wanted to increase its dollar reserves by another $1 million, then ultimately Great Britain had to sell $1 million worth of goods and services to Americans in order to earn the dollars. The Bretton Woods system effectively expanded the scope for US inflation to the entire world, thus magnifying the benefits to those who controlled the American printing press.

Of course, the other members of Bretton Woods understood these details. The US achieved its privileged outcome in the negotiations because of its economic and military might at that point in world history. But in order to restrain the natural temptation for runaway inflation by US officials, the Bretton Woods system linked the dollar itself to gold. Specifically, any central bank could redeem its dollars for gold at the fixed rate of $35 per ounce.

The Bretton Woods system has been described as a "gold-exchange standard," in contrast to the classical gold standard. In the original framework — which was smashed, like so many other aspects of Western civilization, in World War I — each nation tied its own currency to gold. Then, the currencies in turn traded at fixed exchange rates against each other, because of their mutual ties to gold. Individual citizens could present the currencies for redemption in gold, keeping a very tight check on inflation. If any central bank began to issue too much currency in relation to its gold reserves, speculators would begin depleting the reserves, causing the central bank to quickly reverse course.

Under the diluted Bretton Woods system, individual citizens had no right of redemption. Most currencies were only indirectly linked to gold (via their link to the dollar). And, of course, even this tenuous link was destroyed when Richard Nixon abandoned the dollar's convertibility to gold in 1971. At this point, the entire global financial system was based utterly on fiat money.

No longer shackled by the peg to gold, the Federal Reserve began printing money with reckless abandon. The obvious results were an acceleration in US consumer prices, and an explosion in the US trade deficit, trends that noticeably worsen after 1971:

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Say what you will about the powerful people running the global monetary system, but they aren't stupid. They can see as well as the rest of us that there is no "exit strategy" for Bernanke's bouts of massive inflation, or "quantitative easing" as they now call it. At some point, the trillion(s) in excess reserves will begin leaking back into the broader monetary aggregates. At that point, Bernanke or a successor will need to choose between saving the dollar or saving major Wall Street institutions. I predict that he will sacrifice the dollar, and it seems many elites around the world have come to the same conclusion.

It is in this context that World Bank president Zoellick writes:

The G20 should complement [a] growth recovery programme with a plan to build a co-operative monetary system that reflects emerging economic conditions. This new system is likely to need to involve the dollar, the euro, the yen, the pound and a renminbi that moves towards internationalisation and then an open capital account.

The system should also consider employing gold as an international reference point of market expectations about inflation, deflation and future currency values. Although textbooks may view gold as the old money, markets are using gold as an alternative monetary asset today. (emphasis added)

To repeat, gold is the bane of central bankers; it ties their hands and limits their discretion when conducting monetary policy. However, the game collapses if people lose faith in the fiat currency underpinning the whole system. As the recklessness of Bernanke's moves becomes apparent to more and more people, the central planners around the world will need to throw a bone to the fearful public. A "basket of currencies," each of which is still fiat-paper money, will not suffice.

As Zoellick is a member of the Council on Foreign Relations, and a participant in the notorious Bilderberg meetings, some analysts are understandably suspicious of his motives. After all, if powerful people were trying to introduce a regional currency to replace the dollar — in the same way that the euro has supplanted the traditional European currencies — then it would be necessary to first wreck the dollar. In its place, it would be very tempting to offer a new currency with a tie to gold.

In this light, what appear to be "inexplicable" and contradictory actions by the Federal Reserve and other powerful figures would make perfect sense.

Regardless of the machinations of the political insiders, the laws of economics cannot be denied. Central bankers cannot be trusted with the printing press, especially when there is no formal check on their inflationary policies. It is no coincidence that gold is hitting such heights as investors the world over hunker down for what may very well be a collapse of the dollar system.

But it is not just about the past. He presents a great model for the future too with essays on how to tell real from fake gold standards, how to calculate the money supply and follow what the Fed is up to, and how to reform the international monetary system to keep money from the destructive hands of the state.

This book might be considered an intermediate text on the topic. If you have read Menger, Rothbard, Mises, or Hayek on the topic of money and you want to know what is next, this is your answer. Joseph Salerno is the master of the subject, and he demonstrates absolute virtuosity in these pages.

Salerno’s yardstick concerns the soundness of money. He is speaking of a subject too rarely raised: the quality of the money itself. Money originated as a commodity out of market exchange. The further the government and central bank drive money from its original soundness, toward a paper money and finally toward digits that government can manufacture out of nothing, the less sound the money becomes, and the more instability, inflation, false signalling, and economic chaos that results.

As he makes clear, money is either absolutely sound (meaning, part of the market order) or it is headed on that slide toward destruction. In the final commentary section, Salerno directly addresses modern monetary madness and speculates on the future.

A must-read in these times of monetary and financial crisis. Joseph Salerno is a grand master of monetary economics, unparalleled in combining state-of-the-art theory with profound knowledge of the history of economic thought, and a balanced judgment of policy issues. - Jorg Guido Hulsmann, University of Paris, Angers

It is the questions asked as much as the answers given that make this such an excellent collection. The articles combine deep historical knowledge, a penetrating grasp of the relevant theory and a strikingly clear writing style to shed light on a host of issues that need to be better understood if we are to get out of, and thereafter stay out of, the economic problems traditional policies continuously create. - Steven Kates, RMIT University, Melbourne, Australia

Money, Sound and Unsound by Joseph Salerno is modern Austrian monetary economics at its best. It appears at a time when monetary policy is about to commit again all the errors of the past that are so clearly exposed in this book. - Antony Mueller, Instituto Ludwig von Mises Brasil

This tome covers nearly thirty years of important contributions by Professor Salerno defining and defending sound money from its critics and pseudo friends. The volume be a must in the library of anyone, whether scholar, pundit, policy wonk, or educated laymen, who truly wants to understand our current crisis and participate in a meaningful way in a program for a return to sound money. - John P. Cochran, Metropolitan State College of Denver

This is an astoundingly thorough, incisive and even inspired book. It deserves to be mentioned in the same breath as Mises's The Theory of Money and Credit and Hulsmann’s the Ethics of Money Production. I have known and admired Joe Salerno for many years. May this be the first of many more of his books. If we are to attain monetary sanity, this publication will be one of only a very few that will lead the way. - Walter Block, Loyola University, New Orleans

Now in the midst of financial upheavals the book by Dr Salerno – Money, Sound and Unsound – is an eye opener. The book debunks various fallacies spread by popular media and various experts. The book also provides the reader with the necessary framework of thinking to navigate in the chaotic economic environment. This book is a must not only for the students of economics but also a must for every investor who wants to protect his wealth. - Frank Shostak, Mann Financial

Professor Salerno has written a magnificent book, fascinating and thorough in its scholarship of monetary theory and the history of monetary affairs. It is an indispensable reference for students of monetary economics, a truly "must read". - Thorsten Polleit, Frankfurt School of Finance & Management

Money: Sound and Unsound is an indispensable collection of 26 essays on that subject, written over the years by a brilliant American economist of the Austrian school, Joseph Salerno. In defending gold as the alternative to the government's fiat money, Salerno effectively takes on all comers, including Milton Friedman. Try his two scintillating essays on Alan Greenspan, or his learned discussion of war and inflation, or his straightforward essay "Gold Standards: True and False." ~ Gene Epstein, Barron's

To understand the current monetary chaos, it is necessary to trace briefly the international monetary developments of the 20th century, and to see how each set of unsound inflationist interventions has collapsed of its own inherent problems, only to set the stage for another round of interventions. The 20th-century history of the world monetary order can be divided into nine phases. Let us examine each in turn.

We can look back upon the "classical" gold standard, the Western world of the 19th and early 20th centuries, as the literal and metaphorical Golden Age. With the exception of the troublesome problem of silver, the world was on a gold standard, which meant that each national currency (the dollar, pound, franc, etc.) was merely a name for a certain definite weight of gold. The "dollar," for example, was defined as 1/20 of a gold ounce, the pound sterling as slightly less than 1/4 of a gold ounce, and so on. This meant that the "exchange rates" between the various national currencies were fixed, not because they were arbitrarily controlled by government, but in the same way that one pound of weight is defined as being equal to sixteen ounces.

The international gold standard meant that the benefits of having one money medium were extended throughout the world. One of the reasons for the growth and prosperity of the United States has been the fact that we have enjoyed one money throughout the large area of the country. we have had a gold or at least a single dollar standard within the entire country, and did not have to suffer the chaos of each city and county issuing its own money, which would then fluctuate with respect to the moneys of all the other cities and counties. The 19th century saw the benefits of one money throughout the civilized world. One money facilitated freedom of trade, investment, and travel throughout that trading and monetary area, with the consequent growth of specialization and the international division of labor.

It must be emphasized that gold was not selected arbitrarily by governments to be the monetary standard. Gold had developed for many centuries on the free market as the best money; as the commodity providing the most stable and desirable monetary medium. Above all, the supply and provision of gold was subject only to market forces, and not to the arbitrary printing press of the government.

The international gold standard provided an automatic market mechanism for checking the inflationary potential of government. It also provided an automatic mechanism for keeping the balance of payments of each country in equilibrium. As the philosopher and economist David Hume pointed out in the mid-18th century, if one nation, say France, inflates its supply of paper francs, its prices rise; the increasing incomes in paper francs stimulate imports from abroad, which are also spurred by the fact that prices of imports are now relatively cheaper than prices at home.

At the same time, the higher prices at home discourage exports abroad; the result is a deficit in the balance of payments, which must be paid for by foreign countries cashing in francs for gold. The gold outflow means that France must eventually contract its inflated paper francs in order to prevent a loss of all of its gold. If the inflation has taken the form of bank deposits, then the French banks have to contract their loans and deposits in order to avoid bankruptcy as foreigners call upon the French banks to redeem their deposits in gold. The contraction lowers prices at home, and generates an export surplus, thereby reversing the gold outflow until the price levels are equalized in France and in other countries as well.

It is true that the interventions of governments previous to the 19th century weakened the speed of this market mechanism, and allowed for a business cycle of inflation and recession within this gold-standard framework. These interventions were particularly: the governments' monopolizing of the mint, legal tender laws, the creation of paper money, and the development of inflationary banking propelled by each of the governments. But while these interventions slowed the adjustments of the market, these adjustments were still in ultimate control of the situation. So while the classical gold standard of the 19th century was not perfect, and allowed for relatively minor booms and busts, it still provided us with by far the best monetary order the world has ever known, an order which worked, which kept business cycles from getting out of hand, and which enabled the development of free international trade, exchange, and investment.For a recent study of the classical gold standard, and a history of the early phases of its breakdown in the 20th century, see Melchior Palyi, The Twilight of Gold, 1914–1936 (Chicago: Henry Regnery, 1972).

If the classical gold standard worked so well, why did it break down? It broke down because governments were entrusted with the task of keeping their monetary promises, of seeing to it that pounds, dollars, francs, etc., were always redeemable in gold as they and their controlled banking system had pledged. It was not gold that failed; it was the folly of trusting government to keep its promises. To wage the catastrophic war of World War I, each government had to inflate its own supply of paper and bank currency. So severe was this inflation that it was impossible for the warring governments to keep their pledges, and so they went "off the gold standard," i.e., declared their own bankruptcy, shortly after entering the war. All except the United States, which entered the war late, and did not inflate the supply of dollars enough to endanger redeemability.

But, apart from the United States, the world suffered what some economists now hail as the Nirvana of freely-fluctuating exchange rates (now called "dirty floats"), competitive devaluations, warring currency blocs, exchange controls, tariffs and quotas, and the breakdown of international trade and investment. The inflated pounds, francs, marks, etc., depreciated in relation to gold and the dollar; monetary chaos abounded throughout the world.

In those days there were, happily, very few economists to hail this situation as the monetary ideal. It was generally recognized that phase II was the threshold to international disaster, and politicians and economists looked around for ways to restore the stability and freedom of the classical gold standard.

How to return to the Golden Age? The sensible thing to do would have been to recognize the facts of reality, the fact of the depreciated pound, franc, mark, etc., and to return to the gold standard at a redefined rate: a rate that would recognize the existing supply of money and price levels. The British pound, for example, had been traditionally defined at a weight which made it equal to $4.86. But by the end of World War I, the inflation in Britain had brought the pound down to approximately $3.50 on the free foreign-exchange market. Other currencies were similarly depreciated. The sensible policy would have been for Britain to return to gold at approximately $3.50, and for the other inflated countries to do the same. Phase I could have been smoothly and rapidly restored. Instead, the British made the fateful decision to return to gold at the old par of $4.86.On the crucial British error and its consequence in leading to the 1929 depression, see Lionel Robbins, The Great Depression (New York: Macmillan, 1934).

They did so for reasons of British national "prestige," and in a vain attempt to reestablish London as the "hard money" financial center of the world. To succeed at this piece of heroic folly, Britain would have had to deflate severely its money supply and its price levels, for at a $4.86 pound British export prices were far too high to be competitive in the world markets. But deflation was now politically out of the question, for the growth of trade unions, buttressed by a nationwide system of unemployment insurance, had made wage rates rigid downward; in order to deflate, the British government would have had to reverse the growth of its welfare state. In fact, the British wished to continue to inflate money and prices. As a result of combining inflation with a return to an overvalued par, British exports were depressed all during the 1920s and unemployment was severe all during the period when most of the world was experiencing an economic boom.

How could the British try to have their cake and eat it at the same time? By establishing a new international monetary order which would induce or coerce other governments into inflating or into going back to gold at overvalued pars for their own currencies, thus crippling their own exports and subsidizing imports from Britain. This is precisely what Britain did, as it led the way, at the Genoa Conference of 1922, in creating a new international monetary order, the gold-exchange standard.

The gold-exchange standard worked as follows: The United States remained on the classical gold standard, redeeming dollars in gold. Britain and the other countries of the West, however, returned to a pseudo-gold standard, Britain in 1926 and the other countries around the same time. British pounds and other currencies were not payable in gold coins, but only in large-sized bars, suitable only for international transactions. This prevented the ordinary citizens of Britain and other European countries from using gold in their daily life, and thus permitted a wider degree of paper and bank inflation. But furthermore, Britain redeemed pounds not merely in gold, but also in dollars; while the other countries redeemed their currencies not in gold, but in pounds. And most of these countries were induced by Britain to return to gold at overvalued parities. The result was a pyramiding of United States on gold, of British pounds on dollars, and of other European currencies on pounds — the "gold-exchange standard," with the dollar and the pound as the two "key currencies."

Now when Britain inflated, and experienced a deficit in its balance of payments, the gold-standard mechanism did not work to quickly restrict British inflation. For instead of other countries redeeming their pounds for gold, they kept the pounds and inflated on top of them. Hence Britain and Europe were permitted to inflate unchecked, and British deficits could pile up unrestrained by the market discipline of the gold standard. As for the United States, Britain was able to induce the United States to inflate dollars so as not to lose many dollar reserves or gold to the United States.

The point of the gold-exchange standard is that it cannot last; the piper must eventually be paid, but only in a disastrous reaction to the lengthy inflationary boom. As sterling balances piled up in France, the United States, and elsewhere, the slightest loss of confidence in the increasingly shaky and jerry-built inflationary structure was bound to lead to general collapse. This is precisely what happened in 1931; the failure of inflated banks throughout Europe, and the attempt of "hard money" France to cash in its sterling balances for gold, led Britain to go off the gold standard completely. Britain was soon followed by the other countries of Europe.

The world was now back to the monetary chaos of World War I, except that now there seemed to be little hope for a restoration of gold. The international economic order had disintegrated into the chaos of clean and dirty floating exchange rates, competing devaluations, exchange controls, and trade barriers; international economic and monetary warfare raged between currencies and currency blocs. International trade and investment came to a virtual standstill; and trade was conducted through barter agreements conducted by governments competing and conflicting with one another. Secretary of State Cordell Hull repeatedly pointed out that these monetary and economic conflicts of the 1930s were the major cause of World War II.Cordell Hull, Memoirs (New York, 1948), vol. I, p. 81. Also see Richard N. Gardner, Sterling-Dollar Conspiracy (Oxford: Clarendon Press, 1956), p. 141.

The United States remained on the gold standard for two years, and then, in 1933–1934, went off the classical gold standard in a vain attempt to get out of the depression. American citizens could no longer redeem dollars in gold, and were even prohibited from owning any gold, either here or abroad. But the United States remained, after 1934, on a peculiar new form of gold standard, in which the dollar, now redefined to 1/35 of a gold ounce, was redeemable in gold to foreign governments and central banks. A lingering tie to gold remained. Furthermore, the monetary chaos in Europe led to gold flowing into the only relatively safe monetary haven, the United States.

The chaos and the unbridled economic warfare of the 1930s points up an important lesson: the grievous political flaw (apart from the economic problems) in the Milton Friedman-Chicago School monetary scheme for freely-fluctuating fiat currencies. For what the Friedmanites would do — in the name of the free market — is to cut all ties to gold completely, leave the absolute control of each national currency in the hands of its central government issuing fiat paper as legal tender — and then advise each government to allow its currency to fluctuate freely with respect to all other fiat currencies, as well as to refrain from inflating its currency too outrageously. The grave political flaw is to hand total control of the money supply to the Nation-State, and then to hope and expect that the State will refrain from using that power. And since power always tends to be used, including the power to counterfeit legally, the naivete, as well as the statist nature, of this type of program should be starkly evident.

And so, the disastrous experience of phase IV, the 1930s world of fiat paper and economic warfare, led the US authorities to adopt as their major economic war aim of World War II the restoration of a viable international monetary order, an order on which could be built a renaissance of world trade and the fruits of the international division of labor.

The new international monetary order was conceived and then driven through by the United States at an international monetary conference at Bretton Woods, New Hampshire, in mid-1944, and ratified by the Congress in July, 1945. While the Bretton Woods system worked far better than the disaster of the 1930s, it worked only as another inflationary recrudescence of the gold-exchange standard of the 1920s and — like the 1920s — the system lived only on borrowed time.

The new system was essentially the gold-exchange standard of the 1920s but with the dollar rudely displacing the British pound as one of the "key currencies." Now the dollar, valued at 1/35 of a gold ounce, was to be the only key currency. The other difference from the 1920s was that the dollar was no longer redeemable in gold to American citizens; instead, the 1930's system was continued, with the dollar redeemable in gold only to foreign governments and their central banks. No private individuals, only governments, were to be allowed the privilege of redeeming dollars in the world gold currency.

In the Bretton Woods system, the United States pyramided dollars (in paper money and in bank deposits) on top of gold, in which dollars could be redeemed by foreign governments; while all other governments held dollars as their basic reserve and pyramided their currency on top of dollars. And since the United States began the postwar world with a huge stock of gold (approximately $25 billion) there was plenty of play for pyramiding dollar claims on top of it. Furthermore, the system could "work" for a while because all the world's currencies returned to the new system at their pre-World War II pars, most of which were highly overvalued in terms of their inflated and depreciated currencies. The inflated pound sterling, for example, returned at $4.86, even though it was worth far less than that in terms of purchasing power on the market. Since the dollar was artificially undervalued and most other currencies overvalued in 1945, the dollar was made scarce, and the world suffered from a so-called dollar shortage, which the American taxpayer was supposed to be obligated to make up by foreign aid. In short, the export surplus enjoyed by the undervalued American dollar was to be partly financed by the hapless American taxpayer in the form of foreign aid.

There being plenty of room for inflation before retribution could set in, the US government embarked on its postwar policy of continual monetary inflation, a policy it has pursued merrily ever since. By the early 1950s, the continuing American inflation began to turn the tide of international trade. For while the United States was inflating and expanding money and credit, the major European governments, many of them influenced by "Austrian" monetary advisers, pursued a relatively "hard money" policy (e.g., West Germany, Switzerland, France, Italy). Steeply inflationist Britain was compelled by its outflow of dollars to devalue the pound to more realistic levels (for a while it was approximately $2.40).

All this, combined with the increasing productivity of Europe, and later Japan, led to continuing balance-of-payments deficits with the United States. As the 1950s and 1960s wore on, the United States became more and more inflationist, both absolutely and relatively to Japan and Western Europe. But the classical gold-standard check on inflation — especially American inflation — was gone. For the rules of the Bretton Woods game provided that the West European countries had to keep piling up their reserve, and even use these dollars as a base to inflate their own currency and credit.

But as the 1950s and 1960s continued, the harder-money countries of West Europe (and Japan) became restless at being forced to pile up dollars that were now increasingly overvalued instead of undervalued. As the purchasing power and hence the true value of dollars fell, they became increasingly unwanted by foreign governments. But they were locked into a system that was more and more of a nightmare. The American reaction to the European complaints, headed by France and DeGaulle's major monetary adviser, the classical gold-standard economist Jacques Rueff, was merely scorn and brusque dismissal. American politicians and economists simply declared that Europe was forced to use the dollar as its currency, that it could do nothing about its growing problems, and therefore the United States could keep blithely inflating while pursuing a policy of "benign neglect" toward the international monetary consequences of its own actions.

But Europe did have the legal option of redeeming dollars in gold at $35 an ounce. And as the dollar became increasingly overvalued in terms of hard money currencies and gold, European governments began more and more to exercise that option. The gold-standard check was coming into use; hence gold flowed steadily out of the United States for two decades after the early 1950s, until the US gold stock dwindled over this period from over $20 billion to $9 billion. As dollars kept inflating upon a dwindling gold base, how could the United States keep redeeming foreign dollars in gold — the cornerstone of the Bretton Woods system?

These problems did not slow down continued US inflation of dollars and prices, nor the United States policy of "benign neglect," which resulted by the late 1960s in an accelerated pileup of no less than $80 billion in unwanted dollars in Europe (known as Eurodollars). To try to stop European redemption of dollars into gold, the United States exerted intense political pressure on the European governments, similar but on a far larger scale to the British cajoling of France not to redeem its heavy sterling balances until 1931. But economic law has a way, at long last, of catching up with governments, and this is what happened to the inflation-happy US government by the end of the 1960s. The gold-exchange system of Bretton Woods — hailed by the US political and economic establishment as permanent and impregnable — began to unravel rapidly in 1968.

As dollars piled up abroad and gold continued to flow outward, the United States found it increasingly difficult to maintain the price of gold at $35 an ounce in the free gold markets at London and Zurich. Thirty-five dollars an ounce was the keystone of the system, and while American citizens have been barred since 1934 from owning gold anywhere in the world, other citizens have enjoyed the freedom to own gold bullion and coin. Hence, one way for individual Europeans to redeem their dollars in gold was to sell their dollars for gold at $35 an ounce in the free gold market. As the dollar kept inflating and depreciating, and as American balance-of-payments deficits continued, Europeans and other private citizens began to accelerate their sales of dollars into gold. In order to keep the dollar at $35 an ounce, the US government was forced to leak out gold from its dwindling stock to support the $35 price at London and Zurich.

A crisis of confidence in the dollar on the free gold markets led the United States to effect a fundamental change in the monetary system in March 1968. The idea was to stop the pesky free gold market from ever again endangering the Bretton Woods arrangement. Hence was born the "two-tier gold market." The idea was that the free gold market could go to blazes; it would be strictly insulated from the real monetary action in the central banks and governments of the world. The United States would no longer try to keep the free-market gold price at $35; it would ignore the free gold market, and it and all the other governments agreed to keep the value of the dollar at $35 an ounce forevermore.

The governments and central banks of the world would henceforth buy no more gold from the "outside" market and would sell no more gold to that market; from now on gold would simply move as counters from one central bank to another, and new gold supplies, free gold market, or private demand for gold would take their own course completely separated from the monetary arrangements of the world.

Along with this, the United States pushed hard for the new launching of a new kind of world paper reserve, Special Drawing Rights (SDRs), which it was hoped would eventually replace gold altogether and serve as a new world paper currency to be issued by a future World Reserve Bank; if such a system were ever established, then the United States could inflate unchecked forevermore, in collaboration with other world governments (the only limit would then be the disastrous one of a worldwide runaway inflation and the crackup of the world paper currency). But the SDRs, combatted intensely as they have been by Western Europe and the "hard-money" countries, have so far been only a small supplement to American and other currency reserves.

All pro-paper economists, from Keynesians to Friedmanites, were now confident that gold would disappear from the international monetary system; cut off from its "support" by the dollar, these economists all confidently predicted, the free-market gold price would soon fall below $35 an ounce, and even down to the estimated "industrial" nonmonetary gold price of $10 an ounce. Instead, the free price of gold, never below $35, had been steadily above $35, and by early 1973 had climbed to around $125 an ounce, a figure that no pro-paper economist would have thought possible as recently as a year earlier.

Far from establishing a permanent new monetary system, the two-tier gold market only bought a few years of time; American inflation and deficits continued. Eurodollars accumulated rapidly, gold continued to flow outward, and the higher free-market price of gold simply revealed the accelerated loss of world confidence in the dollar. The two-tier system moved rapidly toward crisis — and to the final dissolution of Bretton Woods.On the two-tier gold market, see Jacques Rueff, The Monetary Sin of the West (New York: Macmillan, 1972).

On August 15, 1971, at the same time that President Nixon imposed a price-wage freeze in a vain attempt to check bounding inflation, Mr. Nixon also brought the postwar Bretton Woods system to a crashing end. As European central banks at last threatened to redeem much of their swollen stock of dollars for gold, President Nixon went totally off gold. For the first time in American history, the dollar was totally fiat, totally without backing in gold. Even the tenuous link with gold maintained since 1933 was now severed. The world was plunged into the fiat system of the 1930s — and worse, since now even the dollar was no longer linked to gold. Ahead loomed the dread spectre of currency blocs, competing devaluations, economic warfare, and the breakdown of international trade and investment, with the worldwide depression that would then ensue.

What to do? Attempting to restore an international monetary order lacking a link to gold, the United States led the world into the Smithsonian Agreement on December 18, 1971.

The Smithsonian Agreement, hailed by President Nixon as the "greatest monetary agreement in the history of the world," was even more shaky and unsound than the gold-exchange standard of the 1920s or than Bretton Woods. For once again, the countries of the world pledged to maintain fixed exchange rates, but this time with no gold or world money to give any currency backing. Furthermore, many European currencies were fixed at undervalued parities in relation to the dollar; the only US concession was a puny devaluation of the official dollar rate to $38 an ounce. But while much too little and too late, this devaluation was significant in violating an endless round of official American pronouncements, which had pledged to maintain the $35 rate forevermore. Now at last the $35 price was implicitly acknowledged as not graven on tablets of stone.

It was inevitable that fixed exchange rates, even with wider agreed zones of fluctuation, but lacking a world medium of exchange, were doomed to rapid defeat. This was especially true since American inflation of money and prices, the decline of the dollar, and balance-of-payments deficits continued unchecked.

The swollen supply of Eurodollars, combined with the continued inflation and the removal of gold backing, drove the free-market gold price up to $215 an ounce. And as the overvaluation of the dollar and the undervaluation of European and Japanese hard money became increasingly evident, the dollar finally broke apart on the world markets in the panic months of February–March 1973. It became impossible for West Germany, Switzerland, France and the other hard money countries to continue to buy dollars in order to support the dollar at an overvalued rate. In little over a year, the Smithsonian system of fixed exchange rates without gold had smashed apart on the rocks of economic reality.

With the dollar breaking apart, the world shifted again, to a system of fluctuating fiat currencies. Within the West European bloc, exchange rates were tied to one another, and the United States again devalued the official dollar rate by a token amount to $42 an ounce. As the dollar plunged in foreign exchange from day to day, and the West German mark, the Swiss franc, and the Japanese yen hurtled upward, the American authorities, backed by the Friedmanite economists, began to think that this was the monetary ideal. It is true that dollar surpluses and sudden balance-of-payments crises do not plague the world under fluctuating exchange rates. Furthermore, American export firms began to chortle that falling dollar rates made American goods cheaper abroad, and therefore benefitted exports. It is true that governments persisted in interfering with exchange fluctuations ("dirty" instead of "clean" floats), but overall it seemed that the international monetary order had sundered into a Friedmanite utopia.

But it became clear all too soon that all is far from well in the current international monetary system. The long-run problem is that the hard-money countries will not sit by forever and watch their currencies become more expensive and their exports hurt for the benefit of their American competitors. If American inflation and dollar depreciation continues, they will soon shift to the competing devaluation, exchange controls, currency blocs, and economic warfare of the 1930s.

But more immediate is the other side of the coin: the fact that depreciating dollars means that American imports are far more expensive, American tourists suffer abroad, and cheap exports are snapped up by foreign countries so rapidly as to raise prices of exports at home (e.g., the American wheat-and-meat price inflation). So that American exporters might indeed benefit, but only at the expense of the inflation-ridden American consumer. The crippling uncertainty of rapid exchange-rate fluctuations was brought starkly home to Americans with the rapid plunge of the dollar in foreign-exchange markets in July 1973.

Since the United States went completely off gold in August 1971 and established the Friedmanite fluctuating fiat system in March 1973, the United States and the world have suffered the most intense and most sustained bout of peacetime inflation in the history of the world. It should be clear by now that this is scarcely a coincidence. Before the dollar was cut loose from gold, Keynesians and Friedmanites, each in their own way devoted to fiat paper money, confidently predicted that when fiat money was established, the market price of gold would fall promptly to its nonmonetary level, then estimated at about $8 an ounce.

In their scorn of gold, both groups maintained that it was the mighty dollar that was propping up the price of gold, and not vice versa. Since 1971, the market price of gold has never been below the old fixed price of $35 an ounce, and has almost always been enormously higher. When, during the 1950s and 1960s, economists such as Jacques Rueff were calling for a gold standard at a price of $70 an ounce, the price was considered absurdly high. It is now even more absurdly low. The far higher gold price is an indication of the calamitous deterioration of the dollar since "modern" economists had their way and all gold backing was removed.

It is now all too clear that the world has become fed up with the unprecedented inflation, in the United States and throughout the world, that has been sparked by the fluctuating fiat currency era inaugurated in 1973. We are also weary of the extreme volatility and unpredictability of currency exchange rates. This volatility is the consequence of the national fiat-money system, which fragmented the world's money and added artificial political instability to the natural uncertainty in the free-market price system. The Friedmanite dream of fluctuating fiat money lies in ashes, and there is an understandable yearning to return to an international money with fixed exchange rates.

Unfortunately, the classical gold standard lies forgotten, and the ultimate goal of most American and world leaders is the old Keynesian vision of a one-world fiat paper standard, a new currency unit issued by a World Reserve Bank (WRB). Whether the new currency be termed "the bancor" (offered by Keynes), the "unita" (proposed by World War II US Treasury official Harry Dexter White), or the "phoenix" (suggested by The Economist) is unimportant. The vital point is that such an international paper currency, while indeed free of balance-of-payments crises (since the WRB could issue as much bancors as it wished and supply them to its country of choice), would provide for an open channel for unlimited world-wide inflation, unchecked by either balance-of-payments crises or by declines in exchange rates.

The WRB would then be the all-powerful determinant of the world's money supply and its national distribution. The WRB could and would subject the world to what it believes will be a wisely-controlled inflation. Unfortunately, there would then be nothing standing in the way of the unimaginably catastrophic economic holocaust of world-wide runaway inflation, nothing, that is, except the dubious capacity of the WRB to fine-tune the world economy.

While a world-wide paper unit and central bank remain the ultimate goal of world's Keynesian-oriented leaders, the more realistic and proximate goal is a return to a glorified Bretton Woods scheme, except this time without the check of any backing in gold. Already the world's major central banks are attempting to "coordinate" monetary and economic policies, harmonize rates of inflation, and fix exchange rates. The militant drive for a European paper currency issued by a European central bank seems on the verge of success. This goal is being sold to the gullible public by the fallacious claim that a free-trade European Economic Community (EEC) necessarily requires an overarching European bureaucracy, a uniformity of taxation throughout the EEC, and, in particular, a European central bank and paper unit. Once that is achieved, closer coordination with the Federal Reserve and other major central banks will follow immediately. And then, could a World Central Bank be far behind? Short of that ultimate goal, however, we may soon be plunged into yet another Bretton Woods, with all the attendant crises of the balance of payments and Gresham's Law that follow from fixed exchange rates in a world of fiat moneys.

As we face the future, the prognosis for the dollar and for the international monetary system is grim indeed. Until and unless we return to the classical gold standard at a realistic gold price, the international money system is fated to shift back and forth between fixed and fluctuating exchange rates, with each system posing unsolved problems, working badly, and finally disintegrating. And fueling this disintegration will be the continued inflation of the supply of dollars and hence of American prices, which show no sign of abating. The prospect for the future is accelerating and eventually runaway inflation at home, accompanied by monetary breakdown and economic warfare abroad. This prognosis can only be changed by a drastic alteration of the American and world monetary system: by the return to a free-market commodity money such as gold, and by removing government totally from the monetary scene.

This article is excerpted from What Has Government Done to Our Money? An MP3 audio file of this article, read by Jeff Riggenbach, is available for download.

No doubt sensing the danger of the public's growing recognition of the superiority of gold over paper fiat currency, the US government has been stepping up its regulation of the gold market. Last week a House subcommittee hearing investigated the allegedly underhanded practices of a major gold dealer — all in the interests of protecting the consumer, of course!

In this context, it's worthwhile to review the basics of Austrian economics regarding money and the special role of gold.

Carl Menger was the founder of the Austrian School proper, with his Grundsätze (translated as Principles of Economics) published in 1871. In addition to being one of the three pioneers credited with the discovery of modern subjectivist price theory (which overthrew the Classical School's labor theory of value), Menger also gave economics the first satisfactory explanation of the origin of money.

Most people assume that since money is a very useful institution, and since it obviously is not "natural" but was developed by humans, therefore some wise king or group of experts must have deliberately invented money. But this is a classic fallacy that Friedrich Hayek spent much of his career attacking. There are many aspects of society — including language and the market economy itself — that were not consciously planned by a group of experts. Drawing on the Scottish thinker Adam Ferguson, Hayek said they are the products of human action but not of human design.

This approach fits Menger's theory of the origin of money. (For a full exposition, including the later contributions of Mises, see this article.) Nobody set out to consciously create a medium of exchange, yet that is what self-interested individuals ended up producing.

Specifically, here is what Menger says must have happened: First, there must have been a time when humans had goods and traded with each other before there existed a money commodity. Even at this early stage, different goods would have different degrees of marketability (or liquidity). For example, a farmer who wanted to trade some of his eggs in order to obtain new shirts would probably have a much easier time than an astronomer who wanted to trade a fancy telescope to obtain new shirts.

Notice that marketability is not the same thing as market value. A fancy telescope might be "worth" dozens of new shirts, whereas it might take several eggs just to buy one shirt. But we say that the eggs are far more marketable or liquid, because the farmer won't have to spend a long time searching out the appropriate buyer. In contrast, if the astronomer is willing to wait several weeks before his sale, he can probably achieve a much better price.

Menger saw the implications of this difference in marketability. People who wanted to trade away goods that were relatively unmarketable would be willing to accept goods in exchange that they didn't directly want, just so long as the new goods were more marketable than the ones they started out with. For example, our astronomer might not be interested in obtaining more pigs — he's trying to get new shirts, after all — but if he stumbles across a farmer willing to trade 3 pigs for a fancy telescope, then the astronomer will probably jump on the offer. He knows he is far more likely to find a tailor offering to sell new shirts for pigs than a tailor offering to sell new shirts for a fancy telescope.

Once this process began, it would snowball. Those goods that started out as more marketable would see their marketability enhanced because of this fact. In other words, those goods that initially had a large market — goods such as butter, eggs, and so forth — would gain an even bigger market once traders began accepting them as stepping stones to the goods they ultimately desired.

In the end, Menger reasoned, one or more goods would eventually be acceptable in trade to virtually every single person in the community. That is, everyone who wanted to trade away goods, would be willing to accept one particular good as a stepping stone to obtaining the goods ultimately desired.

Notice that we have just explained the "spontaneous" emergence of money out of a state of barter. For money is simply a commodity that can stand on one side of every transaction. It is the most marketable and liquid of all goods.

No king or group of experts invented money. It developed naturally on the market.

Many Austrian economists, including Ludwig von Mises, have been staunch advocates of "sound money," stressing the importance of linking paper currencies to the precious metals or, better yet, returning the production of money to the free market where it belongs.

Sometimes the free-market advocates of gold and silver may sound as if they are "centrally planning" the money market. Strictly speaking, the free-market economist shouldn't say, "The government ought to pass laws forcing everyone to use gold as money."

Rather, the free-market economist should say that the government ought to stop meddling in the areas of money (and banking) altogether. Then, in a genuinely free market, we can predict that people the world over would once again return to using gold and silver as commodity moneys.

We have seen above the general process through which the market first developed money. The crucial point is that money emerged from barter as an actual good that had uses besides serving as a medium of exchange. Historically, many different commodities have been money, including tobacco, cattle, and even cigarettes (in a World War II POW camp, as famously described in this article).

However, as "the market" became one global market in the 19th century, people the world over gravitated toward the use of gold (for large transactions) and silver (for smaller ones) as the moneys of choice. This is why gold and silver tend to be identified as "the market's money" in the age of modern commerce. There is nothing magical about this selection, and if conditions change, other commodities could displace the two precious metals. But it's worthwhile to review the reasons for their (current) superiority.

A convenient money will have several properties. For example, it should be physically durable and easy to transport. It should also be easily recognizable and homogeneous across units. Further, it should be easily subdivided into smaller pieces. Finally, its market value should be convenient for typical purchases.

Gold and silver score well on all counts, while other historical money commodities do poorly on one or more criteria. For example, cattle are hard to ship to a foreign merchant, and you can't "make change" with a cow. Other metals such as copper are too plentiful to be useful as money; it would take a huge quantity of copper (as opposed to gold) to make a large purchase. And although diamonds and emeralds might at first appear suitable, the problem is that each item is hard for the average trader to appraise; diamonds aren't interchangeable the way gold bars are.

Historically, governments weaned their subjects off gold and silver by first getting them to hold paper notes that were legal claims on the precious metals. In other words, the only reason Americans originally carried around pieces of paper featuring pictures of US presidents was that they were a convenient form of carrying around gold and silver. Notice the difference between a gold certificate and a superficially similar bill from your wallet or purse:

Alas, one of the first acts of FDR was to end the paper dollar's link to gold, in 1933. However, under the Bretton Woods agreement after World War II, the United States still pledged that it would redeem paper dollars presented by other central banks for gold.

Plagued by the costs of the Vietnam War and the Great Society, Richard Nixon finally ended this pledge too, in 1971. The rest, as they say, is history:

With no constraints on the printing press, the Federal Reserve flooded the world with more dollars, causing prices to take off.

Governments and central banks don't want to tie their paper currencies to gold, and they certainly don't want to exit the monetary field altogether. This partly explains the recent crackdown on gold dealers:

At House subcommittee hearings Thursday on the advertising tactics of gold dealers, regulators discussed investigating some companies for using aggressive sales tactics to sell overpriced gold coins.

Under a bill in Congress, gold dealers would have to disclose to buyers the purchase price and the melt and resale values of the coin or bullion. …

At the hearing, Rep. Anthony Weiner (D-NY), said: "The television gold industry is an industry, and is led by one particular company that has built up the industry on fear, lies and rip-offs."

But as this other news article explains, even central bankers are getting nervous:

Europe's central banks have all but halted sales of their gold reserves, ending a run of large disposals each year for more than a decade.…

The shift away from gold selling comes as European central banks reassess gold amid the financial crisis and Europe's sovereign debt crisis.

In the 1990’s and 2000’s, central banks swapped their non-yielding bullion for sovereign debt, which gives a steady annual return. But now, central banks and investors are seeking the security of gold.

Try as they might, central bankers and politicians can't repeal the laws of economics. They can use various means to foist unbacked paper currencies on their subjects, but printing up more bills will still lead to rising prices.

The Fed's "bold" moves may have temporarily averted a crash in the US financial markets, and the European Central Bank's interventions may have postponed a string of defaults by indebted governments.

But more and more investors — including the central bankers themselves — know that these stopgap measures merely pushed back the day of reckoning. As the crisis looms, people are rushing back to gold.

Having survived the assaults of ignorant moralists before the Reformation, the foreign-exchange market was subjected, during the far more secular age of the late 16th century onward, to the assaults of regulators on behalf of the nation-state. Writers who have been misnamed "bullionists" adopted the ignorant view that an outflow of gold or silver bullion abroad was iniquitous, and that this calamity was brought about by the machinations of evil foreign exchange dealers, who deliberately sought gain by depreciating he value of the nation's currency.

Nowhere was there any insight that the outflow of bullion might have been performing an economic function, or was the result of underlying supply-and-demand forces. Despite their insights into Gresham's law and debasement, Thomas Smith and Thomas Gresham would have to be placed in the "bullionist" category. The policy conclusion of the bullionists was all too simple — the state should outlaw the export of bullion and should severely regulate or even nationalize the foreign exchange market.

The exchange dealers battled back, with sensible and powerful arguments. Thus in 1576 they argued, in a "Protest against the State Control of Exchange Business," that state intervention would cause a drying up of commerce. On the low value of the English pound, they replied, "we can say nothing but that our exchanges are made with a mutual consent between merchant and merchant, and that abundance of the deliveries or of the takers make the exchange rise and fall."

One prominent bullionist of the early 17th century was Thomas Milles (ca. 1550 — ca. 1627). In a series of tracts from 1601 to 1611, Milles advances the old bullionist position. Foreign exchange transactions, Milles opined, were evil; they were institutions with which private merchants and bankers, "covetous persons (whose end is private gain)," rule in the place of kings. Something new, however, had been added. For the powerful East India Company had been chartered in 1600, to monopolize all trade with the Far East and the Indies.

The East India trade was unique in that Europeans purchased a great deal of valuable muslins and spices, but the Indies in turn bought very little from Europe except gold and silver. European nations, therefore, had an "unfavorable balance of trade" with the Far East, and the India trade therefore quickly became a favorite target for mercantilist writers. Not only were goods being imported from the East as against few exports, but specie, bullion, seemed to flow eternally eastward. Milles therefore took up the bullionist cudgels by calling for restriction or prohibition of the Indies trade, and attacking the activities of the East India Company.

Milles was also eager to intensify regulations against the Merchant Adventurers, the governmentally privileged monopoly for the export of woolen cloth to the Netherlands. Instead, he craved a return to the old, privileged raw-wool export monopoly of the Merchant Staplers. In fact, Milles went so far as to call the old regulated Stapler trade the "first step towards heaven."

It is certainly likely that Milles's eagerness to regulate and prohibit foreign trade and bullion flows was connected with his own occupation as a customs official. The more regulation, the more work and power for Thomas Milles.

Stung to the quick, the secretary of the Merchant Adventurers, John Wheeler (ca. 1553–1611) replied to Milles's charges in his Treatise of Commerce, in 1601. Wheeler upheld the "orderly competition" of the 3,500 merchant members joined together in the privileged monopoly, as against the unorganized, dispersed, "straggling and promiscuous trade" of free competition. He also engaged in semantic trickery by asserting that monopoly by definition means only "single seller"; hundreds of merchants linked together into a privileged export company were able, after all, to act virtually as one privileged firm. In Wheeler's own words, these merchants were "united and held together by their good government and by their politic and merchantilike orders" — backed up, we must not forget, by the armed might of the state.

Sneering at the idea of free competition, Wheeler smugly opined that any merchant who loses a little liberty will be better off "being restrained … in that estate, than if he were left to his own greedy appetite." When John Kayll, over a decade later in The Trades Increase (1615), protested that the monopoly of the Merchant Adventurers would "unjustly keep others out forever," his pamphlet was suppressed by the archbishop of Canterbury and he earned a stint in jail for his pains.See Joyce Oldham Appleby, Economic Thought and Ideology in Seventeenth-Century England (Princeton, N.J.: Princeton University Press, 1978), p. 106.

Later, in the 1650s, Thomas Violet had a Milles-type motive for special pleading in his call for prohibition of the export of bullion. Violet had been a professional "searcher" and government informer seeking out violations of the law prohibiting the export of bullion. Now, in A True discoverie to the commons of England (1651), he sought to reinstate that good old law, and he accompanied his call for reinstatement of bullion prohibition with a request that he himself be employed once again to seek out violators. To the embarrassing fact that he, Violet, had himself been convicted and punished for violating these very provisions, he countered with a ready quip — "an old deer-stealer is the best keeper of a park."

The most distinguished bullionist of the early 17th century was Gerard de Malynes (d.1641). Malynes was a Fleming born in Antwerp to the prominent van Mechelen family, probably changing his name to Malynes when he emigrated to London in the 1580s (perhaps in response to the Spanish persecution of Protestants in the Netherlands in that era). Malynes was listed as an alien in the records of that period, and as a member of the "Dutch" Protestant Church. He is also depicted in the records as a "merchant stranger," that is, as a merchant from abroad.

Malynes turned out to be a speculator and an unscrupulous, even crooked, businessman, embezzling money from his Dutch business associates. He was often on the verge of bankruptcy, and his partner and father-in-law, the Antwerp-born Willem Vermuyden, died in debtors' prison. Malynes, nonetheless, was a linguist and highly educated scholar, deeply interested in literature, the Latin language, mathematics, and classical Greek philosophy. He was also well-versed in Scholastic doctrine.

A member of a royal commission of 1600 to study economic problems, Malynes began his bullionist writings in 1601, in particular A Treatise on the Canker of England's Commonwealth, and published many tracts into the 1620s. Like Gresham and the 16th-century bullionists, Malynes fulminated against the foreign-exchange dealers, asserting superficially and incorrectly that exchange rates were set by willful conspiracies of exchange dealers. Malynes was more rigorous than previous bullionists; instead of institutions to control exchange dealings, he advocated a government "bank" which would enjoy a monopoly on all foreign exchange transactions.

Intertwined with his star-crossed business career was Malynes's service in government, becoming at various times a top bureaucrat at the Royal Mint and a financial adviser to the crown. Malynes also had a personal stake in the revival of rigorous exchange control, for he himself eagerly anticipated filling the resurrected post of royal exchanger. To Malynes, there was a "just" exchange rate at the legal par, and the government's task was to enforce it.

In an earlier tract in 1601, Saint George for England Allegorically Described, Malynes, harking back to an old theme, denounced foreign exchange dealings as "usury," and expressed the hope that by tight control this usury could die a gradual death.

To advocate rigorous exchange control, Malynes of course had to deny that the foreign exchange market could in any way equilibrate or regulate itself, or that exchange rates were set by supply-and-demand forces. To Malynes goes the dubious credit for the emergence of the spurious and pernicious "terms-of-trade" fallacy. This doctrine argues that a balance of trade deficit and export of bullion will not regulate itself. For higher foreign exchange rates and cheaper domestic currency will not, as one might believe, spur exports and retard imports. Instead, the "unfavorable" terms of trade of, say, the pound in terms of foreign currency will lead to even more imports and fewer exports, thus driving more bullion out of the country.

Even if a cheaper pound will bring in less foreign-exchange revenue (a highly unlikely event seen more often in armchair speculation than in practice), one wonders where the English would continue to find either foreign currency or specie to pay for the higher-priced foreign products. Surely the specie would eventually run out, and for that reason alone some market mechanism would have to come into play to restrict foreign imports or the export of specie.

Thus Malynes managed to take the absurd position that, whatever happens in the foreign exchange market, specie will keep flowing out of England: flowing out if the pound should be expensive, since this will restrict exports and encourage imports (a correct insight), but also flowing out if the reverse happens, because of the "terms-of-trade" argument. The specie outflow was therefore blamed on the metaphysical malevolence of the exchange dealers, and it could only be cured by severe government control, including prohibition of the export of bullion.

Malynes also advocated control of the exchange rate at the legal mint par, which would mean in the context of the time a substantial appreciation, or higher value, of the pound sterling. Yet, continuing in the faulty terms-of-trade mode, Malynes saw no problem of specie outflow from such a marked appreciation of the currency. In fact, he hailed the higher domestic prices that would supposedly draw more specie into the country.

In a similar bizarre twist, Malynes, correctly noting that the inflationary influx of specie from the New World had hit the other countries of western Europe before coming into England, concluded that this was a terrible event for England. For instead of realizing that lower prices made English goods more competitive abroad, Malynes concluded that these "unfavorable terms of trade" put England into a poor competitive position and led to a permanent outflow of specie.

In view of his record in propounding tissues of egregious fallacies, it is curious that Malynes has had a good press among historians of economic thought, even among those who disagree with his basic outlook. They seem to laud him for recognizing that prices vary directly with the quantity of money, so that a country losing gold will find its prices falling, whereas a country accumulating gold will see its prices rise. But Malynes, eager to indict the workings of international prices and exchanges rather than explain how they work, was scarcely willing to develop the full implication of his occasional insights. Furthermore, considering that this "quantity theory" had long been known, and developed and integrated for centuries, by the Spanish Scholastics, Bodin, and others, Malynes's achievements seem dubious at best.

England suffered a severe recession in the early 1620s, and Gerard Malynes returned to the attack, publishing a series of tracts repeating his well-known views, and calling for stringent measures to curb the Merchant Adventurers and especially the East India Company, as well as any other traders who dared to export bullion from the kingdom. His influence was bolstered by having been a member of the royal commission on the exchanges in 1621.

Taking up the torch in defense of the Merchant Adventurers was one of its members, Edward Misselden (d. 1654). In a tract entitled Free Trade or the Means to Make Trade Flourish (1622), following service on a Privy Council committee of inquiry on the depression of trade, Misselden advanced somewhat beyond Malynes's analysis. He acknowledged that bullion was exported from England, not due to the machinations of wicked exchange dealers, but from imports exceeding exports, from what would later be called an "unfavorable balance of trade."

Misselden, then, was not concerned with regulating the exchanges. But he did want the state to force a favorable balance into being by subsidizing exports, restricting or prohibiting imports, and cracking down on the export of bullion. In short, he called for the usual set of mercantilist measures. Misselden was largely concerned to defend his Merchant Adventurers.

Like Wheeler a generation earlier, he maintained that his company was not at all a monopolist, but simply the organization of orderly and structured competition. Besides, wrote Misselden, his Merchant Adventurers exported cloth to Europe and therefore fitted in with the interests of England. The truly evil firm was the privileged East India Company, which had a decidedly unfavorable balance of trade of its own with the Indies, and which continually exported bullion abroad.

Misselden now entered into a series of angry pamphlet debates with Malynes, who replied in the same year with The Maintenance of Free Trade. (Neither party, of course, had the slightest interest in what would now be called "free trade.") In 1623, Misselden accepted a post as deputy governor of the Merchant Adventurers in Holland, perhaps as a reward for his stirring defense of the company in the public prints. But, in addition, the East India Company, seeing in Misselden an effective champion and a troublesome foe, made him a member and one of their commissioners in Holland during the same year.

As a result, when his second pamphlet, The Circle of Commerce, was published in 1623, Misselden displayed a miraculous change of heart. For the East India Company had been suddenly transformed from villain to hero. Misselden, quite sensibly, now pointed out that while the East India Company did export specie in exchange for products from the Indies, it can and does re-export these goods in exchange for specie.

The outstanding defender of the East India Company in the early 17th century was one of its prominent directors, Sir Thomas Mun (1571–1641). Mun was early engaged as a merchant in the Mediterranean trade, especially with Italy and the Middle East. In 1615, Mun was elected a director of the East India Company, and after that he "spent his life in actively promoting its interests." He entered the lists on behalf of the company in 1621, with his tract, A Discourse of Trade from England unto the East-Indies.

The following year he and Misselden were both members of the Privy Council committee of inquiry. Mun's second and major work, England's Treasure by Forraign Trade, or the Balance of Forraign Trade is the Rule of our Treasure, taking a broader view of the economy, was written around 1630 and published posthumously by Mun's son John in 1664. When published, it carried the stamp of approval of Henry Bennett, secretary of state in the Restoration government, and also an architect of England's mercantilist policy against the Dutch. The pamphlet was highly influential and was reprinted in several editions, the last being published in 1986.

Thomas Mun set forth what would become the standard mercantilist line. He pointed out that there was nothing particularly evil about the East India Company trade. The company imports valuable drugs, spices, dyes, and cloth from the Indies, and it re-exports most of these products to other countries. Overall, in fact, the company has actually imported more specie than it has exported. In any case, the focus of English policy should not be on the specific trade of one company or with one country, but on the overall or general balance of trade. There it must make sure that the country exports more than it purchases from abroad, thereby also increasing the wealth of the nation. As Mun succinctly put it at the beginning of England's Treasure, "The ordinary means to increase our wealth and treasure is by foreign trade, wherein we must ever observe this rule: to sell more to strangers yearly than we consume of theirs in value."

To that end, Mun advocated sumptuary laws banning consumption of imported goods, protective tariffs, and subsidies and directives to consume domestic manufactures. Mun, on the other hand, opposed any direct restrictions on the export of bullion, such as conducted by the East India Company.

Mun was wise enough in combating the fallacies of Malynes and Misselden. Against Malynes, he pointed out that the movements of the exchange rate reflect, not the manipulations of bankers and dealers, but the supply and demand of currencies: "That which causes an under or overvaluing of monies by exchange is the plenty or scarcity thereof."

Misselden had advocated debasement of the currency as a means of increasing the price level. Such increase, Misselden had argued in pre-Keynesian fashion, "will be abundantly recompensed unto all in the plenty of money, and quickening of trade, in every man's hand." As a leader of the Merchant Adventurers, Misselden was undoubtedly highly interested in the spur that debasement would give to exports. But Mun denounced debasement, first as bringing confusion by changing the measure of value, and second by increasing prices all around: "If the common measure be changed, our lands, leases, wares both foreign and domestic, must alter in proportion."

Neither did Mun bend his energies towards an export surplus because he was enamored of the idea of accumulating specie in England. Adhering to the quantity theory of money, Mun realized that such accumulation would simply drive prices up, which would not only be to no avail but would discourage exports. Mun wanted to accumulate specie not for its own sake, nor to drive up prices at home, but to "drive trade," to increase foreign trade still further. An expansion of foreign trade per se seems to be Thomas Mun's main objective. And this overriding goal is not very puzzling from a leader of the great East India Company.

Furthermore, foreign trade, as fully for Thomas Mun as for Montaigne, increased the national power — as well as the power of English traders — at the expense of other nations. England and her inhabitants only wax great at the expense of foreigners. As Mun put it succinctly, in trade "one man's necessity becomes another man's opportunity," and "one man's loss is another man's gain." In an odd prefigurement of the Keynesian view that national debt held at home is immaterial because "we only owe it to ourselves," Mun and his fellow mercantilists considered internal trade unimportant because there we only transfer wealth among ourselves. The export balance in foreign trade then becomes of crucial importance, so that the export merchant becomes by far the most productive occupation in the economy.

That Mun was far from being a primitive inflationist is seen by the scorn he properly and contemptuously heaped upon the common plea — and favorite mercantilist complaint — that business and the economy were suffering from a "scarcity of money." (The conclusion invariably drawn from such analysis is that the government was duty-bound to do something quickly to augment the money stock.) Mun wittily riposted in his Discourse of Trade,

concerning the evil or want of silver, I think it hath been, and is a general disease of all nations, and so will continue until the end of the world; for poor and rich complain they never have enough; but it seems that the malady is grown mortal here with us, and therefore it cries out for remedy. Well, I hope it is but imagination maketh us sick, when all our parts be sound and strong.

Thomas Mun may have been the most prominent and sophisticated of the early 17th-century mercantilists in England. Yet, as Schumpeter points out, these were all pamphleteers not particularly interested in analysis of the economy, special pleaders rather than aspiring scientists.As Schumpeter puts it, these men were "special pleaders for or against some individual interest, such as the Company of Merchant Adventurers or the East India Company; advocates or foes of a particular measure or policy…. All of them flourished … owing to the rapid increase of the opportunities for printing and publishing. Newspapers also, rare ventures in the sixteenth century, became plentiful in the seventeenth." J.A. Schumpeter, History of Economic Analysis (New York: Oxford University Press, 1954), pp. 160–61.

Perhaps the best economic analyst of all in this period was Rice Vaughn, whose A Discourse of Coin and Coinage, though published in 1675, was written in the mid-1620s. Vaughn held, in the first place, that the disappearance of silver during this period was the effect of what we now call "Gresham's law" — the bimetallic undervaluation by the English government of silver as against gold. Since silver, rather than gold, was the money for most transactions, this undervaluation had a certain deflationary effect.

In the course of his tract, Vaughn pointed out that an export surplus will not have the desired effect of bringing precious metals into the kingdom if the value of the gold or silver pound in England is low in terms of purchasing power; for then goods will be imported instead of the monetary metals, and the export surplus will disappear.Barry E. Supple, Commercial Crisis and Change in England, 1600–1642 (Cambridge: Cambridge University Press, 1964), pp. 219–20.

Vaughn was also astute enough to recognize that prices do not all move together when the value of money changes; for example, that domestic prices usually lag behind the debasement or devaluation of money standards.

Most importantly, Rice Vaughn, remarkably, harked back to the Scholastic, continental subjective-utility and scarcity tradition in the determination of the values and prices of goods. Vaughn concisely pointed out that the value of a good is dependent on its subjective utility and hence demand by consumers ("Use and delight, or the opinion of them, are the true causes why all things have a Value and Price set upon them"), while the actual price is determined by the interaction of this subjective utility with the relative scarcity of the good ("the proportion of that value and price is wholly governed by rarity and abundance").Appleby, op. cit., note 6, pp. 49, 179; also see Terence W. Hutchison, Before Adam Smith: The Emergence of Political Economy, 1662–1776 (Oxford: Basil Blackwell, 1988), p. 386.

This article is excerpted from An Austrian Perspective on the History of Economic Thought, vol. 1, Economic Thought Before Adam Smith. An MP3 audio file of this article, read by Jeff Riggenbach, is available for download.

The honor — if that be the proper term — of being the first English mercantilist writer should have gone, for four centuries, to Sir Thomas Smith the Elder (1513–1577). Instead, his remarkable work, A Discourse on the Commonwealth of this Realm of England, written in 1549 and published anonymously in 1581, was at first unidentified, and since its 1893 reprint has been incorrectly attributed to another Tudor official, John Hales (d. 1571).

Thomas Smith was born into a poor family of small shepherds in the county of Essex. Impoverished but brilliant, Smith managed to enter Cambridge, where his scholarly abilities were soon recognized. There he rose to become Regius Professor of civil law, and then vice chancellor of the university. Smith was a notable orator and a learned and brilliant polymath who wrote books on Greek pronunciation and English spelling, and was deeply interested in mathematics, chemistry, linguistics, and history.

Smith embarked on a career as politician and bureaucrat by becoming a secretary under the protectorate of Lord Somerset, from 1547 to 1549. Though an Anglican, Smith was a moderate who cared little for religious matters, so he was able to serve as privy councillor under Catholic Queen Mary on the recommendation of his old Cambridge colleague, the Catholic Bishop Stephen Gardiner. Under Queen Elizabeth, his influence continued through the powerful position at court of his old Cambridge student, Sir William Cecil, later Lord Burghley. Smith, however, was often out of power, a fate helped by his arrogant, boorish, and feisty personality.

Thomas Smith was a bitter critic of debasement, and he therefore became a vocal opponent of his mentor Lord Somerset's policy of repeated debasement in order to acquire increased revenue for the Crown. Sent into exile from the court in 1549, Smith brooded and then did what was characteristic of him — marshaled and wrote down his thoughts in the form of a treatise. This penetrating, lively work was written in the form of a dialogue among several characters, with The Doctor being the spokesman for the author's own views. Later Smith was to repeat the dialogue form in his book Dialogue on the Queen's Marriage (1561). The former work was not meant for publication, Smith noting in the tract that "it is dangerous to meddle in the king's matters," as indeed it was.

The basic thrust of the Discourse on the Commonwealth was an attack on debasement, and its consequences in high prices, inflation, and social unrest. Debasement, and not the arbitrary decision of farmers or merchants, is responsible for higher prices. The principal losers from this policy are people on fixed incomes. The Discourse was published after Sir Thomas's death by his nephew William; included are later passages, interpolated by Thomas during the 1570s, attributing the Elizabethan inflation of the later 16th century to another factor — the influx of newly mined specie from the western hemisphere. It is not known whether Smith was familiar with the similar Navarrus analysis of 1556, or the Bodin analysis of French inflation 12 years later, or whether this was Smith's independent discovery as price inflation moved from Spain northward into Europe.

In 1562, Smith returned to the debasement theme, in a lengthy work, still unpublished, The Wages of a Roman Footsoldier, or A Treatise on the Money of the Romans. This treatise on Roman money and coinage was written in answer to a question posed to him by his friend and colleague Cecil, at this point Queen Elizabeth's principal secretary. Again, Smith returns to his attack on debasement as evidence of "the decay of the state," and as a cause of "excessive prices."

In both the Discourse and the Treatise Smith took the convenient if fallacious position that the king himself is the greatest loser from the high prices caused by debasement. Since debasement adds to the king's revenue immediately and before prices have had a chance to rise, the king, on the contrary, is the prime beneficiary of debasement and other measures of monetary inflation.

Smith's Discourse is strikingly modern in frankly grounding its social analysis in the individual's drive for his own self-interest. Self-interest, Smith declared, is "a natural fact of human life to be channeled by constructive policy rather than thwarted by repressive legislation." Not that Smith abandons nascent mercantilism for any sort of liberal or laissez-faire outlook. Self-interest is not to be left alone within a property-rights framework. It is to be channeled and directed by government to a "common goal" set by the state. But at least Smith was wise enough to point out that it is better for men to be "provoked with lucre" towards proper goals than to have governments "take this reward from them." In short, government should work in tandem with the powerful incentive provided by individual self-interest.

Smith sees that economic incentives are always at work in the market to move economic resources out of less profitable, and into more profitable, uses. And governments should work with such incentives, rather than against them.

Smith, however, was assuredly a mercantilist, as seen by his desire to foster the manufacture of woolen cloth within England, and his desire to prohibit the export of raw wool to be manufactured abroad.

John Hales came from a prominent Kentish family, and was a friend of Smith and a fellow Tudor official. Yet his economic and social philosophy was very different. In 1549, for example, the year that Smith's Discourse was written (and which included an attack on new taxes on manufactured cloth) Hales was the very person responsible for instituting the tax. Hales also disliked two favorite themes of the Discourse: love for the civil law, and admiration for sheep farming. Hales, furthermore, far from being indifferent to religion, was a deacon and a dedicated organizer of Bible readings.

Most important in any contrast between Hales and the author of the Discourse, Hales attributed the high prices, not to debasement, but to three very different supply-side factors: scarcity of cattle and poultry, speculation, and excessively high taxes. None of these factors in truth can account for any general price increase.

Finally, Hales took the old-fashioned moral position of attributing all ills, including high prices, to man's all-pervasive greed. (Why greed should have increased rapidly in recent years to account for high prices was of course a problem that was not even addressed.) Greed and the desire for profit were the great social evils. The only cure for all this, opined Hales, was to purge man of self-love: "To remove the self love that is in many men, to take away the inordinate desire of riches wherewith many be cumbered, to expel and quench the insatiable thirst of ungodly greediness, wherewith they be diseased" and to replace this "diseased" self-love by a twin other-love of Church-and-state "to make us know and remember that we all … be but members of one body mystical of our Saviour Christ and of the body of the realm."

Again, in his Defence, written the same year as the Discourse, John Hales expressly denies that self-love can be in any sense the foundation of the public good:

It may not be lawful for everyman to use his own as he listeth, but everyman must use that he hath to the most benefit of his country. There must be something devised to quench the insatiable thirst of greediness of men, covetousness must be weeded out by the roots, for it is the destruction of all good things.

Sir Thomas Smith was responsible, rather than his associate Sir Thomas Gresham (c. 1519–1579), for the first expression of "Gresham's law" in England. Until recently, it had been thought that the well-known and anonymous Memorandum for the Understanding of the Exchange had been submitted by Gresham to Queen Elizabeth early in her reign in 1559. It now turns out, however, that the Memorandum was written by Smith early in Queen Mary's reign, in 1554. The Memorandum was certainly not a free-market tract, advocating as it did various state controls over the foreign exchange market. It did, however, not only denounce debasement and call for a high-valued currency, but it also enunciated "Gresham's law" that the cause of a shortage of gold coin in England was the legal undervaluation of gold.

Gresham, fiscal agent of the Crown in Antwerp, himself adhered to "Gresham's law," which was set forth by the royal commission of 1560 that he heavily influenced. Gresham was also a full-fledged statist and architect of Tudor monopoly privilege. A member of the monopoly wool-cloth export company, the Merchant Adventurers, Gresham was the chief architect of England's tightening of that monopoly during the 1550s and 1560s — banning Hanseatic merchants from exporting English cloth, increasing tariffs on foreign cloth and, finally, making the Adventurers far more oligarchic and tightly controlled from the top.

Influenced greatly by the Memorandum, and echoing its Gresham's-law position, was the younger Sir Richard Martin (1534–1617), goldsmith, warden, and master of the Mint during all of Queen Elizabeth's reign. Trained as a goldsmith from youth, Martin also served as prime warden of the Worshipful Company of Goldsmiths and alderman of London for many years, and was twice Lord Mayor. In the royal commission of 1576 on currency and the exchanges, whose members were handpicked by Sir Thomas Smith, then principal secretary to the queen, Gresham and Martin, as well as Cecil, were all included. The commission did not include Smith himself, who had fallen ill. Their backing of Gresham's law was echoed a generation later by the royal commission of 1600, on which Martin served and prepared the principal memoranda.

Excerpted from An Austrian Perspective on the History of Economic Thought, vol. 1, Economic Thought Before Adam Smith. An MP3 audio file of this article, read by Jeff Riggenbach, is available for download.

We cannot trace the details of the nefarious activities of rulers in monopolizing money beyond the time of the Greek philosopher Diogenes, who is reported, as early as the 4th century BC, to have called money the politicians' game of dice. But from Roman times to the 17th century, when paper money in various forms begins to be significant, the history of coinage is an almost-uninterrupted story of debasements, or the continuous reduction of the metallic content of the coins and a corresponding increase in all commodity prices.

Nobody has yet written a full history of these developments. It would indeed be all too monotonous and depressing a story, but I do not think it an exaggeration to say that history is largely a history of inflation, and usually of inflations engineered by governments and for the gain of governments—though the gold and silver discoveries in the 16th century had a similar effect.

Historians have again and again attempted to justify inflation by claiming that it made possible the great periods of rapid economic progress. They have even produced a series of inflationist theories of history,See Werner Sombart, Der moderne Kapitalismus, 2nd ed. (Munich and Leipzig, 1916–1917), vol. 2; and before him, Archibald Alison, History of Europe (London, 1833), vol. 2; and others. Cf. on them Paul Barth, Die Philosophie der Geschichte als Soziologie, 2nd ed. (Leipzig, 1915), who has a whole chapter on "History as a function of the value of money," and Marianne von Herzfeld, "Die Geschichte als Funktion der Geldwertbewegungen," Archiv für Sozialwissenschaft und Sozialpolitik 56, no. 3 (1926). which have, however, been clearly refuted by the evidence: prices in England and the United States were at the end of the period of their most rapid development almost exactly at the same level as 200 years earlier. But their recurring rediscoverers are usually ignorant of the earlier discussions.

The early Middle Ages may have been a period of deflation that contributed to the economic decline of the whole of Europe. But even this is not certain. It would seem that on the whole, the shrinking of trade led to the reduction of the amount of money in circulation, not the other way round. We find too many complaints about the dearness of commodities and the deterioration of the coin to accept deflation as more than a local phenomenon in regions where wars and migrations had destroyed the market and the money economy shrank as people buried their treasure.

But where, as in northern Italy, trade revived early, we find at once all the little princes vying with one another in diminishing the coin—a process that, in spite of some unsuccessful attempts by private merchants to provide a better medium of exchange, lasted throughout the following centuries until Italy came to be described as the country with the worst money and the best writers on money.

But though theologians and jurists joined in condemning these practices, they never ceased until the introduction of paper money provided governments with an even cheaper method of defrauding the people. Governments could not, of course, pursue the practices by which they forced bad money upon the people without the cruelest measures. As one legal treatise on the law of money sums up the history of punishment for merely refusing to accept the legal money,

From Marco Polo we learn that, in the 13th century, Chinese law made the rejection of imperial paper money punishable by death, and twenty years in chains or, in some cases death, was the penalty provided for the refusal to accept French assignats. Early English law punished repudiation as lese-majesty. At the time of the American revolution, non-acceptance of Continental notes was treated as an enemy act and sometimes worked a forfeiture of the debt.Arthur Nussbaum, Money in the Law, National and International (Brooklyn: Foundation Press, 1950), p. 53.

Some of the early foundations of banks at Amsterdam and elsewhere arose from attempts by merchants to secure for themselves a stable money, but rising absolutism soon suppressed all such efforts to create a nongovernmental currency. Instead, it protected the rise of banks issuing notes in terms of the official government money. Even less than in the history of metallic money can we here sketch how this development opened the doors to new abuses of policy.

It is said that the Chinese had been driven by their experience with paper money to try to prohibit it for all time (of course unsuccessfully) before the Europeans ever invented it.On the Chinese events, see Willem Vissering, On Chinese Currency, Coin and Paper Money (Leiden, The Netherlands, 1877) and Gordon Tullock, "Paper Money — A Cycle in Cathay," Economic History Review 9, no. 3 (1956), who does not, however, allude to the often recounted story of the "final prohibition." Certainly European governments, once they knew about this possibility, began to exploit it ruthlessly, not to provide people with good money, but to gain as much as possible from it for their revenue.

Ever since the British government, in 1694, sold the Bank of England a limited monopoly of the issue of bank notes, the chief concern of governments has been not to let slip from their hands the power over money, formerly based on the prerogative of coinage, to really independent banks. For a time, the ascendancy of the gold standard and the consequent belief that to maintain it was an important matter of prestige, and to be driven off it a national disgrace, put an effective restraint on this power. It gave the world the one long period—200 years or more—of relative stability during which modern industrialism could develop, albeit suffering from periodic crises.

But as soon as it was widely understood some 50 years ago that the convertibility into gold was merely a method of controlling the amount of a currency, which was the real factor determining its value, governments became only too anxious to escape that discipline, and money became more than ever before the plaything of politics. Only a few of the great powers preserved for a time tolerable monetary stability, and they brought it also to their colonial empires. But Eastern Europe and South America never knew a prolonged period of monetary stability.

But while governments have never used their power to provide a decent money for any length of time, and have refrained from grossly abusing it only when they were under such a discipline as the gold standard imposed, the reason that should make us refuse any longer to tolerate this irresponsibility of government is that we know today that it is possible to control the quantity of a currency so as to prevent significant fluctuations in its purchasing power. Moreover, though there is every reason to mistrust government if not tied to the gold standard or the like, there is no reason to doubt that private enterprise whose business depended on succeeding in the attempt could keep stable the value of a money it issued.

Before we can proceed to show how such a system would work we must clear out of the way two prejudices that will probably give rise to unfounded objections against the proposal.

The first misconception concerns the concept of "legal tender." It is not of much significance for our purposes, but is widely believed to explain or justify government monopoly in the issue of money. The first shocked response to the proposal here discussed is usually, "But there must be a legal tender," as if this notion proved the necessity for a single, government-issued money believed indispensable for the daily conduct of business.

In its strictly legal meaning, "legal tender" signifies no more than a kind of money a creditor cannot refuse in discharge of a debt due to him in the money issued by government.See Nussbaum, Money in the Law; F.A. Mann, The Legal Aspects of Money, 3rd ed. (London: Oxford University Press, 1971); and S.P. Breckinridge, Legal Tender (Chicago: University of Chicago Press, 1903). Even so, it is significant that the term has no authoritative definition in English statute law.Mann, Legal Aspects of Money, p. 38. On the other hand, the refusal until recently of English courts to give judgment for paying in any other currency than the pound sterling has made this aspect of legal tender particularly influential in England. But this is likely to change after a recent decision (Miliangos v. George Frank Textiles Ltd. [1975]) established that an English court can give judgment in a foreign currency on a money claim in a foreign currency, so that, for instance, it is now possible in England to enforce a claim from a sale in Swiss francs. See Financial Times, November 6, 1975; the report is reproduced in F.A. Hayek, Choice in Currency, Occasional Paper 48 (London: Institute of Economic Affairs, 1976), pp. 45–46. Elsewhere, it simply refers to the means of discharging a debt contracted in terms of the money issued by government or due under an order of a court.

Insofar as government possesses the monopoly of issuing money and uses it to establish one kind of money, it must probably also have power to say by what kind of objects debts expressed in its currency can be discharged. But that means neither that all money need be legal tender, nor even that all objects given by the law the attribute of legal tender need to be money. (There are historical instances in which creditors have been compelled by courts to accept commodities, such as tobacco, which could hardly be called money, in discharge of their claims for money.)Nussbaum, Money in the Law, pp. 54–55.

The term "legal tender" has, however, in popular imagination come to be surrounded by a penumbra of vague ideas about the supposed necessity for the state to provide money. This is a survival of the medieval idea that it is the state that somehow confers value on money it otherwise would not possess. And this, in turn, is true only to the very limited extent that government can force us to accept whatever it wishes in place of what we have contracted for.

In this sense, it can give the substitute the same value for the debtor as the original object of the contract. But the superstition that it is necessary for government (usually called "the state" to make it sound better) to declare what is to be money, as if it had created the money that could not exist without it, probably originated in the naive belief that such a tool as money must have been "invented" and given to us by some original inventor. This belief has been wholly displaced by our understanding of the spontaneous generation of such undesigned institutions by a process of social evolution of which money has since become the prime paradigm (law, language, and morals being the other main instances). When the medieval doctrine of the valor impositus was in this century revived by the much-admired German Professor G.F. Knapp, it prepared the way for a policy that in 1923 carried the German mark down to one-trillionth of its former value!

There certainly can be and has been money, even very satisfactory money, without government doing anything about it, though it has rarely been allowed to exist for long.[8] Occasional attempts by the authorities of commercial cities to provide a money of at least a constant metallic content, such as the establishment of the Bank of Amsterdam, were for long periods fairly successful, and their money was used far beyond the national boundaries. But even in these cases the authorities sooner or later abused their quasi-monopoly positions. The Bank of Amsterdam was a state agency which people had to use for certain purposes and its money even as exclusive legal tender for payments above a certain amount. Nor was it available for ordinary small transactions or local business beyond the city limits. The same is roughly true of the similar experiments of Venice, Genoa, Hamburg, and Nuremberg. But a lesson is to be learned from the report of a Dutch author about China a hundred years ago, who observed of the paper money then current in that part of the world that "because it is not legal tender and because it is no concern of the State it is generally accepted as money."Vissering, On Chinese Currency.

We owe it to governments that within given national territories today in general only one kind of money is universally accepted. But whether this is desirable, or whether people could not, if they understood the advantage, get a much better kind of money without all the to-do about legal tender, is an open question. Moreover, a "legal means of payment" (gesetzliches Zahlungsmittel) need not be specifically designated by a law. It is sufficient if the law enables the judge to decide in what sort of money a particular debt can be discharged.

The common sense of the matter was put very clearly 80 years ago by a distinguished defender of a liberal economic policy, the lawyer, statistician, and high civil servant Lord Thomas Henry Farrer. In a paper written in 1895, he contended that if nations

make nothing else but the standard unit [of value they have adopted] legal tender, there is no need and no room for the operation of any special law of legal tender. The ordinary law of contract does all that is necessary without any law giving special function to particular forms of currency. We have adopted a gold sovereign as our unit, or standard of value. If I promised to pay 100 sovereigns, it needs no special currency law of legal tender to say that I am bound to pay 100 sovereigns, and that, if required to pay the 100 sovereigns, I cannot discharge the obligation by anything else.Thomas Henry Farrer, 1st Baron Farrer, Studies in Currency (London: 1898), p. 43.

And he concludes, after examining typical applications of the legal tender conception, that,

Looking to the above cases of the use or abuse of the law of legal tender other than the last [i.e. that of subsidiary coins] we see that they possess one character in common—viz. that the law in all of them enables a debtor to pay and requires a creditor to receive something different from that which their contract contemplated. In fact it is a forced and unnatural construction put upon the dealings of men by arbitrary power.Ibid., p. 45. The locus classicus on this subject from which I undoubtedly derived my views on it, though I had forgotten this when I wrote the First Edition of this Paper, is Carl Menger's discussion in "Geld," Collected Works of Carl Menger, (London: London School of Economics, 1892), of legal tender under the even more appropriate equivalent German term Zwangskurs.

To this he adds a few lines later that "any Law of Legal Tender is in its own nature 'suspect.'"Ibid., p. 47.

The truth is indeed that legal tender is simply a legal device to force people to accept in fulfillment of a contract something they never intended when they made the contract. It becomes thus, in certain circumstances, a factor that intensifies the uncertainty of dealings and consists, as Lord Farrer also remarked in the same context,

in substituting for the free operation of voluntary contract, and a law which simply enforces the performance of such contracts, an artificial construction of contracts such as would never occur to the parties unless forced upon them by an arbitrary law.

All this is well illustrated by the historical occasion when the expression "legal tender" became widely known and treated as a definition of money. In the notorious Legal Tender Cases, fought before the Supreme Court of the United States after the Civil War, the issue was whether creditors must accept, at par, current dollars in settlement of their claims for money they had lent when the dollar had a much higher value.Cf. Nussbaum, Money and the Law, pp. 586–92. The same problem arose even more acutely at the end of the great European inflations after the First World War when, even in the extreme case of the German mark, the principle "mark is mark" was enforced until the end—although later some efforts were made to offer limited compensation to the worst sufferers.In Austria after 1922, the name "Schumpeter" had become almost a curse word among ordinary people, referring to the principle that "krone is krone," because the economist Joseph Alois Schumpeter, during his short tenure as minister of finance, had put his name to an order-of-council merely spelling out what was undoubtedly valid law, namely that debts incurred in crowns when they had a higher value could be repaid in depreciated crowns, ultimately worth only 1/15,000th of their original value.

A government must of course be free to determine in what currency taxes are to be paid and to make contracts in any currency it chooses (in this way it can support a currency it issues or wants to favor), but there is no reason why it should not accept other units of accounting as the basis of the assessment of taxes. In noncontractual payments, such as damages or compensations for torts, the courts would have to decide the currency in which they have to be paid, and might for this purpose have to develop new rules; but there should be no need for special legislation.

There is a real difficulty if a government-issued currency is replaced by another because the government has disappeared as a result of conquest, revolution, or the breakup of a nation. In that event, the government taking over will usually make legal provisions about the treatment of private contracts expressed in terms of the vanished currency. If a private issuing bank ceased to operate and was unable to redeem its issue, this currency would presumably become valueless and the holders would have no enforceable claim for compensation. But the courts may decide that in such a case contracts between third parties in terms of that currency, concluded when there was reason to expect it to be stable, would have to be fulfilled in some other currency that came to the nearest-presumed intention of the parties to the contract.

It is a misunderstanding of what is called Gresham's law to believe that the tendency for bad money to drive out good money makes a government monopoly necessary. The distinguished economist W.S. Jevons emphatically stated the law in the form that better money cannot drive out worse precisely to prove this. It is true he argued then against a proposal of the philosopher Herbert Spencer to throw the coinage of gold open to free competition, at a time when the only different currencies contemplated were coins of gold and silver.

Perhaps Jevons, who had been led to economics by his experience as assayer at a mint, even more than his contemporaries in general, did not seriously contemplate the possibility of any other kind of currency. Nevertheless his indignation about what he described as Spencer's proposal

that, as we trust the grocer to furnish us with pounds of tea, and the baker to send us loaves of bread, so we might trust Heaton and Sons, or some of the other enterprising firms of Birmingham, to supply us with sovereigns and shillings at their own risk and profit,W.S. Jevons, Money and the Mechanism of Exchange (London: Kegan Paul, 1875), p. 64, as against Herbert Spencer, Social Statics, abridged and revised ed. (London: Williams & Norgate, 1902).

led him to the categorical declaration that generally, in his opinion, "there is nothing less fit to be left to the action of competition than money."Jevons, ibid., p. 65. An earlier characteristic attempt to justify making banking and note issue an exception from a general advocacy of free competition is to be found in 1837 in the writings of S.J. Loyd (later Lord Overstone), Further Reflections on the State of Currency and the Action of the Bank of England ( London: 1837), p. 49.

It is perhaps characteristic that even Herbert Spencer had contemplated no more than that private enterprise should be allowed to produce the same sort of money as government then did, namely gold and silver coins. He appears to have thought them the only kind of money that could reasonably be contemplated, and in consequence that there would necessarily be fixed rates of exchange (namely of 1:1, if of the same weight and fineness) between the government and private money. In that event, indeed, Gresham's law would operate if any producer supplied shoddier ware. That this was in Jevons's mind is clear, because he justified his condemnation of the proposal on the grounds that,

while in all other matters everybody is led by self-interest to choose the better and reject the worse; but in the case of money, it would seem as if they paradoxically retain the worse and get rid of the better.Jevons, ibid., p. 82. Jevons's phrase is rather unfortunately chosen, because in the literal sense Gresham's law of course operates by people getting rid of the worse and retaining the better for other purposes.

What Jevons, as so many others, seems to have overlooked, or regarded as irrelevant, is that Gresham's law will apply only to different kinds of money between which a fixed rate of exchange is enforced by law.Cf. F.A. Hayek, Studies in Philosophy, Politics and Economics (London and Chicago: Routledge and Kegan Paul, 1967) and F.W. Fetter, "Some Neglected Aspects of Gersham's Law," Quarterly Journal of Economics 46/2 (1931–1932). If the law makes two kinds of money perfect substitutes for the payment of debts and forces creditors to accept a coin of a smaller content of gold in the place of one with a larger content, debtors will, of course, pay only in the former and find a more profitable use for the substance of the latter.

With variable exchange rates, however, the inferior quality money would be valued at a lower rate and, particularly if it threatened to fall further in value, people would try to get rid of it as quickly as possible. The selection process would go on towards whatever they regarded as the best sort of money among those issued by the various agencies, and it would rapidly drive out money found inconvenient or worthless.If, as he is sometimes quoted, Gresham maintained that better money quite generally could not drive out worse, he was simply wrong, until we add his probably tacit presumption that a fixed rate of exchange was enforced.

Indeed, whenever inflation got really rapid, all sorts of objects of a more stable value, from potatoes to cigarettes and bottles of brandy to eggs and foreign currencies like dollar bills, have come to be increasingly used as money, so that at the end of the great German inflation it was contended that Gresham's law was false and the opposite true.Cf. C. Bresciani-Turroni, The Economics of Inflation (London: Allen & Unwin, 1937), p. 174: "In monetary conditions characterised by a great distrust in the national currency, the principle of Gresham's law is reversed and good money drives out bad, and the value of the latter continually depreciates." But even he does not point out that the critical difference is not the "great distrust" but the presence or absence of effectively enforced fixed rates of exchange. It is not false, but it applies only if a fixed rate of exchange between the different forms of money is enforced.

This article is excerpted from chapters 4, 5, and 6 of Denationalisation of Money: The Argument Refined.

Some of the silver fallacies were stated by Mr. St. John in his address before the silver convention with such precision that his speech offers a favorable opportunity for dealing with them.

He says that "it is among the first principles in finance that the value of each dollar, expressed in prices, depends upon the total number of dollars in circulation." There is no such principle of finance as the one here formulated. The "quantity doctrine" of currency is gravely abused by all bimetallists, from the least to the greatest, and it is at best open to great doubt.

When the dollars in question are dollars of some money of account that can circulate beyond the territory of the State in which it is issued, the quantity doctrine cannot be true within that territory. It may be noted, in passing, that this is the reason why no scheme of the silver people for manipulating prices in the United States can possibly succeed. Silver and gold will be exported and imported until their values conform throughout the world, and prices fixed in one or the other of them will conform to the world's prices, after all the trouble and waste and loss of translating them two or three times over have been endured.

The quantity doctrine, however, means that the value of the currency is a question of supply and demand, and everybody knows that to double or halve the supply does not halve or double the value, or have any other effect that is simple and direct. If it did have such effect, speculation would not be what it is.

Mr. St. John goes on to argue that our population increases two millions every year, on account of which we need more dollars; that the production of gold does not furnish enough to meet this need, and that, therefore, prices fall. This argumentation is very simple and very glib. Prosperity and adversity are put into a syllogism of three lines.

But if we can avert the fall in prices and adversity by coining silver, it must be by adding the silver to the gold that we now have. "High" and "low" prices are only relative terms. They mean higher and lower than at another time or place; higher and lower than we have been used to. If misery depends on ten-cent corn we are advised to cut the cents in two and we shall get twenty-cent corn and prosperity. Corn will not be altered in value in gold, or outside of the United States, and, as all other things will be marked up at the same time and in the same way, its value in other things will not be altered by this operation.

When we get used to twenty-cent corn it will seem just as low and just as "hard for the debtor" as ten-cent corn is now. Then we can divide by ten and get two-dollar corn, by adding free coinage of copper. When we get used to that we shall be no better satisfied with it. We can then make paper dollars and coin them without limit. Million-dollar corn will then become as bitter a subject for complaint as ten-cent corn is now. The fact that people are discontented is no argument for anything.

The fact that prices are low is made the subject of social complaint and of political agitation in the United States. Prices have undergone a wave since 1850. They rose until about 1872. They have fallen again. They are lower than they were at the top of the wave all the world over. This fact, the explanation of which would furnish a very complicated task for trained statisticians and economists, is made a topic of easy interpretation and solution in political conventions and popular harangues, and it is proposed to adopt violent and portentous measures upon the basis of the flippant notions that are current about it.

But what difference does it make whether the "plane" of prices is high or low? If corn is at forty cents a bushel and calico at twenty cents a yard, a bushel buys two yards. If corn is at ten cents a bushel and calico at five cents a yard, a bushel will buy two yards. So of everything else. If, then, there has been a general fall, and that is the alleged grievance, neither farmers nor any other one class has suffered by it.

It is undoubtedly true that a period of advancing prices stimulates energy and enterprise. It does so even when, if all the facts were well known, it might be found that capital was really being consumed in successive periods of production. Falling prices discourage enterprise, although, if all facts were known to the bottom, it might be found that capital was being accumulated in successive periods of production.

It is also true that a depreciation of the money of account, while it is going on, stimulates exports and restrains imports.

But who can tell how we are to make prices always go up, unless by constant and unlimited inflation? Who can tell how we are to avoid fluctuations in prices or eliminate the element of contingency, risk, foresight, and speculation?

It is also true that, although high prices and low prices are immaterial at any one time, the change from one to the other, from one period of time to another, affects the burden of outstanding time contracts. Men make contracts for dollars, not for dollar's-worths. Selling long or short is one thing; lending is another.

Borrowers and lenders never guarantee each other the purchasing power of dollars at a future time. If the contracts were thus complicated they would become impossible. Between 1850 and 1872 the debtors made no complaint and the creditors never thought of getting up an agitation to have debts scaled up. The debtors now are demanding that they be allowed to play "heads I win, tails you lose," and Mr. St. John and others tell us that they have the votes to carry it, as if that made any difference in the forum of discussion.

Increase in population does not prove an increased need of money. It may prove the contrary. If the population becomes more dense over a given area, a higher organization may make less money necessary. If railroads and other means of communication are extended, money is economized. If banks and other credit institutions are multiplied, and if credit operations are facilitated by public security, good administration of law, etc., less money is needed.

If these changes are going on at the same time that population is increasing (and such is undoubtedly the case in the United States), who can tell whether the net result is to make more or less currency necessary? Nobody; and all assertions about the matter are wild and irresponsible.

If it was true that an increase of two millions in the population called for more dollars, how does anybody know whether the current gold production is adequate to meet the new requirement or not? The assertion is arithmetical. It says that two quantities are not equal to each other.

The first quantity is the increase in the currency called for by two million more people. How much more is needed? Nobody knows, and there is no way to find out. The silver men have put figures for it from time to time, but the figures rested on nothing and were mere bald assertions.

The second quantity is the amount of new gold annually available for coinage in the United States. How much is this? Nobody knows, because if an attempt is made to define what is meant it is found that there is no idea in the words. The people of the United States buy and coin just as much gold as they want at any time.

Hence two things are said to be unequal to each other, when nobody knows how big either one of them is. It may be added that it makes no difference how big either one of them is. How much additional tin is needed annually for the increase of our population? Do the mines produce it? Nobody knows or asks. The mines produce, and the people buy, what they want. The case is the same as to gold.

We find, then, that Mr. St. John begins with a doctrine that is untenable; then he asserts a relation between population and the need of money that does not exist; then he assumes that this need is greater than the amount of new gold produced, although neither he nor anybody else knows how big either one of these quantities is.

This is the argumentation by which he aims to show that prices are reduced and misery produced by the single gold standard. It is the argumentation that is current among the silver people. Not a step of it will bear examination. The inference that we must restore the free coinage of silver to escape this strangulation of prosperity falls to the ground.

The first remained a teacher during his entire life, never in any prestigious institution and never exercising any power. Indeed, he used his post teaching against the exercise of power, and became the world's most powerful intellectual voice for radical liberalism or libertarianism. This man who loved liberty died in 1995 and his work has taken flight the world over. His books are selling as never before, all of them, and his star is rising by the day.

His name was Murray N. Rothbard.

The second one became the most powerful and influential economist in the world, practically running the world for a very long time. While in power, he was revered by everyone who was anyone. His every utterance could cause hundreds of billions to be made or lost in the market. But he will live out the rest of his days under a cloud of derision and discredit, defending himself against the perception that he created history's largest financial calamity.

His name is Alan Greenspan.

Let us track these two lives and consider the choices they made.

As Charles Burris has pointed out, they were both born in New York City, in 1926. Rothbard was born on Tuesday, March 2. The following Saturday, March 6, Alan Greenspan was born. They had a similar background and upbringing, Greenspan of German-Jewish heritage and Rothbard of Russian-Jewish heritage. Both attended private schools and pursued their respective passions.

It is after high school their lives diverged. Whereas Rothbard followed a very mainstream path in academic economics — one that would seem to set him up as a giant in the profession — Greenspan went to the Julliard School of Music to pursue his true love, which was the clarinet.

As remarkable as it may seem today, Greenspan was not interested in economics or banking or any technical field. His interests were the arts, at least initially. There is nothing wrong with that, and indeed music has long been considered a foundation of a great education.

I mention this because it is an implausible beginning for the man who would later take the helm of the institution that would purport to manage the world reserve currency — a man after whom a professorship at New York University has been named.

Meanwhile, Rothbard chose to attend Columbia University. He was not an economics major. His passion was mathematics — and this was even before the full mathematicization of the profession. At Columbia, he studied under the famed statistician Harold Hotelling. It might have been Hotelling who led Rothbard to economic studies, but very early on, Rothbard the mathematician could see what was wrong with that application of statistical methods to economic theory. He would later build on Mises to construct a systematic theory of economics rooted in logical deduction in the manner of 19th-century theorists. All the while, his libertarianism was also in strong formation from early in his youth.

As implausible as it may seem today, Rothbard's biography would seem to be exactly that which would make for professional triumph with the mainstream of opinion and with the powers that be. What made that impossible were the choices he made — choices made on principle and for the love of truth and liberty.

Greenspan, for his part, declined to carry out his musical dreams. His grades were only average so he departed to play with the Henry Jerome Orchestra, playing saxophone or clarinet as necessary. He traveled the country on buses between engagements. Soon he tired of that life and in 1945 changed both his school and his major to economics.

The school was New York University, where Mises had begun teaching that very year. But Greenspan did not study with Mises, whom he might have regarded as a washed-up old man who could do nothing for his primary concern, which was his career. Instead, he chose the division called "the factory": 9,000 students competed in various fields of specialization in business. He graduated with honors in 1945 and enrolled in the masters program, graduating in 1948.

At this point, the lives of Rothbard and Greenspan briefly intersect in an interesting way: at Columbia University. Two years earlier, Rothbard had received his own masters in economics from Columbia, and had enrolled in the PhD program. Professor Arthur Burns was the most prominent faculty member. Burns would later become Eisenhower's head of the Council of Economic Advisers and head of the Federal Reserve. One might say that he was the Greenspan of his day.

Greenspan dropped out of the Columbia economics program to follow Burns to Washington and model himself after his tendency toward chasing powerful positions and powerful people. Greenspan watched Burns carefully, very impressed at how economics in an age of positivism can be used in the service of state-connected careers.

Rothbard meanwhile stayed behind at Columbia, writing and studying. One of his seminal articles in this period was published in a book in honor of Mises — that supposedly washed-up old man who just so happened to have a penchant for speaking truth to power.

Just as Burns became Greenspan's model, Mises had become Rothbard's model. Two more opposing career paths can hardly be imagined. Mises had been tossed out of two countries for his principled stance, and even forfeited a prestigious position in the profession for being unwilling to go along with the Keynesian revolution.

Rothbard would follow a similar path. His article written in honor of Mises, published in 1956, was a reconstruction of utility and welfare economics along nonmathematical lines.

Here we have the graduate student doing what a principled person does: he was pursuing truth through research and writing. He might have chosen to echo the rising Keynesianism and positivism of his day. Certainly he was intellectually capable of become the master of both fields. Instead, he rejected them intellectually and took a different path along lines laid out by Mises.

And what was Greenspan doing? He was running around Washington pandering to the big shots, watching their every move, striving to be like them, and attempting to follow in their footsteps by cultivating press contacts and relationships to people in high places.

Rothbard received his PhD in 1956 but only after jumping over a thousand barriers that had been put in his path by none other than Greenspan's own mentor. There were times when Burns's recalcitrance drove Murray to despair. He felt that he could not comply with Burns's dictates and could not please Burns — and that Burns seemed to be sabotaging his work.

Ironically, Rothbard and Burns had known each other since childhood. They lived in the same apartment building since high school. There can be no question that this was a personal attack against Murray.

Only once Burns became so wrapped up in Washington politics that he could no longer care did Rothbard finally win out. His PhD was awarded in 1956.

Now let me make a few comments about Rothbard's dissertation. It was an empirical account of America's first serious business cycle, the panic of 1819. He scoured every source he could, producing many pages of detailed economic data. He also knew the importance of ideology and personality in the history of economics, so he recounted the debates over the policy response. Then as now, people urged intervention. But unlike today, the government did not respond to the demands for inflation, price supports, bailouts, and fiscal stimulus. As a result, the panic ended and the economy recovered very quickly.

What was the fate of this dissertation? For more than 50 years, it has been the standard reference on this episode. It was printed and reprinted many times. Today, the Mises Institute has an edition out of this book and it continues to sell on a large scale.

Let me hop ahead to Greenspan's dissertation, which wasn't filed with New York University until two decades later, in 1977. It was quickly sealed and continues to be unavailable to anyone. No one had any idea what was in it until last year, when a single copy was leaked to a reporter for Barron's. What it contained was so irrelevant that it barely made the news. It was a collection of reports he had written for various purposes over the previous 20 years — a PhD granted for life experience, as it were.

What did Greenspan do in the intervening years? He founded a consulting company, Townsend-Greenspan and worked for the National Industrial Conference Board.

To understand Greenspan's firm and what it did, it is important to understand the role of the economic expert in an age of positivism. In the postwar period, the scientist with Gnostic-style knowledge and shadowy connections to power ascended to massive public fame. The substance itself didn't matter so much as the illusion of expertise. What his firm sold was Greenspan — to such powerful, regime clients as J.P. Morgan and Co.

Greenspan carefully crafted his image as an omniscient pundit on all matters related to economics. He used his connections to Burns and rising connections to all related power elites to build up a reputation as a monklike data collector, pouring over charts and coming up with printable comments and predictions.

It was mostly illusion. There were no charts and data collections and machines to make perfect predictions. What Greenspan did was commodify his own pandering ways and sell them to a culture hungry for illusions.

All throughout the 1960s and the decades following, he worked to craft his persona to fit perfectly with the prevailing ethos. That ethos was statism — the glorification of central management by the experts. Greenspan sought to be top of the heap.

Let me say a few words about Greenspan's connection to Ayn Rand. The press routinely misunderstands the meaning of this relationship. The only writer who I think has gotten it right, aside from people in the inner circle like George Reisman and Nathaniel Branden, is Frederick Sheehan, author of Panderer to Power. Sheehan points out that Greenspan's relationship to the Rand circle was always opportunistic and never really had any effect on Greenspan's life.

She was a famous author on the rise. Greenspan was a master of hitching his wagon to any horse on the move. Rand herself called him the "undertaker." She would frequently ask her associates, "Do you think Alan might basically be a social climber?" Her intuition was, of course, correct.

But what the Rand episode further illustrates is actually terribly unflattering for Greenspan. It is bad enough for a person to cravenly seek power while remaining in ignorance. But as Greenspan revealed in his 1966 article called "Gold and Economic Freedom," he actually knew the truth. He knew that the Fed creates business cyles — he wrote this in his article, even getting the story of the Great Depression right. He knew that fiat money builds the state. He said that gold is the only monetary guarantee of freedom.

It is bad enough when a person devotes his life to the service of power when he does it in a state of intellectual ignorance. But when the same person pursues this path in a state of published knowledge, it is nothing short of reprehensible. Thus was his relationship to Rand no different from his relationship to anyone else: he used her as a steppingstone toward his real goal.

It was only a few years following this article that Greenspan angled his way into the Nixon campaign of 1968, taking the job of coordinator of domestic-policy research. He began a shuttle back and forth between New York and Washington that would define the rest of his life.

In 1970, his mentor Burns was sworn in as the head of the Fed — and here is when Greenspan set his sights on that position as his lifetime goal. Every choice he made after that point was dedicated to this. All the while, he maintained his high public profile, making as many as 80 speeches a year and pulling in huge consulting fees, while otherwise pretending to live a monastic existence, studying charts and tables and doling out bits of advise and wisdom for high dollars.

Despite the personality cult he was building, his predictions were almost always wrong. Let me give only the most famous example. On January 7, 1973, the New York Times featured his picture with a spread on brilliant market forecasters. He was quoted as follows: "It's very rare that you can be as unqualifiedly bullish as you can now." Four days later, the market peaked and bottomed out 46 percent lower one year later. This was typical for him: somehow able to build a reputation as a prophet while being wrong on everything. His method was always the same: using high-flown rhetoric and obscure language while dissembling and faking his way through life.

It was a perfect method for government work. And so, that same year, he became head of the Council of Economic Advisers. In 1974, he urged President Ford to propose a new tax as a means of combating inflation. He was involved in the "Whip Inflation Now" campaign, complete with WIN buttons — though he knew full well that the real culprit was not a lack of morale but a Fed that would not stop the printing press.

A few years later he wormed his way into the Reagan inner circle and became head of the Social Security Commission that ended up raising payroll taxes, which seemed to save the system but only ended up delaying the inevitable.

All of this was mere prelude toward 1987, when the goal of his career was at hand. He was nominated for the position he had been training for during his entire life: head of the Fed. What happened soon after was the famous stock market crash of 1987. Here he did what he would do again and again during his 20-year tenure. He met every crisis with the same tactic: he opened the monetary spigots.

Monetary pumping was his one weapon. Think of the occasions: the Mexican debt crisis of 1996, the Asian Contagion of 1997, Long-Term Capital Management in 1998, the Y2K crisis of 1999 and 2000, the dot-com collapse, and finally the 9-11 terrorist incidents in Washington and New York. Oh, and never forget that Greenspan, on November 13, 2001, received the Enron Prize.

What was behind all of this? Essentially, he proved himself adept at serving the state whenever it needed help. Politicians used Greenspan as what Sheehan calls their "air-raid shelter." He did them a favor and they returned it by appointing him again and again, and they fawned over him as no one has ever been fawned over. And it's no wonder. He was history's biggest counterfeiter.

You can see the map of this in the federal-funds rate. Looking at the chart from the 1960s to the present, we see a huge arch, with the peak in 1979, and the rate trending steadily downward to the present level of zero. The only way this could be justified would be through a large increase in savings and capital, and we have not seen this. This picture of lower and lower rates is wholly artificial. Not only that, they are bubble inducing in the extreme.

What we are experiencing now, in the United States and other countries, is a direct result of Greenspan's tenure, which led to the greatest financial catastrophe in modern times. And make no mistake: every bit of this can be blamed on Greenspan directly.

We know from on-record reports of everyone who worked with him that he ruled the Federal Open Market Committee meetings with an iron fist, never seeking anyone else's opinion nor tolerating dissent to his political intuitions. He would beat back any contrary view with withering stares and implicit and explicit rebukes. It was rule by fear and intimidation. He would frequently make declarations on the state of the economy that had no basis at all in reality, and everyone in the room would know it. But after a while, it became clear that no one could penetrate his brain. Instead, those gathered would just roll their eyes and walk away in despair, muttering among themselves. He could make or break subordinates and colleagues.

He continued to cultivate his public image as a way of crushing disagreement within the Fed. The message he sent through his high status was this: don't you dare disagree with this god on earth whom all people adore. For a time, we had the entire Wall Street and Washington establishment singing one long and united chorus of the hymn Thank God for Greenspan. He encouraged this, sending his minions out to tell the press that he deserved credit for all things: an uptick in employment, a downtick in the trade deficit, an optimistic earnings report from Wall Street. No matter what the news, he would take credit for it, even if the news had no bearing at all on any Fed policies.

Those were crazy times. A fake article appeared in the New Republic that told of a cult on Wall Street involving candles and an iconic image of Greenspan in the back room. The story was preposterous but believable. It took a very long time before anyone figured out that it was a fake.

As for his behavior within the Fed itself, his war on dissent, typical of any dictator, was too much for anyone at the Fed with intelligence and integrity. Janet Yellen resigned as governor in 1997, saying bitterly as she left that it is a "great job, if you like to travel around the country and read speeches written by the staff." She recalled, for example, that Greenspan would not even let her talk to the Fed staff because he feared that they would develop some affection or loyalty toward anyone but Greenspan personally.

Bert Ely, a Fed consultant, concludes with a point written about most despots in human history: "The chairman is not a secure man. He has to be one in the spotlight, and he doesn't want competition."

I don't need to tell you how the story of Greenspan ends. His world came crashing down around him. He spends all of his time today trying to explain his way out of the blame. Much to his everlasting disgrace, he has intimated on many occasions that the meltdown of 2008 was not his failure or a failure of the government at all but a result of inherent flaws in the market.

Ayn Rand speculated that this undertaker might just be a social climber. She did not and could not have known that he would eventually climb his way to the top, fall all the way down, and while he was writhing in pain would betray the entire cause to which he pretended devotion. But anyone who looked at his life could see the pattern. It was not a complex one. He served the state. As Rothbard himself wrote of Greenspan, "Greenspan's real qualification is that he can be trusted never to rock the establishment's boat." Indeed he served the establishment from the first day to the last.

Now, I would like to turn back to Rothbard and his life. When we last left him, he had completed his dissertation. He was about to embark on an enormous journey that would consume his entire life. He published in the established journals as long as he could but at some point, his quest for truth and love of liberty meant that he would be cut off from them.

Despite his brilliance, background, and credentials, he did not get a prestigious academic post. He worked for a private academic foundation, reviewing all the latest books on history, philosophy, law, and economics. His massive treatise on economics that appeared in 1963 began as a tutorial written on behalf of this foundation.

When he did get a position, it was at Brooklyn Polytechnic in New York. He had a dumpy office and taught mostly unimpressive students. But it hardly mattered at all to him. He had the freedom to write and publish and tell the truth, and that's what he wanted more than anything.

And yet even here, his options were limited. One might think that, as a supporter of the free market, conservative journals of opinion would be open to him. But soon after the Cold War intensified, he could no longer be quiet on an issue that was vastly important to him, namely, the relationship between liberty and military expansionism. He saw the warfare state as nothing but a species of socialism. And so he adhered to the credo of the old classical liberals: a free market plus a peaceful international outlook. For this, he was excommunicated by the conservatives.

The result was that he ended up building his own global movement, one that began in his living room and extended to the whole human race. His two-dozen books and thousands of articles ended up inspiring a vast, worldwide movement for liberty. His economic writings bridged the gap between Mises and the current generation of Austrians. His wonderful personality demonstrated to one and all that it is possible to have fun while fighting leviathan.

As for Rothbard's own character, the contrast with Greenspan could not be starker. If Greenspan was the dreary undertaker, Rothbard was the happy warrior. Rothbard thrilled to spend time with students and faculty and anyone interested in liberty. When you spoke to him, he was glad to talk about the field of interest that was the other person's specialization. Whether it was history, philosophy, ethics, economics, politics, religion, Renaissance painting, music, sports, Baroque church architecture, or even the soaps on TV, he always made others feel more important.

He was always excited to give credit to others and to draw attention to the contribution of everyone to the great cause. He never held a grudge for long: even for those who betrayed him personally, there was always an opportunity for reconciliation open. All of these traits extended from his amazing generosity of spirit, which I attribute to his love of truth above all else.

His too-short life was cut off in 1995. But that was also the year that the web browser became common in offices and homes. Those classes that Rothbard taught in his small New York classroom are now being broadcast around the world through iTunes and Mises.org. His books are all in print and selling as never before. There are not only his books but books on his books and an entire literature growing up around his legacy.

Many have said that Rothbard was his own worst enemy. People said the same of Mises. The idea here is that they could have helped their careers by going along to get along. That is true enough. But is getting along all we really want out of life? Or do we want to make a difference in a way that will outlast us?

At some point in all our lives, we will all come to realize that all the money and all the power and goods we can accumulate will be useless to us after we die. Even large fortunes can dissipate after a generation or two. The legacy we will leave on this earth comes down to the principles by which we lived. It is the ideas we hold and the way we pursued them that is the source of our immortality.

Greenspan will leave an economy in shambles and a lifetime of pandering. Rothbard left a grand vision of liberty united with science, an example of what it means to truly think long term.

In all ages and in all times, people must make a choice. Will we accept the world as it is and try to fit in, getting as much as we can from the system until we bow out? Or will we stick to principle, pay whatever price that involves, and leave the world a better place? I submit to you that anyone who has ever truly loved liberty has chosen the second course. That is the course that the Mises Institute is dedicated to following. May we each make that choice too.

We live in an era of unparalleled confusion of thought on monetary questions. The overwhelming majority of professional economists now advocate fiat paper money. But almost as bad, the handful of economists who do favor a return to a gold standard cannot agree among themselves about what kind of gold standard they want.

The gold-standard advocates may be roughly divided into four groups, with numberless disagreements within these:

Those who favor returning to the restricted gold-exchange standard prevailing under the IMF system from 1946 to 1971, with the dollar again made convertible into gold either at $35 an ounce or some indefinitely higher figure, but still convertible only by foreign central banks or official institutions.

Those who favor returning to a fractional-reserve gold standard, with dollars convertible into gold by anyone who holds them and with a specified minimum percentage gold reserve or maximum expansion of deposits or notes — this means those who would return to the pre-1933 form of the gold standard. This probably includes the majority of present gold-standard advocates. A few of them favor abolition of the Federal Reserve System or any central bank; most do not. There is no agreement among them on the gold-conversion rate, the minimum percentage gold reserve or the maximum permitted expansion of bank deposits or notes.

Those who favor a "locked" gold standard, with no future increase in deposits or notes permitted except dollar-for-dollar for an increased domestic gold supply.

Those who favor a full gold standard, consisting only of gold coins or gold certificates 100-percent backed by gold.

Murray Rothbard puts himself in the last group — he is possibly its sole present member. This may look at first glance like the most extreme, deflationary, and impractical position that could be imagined. But Professor Rothbard defends it brilliantly — not only with prodigious historical, legal, and economic scholarship but also with unrelenting logic.

He traces the origin of the fractional-reserve system back to the practice of the old goldsmiths who, he contends, simply perpetrated a fraud by in effect issuing and lending out warehouse receipts for far more gold than they actually held. Modern banks simply continued to practice this fraud, and modern states to sanction it. The truth, he asserts, is that "fractional reserve banking is disastrous both for the morality and for the fundamental bases and institutions of the market economy."

Rothbard's conclusion, in sum, is that

the soundest monetary system and the only one fully compatible with the free market and with the absence of force or fraud from any source is a 100 percent gold standard. This is the only system compatible with the fullest preservation of the rights of property. It is the only system that assures the end of inflation, and with it, of the business cycle.

There will be loud and angry answers to this conclusion, but Rothbard has anticipated most of them. He explains why, for example, there is never any need for a larger supply of money than that already in existence.

This reviewer agrees with practically all the recommendations that Professor Rothbard makes except those concerning when and how to get back to a full gold standard. Here I would classify myself with the tiny group I have labeled "3." But what needs to be emphasized here is not detailed differences in opinion, but that Murray Rothbard has given us another provocative, informative, and elegantly reasoned economic tract.

This article first published in the Inflation Survival Letter and later republished in Libertarian Review January 1975, vol 4. no 1. p. 1.

As any good (and annoying) teacher would, I avoided giving a definitive answer one way or the other. Instead, I tried to give the best possible case for each answer, to prod the students to think it through for themselves. In this article, I summarize how even a Rothbardian could plausibly answer this question either in the affirmative or the negative.

Before jumping into the hard case, let's do the easy one first. According to Mises, Hayek, and Rothbard, the modern commercial banking system triggers the familiar boom-bust cycle when it floods the credit market with "excess" money.

Suppose we have an economy that is originally in equilibrium, where the interest rate reflects the genuine amount of savings that private individuals are taking out of their incomes. Suddenly, the commercial banks decide to grant $100 million in new loans even though this new credit doesn't correspond to anyone's extra saving. (I describe the process here.)

Because of the greater supply of credit, the market interest rate drops. This "false signal" leads entrepreneurs to borrow more funds and start longer projects than they otherwise would have. A false, unsustainable boom starts, giving most people an illusory sense of prosperity.

Later on, when the banks become worried about rising price inflation, they will slow down or even reverse their injections of unbacked new money. The market interest rate will rise back toward its correct value, and many businesses will be caught with their pants down. They'll need to reduce output, or even shut down altogether. Workers and other resources will be released from those sectors that were stimulated the most during the boom. A general bust or recession sets in.

Now the hard part: Suppose we were in a dream Rothbardian world, where gold itself is money—price tags are quoted in ounces of the yellow metal, people walk around with actual gold coins clinking in their pockets, and so forth. Furthermore, the banks practice 100 percent reserves with their demand deposits (checking accounts).

In this scenario, isn't it theoretically possible that the Misesian boom-bust cycle could still occur? Specifically, suppose that the owner of a gold mine stumbles upon the mother lode. In a very short time, he gains physical possession of several tons of new gold that nobody knew existed the month before.

Instead of going to the casino or the yacht dealership, the gold miner goes to his bank and explains, "I am lending you this new money. I recognize that you run a tight 100-percent-reserve ship, but I am adding this to my savings account, not my checking account. I know that I am giving up my money now, in exchange for your promise to pay me back the loan, with interest, down the road."

Now the bank can enter the credit markets with a huge influx of loanable funds. This new supply of savings will clearly push down the market rate of interest, allowing many businesses to expand and start long-term projects that were unprofitable before the gold discovery.

We finally see the conundrum: Is this an example of an unsustainable boom? After all, nobody in the community restricted consumption in order to free up physical resources. So how is this scenario essentially different from the case where the fractional-reserve bankers simply create new loans out of thin air?

As I explained in the introduction, I am not here to say what the definitive answer to this question is. I want to show that one could give a fairly "Rothbardian" answer that goes either way. I think modern Austrians who subscribe to Rothbard's 100-percent-reserves dictum might come down on different sides of this question.

Both Mises and Rothbard viewed interest as a "real" phenomenon. They both argued that in the undisturbed market economy, the "natural" interest rate reflects the subjective preferences people have for consuming sooner rather than later.

Mises and Rothbard also stressed the point that there was no "optimum" quantity of money. Any amount of money could perform its services as a universally accepted medium of exchange, once prices adjusted. The community would obviously grow wealthier (per capita) if farmers harvested more wheat, or if musicians held more concerts. But if the government printed up more paper money, this didn't make the community richer on average, because the same amount of real goods and services were produced. The new money simply raised prices.

Indeed, even in the case of a commodity money such as gold, new quantities delivered to the market did not make the community richer, except insofar as the new gold was used for industrial or commercial applications. For example, if some of the newly mined gold went towards arthritis treatment, or toward the production of more necklaces, then this increase would be socially beneficial. But the crucial point is that in its monetary capacity, five million tons of gold is just as useful as one million or ten million.

After stressing these standard Misesian and Rothbardian insights on the nature of interest and money, one could very plausibly argue that our mother-lode scenario would trigger an unsustainable boom. After all, suppose the gold miner didn't dump the new tons on the credit market, but instead spent them on consumption goods. Clearly this would just redistribute wealth from the rest of the community into the hands of the miner.

Consider: The total production of cars, food, clothing, and houses wouldn't go up simply because someone stumbled on a bunch of yellow metal. Therefore, the increased consumption of the gold miner could only come at the expense of others in the community, who did not get their hands on the new gold until late in the game.

Note that there is nothing unethical or dubious about a gold miner spending his justly acquired property in order to boost his consumption. We are merely arguing that this extra gold "production" is not socially useful in the same way that extra production by the farmers or dentists would be.

If we can see that spending the new gold on consumption would merely rearrange the same total quantity of real goods and services, then it is clear that the community's real income hasn't risen on account of the discovery of the mother lode.

Finally, if the analysis so far has been correct, then it obviously follows that if the gold miner takes his new money and lends it out at interest, he will distort the production structure away from its proper configuration. At the lower interest rate, businesses will borrow more money (consisting in ounces of gold) for investment spending. Yet nobody in the community will have cut back on consumption just because some guy happened to stumble on a few tons of new gold. If anything, people will consume more once interest rates drop.

Thus we see that a standard Rothbardian analysis could very plausibly conclude that a boom–bust cycle is theoretically possible on a free market.

Although the above analysis was purposely constructed along Rothbardian lines, it presents a problem: Murray Rothbard thought that the boom-bust cycle could not possibly happen on a genuinely free market. That's why he placed the analysis of Austrian business cycle theory in the section dealing with government intervention in his treatise Man, Economy, and State.

To my knowledge, Rothbard never specifically addressed the theoretical scenario we are imagining in this article. But if a Rothbardian wanted to deny that a free market could lead to a boom-bust cycle, even under these hypothetical conditions, how might he argue?

First, let's be a bit more concrete in our description of the normal, month-to-month operations of the gold miner. Other businesses collect payment from their customers in physical gold, and they pay their expenses the same way. At the end of each month, the net income of the business is the excess revenues over expenses, measured in gold ounces.

But for the man who owns a gold mine, things are different. He has to pay employees in gold ounces (or grams), and he has to pay for his electricity, gasoline, and other inputs with gold ounces too — just like any other businessman.

The difference is that the revenues of the gold miner come, not from paying customers, but from the new gold that is brought to the surface. In this hypothetical economy, the man is literally finding money buried in the ground. After suitably polishing it up (and perhaps having someone turn it into recognizable coins), these hunks of yellow metal are perfectly interchangeable with the other units of money in people's pockets.

Now we have to ask: is there anything odd or illegitimate about this constant stream of income for the gold miner, month after month? After all, he is able to use his gold production each month to pay his business expenses and to enjoy a nice lifestyle himself.

When push comes to shove, it is hard to see how a Rothbardian could, in any way, object to the miner's real income (assuming he had acquired ownership to the mine in a legal and proper fashion). In the first place, the new gold lowers the purchasing power of an ounce of gold, allowing everyone to benefit more readily from gold's nonmonetary uses (dental work, jewelry, etc.).

If we try to argue that the portion of gold that goes into cash balances (as opposed to necklaces and tooth fillings) is somehow socially useless, we run into the problem that these transactions occur on a voluntary basis, and the people trading for the gold would definitely report that they gained from the exchange.

Generally speaking, Rothbardians don't think economic science can deny the social utility of an exchange, so long as it is truly voluntary and no one else's property rights are violated. If a producer wants to burn half his coffee crop in order to extract more revenues from his customers, Rothbard has no problem with that outcome — again, so long as the government plays no part in the restrictive policy.

In this light, then, it's hard to see how a Rothbardian could claim that the gold miner's net income is somehow less deserved or "real" than anyone else's. After all, a Rothbardian would say that a fortune teller's monthly income is due to her "marginal productivity," as measured by her customers' willingness to pay. It's not our job as economists to say whether the customers' preferences are "legitimate" or "socially useful" from some objective standpoint.

If we've come this far, it's a short step to say that a massive gold discovery doesn't change the essence of the argument. If it's perfectly legitimate and "efficient" for the gold miner to bring, say, 1,000 new ounces of gold to market every month, there's no reason our opinion should change if he suddenly brings 10 tons of gold to market. That is still his income, and the community is that much richer, in nominal terms.

It's true, we might quibble and say in real terms — adjusted for price inflation — the community isn't richer. That is fine. We can look at the increase in the gold prices of milk, eggs, gasoline, and so forth, to account for the fact that a new influx of 10 tons of gold will cause (gold) price inflation. That still doesn't change the fact that the gold miner's nominal income was what it was, and is just as legitimate as it would have been had he only brought 1,000 ounces of gold to market, as usual.

We've finally reached our destination: If we accept that the gold miner's nominal income — measured in gold — is every bit as "legitimate" as anybody else's, then if he decides to save 9.5 tons of his new gold holdings by lending them out, it is perfectly accurate to say that the amount of savings in the community has increased.

Again, if we wish we can bring up the distinction between nominal and real (price-inflation adjusted) savings, but as good Misesians we must not lose sight of the "driving force of money." We can't fall into the mainstream trap of thinking about the economy as a set of "real" exchanges, and then throwing money on as an afterthought. Yes, the new influx of gold will drive up the gold-prices of goods and services in the community, and this rise in prices will cause lenders to insist on a higher nominal interest rate than they would otherwise. This inclusion of a "price premium" in the gross-market interest rate will work in the opposition direction of the increased savings, keeping the interest rate from falling as much as it otherwise would have.

In any event, it is difficult to see how a Rothbardian could claim that the gold miner's actions — bringing new gold to market, which everyone is eager to acquire, and then deciding to save a large portion of his windfall income, rather than blowing it on Caribbean cruises — are somehow detrimental to the rest of the community.

Rothbard argued against the very concept of a negative externality, so long as everyone's property rights were respected. The "correct" market interest rate in our hypothetical scenario would be just as we have described — it is the interest rate that would spontaneously emerge from the voluntary trades of everyone in the community, including the gold miner.

In this essay I have deliberately ignored certain tensions between the two sides, lest I come down one way or another on the issue. We know that it can't be the case that the two trains of thought above are both correct, because they lead to opposite conclusions. And yet, the reader must agree that each is a plausible application of Rothbardian thought.

In the real world, of course, the real danger of credit expansion and the boom-bust cycle comes from fiat money and fractional-reserve banking. Yet it is still important for economists in the Austrian tradition to think through hypothetical scenarios in order to refine our thinking and weed out any inconsistencies in our principles.

This audio Mises Daily is narrated by Steven Ng.

After downplaying the significance of Ron Paul's win at CPAC, Frum concedes that many Americans have taken to Paul's message of tying the dollar back to gold. Frum thinks that such a quaint view ignores American history. He writes,

G.K. Chesterton observed that you should never pull down a fence until you understand why it was put up.

So let's rediscover why it was that Americans abandoned the gold standard in the first place.

In the first place, it's a bit ironic to use a quip from G.K. Chesterton — the epitome of a wise conservative in the true sense of the word — to support the New Deal's uprooting of the gold standard, which Frum himself acknowledges was considered a bulwark of Western civilization.

In any event, it's very odd to say that "Americans abandoned the gold standard." Let's recall the actual events: Gold was originally the voluntary, market-chosen money (along with silver). Americans were willing to hold paper notes denominated as "dollars" only because they were originally legal claims entitling the bearer to a specified weight of gold (or silver).

Then, in 1933 the newly sworn in President Roosevelt voided Uncle Sam's contractual obligations. He further required that all Americans turn in their gold under threat of imprisonment and a $10,000 fine. It was not even legal for Americans to tie clauses of contracts to the world price of gold, until the 1970s.

It wasn't even the case that FDR campaigned on a pledge to end the dollar's tie to gold. Indeed, one of Herbert Hoover's bitter complaints was that FDR caused unnecessary chaos in the financial markets after his election in November 1932 by not explaining what his gold policy would be during Hoover's lame duck session. (In those days new presidents were not sworn in until March 4.)

There are many ways of describing the above history, but "Americans abandoned the gold standard" would not be high on my personal list. By the same token, if a Texan were complaining about outrageous federal taxes, I wouldn't say, "Hey, you should recall why America retained the Confederacy."

Let's explore Frum's explanation of why "America" abandoned the gold standard in the early 1930s:

In 1929, the U.S. economy slumped into recession. Under the weight of a series of terrible decisions, that recession collapsed into the worldwide Great Depression.

But why did decision-makers make so many bad decisions? The short answer is that they were trapped. Almost all of the right decisions would have ballooned the U.S. federal budget deficit. As budget deficits expanded, investors would inevitably worry that their dollars might lose value in the future. They would demand to trade their dollars for gold at the fixed price of $20.67 to the ounce. Under the rules of the gold standard, the U.S. government would be obliged to sell.

As long as the deficits continued, the U.S. government would lose gold. Threatened with the exhaustion of its gold supply, the government felt it had no choice: It had to close the budget deficit. So, in the throes of a severe downturn, the U.S. government did exactly the opposite of what economists would otherwise advise: It cut spending and raised taxes — capsizing the economy even deeper into depression.

It's very strange to hear gold standard advocates criticize President Hoover for imposing steep tax increases in 1932, the Depression's worst year. Yet the gold standard they champion was the reason for the tax increases they deplore. (emphasis added)

I don't need to dwell on the bad economics behind Frum's assertions. David Friedman has already done a fabulous job, and I would merely be repeating the same things I wrote just one week ago when correcting Paul Krugman's faulty ghost stories of Herbert Hoover.

For the present piece, I just want to make an observation: isn't it ironic that David Frum, former speechwriter for George W. Bush and a fellow at the American Enterprise Institute, thinks that it is common knowledge that deficit spending is the way to fix a depressed economy?After this piece was written, Frum parted ways with AEI. To his credit, Frum is consistent: he actually criticized conservative Republicans for opposing Obama's stimulus package.

In my younger days, when I was even more naïve than I am now, I couldn't understand how "right-wingers" could be so good on domestic issues like taxes and business regulations, but so awful on foreign-policy issues. I couldn't understand how self-described conservatives could detest and fear big government when it came to the Department of Health and Human Services, but not when it came to the CIA and the Pentagon.

Now I realize that there's no hypocrisy or inconsistency at all, at least not among some of the top neoconservative theorists: They are quite consistent in believing that politicians in Washington, DC, have both the ability and the desire to make the world a better place, whether in foreign lands or in American inner cities. All it takes is several trillion dollars and a few experts like David Frum advising them.

After painting a picture of how awful a modern gold standard would be — it would have made the recent trillion-dollar-plus deficits impossible, yikes! — Frum argues that the entire discussion is moot:

No government ever can return to the gold standard.

Back in the 1930s, governments accepted horrific suffering because they were terrified of the consequences of going off gold. When President Franklin Roosevelt told his budget director, Lewis Douglas, of his decision to quit gold, Douglas replied: "This is the end of Western civilization." He wasn't kidding either.

In fact, the decision was the turning point of the Depression, the beginning of recovery. And every monetary economist knows it. Which means that the first thing any future gold-standard government would do in the event of recession would be to jettison gold. And every market trader knows that too.

So … as soon as the first sign of recession materializes on the horizon, the traders would dump the currency of the gold standard country. The gold standard country would then have to decide whether to self-impose draconian 1932-style budget-balancing or forgo the whole painful experience and surrender right away to what is inevitable sooner or later.

Since everybody knows that a gold standard country would quit gold as soon as times got tough, nobody will ever believe the decision to restore the gold standard in the first place.

It's as dead as monocles and walking sticks. Deader, really.

I have dealt with the history of governments breaking their ties to gold here. What I want to do now is show how Frum's closing argument contradicts the writings of G.K. Chesterton, underscoring the irony I alluded to earlier. To reiterate, Frum is claiming that history has moved on and the gold standard is now obsolete. I couldn't find a quote from Chesterton on the gold standard per se, but I did find this:

One of the first things that are wrong is this: the deep and silent modern assumption that past things have become impossible. There is one metaphor of which the moderns are very fond; they are always saying, "You can't put the clock back." The simple and obvious answer is "You can." A clock, being a piece of human construction, can be restored by the human finger to any figure or hour. In the same way society, being a piece of human construction, can be reconstructed upon any plan that has ever existed. (G.K. Chesterton, What's Wrong with the World

It's difficult to pinpoint the precise error in Frum's reasoning, since it is a string of assertions. Under Murray Rothbard's plan for a return to a genuine gold dollar, paper notes would be backed 100% by gold reserves. So even if investors around the world doubted the commitment of, say, a newly elected President Paul to honor the US government's gold obligations, this would pose no problem. Governments get into trouble when they print more paper money than they can redeem, leaving themselves vulnerable to a "bank run" by speculators. Under a 100% reserve gold standard, it's true that the federal government's ability to run deficits would be curtailed, but that's one of the advantages of the proposal.

Although he writes with confidence, David Frum's rejection of the gold standard is based on faulty history, bad economics, and a belief in the power of Washington to manage the economy. On top of it all, Frum ends with a non sequitur akin to my declaration that a diet can't reduce my waistline, since I would just go off it in two weeks.

The international gold standard works without any action on the part of governments. It is effective, real cooperation of all members of the world-embracing market economy. There is no need for any government to interfere in order to make the gold standard work as an international standard.

What governments call international monetary cooperation is concerted action for the sake of credit expansion. They have learned that credit expansion, when limited to one country only, results in an external drain. They believe that it is only the external drain that frustrates their plans of lowering the rate of interest and thus of creating an everlasting boom. If all governments were to cooperate in their expansionist policies, they think, they could remove this obstacle. What is required is an international bank issuing fiduciary media that are dealt with as money-substitutes by all people in all countries.

There is no need to stress again here the point that what makes it impossible to lower the rate of interest by means of credit expansion is not merely the external drain. This fundamental issue is dealt with exhaustively in other chapters and sections of this book.

But there is another important question to be raised.

Let us assume that there exists an international bank issuing fiduciary media the clientele of which is the world's whole population. It does not matter whether these money-substitutes go directly into the cash holdings of the individuals and firms or are only kept by the various nations' central banks as reserves against their issuance of national money-substitutes. The deciding point is that there is a uniform world currency. The national banknotes and checkbook money are redeemable in money-substitutes issued by the international bank. The necessity of keeping its national currency at par with the international currency limits the power of every nation's central banking system to expand credit. But the world bank is restrained only by those factors that limit credit expansion on the part of a single bank operating in an isolated economic system or in the whole world.

We may as well assume that the international bank is, not a bank issuing money-substitutes a part of which are fiduciary media, but a world authority issuing international fiat money. Gold has been entirely demonetized. The only money in use is that created by the international authority. The international authority is free to increase the quantity of this money provided it does not go so far as to bring about the crack-up boom and the breakdown of the currency.

Then the ideal of the Keynesians is realized. There is an institution operating that can exercise an "expansionist pressure on world trade." It is free to pour a horn of plenty over the world.

However, the champions of such plans have neglected a fundamental problem, namely, that of the distribution of the additional quantities of this credit money or of this paper money.

Let us assume that the international authority increases the amount of its issuance by a definite sum, all of which goes to one country, Ruritania. The final result of this inflationary action will be a rise in prices of commodities and services all over the world. But while this process is going on, the conditions of the citizens of various countries are affected in a different way. The Ruritanians are the first group blessed by the additional manna. They have more money in their pockets while the rest of the world's inhabitants have not yet got a share of the new money. They can bid higher prices, while the others cannot. Therefore the Ruritanians withdraw more goods from the world market than they did before. The non-Ruritanians are forced to restrict their consumption because they cannot compete with the higher prices paid by the Ruritanians. While the process of adjusting prices to the altered money relation is still in progress, the Ruritanians are in an advantageous position against the non-Ruritanians. When the process finally comes to an end, the Ruritanians have been enriched at the expense of the non-Ruritanians.

The main problem in such expansionist ventures is the proportion according to which the additional money is to be allotted to the various nations. Each nation will be eager to advocate a mode of distribution that will give it the greatest possible share in the additional currency. The industrially backward nations of the East will, for instance, probably recommend equal distribution per capita of population, a mode that would obviously favor them at the expense of the industrially advanced nations. Whatever mode may be adopted, all nations would be dissatisfied and would complain of unfair treatment. Serious conflicts would ensue and would disrupt the whole scheme.

It would be irrelevant to object that this problem did not play an important role in the negotiations that preceded the establishment of the International Monetary Fund and that it was easy to reach an agreement concerning the use of the IMF's resources. The Bretton Woods Conference was held under very particular circumstances. Most of the participating nations were at that time entirely dependent on the benevolence of the United States. They would have been doomed if the United States had stopped fighting for their freedom and aiding them materially by lend-lease.

The government of the United States, on the other hand, looked upon the monetary agreement as a scheme for a disguised continuation of lend-lease after the cessation of hostilities. The United States was ready to give and the other participants — especially those of the European countries, most of them at that time still entirely occupied by the German armies, and those of the Asiatic countries — were ready to take whatever was offered to them. The problems involved will become discernible as soon as the wartime attitude in the United States toward financial and trade matters is replaced by a more realistic mentality.

This article is excerpted from chapter 17 of Human Action: The Scholar's Edition and is read by Jeff Riggenbach.

This audio Mises Daily is narrated by Jeff Riggenbach.

Men have chosen the precious metals gold and silver for the money service on account of their mineralogical, physical, and chemical features. The use of money in a market economy is a praxeologically necessary fact. That gold—and not something else—is used as money is merely a historical fact and as such cannot be conceived by catallactics. In monetary history too, as in all other branches of history, one must resort to historical understanding. If one takes pleasure in calling the gold standard a "barbarous relic,"Lord Keynes in the speech delivered before the House of Lords, May 23. 1944.

one cannot object to the application of the same term to every historically determined institution. Then the fact that the British speak English — and not Danish, German, or French — is a barbarous relic too, and every Briton who opposes the substitution of Esperanto for English is no less dogmatic and orthodox than those who do not wax rapturous about the plans for a managed currency.

The demonetization of silver and the establishment of gold monometallism was the outcome of deliberate government interference with monetary matters. It is pointless to raise the question concerning what would have happened in the absence of these policies. But it must not be forgotten that it was not the intention of the governments to establish the gold standard. What the governments aimed at was the double standard. They wanted to substitute a rigid, government-decreed exchange ratio between gold and silver for the fluctuating market ratios between the independently coexistent gold and silver coins. The monetary doctrines underlying these endeavors misconstrued the market phenomena in that complete way in which only bureaucrats can misconstrue them. The attempts to create a double standard of both metals, gold and silver, failed lamentably. It was this failure that generated the gold standard. The emergence of the gold standard was the manifestation of a crushing defeat of the governments and their cherished doctrines.

In the 17th century, the rates at which the English government tariffed the coins overvalued the guinea with regard to silver and thus made the silver coins disappear. Only those silver coins that were much worn by usage or in any other way defaced or reduced in weight remained in current use; it did not pay to export and to sell them on the bullion market. Thus England got the gold standard against the intention of its government. Only much later the laws made the de facto gold standard a de jure standard. The government abandoned further fruitless attempts to pump silver standard coins into the market and minted silver only as subsidiary coins with a limited legal tender power. These subsidiary coins were not money, but money-substitutes. Their exchange value depended not on their silver content, but on the fact that they could be exchanged at every instant, without delay and without cost, at their full face value against gold. They were de facto silver printed notes, claims against a definite amount of gold.

Later in the course of the 19th century, the double standard resulted in a similar way in France and in the other countries of the Latin Monetary Union in the emergence of de facto gold monometallism. When the drop in the price of silver in the later 1870s would automatically have effected the replacement of the de facto gold standard by the de facto silver standard, these governments suspended the coinage of silver in order to preserve the gold standard. In the United States, the price structure on the bullion market had already, before the outbreak of the Civil War, transformed the legal bimetallism into de facto gold monometallism.

After the greenback period, there ensued a struggle between the friends of the gold standard on the one hand and those of silver on the other hand. The result was a victory for the gold standard. Once the economically most advanced nations had adopted the gold standard, all other nations followed suit. After the great inflationary adventures of the First World War, most countries hastened to return to the gold standard or the gold-exchange standard.

The gold standard was the world standard of the age of capitalism, increasing welfare, liberty, and democracy, both political and economic. In the eyes of the free traders its main eminence was precisely the fact that it was an international standard as required by international trade and the transactions of the international money and capital market.T.E. Gregory, The Gold Standard and Its Future (3d ed. London, 1934), pp. 22 ff. It was the medium of exchange by means of which Western industrialism and Western capital had borne Western civilization into the remotest parts of the earth's surface, everywhere destroying the fetters of age-old prejudices and superstitions, sowing the seeds of new life and new well-being, freeing minds and souls, and creating riches unheard of before. It accompanied the triumphal unprecedented progress of Western liberalism ready to unite all nations into a community of free nations peacefully cooperating with one another.

It is easy to understand why people viewed the gold standard as the symbol of this greatest and most beneficial of all historical changes. All those intent upon sabotaging the evolution toward welfare, peace, freedom, and democracy loathed the gold standard, and not only on account of its economic significance. In their eyes the gold standard was the labarum, the symbol, of all those doctrines and policies they wanted to destroy. In the struggle against the gold standard, much more was at stake than commodity prices and foreign-exchange rates.

The nationalists are fighting the gold standard because they want to sever their countries from the world market and to establish national autarky as far as possible. Interventionist governments and pressure groups are fighting the gold standard because they consider it the most serious obstacle to their endeavors to manipulate prices and wage rates. But the most fanatical attacks against gold are made by those intent upon credit expansion. With them, credit expansion is the panacea for all economic ills. It could lower or even entirely abolish interest rates, raise wages and prices for the benefit of all except the parasitic capitalists and the exploiting employers, free the state from the necessity of balancing its budget — in short, make all decent people prosperous and happy. Only the gold standard, that devilish contrivance of the wicked and stupid "orthodox" economists, prevents mankind from attaining everlasting prosperity.

The gold standard is certainly not a perfect or ideal standard. There is no such thing as perfection in human things. But nobody is in a position to tell us how something more satisfactory could be put in place of the gold standard. The purchasing power of gold is not stable. But the very notions of stability and unchangeability of purchasing power are absurd. In a living and changing world there cannot be any such thing as stability of purchasing power. In the imaginary construction of an evenly rotating economy there is no room left for a medium of exchange. It is an essential feature of money that its purchasing power is changing. In fact, the adversaries of the gold standard do not want to make money's purchasing power stable. They want rather to give to the governments the power to manipulate purchasing power without being hindered by an "external" factor, namely, the money relation of the gold standard.

The main objection raised against the gold standard is that it makes operative in the determination of prices a factor that no government can control — the vicissitudes of gold production. Thus an "external" or "automatic" force restrains a national government's power to make its subjects as prosperous as it would like to make them. The international capitalists dictate and the nation's sovereignty becomes a sham.

However, the futility of interventionist policies has nothing at all to do with monetary matters. It will be shown later why all isolated measures of government interference with market phenomena must fail to attain the ends sought. If the interventionist government wants to remedy the shortcomings of its first interferences by going further and further, it finally converts its country's economic system into socialism of the German pattern. Then it abolishes the domestic market altogether, and with it money and all monetary problems, even though it may retain some of the terms and labels of the market economy.Cf. Human Action, chapters XXVII–XXXI. In both cases it is not the gold standard that frustrates the good intentions of the benevolent authority.

The significance of the fact that the gold standard makes the increase in the supply of gold depend upon the profitability of producing gold is, of course, that it limits the government's power to resort to inflation. The gold standard makes the determination of money's purchasing power independent of the changing ambitions and doctrines of political parties and pressure groups. This is not a defect of the gold standard; it is its main excellence. Every method of manipulating purchasing power is by necessity arbitrary. All methods recommended for the discovery of an allegedly objective and "scientific" yardstick for monetary manipulation are based on the illusion that changes in purchasing power can be "measured." The gold standard removes the determination of cash-induced changes in purchasing power from the political arena. Its general acceptance requires the acknowledgment of the truth that one cannot make all people richer by printing money. The abhorrence of the gold standard is inspired by the superstition that omnipotent governments can create wealth out of little scraps of paper.

It has been asserted that the gold standard too is a manipulated standard. The governments may influence the height of gold's purchasing power either by credit expansion — even if it is kept within the limits drawn by considerations of preserving the redeemability of the money-substitutes — or indirectly by furthering measures that induce people to restrict the size of their cash holdings. This is true. It cannot be denied that the rise in commodity prices that occurred between 1896 and 1914 was to a great extent provoked by such government policies. But the main thing is that the gold standard keeps all such endeavors toward lowering money's purchasing power within narrow limits. The inflationists are fighting the gold standard precisely because they consider these limits a serious obstacle to the realization of their plans.

What the expansionists call the defects of the gold standard are indeed its very eminence and usefulness. It checks large-scale inflationary ventures on the part of governments. The gold standard did not fail. The governments were eager to destroy it, because they were committed to the fallacies that credit expansion is an appropriate means of lowering the rate of interest and of "improving" the balance of trade.

No government is, however, powerful enough to abolish the gold standard. Gold is the money of international trade and of the supernational economic community of mankind. It cannot be affected by measures of governments whose sovereignty is limited to definite countries. As long as a country is not economically self-sufficient in the strict sense of the term, as long as there are still some loopholes left in the walls by which nationalistic governments try to isolate their countries from the rest of the world, gold is still used as money. It does not matter that governments confiscate the gold coins and bullion they can seize and punish those holding gold as felons. The language of bilateral clearing agreements by means of which governments are intent upon eliminating gold from international trade, avoids any reference to gold. But the turnovers performed on the ground of those agreements are calculated on gold prices. He who buys or sells on a foreign market calculates the advantages and disadvantages of such transactions in gold. In spite of the fact that a country has severed its local currency from any link with gold, its domestic structure of prices remains closely connected with gold and the gold prices of the world market. If a government wants to sever its domestic price structure from that of the world market, it must resort to other measures, such as prohibitive import and export duties and embargoes. Nationalization of foreign trade, whether effected openly or directly by foreign exchange control, does not eliminate gold. The governments qua traders are trading by the use of gold as a medium of exchange.

The struggle against gold, which is one of the main concerns of all contemporary governments, must not be looked upon as an isolated phenomenon. It is but one item in the gigantic process of destruction that is the mark of our time. People fight the gold standard because they want to substitute national autarky for free trade, war for peace, totalitarian government omnipotence for liberty.

It may happen one day that technology will discover a method of enlarging the supply of gold at such a low cost that gold will become useless for the monetary service. Then people will have to replace the gold standard by another standard. It is futile to bother today about the way in which this problem will be solved. We do not know anything about the conditions under which the decision will have to be made.

This audio Mises Daily is narrated by Jeff Riggenbach.

Sooner or later, if and when the power of the Federal Reserve over money is revoked in a constitutional manner, and if and when constitutional coin comes back into use, these questions will need to be asked, answered, and understood. That is what this article does in a compact fashion.

In his meticulously researched two-volume work, Pieces of Eight, constitutional lawyer Edwin Vieira Jr. shows beyond any doubt that the constitutional dollar in the United States is an "historically determinate, fixed weight of fine silver." The Coinage Act of 1792 is but one source among many that makes this evident, reading,

"the money of account of the United States shall be expressed in dollars or units … of the value [mass or weight] of a Spanish milled dollar as the same is now current, and to contain three hundred and seventy-one grains and four sixteenth parts of a grain of pure … silver.

The United States has a legal and constitutional silver standard, although we would not know it today, since the government has illegally and unconstitutionally removed silver as currency and replaced it with the Federal Reserve notes that we know as dollar bills. The term "dollar bills" obscures the actual and tangible meaning of "dollar" as a specific weight of silver.

The United States has historically minted gold coins as well as silver coins, as the constitution instructed. It regulated their "value," the weight of gold they contained, in order to bring the meaning of a gold dollar into conformity with the silver standard coin, which contains 371.25 grains of pure silver. This too was constitutionally mandated. The government did the same for foreign coins up until 1857.

The United States never was or could be constitutionally on a dual standard or a gold standard. It circulated silver and gold coins as media of exchange by adjusting the content of the gold dollar to a silver-standard dollar. For example, the Coinage Act of 1792 authorizes "Eagles — each to be of the value of ten dollars or units [i.e., of ten silver dollars], and to contain two hundred and forty-seven grains, and four eighths of a grain of pure … gold." Since the dollar contained 371.25 grains of silver, this brought into legal equivalence 3712.5 grains of silver and 247.5 grains of gold. The ratio was 1:15.

In the Coinage Act of 1834, Congress adjusted the gold eagle: "Each eagle shall contain two-hundred and thirty-two grains of pure gold." This brought into legal equivalence 3712.5 grains of silver and 232 grains of gold. The ratio was 1:16. The reason for the change was that gold had appreciated in market value relative to silver.

Old coins could be brought in and reminted for free (after waiting 40 days.) If old coins were not reminted, they were to be accepted as payments "at the rate of ninety-four and eight-tenths of a cent per pennyweight." The weights of the earlier and later eagles were influenced by a change in the standard gold alloy. The rate of 94.8 cents per pennyweight took that change as well as the alteration in the pure gold content into account, so that payments made in either the old or the new coins became very nearly equivalent in terms of the amounts of pure gold being paid.

With this as an introduction, let us go on to an explanation of Gresham's law and the reason why Congress was constitutionally mandated to make such adjustments in the weight of gold in the gold-dollar coin.

Suppose that the dollar is defined as a unit that contains 371.25 grains of silver, and suppose that the unit is physically identified with a specific silver coin that contains that mass of silver. Since grains are unfamiliar units, let us use ounces. Let us note that There are 480 grains in one troy ounce. Hence, 371.25 grains weighs 0.7734375 oz. That is to say that if a silver-dollar standard is officially and constitutionally instituted, with each dollar having the mass of 371.25 grains of silver, this means that the dollar is defined as containing 0.7734375 troy ounces of silver.

In all nonfraudulent exchanges involving dollars, someone who pays or receives a dollar is supposed to pay or receive that mass (or loosely weight) of silver in coin or its equivalent in bullion (bars or ingots). The dollar sign, "$," in such a regime means 1 silver dollar of the official weight of 0.7734375 troy ounces of pure silver. The word "dollar" means the silver coin of that specific mass.

A standard is something that is unchanging. A yard always has 36 inches. A pound always has 16 ounces. A standard, constitutional dollar always has the same amount of the metal that is chosen as its definition, until the constitution is amended to alter the standard, or unless the constitution allows the legislature to alter the standard.

Economically, there can only be a single such standard dollar at a time. One cannot simultaneously have the dollar mean a certain amount of silver and another amount of gold. An economy cannot have two concurrent and different standards of the dollar. The reason for this is that, as will now be discussed, the relative prices of any two metals fluctuate over time.

The exchange rates of gold for silver vary over time due to the changing supplies and demands for these metals in markets. At one time, 1 oz of gold may exchange for 16 oz of silver, while at another time it may exchange for 25 oz of silver. These fluctuations go on unceasingly.

If an attempt is made to define a dollar by two standards simultaneously, it will fail. If a dollar is made to be 1 oz of gold and also 16 oz of silver, what is a dollar when those metals no longer exchange at that ratio? What is a dollar when they exchange at 1 oz of gold to 25 oz of silver? There is no answer. There is no answer because the dollar cannot simultaneously be two different weights of two different metals whose rates of exchange vary over time. One or the other of the two metals has to be chosen as a standard.

Fluctuations occur in the market even if the government sets an official rate of exchange between the two metals, which is what was done in the various coinage acts. The government can attempt to force a given exchange rate, but this will not alter the fact that the market exchange rate departs from the forced exchange rate. The result of a discrepancy between legal and market rates of exchange will be that one of the metals will disappear from circulation. That result comes under the heading of Gresham's law in operation.

There are two ways that the government can, without the direct use of force, keep both silver and gold circulating as money even if only one of them is the standard. One way is to regulate the value of the official gold dollar as time passes, which means to change the official rate of exchange between gold and silver in order to bring it into accord with the market rate of exchange. That is what the coinage acts did.

The other way is to avoid using a gold dollar altogether and produce gold coins that have a known weight but no designation as a dollar. The gold coin can "float" or have a changing price against the silver-standard dollar. This method was not used but it could and should be used in the future if and when the constitutional silver dollar is restored as the unit of account.

Let us examine in more detail how a money standard, such as the silver standard, works; and then let us examine Gresham's law.

Suppose that there is a single silver standard: that of a dollar containing 0.7734375 oz of silver. Suppose also that at some specific time, the price of a troy ounce of gold in terms of silver is $16 in the market. This means that 1 oz of gold exchanges in the market for 16 silver dollars, each dollar containing 0.7734375 oz of silver. That is, 1 oz of gold exchanges for 12.375 oz of silver.

Now suppose that the government issues a gold coin. If an official gold coin is made that says it is a $16 gold coin, stamped literally 16 dollars, it will contain 1 troy ounce of gold, worth exactly $16, that is, worth 16 silver dollars. Suppose that the government goes one step further: it makes this exchange rate the official rate, such that in debt contracts one is permitted to pay either 16 silver dollars or 1 of these gold coins.

The official exchange rate is 1/16 oz of gold per silver dollar. The silver standard and accompanying law make silver a legal payment or legal tender in debt contracts, unless perhaps the private parties to the contract are allowed to specify otherwise. With gold's price officially fixed at 1 oz per 16 silver dollars, then gold at that price is also a legal tender in payment of debts. The government in this example is attempting to keep both gold and silver in circulation by making the official rate the same as the market rate.The law may also enable one to legally write contracts to protect against future changes in the market rate of exchange, but that is another matter. We want to see what occurs if the official rate of exchange of silver and gold deviates from the market rate as time passes.

In the unlikely case that the market price of gold remains at $16 indefinitely, this gold coin provides a substitute or equivalent to the silver standard, even though there is but a single standard. If this market ratio prevails through time, staying at the official rate, there is no real difference between gold and silver for payment purposes. In this situation, one can think in terms of either a silver or a gold standard, even though there is really only a single standard. There is no significant difference.

However, this situation never actually occurs. Market prices do change. A single standard then becomes essential in an economic sense if the dollar is to retain a clear definition as a standard. The silver standard fixes the dollar at 371.25 grains of silver, no matter what happens to the market price of gold in terms of silver. If the relative prices of silver and gold change, that shows up in a change solely in the price of gold. This will make the "16 dollar" designation on the gold coin obsolete from a market point of view, but not from an official point of view.

This disparity will set in motion certain events that we now look into. These events are certain to occur because the discrepancy between the market and official rates will create a profit incentive.

Consider two examples in which the market prices deviate from the official exchange ratio. The first example occurs when gold rises in price relative to silver. Suppose that 1 oz of gold becomes able to buy 20 silver dollars in the market. The market exchange ratio becomes 0.05 oz of gold per silver dollar, while the official rate is still 0.0625 oz of gold per silver dollar. The gold piece becomes more valuable. An ounce of gold now exchanges for 15.46875 oz of silver, which is the amount of silver in 20 silver dollars. At the official rate, it exchanges for only 12.375 oz of silver.

Now we explore the profit opportunity that lies at the heart of Gresham's law: If someone owes 16 dollars and can pay in either silver or gold coins, which will they chose? Will it be silver or gold? Intuitively, one pays with the less expensive metal, which is silver. One holds gold off the market and instead uses silver for payments. The more expensive metal disappears from circulation as money or coin, although it will continue to be used for jewelry, teeth, and industrial applications.

The official contractual rate in debt contracts calls for either 16 silver dollars or 1 gold coin. But 1 gold coin now exchanges for 20 silver dollars in the market. If a person possesses 1 gold coin, he can buy 20 silver dollars in the market by ignoring the official rate of exchange. He can then pay the debt with 16 of these silver dollars and have 4 silver dollars left over. This is clearly preferable to paying out the entire gold coin to satisfy the debt, since he gets rid of the debt and still has 4 dollars left over. Hence, he will pay at the official rate in silver dollars, not in gold coins.

This situation contains a risk-free arbitrage (or profit) opportunity. Exploiting it drives gold out of circulation as money. For example, suppose a person starts by borrowing 1 gold coin. He then buys 20 silver dollars and keeps 4 of them. He then repays the loan of the gold coins with 16 silver dollars, since they are legal tender. He can repeat this operation again and again to augment his pile of free silver. This is a money machine — a risk-free arbitrage — in which one party gains and the other loses.

The lender of gold coins is obeying the law by honoring the official exchange rate, but he is losing on this deal since the 16 silver dollars that he is repaid cannot buy 1 gold coin in the market. He will stop lending gold coins. He will put an end to the money machine. This is why finance theories typically assume that assets are priced so as to preclude risk-free arbitrage opportunities.

Let us think of this in another way, which is in terms of exchange rates. An exchange rate when silver is the standard is expressed as a number of ounces of gold per silver dollar. When gold appreciates in price relative to silver, the exchange rate falls. That is, less gold is required to exchange for each silver dollar. In the example above, one can satisfy the debt at the official exchange rate of 0.0625 oz of gold per silver dollar, whereas the silver dollar fetches only 0.05 oz of gold in the market. Silver that is used to extinguish debt has a greater value than silver that is used to buy gold in the market as coin. Therefore, silver will be used for payments of debt and all other exchanges, not gold.

The result of gold having appreciated in price relative to silver and thus of the market rate of exchange of gold for silver having fallen below the official rate of exchange (0.05 oz of gold per silver dollar as opposed to 0.0625 oz of gold per silver dollar) is that gold will disappear from circulation as payments. This is an example of Gresham's law.

When two metals are legal tender at an official rate of exchange and one metal's market price increases, that metal (here gold) will disappear from circulation as money. Gresham's law is an application of the idea that money machines do not exist in equilibrium, that there is no free lunch, and that risk-free arbitrage opportunities do not exist in equilibrium.

There is another way of describing what happens when gold appreciates in price relative to silver, but the official rate is lower: One could say that the official exchange rate undervalues gold. The undervalued metal disappears from circulation.

This language is misleading and confusing, however. Is silver overvalued? It seems natural to conclude that silver is overvalued if gold is undervalued. However, silver is not overvalued. Silver cannot possibly be overvalued because it is the standard being used to define the dollar.

Despite the very great drawback introduced by the terms "undervalued" and "overvalued" in this context, they have been common in debates on bimetallism. These terms have contributed to confusion, erroneous analysis, and policy blunders with costly consequences, because they obscure the reality that one metal is always the standard. In the United States, that constitutional metal has always been silver.

One also hears Gresham's law stated as "bad money drives out good." This too is misleading, confusing, and erroneous. In the example of gold appreciating and disappearing, silver is by no means "bad money," nor is gold "good money." There is no good and bad money at all. Silver is the metal being used as the standard. It has not driven gold or good money out of circulation. The fixed exchange rate of gold set at too high a level compared to the going market rate has driven gold out of exchange.

For completeness, we consider the opposite case in which gold depreciates relative to the silver standard. Suppose that the market exchange rate rises from 0.0625 oz to 0.076923 oz of gold per silver dollar, which means that one ounce of gold now trades for 13 silver dollars. Suppose that a debt of $16 is to be paid. A person can pay in either silver or gold dollars. This again requires 1 gold coin at the official rate. The cost of that coin in the market is 13 silver dollars. If one had 16 silver dollars, one could use 13 of them to buy 1 gold dollar in order to pay off the debt. One would then have 3 silver dollars left over. Therefore, it's less expensive to pay the debt with gold.

Gresham's law again goes to work. Silver disappears from circulation. When two metals are legal tender at an official rate of exchange and one metal's market price depreciates in terms of the metal used as a standard (silver), that depreciated metal (gold) will circulate, and the other metal (silver) will disappear from circulation as a medium of exchange while maintaining its role as a medium of account.

In practice, a rather small depreciation of gold (1–3 percent) is enough to cause silver coins to disappear from circulation. Suppose we start with an official and market ratio of silver to gold at which there is the equivalent of 0.05 oz of gold in one silver dollar. This means that 1 silver dollar buys exactly $1 worth of gold at the official and market rate, and that 20 silver-dollar coins buy 1 gold coin that weighs 1 oz and is worth 20 times as much as the silver in one silver dollar.

Suppose now that the market price for gold declines such that 0.051 oz of gold buys 1 silver dollar. This is a 2-percent increase in the market exchange ratio. At the official exchange rate of 20 silver dollars per gold coin, the 0.051 oz of gold is worth 0.051 × 20 = $1.02 (i.e., 1.02 silver dollars.) If a person had to pay $1, it would be better to pay it in the less-expensive metal (here gold), at the official rate of 0.05 oz of gold per dollar. People will thus tend to use gold for exchanges and hold silver off the market.

If small changes drive one metal or the other out of circulation, the government has to adjust the official exchange rates frequently if both are to be kept in circulation. This is both costly and inconvenient. The solution to this is straightforward. Choose one metal as a standard and allow the price of the other metal to fluctuate freely or float in the market.

If silver is the standard, then gold coins can be minted with no dollar designation at all. They can be minted with the weight of pure gold shown. Then when they are used as payments or used as a basis for issuing e-credits or gold certificates, their weights can be used in conjunction with the changing price of gold to gauge appropriate payments and receipts.

Q: What is a constitutional dollar literally (in the United States)?

A: It is a silver coin containing 371.25 grains (0.7734375 troy ounces) of pure silver.

Q: Is a gold standard constitutional?

A: No, not for the United States as the constitution is written. It should be noted, however, that individual states have a constitutional power to make specie (silver, gold, or both) legal tender.

Q: What is meant by a metal standard?

A: It means a monetary unit that contains a specific weight of metal.

Q: Can the United States or any country be on two metal standards at the same time?

A: No, this will be impracticable because of the continual changes in relative prices of any two metals.

Q: Can two metals circulate as coin if there is but one standard?

A: Yes. The metal that is not the standard can circulate as a coin of a given weight of that precious metal whose value at any given time is determined by reference to market prices. Such a coin need not carry any specific dollar designation. This obviates Gresham's law.

Q: Does one metal have to drive the other out of circulation?

A: No. As long as the metal that is not the standard is not legally made to exchange at a fixed ratio to the standard metal, both metals can circulate just as silver and gold both trade in today's markets. Gresham's law will not come into play.

Q: How and why does Gresham's law work when a country uses metal coin for money?

A: Gresham's law takes hold when the government fixes an exchange rate between two metals. When the market rate of exchange deviates from the fixed rate, arbitrage opportunities arise that make it profitable to use the less-expensive metal as means of payment at the official rate. Then the more-expensive metal disappears from circulation as a medium of exchange.

Q: What is an accurate rendition of Gresham's law?

A: When two metals are legal tender at an official rate of exchange and when one metal's market price appreciates in terms of the metal used as a standard, the appreciated metal will disappear from circulation as money and the metal used as a standard will circulate. Conversely, when two metals are legal tender at an official rate of exchange and one metal's market price depreciates in terms of the metal used as a standard, the depreciated metal will circulate; the metal used as a standard will disappear from circulation as a medium of exchange, although it is still the medium of account.

Put more simply, when two metals are legal tender at a fixed, official rate of exchange, the metal that is less expensive at the market rate of exchange will tend to circulate for payments while the more expensive metal will tend to disappear as a medium of exchange.

Complicit, by Mark Gilbert, the London bureau chief for Bloomberg financial news, is unusual — a book concerning our recently demised speculative boom that you can still take along to the beach. Using that peculiar British talent of evoking laughter by the use of sneering disdain (he refers to the last suckers to buy into the mania as "the hindmost"), Mr. Gilbert takes the reader on a tour of almost-impossible-to-believe tales of greed, stupidity, and woe across eleven short, engaging chapters.

The book comes at you in a series of brief, loud bursts: every chapter is further divided into sub-sections such as "Be Careful What You Wish For"and "LIBOR Freezes Over." The fact that Mr. Gilbert, as per the book's dust jacket sleeve, plays bass in a rock band makes complete sense, as this offering falls into a bizarre hybrid subgenre — Joey Ramone of the Mersey — that lies somewhere between the Jam and Roger Lowenstein.

Complicit is a frenzied trip down memory lane, even for those of us who lived through the thick of it all. Though I personally watched a proud Lehman Brothers morph into a corpse at the speed of leverage, I found myself growing slowly appalled while reading the alphabet litany of bailout acronyms; every page was a reminder of how much I'd already forgotten.

Naturally, those of Austrian mindset will disagree with almost all of Mr. Gilbert's conclusions about what happened before, during, and after the Great Moderation. But the importance of reading books that you don't agree with exceeds that of reading those that preach to your choir. It expands your understanding of any subject to see how others look at things, and, most importantly, it grants you access to some great reads.

The best chapter is number ten, Giants Fall, where Mr. Gilbert recounts the collapse of Bear Stearns, Lehman, and AIG (let's be honest — every top tier financial behemoth collapsed) along with the Federal Reserve's ad hoc, utterly lawless response.

The book's tone matches exactly the events it describes: it reads like a whirl of jumbled madness, and that's just pitch perfect. If you were there, if you took the cab rides to eat trendy food and the jet jaunts to paradise, if you hugged your bonus tight before throwing it into the wind, you know that a whirl of jumbled madness was exactly what it all felt like.

America long ago watched Lady Liberty replace her golden torch with a dance pole, the better to crotch grind the ignorant marks and empty their pockets with lurid distractions. Mr. Gilbert, though on the other side of the pond, sniffed out the timeless insanity we reek of, noting Playboy playmate Jamie Westenhiser's 2005 announcement that she was henceforth out of the skin trade and into real-estate sales. As Gilbert puts it, "Just as shoeshine boys … offered stock tips … before the Great Crash of 1929, a stripper signaled the top of the U.S. housing market" (p.23). Instead of Colonel Kurtz moaning, "The horror! The horror!" Complicit holds up, "The absurdity! The absurdity!"

When his blood is at high tide, Mr. Gilbert displays the biting wit his people are known for. He derides as useless "fairground hawkers" (p. 5) the mathletes who churn ever more complexity into the financial markets "every time Microsoft Corporation upgrades its Excel spreadsheet software to accommodate more cells, rows, and columns" (p. 5). All of them get manically busy just to create "an investment strategy customized to your particular paranoia and enthusiasm" (p. 35).

Echoing descriptions of how gambling gripped entire peoples during other manias, he likens the derivatives markets to "a casino … they had the whiff of a Nigerian banking scam" (p. 37). He mocks the haggard look of Bank of England governor and whiz kid, Mervyn King, fresh off a viewing of the collapsed Northern Rock bank: he "looked as if he hadn't slept for weeks. A bank run really was the stuff of central banking nightmares" (p. 126). When Mr. Gilbert hits his target, he hits hard.

He gives a shining description of how that bank was crushed under the weight of its own stupidity. Northern Rock managers felt it prudent to loan out 125 percent of home value on offered mortgages, gambling along with their debtors on an overheated housing market. Mr. Gilbert insists, and is undoubtedly correct, that most people who worked at Northern Rock were honest. "There was no pyramid scheme" (p. 121).

Nonetheless, he rightly excoriates the resultant bailout by pointing, not only to the long-term damage it caused to England's economy, as "the system loses its ability to moderate future behavior," (p. 122) but to its inherit injustice too, since "the UK taxpayers were on the credit crunch hook" (p. 122) for gambling debts that they had nothing to do with. His sense of outrage for the "little guy" is admirable and often on display.

Northern Rock, in fact (and in the opinion of Austrian economic thought), was part of a global financial system happily engaged on an inflation-driven pub crawl that, as Mr. Gilbert earlier pointed out, "was mushrooming into an enormous inverted pyramid, with a tiny triangle of real money at the base trying to buttress towering layers of debt and derivatives" (p. 74). Fractional-reserve banking itself is a pyramid scheme by its very nature, and the author seems to hint at it. "The truth … your money isn't sitting patiently in the bank's basement, waiting to race upstairs to the ATM when you make a withdrawal. Your cash is having the time of its life in the global financial casino, drunk on leverage and high on liquidity" (p. 83–84).

If that's not a pyramid of fraud, then what is?

As a believer in a gold standard — a belief considered by almost everyone in the Western world to be a "dunce" cap — almost all of my disagreements with Mr. Gilbert concern money. As in all speculative crazes, it is money that lay at the heart of the boom's story. And without a lucid explanation to the reader about what exactly money is, no story of any boom is complete.

In regards to this all-important question, Complicit is a tease. At the book's starting gun, Mr. Gilbert declares that "where did the money come from?" is a "key question" to answer (p. 1). And he does answer it, perfectly pointing out that "central banks [are] responsible for steering global monetary policy" (p. 46). Even more enticing, he accurately records that "there wasn't anywhere near as much money as there seemed to be … it was all an illusion" (p. 1). Yet, despite the occasional flash of monetary skin, the book as a whole is a frigid prude. Neither "money" nor "credit" is felt important enough to even list in the book's index.

This is odd; Mr. Gilbert is fully aware that money was the crux of the boom. He sees that while "the seeds of the global crisis were sowed in the housing market" (p. 9), the "foundations of the housing boom crumbled easily because they were made of borrowed money" (p. 11). He reminds us that it wasn't just the housing market that got drunk on easy money, since "floods of liquidity were seeping into every part of the financial market" (p. 133). And who else besides the central bankers (who were "responsible for steering global monetary policy") and the politicians who appointed them made all this possible (p. 115)?

Yet, unlike Gilbert's rogues' gallery of short-sighted bank CEOs, idiot traders, foolish investors, and spineless regulators, the central bankers and politicians who were the crazed lunatics behind the curtain get off scot-free. While the author mildly upbraids them for not taking away the punchbowl once the party started to really get out of hand, he never asks why they were serving the poison to begin with. This is all because he never asks what money is.

The last chapter gives one final tease, a brief shout toward bringing back what he calls (correctly) "a true capitalist model" to "allow the free market to dictate the price of money everywhere and anywhere." The very thought of such freedom, though, is quickly dismissed out of hand since "the prevailing lack of trust in market rationality … might prove [it] even less popular than the current system" (p. 169).

As his fellow countryman once wrote in Cato's Letters, "if our money be gone, thank God, our eyes are left."[1] I'd like to see Mr. Gilbert walk through the valley of money, return home, and tell us what his eyes fell upon, then answer why a free market in money "might prove even less popular" then the government-sanctioned monopolies that we are currently forced to deal with. To whom would the freedom to choose be "less popular," and why? Why not allow the working masses to decide the matter, rather than having a central authority dictate to them?

For now, not giving money the respect it deserves leaves Mr. Gilbert offering suggestions to prevent a repeat of the boom's effects but foregoing any attempt to remedy its monetary cause.

In his book-length review of Adam Smith's Wealth of Nations, P.J. O'Rourke lambasted its last chapter, the one in which Mr. Smith "yielded to the temptation to slide down Olympus," climb from his lofty metaphysical perch, and dispense some practical policy suggestions — always a risky proposition.[2] Mr. Gilbert sails the same rough seas in his closing chapter, "Conclusions and Policy Prescriptions."

Mr. Gilbert's primary policy suggestions quite naturally target his villains — the bankers — for enhanced political control (p. 163). In his eyes this comes from the very nature of banking, since "finance is just too dangerous and too important to be allowed to grow unfettered" (p. 168).

As the final chapter ages, it suddenly swerves into a disjointed segue, asking "what proportion of senior (bank) positions women occupy" and suggesting that "a government mandated quota system … might be worth trying" (p.173). Maybe the female touch will sooth market volatility.

$20 $18

With this chivalrous pleading on behalf of the fairer sex, Mr. Gilbert — abruptly and without a hint of premonition — brings Complicit to a crashing halt. I slammed the book closed, pleased with this perfect ending, though I couldn't place exactly why I felt that way. It took a bit of thought until it finally hit me — it brought back memories of the Replacements (the seminal '80s punk band) and their habit during live shows of deliberately goading the crowd, ending a concert by playing, for instance, "Yummy Yummy Yummy" over and again until the audience either stormed out or rioted.

Until Complicit, I'd never read a book, especially not one on financial markets, that ended by giving me the middle finger.

Despite leaving some important questions untouched (questions I would love to see a writer of Mr. Gilbert's ability attempt), Complicit is a rousing, fun look back at the Great Moderation's riotous career, filtered through the mind of someone who labored in the center of it. And ending the story the same way the boom ended for so many a greedy, blinkered little pig — abruptly and without a hint of premonition — only highlights the talent that makes Complicit such an enjoyable read.

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[1] Cato's Letters No. 4: Saturday, November 26, 1720.

[2] O'Rourke, P.J. On The Wealth of Nations (New York, NY, Atlantic Monthly Press, 2007) p. 132.

You may define a mass delusion; you cannot explain it really. It is a malady of the imagination, incurable by reason, that apparently must run its course. If it does not lead people to self-destruction in a wild dilemma between two symbols of faith it will yield at last to the facts of experience.

Once the peace of the world was shattered by this absurd question: Was the male or the female faculty the first cause of the universe?

There was no answer, for man himself had invented the riddle; nevertheless what one believed about it was more important than life, happiness, or civilization.

Proponents of the male principle adopted the color white. Worshippers of the female principle took for their sign and symbol the color red, inclining to yellow. Under these two banners there took place a religious warfare which involved all mankind, dispersed, submerged, and destroyed whole races of people and covered Asia, Africa, and Europe with tragic ruins. Then someone accidentally thought of a third principle which reconciled those two and human sanity was restored on earth. All this is now forgotten.

Since then people have been mad together about a number of things — God, tulips, witches, definitions, alchemy, and vanities of precept. In 1894 they were mad about money — not about the use, possession and distribution of it, but as to the color of it, whether it should be silver — that is to say, white like the symbol of those old worshippers of the masculine faculty, or gold — that is, red inclining to yellow, as was the symbol of those who in the dimness of human history adored the feminine faculty.

And as people divided on this question of silver or gold they became utterly delirious. Either side was willing to see the government's credit ruined, as it very nearly was, for the vindication of a fetish. They did not know it. They had not the remotest notion why or how they were mad because they were unable to realize that they were mad at all.

I have recently turned over the pages of the newspapers and periodicals of that time to verify the recollection that events as they occurred were treated with no awareness of their significance. And it was so. Intelligence was in suspense. The faculty of judgment slept as in a dream; the imagination ran loose, inventing fears and fantasies. That the government stood on the verge of bankruptcy or that the United States Treasury was about to shut up under a run of panic-stricken gold hoarders was regarded not as a national emergency in which all were concerned alike, but as proof that one theory was right and another wrong, so that one side viewed the imminent disaster gloatingly and was disappointed at its temporary postponement, while the other resorted to sophistries and denied self-evident things.

Nor does anyone know to this day why people were then mad. Economists write about it as the struggle for sound money (gold), against unsound money (silver), and that leaves it where it was. Money is not a thing either true or untrue. It is merely a token of other things which are useful and enjoyable. Both silver and gold are sound for that purpose. Their use is of convenience, and the proportions and quantities in which they shall circulate as currency is rationally a matter of arithmetic. Yet here were millions of people emotionally crazed over the question of which should be paramount, one side talking of the crime of dethroning silver and the other of the gold infamy.

All other business having come to a stop while this matter was at an impasse, a truce was effected in this wise by law: gold should remain paramount, nominally, but the Treasury should buy each month a great quantity of silver bullion, turn it into white money, force the white money into circulation and then keep it equal to gold in value. Now, the amount of precious metal in a silver dollar was worth only half as much as the amount of precious metal in a gold dollar. Yet Congress decreed that gold and silver dollars should be interchangeable and put upon the Treasury a mandate to keep them equal in value. How? By what magic? Why, by the magic of a phrase. The phrase was: "It is the established policy of the United States to maintain the two metals at a parity with each other by law."

Naïve trust in the power of words to command reality is found in all mass delusions.

The Coxeyites were laughed at for thinking that prosperity could be created by phrases written in the form of law. Congress thought the same thing. It supposed that the economic distress in the country could be cured by making fifty cents' worth of silver equal to one hundred cents' worth of gold, and that this miracle of parity could be achieved by decree.

Anyone would know what to expect. The gold people ran with white dollars to the Treasury and exchanged them for gold and either hoarded the gold or sold it in Europe. In this way the government's gold fund was continually depleted, and this was disastrous because its credit, the nation's credit in the world at large, rested on that gold fund. It sold bonds to buy more gold, but no matter how fast it got more gold into the Treasury even faster came people with white money to be redeemed in money the color of red inclining to yellow, and all the time the Treasury was obliged by law to buy each month a great quantity of silver bullion and turn it into white money, so that the supply of white money to be exchanged for gold was inexhaustible.

Wall Street was the stronghold of the gold people. It was to Wall Street that the government came to sell bonds for the gold it required to replenish its gold fund. The spectacle of the Secretary of the Treasury standing there with his hat out, like a Turkish beggar, was viewed exultingly by the gold people. "Carlisle's Bonds Won't Go" said the New York Sun in a front page headline, on one of these occasions. Carlisle was the secretary of the United States Treasury, entreating the gold people to buy the government's bonds with gold. They did it each time, but no sooner was the gold in the Treasury than they exchanged it out again with white money.

This could not go on without wrecking the country's financial system. That would mean disaster for everyone, silver and gold people alike; yet nobody knew how to stop. The silver people said the solution was to dethrone the gold token and make white money paramount; the others said the only way was to cast the white money fetish into the nearest ash heap and worship exclusively money of the color red inclining to yellow.

Delusions are states of refuge. The mind, unable to comprehend realities or to deal with them, finds its ease in superstitions, beliefs and modes of irrational procedure. It is easier to believe than to think.

The realities of this period in our economic history, apart from the madness, were extremely bewildering. For five or six years preceding there had been an ecstasy of great profits. The prodigious manner in which wealth multiplied had swindled men's dreams. No one lay down at night but he was richer than when he got up, nor without the certainty of being richer still on the morrow. The golden age had come to pass. Wishing was having. The government had become so rich from duties collected on imported luxuries that the Treasury surplus became a national problem. It could not be properly spent; therefore it was wasted. And still it grew. This time for sure the tree of Mammon would touch the Heavens and human happiness must endure forever.

Then suddenly it had fallen. Speculation, greed and dishonesty had invisibly devoured its heart. The trunk was hollow. Everything turned hollow. People were astonished, horrified and wild with dismay. They would not blame themselves. They wished to blame each other without quite knowing how. The casual facts were hard to see in right relations. Popular imagination had not been trained to grasp them. The whole world was dealing with new forces, resulting from the application of capital to machine production on a vast scale, and there had just appeared for the first time in full magnitude that monstrous contradiction which we name overproduction. This was a worldwide phenomenon, but stranger here than in European countries because this country was newly industrialized on the modern plan and knew not how to manage the conditions it had created; could not understand them in fact.

Still, it was incomprehensible to people — generally; and as the pain of loss, chagrin, and disappointment unbearably increased, the congolmerate mind performed the weird self-saving act of going mad. That is to say, people made a superstition of their economic sins and cast the blame for all their ills upon two objects — gold and silver tokens. Thus what had been an economic crisis only, subject to repair, became a fiasco of intelligence.

The Europeans, all gold people, who had bought enormous quantities of American stocks and bonds, said, "What now! These people are going crazy. They may refuse ever to pay us back in gold." Whereupon they began hastily to sell American securities.

"After all," sighed the London Times, "the United States for all its great resources is a poor country."

In the panic of 1893 confidence was destroyed. People disbelieved in their own things, in themselves, in each other.

Important banking institutions failed for scandalous reasons. Railroads went headlong into bankruptcy, until more than a billion dollars' worth of bonds were in default, and in many cases the disclosures of inside speculation were most disgraceful.

United States senators were discovered speculating in the stock of corporations that were interested in tariff legislation, particularly the "Sugar Trust."

The name of Wall Street became accursed, not that morality was lower in Wall Street than anywhere else, but because the consequences of its sins were conspicuous.

All industry sickened.

A scourge of unemployment fell upon the land; and labor as such, with no theory of its own about money, knowing only what it meant to be out of work, assailed the befuddled intelligence of the country with that embarrassing question: Why were men helplessly idle in this environment of boundless opportunity?

The Coxeyites thought it was for want of money. So many people thought. They proposed that the government should raise money for extensive public works, thereby creating jobs for the workless, but the United States Treasury, which only a short time before contained a surplus so large that Congress had to invent ways of spending it, was now in desperate straits. The government's income was not sufficient to pay its daily bills. However, neither the curse of unemployment nor the poverty of the United States Treasury was owing to a scarcity of money. The banks were overflowing with money — idle money, which they were willing to lend at ½ of 1 percent, just to get it out of their vaults. In one instance, a bank offered to lend a large amount of money without interest. But nobody would borrow money. What should they do with it? There was no profit in business.

So there was unemployment of both labor and capital.

Excerpted from chapter 4 of The Driver (1922). An MP3 audio version of this article, excerpted from the audiobook by Jeff Riggenbach, is available as a free download. 

This audio Mises Daily is narrated by Jeff Riggenbach.

The governments of almost all countries are engaged in a campaign against the capitalists. They are intent upon expropriating them by means of taxation and monetary measures. The capitalists are eager to protect their property by keeping a part of their funds liquid in order to evade confiscatory measures in time. They keep balances with the banks of those countries in which the danger of confiscation or currency devaluation is, for the moment, less than in other countries. As soon as the prospects change, they transfer their balances into countries that temporarily seem to offer more security. It is these funds that people have in mind when speaking of "hot money."

The significance of hot money for the constellation of monetary affairs is the outcome of the one-reserve system. In order to make it easier for the central banks to embark upon credit expansion, the European governments aimed long ago at a concentration of their countries' gold reserves with the central banks. The other banks (the private banks, i.e., those not endowed with special privileges and not entitled to issue banknotes) restrict their cash holdings to the requirements of their daily transactions. They no longer keep a reserve against their daily maturing liabilities. They do not consider it necessary to balance the maturity dates of their liabilities and their assets in such a way as to be any day ready to comply unaided with their obligations to their creditors. They rely upon the central bank.

When the creditors want to withdraw more than the "normal" amount, the private banks borrow the funds needed from the central bank. A private bank considers itself liquid if it owns a sufficient amount either of collateral against which the central bank will lend or of bills of exchange that the central bank will rediscount. (All this refers to European conditions. American conditions differ only technically, but not economically. However, the hot-money problem is not an American problem, as there is, under the present state of affairs, no country that a capitalist could deem a safer refuge than the United States.)

When the inflow of hot money began, the private banks of the countries in which it was temporarily deposited saw nothing wrong in treating these funds in the usual way. They employed the additional funds entrusted to them in increasing their loans to business. They did not worry about the consequences, although they knew that these funds would be withdrawn as soon as any doubts about their country's fiscal or monetary policy emerged.

The illiquidity of the status of these banks was manifest: on the one hand large sums that the customers had the right to withdraw at short notice, and on the other hand loans to business that could be recovered only at a later date. The only cautious method of dealing with hot money would have been to keep a reserve of gold and foreign exchange big enough to pay back the whole amount in case of a sudden withdrawal. Of course, this method would have required the banks to charge the customers a commission for keeping their funds safe.

The showdown came for the Swiss banks on the day in September 1936 on which France devalued the French franc. The depositors of hot money became frightened; they feared that Switzerland might follow the French example. It was to be expected that they would all try to transfer their funds immediately to London or New York, or even to Paris, which, for the immediate coming weeks, seemed to offer a smaller hazard of currency depreciation. But the Swiss commercial banks were not in a position to pay back these funds without the aid of the national bank. They had lent them to business — a great part to business in countries that, by foreign exchange control, had blocked their balances.

The only way out would have been for them to borrow from the national bank. Then they would have maintained their own solvency. But the depositors paid would have immediately asked the national bank for the redemption, in gold or foreign exchange, of the banknotes received. If the national bank were not to comply with this request, it would thereby have actually abandoned the gold standard and devalued the Swiss franc. If, on the other hand, the bank had redeemed the notes, it would have lost the greater part of its reserve. A panic would have resulted. The Swiss themselves would have tried to procure as much gold and foreign exchange as possible. The whole monetary system of the country would have collapsed.

The only alternative for the Swiss national bank would have been not to assist the private banks at all. But this would have been equivalent to the insolvency of the country's most important credit institutions.

Thus, for the Swiss government, no choice was left. It had only one means to prevent an economic catastrophe: to follow suit forthwith and to devalue the Swiss franc. The matter did not brook delay.

By and large, Great Britain, at the outbreak of the war in September 1939, had to face similar conditions. The city of London was once the world's banking center. It has long since lost this function. But foreigners and citizens of the dominions still kept, on the eve of the war, considerable short-term balances in the British banks. Besides, there were the large deposits due to the central banks in the "sterling area." If the British government had not frozen all these balances by means of foreign-exchange restrictions, the insolvency of the British banks would have become manifest. Foreign-exchange control was a disguised moratorium for the banks. It relieved them from the plight of having to confess publicly their inability to fulfill their obligations.

This article is excerpted from chapter 17 of Human Action: The Scholar's Edition and is read by Jeff Riggenbach.

In his extraordinary book Democracy: The God that Failed, Hans-Hermann Hoppe points out that the process of civilization is stopped when government continually violates property rights.

The natural process of civilization comes through delaying consumption, saving, and building capital. Undoing it leads to higher societal time preference.

When natural disasters strike or a gunman robs you in an alley, "the effect of these on time preference is temporary and unsystematic," Hoppe explains.

Victims are entitled to defend themselves against the individual aggressor and prepare themselves for the calamities of the occasional act of God. Resources will be reallocated to defend one against potential robbers, and provisions will be made for potential natural disasters.

However, when government aggresses, it is considered legitimate and "a victim may not legitimately defend himself against such violations." Democracy legitimizes this government aggression because the violence is sanctioned by a majority of voters.

This decivilization process that Hoppe describes continues in fits and starts. The uneducated continue to live in never-never land, believing that each new ruler means change and that their lives and happiness can safely be put in the hands of a kind and caring government. But government's current ham-handedness — with its bailouts, money printing, and rights violations — has alerted more than a few individuals to do what comes naturally: defend themselves and prepare for the worst.

The government's legal-tender money — the dollar — is now under questioning. While the commercial-banking fractional-reserve monetary engine is stalled with loan write-downs and bank failures, the Federal Reserve has expanded its balance sheet like never before. Man of the Year Ben Bernanke is deathly afraid of deflation, and John Maynard Keynes is a hero again. The inflation cake is in the oven, albeit not quite fully baked.

And the current administration does not seem friendly to the property right of allowing us to protect ourselves. The president believes that only law-enforcement officers should have weapons.

So while high-time-preference folks like Shannan DeCesare shout "Merry Christmas to me" after unloading some gold jewelry for $610 at a gold party, low-time-preference types are lining up in pawnshops and gun shows to buy gold, silver, lead, and guns.

DeCesare attended a gold party that the Wall Street Journal describes as an example of the new Tupperware party. These parties appeal to the cash-for-gold crowd trying to maintain a boom-time lifestyle by unloading their valuables. The cash poor end up taking between 65 and 75 percent of what their gold would be worth to a refiner according to the WSJ.

These parties offer a comfortable atmosphere for selling the yellow metal. "It can be really difficult for a lot of people to walk into a jewelry store or pawnshop holding a little bag of gold," Lisa Rosenthal, owner of Party of Gold, told the WSJ. Ms. Rosenthal's company has specialists working more than 1,000 parties a month. And why would anyone sell their gold for 65 to 75 cents on the dollar? In his book More Than You Know: Finding Financial Wisdom in Unconventional Places, author Michael J. Mauboussin has a chapter titled, "All I Need to Know I Learned at a Tupperware Party." People buy Tupperware because they feel like they must reciprocate the host for hosting the party and providing the free party favors. Plus, as Mauboussin explains, "the single most important fact of the Tupperware formula is the tendency to say yes to people you like."

In the case of gold parties, attendees don't want to just show up, drink the wine and eat the appetizers but leave turning their noses up at the low prices offered for their, or their departed mother's, old jewelry, especially when it's their friend down the block hosting the event. They happily trade a metal that has proven to have value for thousands of years for the government's depreciating paper.

But while gold sellers are shy to see the nearby pawn dealer, gold buyers go where they must to see who has inventory for sale. The demand for guns is so good that the gun show in Las Vegas recently charged $14 a head just to walk in and look around — after parking cost of $3. The lot was full and business was brisk.

The demand for space at gun ranges in Salt Lake City was strong enough the day after Christmas that it was a 15- to 20-minute wait to rent an "alley" at the second range we inquired with. The first range contacted was reservation only and completely booked for the day.

Panic buying of ammunition, silver, and gold has created shortages and led to price increases for all three in 2009. "Currently no .380 ammunition — I haven't seen any for about four months… .38 special, it's been at least a couple of months," Denver gun-store manager Richard Taylor told CNN earlier this year. "It's just that there's been a huge demand and it's far outweighed supply right now."

And in November, Bloomberg reported that the US Mint had suspended sales of most American Eagle coins made from precious metals, including gold and silver. With coin sales surging 88 percent in the first 10 months of this year, the mint is out of metal and sales will resume "once sufficient inventories of gold-bullion blanks can be acquired to meet market demand," the mint said in a statement posted on its website.

So, some Americans are unloading their family treasures and cheering for bailouts, money printing, and gun control, while others are stocking up on precious metals, guns, and ammo to protect themselves and their wealth.

There is no question which group is the civilized one.

Nearly all contemporary economists adhere to holistic theories that are utterly futile and sterile for an understanding of monetary phenomena. There is the popular "income-expenditure analysis," which swayed economic thought during the 1930s with the publication of the General Theory of Employment, Interest, and Money by John Maynard Keynes.

     According to Keynesian analysis, there is an ideal level of monetary expenditure at which the national economy achieves full employment under stable price conditions. In its search for this ideal level the income-expenditure analysis endeavors to trace the flow of money payments through the economy. As income is quantitatively the largest source of funds spent, an analysis of its determination and disposition is basic to the approach. In addition, funds for spending may be derived from existing reserves of currency and demand deposits, time deposits, and other liquid assets that are easily converted to cash.

And finally, when the ideal level of total spending has not yet been reached, newly created money, preferably demand deposits created through bank credit expansion, may be used to achieve the desired total. In short, it is the principal role of monetary authorities to ensure growth in the monetary reserve base sufficient to facilitate credit expansion for full employment.

As a holistic theory (from the standpoint of the whole rather than the parts) it does not profess to be concerned with individual economic actions, merely with policy guidelines for governments seeking economic growth and full employment. But even in this limited objective it has failed conspicuously wherever it was tried. For massive unemployment continues to be with us after more than 30 years of Keynesian policies.

And finally, there are the "monetarists" of the Chicago School, whose holistic theories resemble the Keynesian doctrines. The famous "equation of exchange," as developed by Professors Fisher, Marshall, and Pigou, provides their starting point (PT = MV, or P = MVIT). As the price level cannot be expected to remain stable for various reasons, which renders the market system rather unstable, they call on government to take measures to stabilize the level and thus cure the business cycle.

It is true, the economists of the Chicago School reject the compensatory fiscal policies prescribed by the Keynesians because they realize the futility of continuous fine tuning. But they recommend long term stabilization through a steady 3 to 4 percent expansion of the money supply. They have no special trade-cycle theory, merely the prescription for the government to "hold it steady." "If there is a recession issue more money, and if there is inflation, take some out!"

Both schools of thought, the income-expenditure analysts as well as the monetarists, are unalterably opposed to the gold standard. Its discipline is rejected in favor of governmental power over money.

Von Mises's subjective theory makes individual choice and action the center of his investigation. On the cornerstone laid by Carl Menger's theory of the nature and origin of money, Professor Mises, in his Theory of Money and Credit, built a comprehensive and fully integrated structure. With the help of his notable regression theory he completed the subjective theory of money, which had frustrated other economists before him.

Professor Mises demonstrated that the individual demand for money springs from the fact that it is the most marketable good a person can acquire. It is true, money is not suitable to satisfy anyone's needs directly. But its possession permits him to acquire consumers' or producers' goods in the near or more distant future. People want to keep a store of money to provide exchange power for an uncertain future.

Some are satisfied with relatively small holdings; others prefer to hoard larger supplies. And we all change frequently our holdings in accordance with our changing appraisals of future conditions. Money is never "idle," nor is it just "in circulation"; it is always in the possession or under the control of someone.

The demand for money is subject to the same consideration as that for all other goods and services. People expend labor or forego the enjoyment of goods and services in order to acquire money. This is why individual demand and supply ultimately determine the purchasing power of money in the same way as they determine the mutual exchange ratios of all other goods.

The quantity theory of money as understood by Professor Mises is merely another case of the general theory of demand and supply. However, he rejects the quantity theory as commonly presented by the "monetarists" and other contemporary economists as a sterile aberration that proceeds holistically and arrives at empty equations and models.

Professor Mises's trade-cycle theory integrates the sphere of money and that of real goods. If the monetary authorities expand credit and thereby lower the interest in the loan market below the natural rate of interest, economic production is distorted.

At first, it generates overinvestment in capital goods and causes their prices to rise while production of consumers' goods is necessarily neglected. But because of lack of real capital the investment boom is bound to run aground. The boom causes factor prices to rise, which are business costs. When profit margins finally falter, a recession develops in the capital goods industry. During the recession a new readjustment takes place: the malinvestments are abandoned or corrected, and the long-neglected consumers' goods industries attract more resources in accordance with the true state of public saving and spending.

Mises's theory has explained numerous economic booms and busts ever since 1912, when the first edition of The Theory of Money and Credit appeared in print. And it continues to provide the only explanation of the rapid succession of booms and recessions that continue to plague our system.

The subjective theory of Professor Mises also points out the desirability of money that is not managed by government. The orthodox gold standard or gold-coin standard is such money, the value of which is independent of government. It is true, it cannot achieve the unattainable ideal of an absolutely stable currency. There is no such thing as stability and unchangeability of purchasing power.

But the gold standard protects the monetary system from the influence of governments as the quantity of gold in existence is utterly independent of the wishes and manipulations of government officials and politicians, parties and pressure groups. There are no "rules of the game;" no arbitrary rules that people must learn to observe. It is a social institution that is controlled by inexorable economic law.

For nearly 60 years of worldwide inflation and credit expansion, depreciations and devaluations, feverish booms and violent busts, Ludwig von Mises's Theory of Money and Credit has given light in the growing darkness of monetary thought and policy. The world should be grateful that the light is maintained through a new printing of this remarkable analysis.

The Federal Reserve Act of December 23, 1913, was part and parcel of the wave of Progressive legislation on local, state, and federal levels of government that began about 1900. Progressivism was a bipartisan movement that, in the course of the first two decades of the 20th century, transformed the American economy and society from one of roughly laissez-faire to one of centralized statism.

Until the 1960s, historians had established the myth that Progressivism was a virtual uprising of workers and farmers who, guided by a new generation of altruistic experts and intellectuals, surmounted fierce big business opposition in order to curb, regulate, and control what had been a system of accelerating monopoly in the late 19th century. A generation of research and scholarship, however, has now exploded that myth for all parts of the American polity, and it has become all too clear that the truth is the reverse of this well-worn fable.

In contrast, what actually happened was that business became increasingly competitive during the late 19th century, and that various big-business interests, led by the powerful financial house of J. P. Morgan and Company, tried desperately to establish successful cartels on the free market. The first wave of such cartels was in the first large-scale business — railroads. In every case, the attempt to increase profits — by cutting sales with a quota system — and thereby to raise prices or rates, collapsed quickly from internal competition within the cartel and from external competition by new competitors eager to undercut the cartel.

During the 1890s, in the new field of large-scale industrial corporations, big-business interests tried to establish high prices and reduced production via mergers, and again, in every case, the merger collapsed from the winds of new competition. In both sets of cartel attempts, J. P. Morgan and Company had taken the lead, and in both sets of cases, the market, hampered though it was by high protective, tariff walls, managed to nullify these attempts at voluntary cartelization.

It then became clear to these big-business interests that the only way to establish a cartelized economy, an economy that would ensure their continued economic dominance and high profits, would be to use the powers of government to establish and maintain cartels by coercion, in other words, to transform the economy from roughly laissez-faire to centralized, coordinated statism. But how could the American people, steeped in a long tradition of fierce opposition to government-imposed monopoly, go along with this program? How could the public's consent to the New Order be engineered?

Fortunately for the cartelists, a solution to this vexing problem lay at hand. Monopoly could be put over in the name of opposition to monopoly! In that way, using the rhetoric beloved by Americans, the form of the political economy could be maintained, while the content could be totally reversed.

Monopoly had always been defined, in the popular parlance and among economists, as "grants of exclusive privilege" by the government. It was now simply redefined as "big business" or business competitive practices, such as price-cutting, so that regulatory commissions, from the Interstate Commerce Commission (ICC) to the Federal Trade Commission (FTC) to state insurance commissions, were lobbied for and staffed with big-business men from the regulated industry, all done in the name of curbing "big-business monopoly" on the free market.

In that way, the regulatory commissions could subsidize, restrict, and cartelize in the name of "opposing monopoly," as well as promoting the general welfare and national security. Once again, it was railroad monopoly that paved the way.

For this intellectual shell game, the cartelists needed the support of the nation's intellectuals, the class of professional opinion molders in society. The Morgans needed a smokescreen of ideology, setting forth the rationale and the apologetics for the New Order. Again, fortunately for them, the intellectuals were ready and eager for the new alliance.

The enormous growth of intellectuals, academics, social scientists, technocrats, engineers, social workers, physicians, and occupational "guilds" of all types in the late 19th century led most of these groups to organize for a far greater share of the pie than they could possibly achieve on the free market. These intellectuals needed the State to license, restrict, and cartelize their occupations, so as to raise the incomes for the fortunate people already in these fields.

In return for their serving as apologists for the new statism, the State was prepared to offer not only cartelized occupations, but also ever-increasing and cushier jobs in the bureaucracy to plan and propagandize for the newly statized society. And the intellectuals were ready for it, having learned in graduate schools in Germany the glories of statism and organicist socialism, of a harmonious "middle way" between dog-eat-dog laissez-faire on the one hand and proletarian Marxism on the other. Big government, staffed by intellectuals and technocrats, steered by big business, and aided by unions organizing a subservient labor force, would impose a cooperative commonwealth for the alleged benefit of all.

The previous big push for statism in America had occurred during the Civil War, when the virtual one-party Congress after secession of the South emboldened the Republicans to enact their cherished statist program under cover of the war. The alliance of big business and big government with the Republican party drove through an income tax, heavy excise taxes on such sinful products as tobacco and alcohol, high protective tariffs, and huge land grants and other subsidies to transcontinental railroads.

The overbuilding of railroads led directly to Morgan's failed attempts at railroad pools, and finally to the creation, promoted by Morgan and Morgan-controlled railroads, of the Interstate Commerce Commission in 1887. The result of that was the long secular decline of the railroads, beginning before 1900. The income tax was annulled by Supreme Court action, but was reinstated during the Progressive period.

The most interventionist of the Civil War actions was in the vital field of money and banking. The approach toward hard money and free banking that had been achieved during the 1840s and 1850s was swept away by two pernicious inflationist measures of the wartime Republican administration. One was fiat money greenbacks, which depreciated by half by the middle of the Civil War. These were finally replaced by the gold standard after urgent pressure by hard-money Democrats, but not until 1879, 14 full years after the end of the war.

A second, and more lasting, intervention was the National Banking Acts of 1863, 1864, and 1865, which destroyed the issue of bank notes by state-chartered (or "state") banks by a prohibitory tax, and then monopolized the issue of bank notes in the hands of a few large, federally chartered "national banks," mainly centered on Wall Street. In a typical cartelization, national banks were compelled by law to accept each other's notes and demand deposits at par, negating the process by which the free market had previously been discounting the notes and deposits of shaky and inflationary banks.

In this way, the Wall Street–federal government establishment was able to control the banking system, and inflate the supply of notes and deposits in a coordinated manner.

But there were still problems. The national-banking system provided only a halfway house between free banking and government central banking, and by the end of the 19th century, the Wall Street banks were becoming increasingly unhappy with the status quo.

The centralization was only limited, and, above all, there was no governmental central bank to coordinate inflation, and to act as a lender of last resort, bailing out banks in trouble. As soon as bank credit generated booms, then they got into trouble; bank-created booms turned into recessions, with banks forced to contract their loans and assets and to deflate in order to save themselves.

Not only that, but after the initial shock of the National Banking Acts, state banks had grown rapidly by pyramiding their loans and demand deposits on top of national-bank notes. These state banks, free of the high legal-capital requirements that kept entry restricted in national banking, flourished during the 1880s and 1890s and provided stiff competition for the national banks themselves.

Furthermore, St. Louis and Chicago, after the 1880s, provided increasingly severe competition to Wall Street. Thus, St. Louis and Chicago bank deposits, which had been only 16 percent of the St. Louis, Chicago, and New York City total in 1880, rose to 33 percent of that total by 1912. All in all, bank clearings outside of New York City, which were 24 percent of the national total in 1882, had risen to 43 percent by 1913.

The complaints of the big banks were summed up in one word: "inelasticity." The national-banking system, they charged, did not provide for the proper "elasticity" of the money supply; that is, the banks were not able to expand money and credit as much as they wished, particularly in times of recession. In short, the national-banking system did not provide sufficient room for inflationary expansions of credit by the nation's banks.On the National Banking System background and on the increasing unhappiness of the big banks, see Murray N. Rothbard (1984, pp. 89–94), Ron Paul and Lewis Lehrman (1982), and Gabriel Kolko (1983, pp. 139–46).

By the turn of the century, the political economy of the United States was dominated by two generally clashing financial aggregations: the previously dominant Morgan group, which began in investment banking and then expanded into commercial banking, railroads, and mergers of manufacturing firms; and the Rockefeller forces, which began in oil refining and then moved into commercial banking, finally forming an alliance with the Kuhn, Loeb Company in investment banking and the Harriman interests in railroads.Indeed, much of the political history of the United States from the late 19th century until World War II may be interpreted by the closeness of each administration to one of these sometimes cooperating, more often conflicting, financial groupings: Cleveland (Morgan), McKinley (Rockefeller), Theodore Roosevelt (Morgan), Taft (Rockefeller), Wilson (Morgan), Harding (Rockefeller), Coolidge (Morgan), Hoover (Morgan), or Franklin Roosevelt (Harriman–Kuhn, Loeb–Rockefeller).

Although these two financial blocs usually clashed with each other, they were as one on the need for a central bank. Even though the eventual major role in forming and dominating the Federal Reserve System was taken by the Morgans, the Rockefeller and Kuhn, Loeb forces were equally enthusiastic in pushing, and collaborating on, what they all considered to be an essential monetary reform.

The presidential election of 1896 was a great national referendum on the gold standard. The Democratic party had been captured, at its 1896 convention, by the populist, ultrainflationist antigold forces, headed by William Jennings Bryan. The older Democrats, who had been fiercely devoted to hard money and the gold standard, either stayed home on election day or voted, for the first time in their lives, for the hated Republicans.

The Republicans had long been the party of prohibition and of greenback inflation and opposition to gold. But since the early 1890s, the Rockefeller forces, dominant in their home state of Ohio and nationally in the Republican party, had decided to quietly ditch prohibition as a political embarrassment and as a grave deterrent to obtaining votes from the increasingly powerful bloc of German-American voters.

In the summer of 1896, anticipating the defeat of the gold forces at the Democratic convention, the Morgans, previously dominant in the Democratic party, approached the McKinley–Mark Hanna–Rockefeller forces through their rising young satrap, Congressman Henry Cabot Lodge of Massachusetts. Lodge offered the Rockefeller forces a deal: the Morgans would support McKinley for president, and neither sit home nor back a third, Gold Democrat party, provided that McKinley pledged himself to a gold standard. The deal was struck, and many previously hard-money Democrats shifted to the Republicans.

The nature of the American political-party system was now drastically changed: what was previously a tightly fought struggle between hard-money, free-trade, laissez-faire Democrats on the one hand, and inflationist, protectionist, statist Republicans on the other, with the Democrats slowly but surely gaining ascendancy by the early 1890s, was now a party system dominated by the Republicans until the depression election of 1932.

The Morgans were strongly opposed to Bryanism, which was not only populist and inflationist, but also anti–Wall Street bank; the Bryanites, much like populists of the present day, preferred Congressional, greenback inflationism to the more subtle, and more privileged, big bank–controlled variety. The Morgans, in contrast, favored a gold standard.

But, once gold was secured by the McKinley victory of 1896, they wanted to press on to use the gold standard as a hard-money camouflage behind which they could change the system into one less nakedly inflationist than populism but far more effectively controlled by the big-banker elites. In the long run, a controlled Morgan-Rockefeller gold standard was far more pernicious to the cause of genuine hard-money than a candid free-silver or greenback Bryanism.

As soon as McKinley was safely elected, the Morgan-Rockefeller forces began to organize a "reform" movement to cure the "inelasticity" of money in the existing gold standard and to move slowly toward the establishment of a central bank. To do so, they decided to use the techniques they had successfully employed in establishing a pro–gold standard movement during 1895 and 1896.

The crucial point was to avoid the public suspicion of Wall Street and banker control by acquiring the patina of a broad-based grassroots movement. The movement, therefore, was deliberately focused in the Middle West, the heartland of America, and organizations developed that included not only bankers, but also businessmen, economists, and other academics, who supplied respectability, persuasiveness, and technical expertise to the reform cause.

Accordingly, the reform drive began just after the 1896 elections in authentic Midwest country. Hugh Henry Hanna, president of the Atlas Engine Works of Indianapolis, who had learned organizing tactics during the year with the pro–gold standard Union for Sound Money, sent a memorandum, in November, to the Indianapolis Board of Trade, urging a grassroots, Midwestern state like Indiana to take the lead in currency reform.For the memorandum, see James Livingston (1986, pp. 104–05).

In response, the reformers moved fast. Answering the call of the Indianapolis Board of Trade, delegates from boards of trade from 12 Midwestern cities met in Indianapolis on December 1, 1896. The conference called for a large monetary convention of businessmen, which accordingly met in Indianapolis on January 12, 1897. Representatives from 26 states and the District of Columbia were present. The monetary reform movement was now officially underway.

The influential Yale Review commended the convention for averting the danger of arousing popular hostility to bankers. It reported that "the conference was a gathering of businessmen in general rather than bankers in particular" (quoted in Livingston 1986, p. 105).

The conventioneers may have been businessmen, but they were certainly not very grassrootsy. Presiding at the Indianapolis Monetary Convention of 1897 was C. Stuart Patterson, dean of the University of Pennsylvania Law School and a member of the finance committee of the powerful, Morgan-oriented Pennsylvania Railroad. The day after the convention opened, Hugh Hanna was named chairman of an executive committee, which he would appoint. The committee was empowered to act for the convention after it adjourned.

The executive committee consisted of the following influential corporate and financial leaders:

John J. Mitchell of Chicago, president of the Illinois Trust and Savings Bank, and a director of the Chicago and Alton Railroad; the Pittsburgh, Fort Wayne, and Chicago Railroad; and the Pullman Company, was named treasurer of the executive committee.

H. H. Kohlsaat, editor and publisher of the Chicago Times Herald and the Chicago Ocean Herald, trustee of the Chicago Art Institute, and a friend and advisor of Rockefeller's main man in politics, President William McKinley.

Charles Custis Harrison, provost of the University of Pennsylvania, who had made a fortune as a sugar refiner in partnership with the powerful Havemeyer ("Sugar Trust") interests.

Alexander E. Orr, a New York City banker in the Morgan ambit, who was a director of the Morgan-run Erie and Chicago, Rock Island and Pacific railroads, the National Bank of Commerce, and the influential publishing house of Harper Brothers. Orr was also a partner in the country's largest grain-merchandising firm and a director of several life-insurance companies.

Edwin O. Stanard, St. Louis grain merchant, former governor of Missouri, and former vice president of the National Board of Trade and Transportation.

E. B. Stahlman, owner of the Nashville Banner, commissioner of the cartelist Southern Railway and Steamship Association, and former vice president of the Louisville, New Albany, and Chicago Railroad.

A. E. Willson, influential attorney from Louisville and future governor of Kentucky.

But the two most interesting and powerful executive committee members of the Monetary Convention were Henry C. Payne and George Foster Peabody. Henry Payne was a Republican party leader from Milwaukee, and president of the Morgan-dominated Wisconsin Telephone Company, long associated with the railroad-oriented Spooner-Sawyer Republican machine in Wisconsin politics. Payne was also heavily involved in Milwaukee utility and banking interests, in particular as a long-time director of the North American Company, a large public utility–holding company headed by New York City financier Charles W. Wetmore.

So close was North American Company to the Morgan interests that its board included two top Morgan financiers. One was Edmund C. Converse, president of Morgan-run Liberty National Bank of New York City, and soon to be founding president of Morgan's Bankers' Trust Company. The other was Robert Bacon, a partner in J. P. Morgan and Company, and one of Theodore Roosevelt's closest friends, whom Roosevelt would later make assistant secretary of state.

Furthermore, when Theodore Roosevelt became president as the result of the assassination of William McKinley, he replaced Rockefeller's top political operative, Mark Hanna of Ohio, with Henry C. Payne as Postmaster General of the United States. Payne, a leading Morgan lieutenant, was reportedly appointed to what was then the major political post in the Cabinet specifically to break Hanna's hold over the national Republican party. It seems clear that replacing Hanna with Payne was part of the savage assault that Theodore Roosevelt would soon launch against Standard Oil as part of the open warfare about to break out between the Rockefeller–Harriman–Kuhn, Loeb, and the Morgan camps (Burch 1981, p. 189, n. 55).

Even more powerful in the Morgan ambit was the secretary of the Indianapolis Monetary Convention's executive committee, George Foster Peabody. The entire Peabody family of Boston Brahmins had long been personally and financially closely associated with the Morgans. A member of the Peabody clan had even served as best man at J. P. Morgan's wedding in 1865.

George Peabody had long ago established an international banking firm of which J. P. Morgan's father, Junius, had been one of the senior partners. George Foster Peabody was an eminent New York investment banker with extensive holdings in Mexico. He helped reorganize General Electric for the Morgans, and was later offered the job of secretary of the treasury during the Wilson administration. He would function throughout that administration as a "statesman without portfolio" (ibid., pp. 231, 233; Ware 1951, pp. 161–67).

Let the masses be hoodwinked into regarding the Indianapolis Monetary Convention as a spontaneous, grassroots outpouring of small Midwestern businessmen. To the cognoscenti, any organization featuring Henry Payne, Alexander Orr, and especially George Foster Peabody meant but one thing: J. P. Morgan.

The Indianapolis Monetary Convention quickly resolved to urge President McKinley to (1) continue the gold standard and (2) create a new system of "elastic" bank credit. To that end, the convention urged the president to appoint a new Monetary Commission to prepare legislation for a new, revised monetary system. McKinley was very much in favor of the proposal, signaling Rockefeller agreement, and on July 24 he sent a message to Congress urging the creation of a special monetary commission. The bill for a national monetary commission passed the House of Representatives but died in the Senate (Kolko 1983, pp. 147–48).

Disappointed but intrepid, the executive committee, failing a presidentially appointed commission, decided in August 1897 to go ahead and select its own. The leading role in appointing this commission was played by George Foster Peabody, who served as liaison between the Indianapolis members and the New York financial community. To select the commission members, Peabody arranged for the executive committee to meet in the Saratoga Springs summer home of his investment-banking partner, Spencer Trask. By September, the executive committee had selected the members of the Indianapolis Monetary Commission.

The members of the new Indianapolis Monetary Commission were as follows (Livingston 1986, pp. 106–07):

The chairman was former senator George F. Edmunds, Republican of Vermont, attorney, and former director of several railroads.

C. Stuart Patterson was dean of the University of Pennsylvania Law School, and a top official of the Morgan-controlled Pennsylvania Railroad.

Charles S. Fairchild, a leading New York banker, president of the New York Security and Trust Company, was a former partner in the Boston Brahmin investment banking firm of Lee, Higginson, and Company, and executive and director of two major railroads. Fairchild, a leader in New York state politics, had been secretary of the treasury in the first Cleveland Administration. In addition, Fairchild's father, Sidney T. Fairchild, had been a leading attorney for the Morgan-controlled New York Central Railroad.

Stuyvesant Fish, scion of two long-time aristocratic New York families, was a partner of the Morgan-dominated New York investment bank of Morton, Bliss, and Company, and then president of Illinois Central Railroad and a trustee of Mutual Life. Fish's father had been a senator, governor, and secretary of state.

Louis A. Garnett was a leading San Francisco businessman.

Thomas G. Bush of Alabama was a director of the Mobile and Birmingham Railroad.

J. W. Fries was a leading cotton manufacturer of North Carolina.

William B. Dean, merchant from St. Paul, Minnesota, and a director of the St. Paul–based, transcontinental Great Northern Railroad, owned by James J. Hill, ally with Morgan in the titanic struggle over the Northern Pacific Railroad with Harriman, Rockefeller, and Kuhn, Loeb.

George Leighton of St. Louis was an attorney for the Missouri Pacific Railroad.

Robert S. Taylor was an Indiana patent attorney for the Morgan-controlled General Electric Company.

The single most important working member of the commission was James Laurence Laughlin, head professor of political economy at the new Rockefeller-founded University of Chicago, and editor of its prestigious Journal of Political Economy. It was Laughlin who supervised the operations of the Commission's staff and the writing of the reports. Indeed, the two staff assistants to the Commission who wrote reports were both students of Laughlin at Chicago: former student L. Carroll Root, and his then-current graduate student Henry Parker Willis.

The impressive sum of $50,000 was raised throughout the nation's banking and corporate community to finance the work of the Indianapolis Monetary Commission. New York City's large quota was raised by Morgan bankers Peabody and Orr, and heavy contributions to fill the quota came promptly from mining magnate William E. Dodge, cotton and coffee trader Henry Hentz, a director of the Mechanics National Bank, and J. P. Morgan himself.

With the money in hand, the executive committee rented office space in Washington, DC in mid-September and set the staff to sending out and collating the replies to a detailed monetary questionnaire, sent to several hundred selected experts. The Monetary Commission sat from late September into December 1897, sifting through the replies to the questionnaire collated by Root and Willis. The purpose of the questionnaire was to mobilize a broad base of support for the Commission's recommendations, which they could claim represented hundreds of expert views.

Second, the questionnaire served as an important public-relations device, making the Commission and its work highly visible to the public, to the business community throughout the country, and to members of Congress. Furthermore, through this device, the Commission could be seen as speaking for the business community throughout the country.

To this end, the original idea was to publish the Monetary Commission's preliminary report, adopted in mid-December, as well as the questionnaire replies in a companion volume. Plans for the questionnaire volume fell through, although it was later published as part of a series of publications on political economy and public law by the University of Pennsylvania (Livingston 1986, pp. 107–08).

Undaunted by the slight setback, the executive committee developed new methods of molding public opinion using the questionnaire replies as an organizing tool. In November, Hugh Hanna hired as his Washington assistant financial journalist Charles A. Conant, whose task was to propagandize and organize public opinion for the recommendations of the Commission.

The campaign to beat the drums for the forthcoming Commission report was launched when Conant published an article in the December 1 issue of Sound Currency magazine, taking an advanced line on the Commission report, and bolstering the conclusions not only with his own knowledge of monetary and banking history, but also with frequent statements from the as-yet-unpublished replies to the staff questionnaire.

Over the next several months, Conant worked closely with Jules Guthridge, the general secretary of the Commission; they first induced newspapers throughout the country to print abstracts of the questionnaire replies. As Guthridge wrote some Commission members, he thereby stimulated "public curiosity" about the forthcoming report, and he boasted that by "careful manipulation" he was able to get the preliminary report "printed in whole or in part — principally in part — in nearly 7,500 newspapers, large and small."

In the meantime, Guthridge and Conant orchestrated letters of support from prominent men across the country. When the preliminary report was published on January 3, 1898, Guthridge and Conant made these letters available to the daily newspapers. Quickly, the two built up a distribution system to spread the gospel of the report, organizing nearly 100,000 correspondents "dedicated to the enactment of the commission's plan for banking and currency reform" (Livingston 1986, pp. 109–10).

The prime and immediate emphasis of the preliminary report of the Monetary Commission was to complete the promise of the McKinley victory by codifying and enacting what was already in place de facto: a single gold standard, with silver reduced to the status of subsidiary token currency. Completing the victory over Bryanism and free silver, however, was just a mopping-up operation; more important in the long run was the call raised by the report for banking reform to allow greater elasticity.

Bank credit could then be increased in recessions and whenever seasonal pressure for redemption by agricultural country banks forced the large central reserve banks to contract their loans. The actual measures called for by the Commission were of marginal importance. More important was that the question of banking reform had been raised at all.

Since the public had been aroused by the preliminary report, the executive committee decided to organize the second and final meeting of the Indianapolis Monetary Convention, which duly met at Indianapolis on January 25, 1898. The second convention was a far grander affair than the first, bringing together 496 delegates from 31 states.

Furthermore, the gathering was a cross-section of America's top corporate leaders. While the state of Indiana naturally had the largest delegation, of 85 representatives of boards of trade and chambers of commerce, New York sent 74, including many from the city's Board of Trade and Transportation, Merchant's Association, and Chamber of Commerce.

Such corporate leaders as Cleveland iron manufacturer Alfred A. Pope, president of the National Malleable Castings Company, attended; as did Virgil P. Cline, legal counsel to Rockefeller's Standard Oil Company of Ohio; and C.A. Pillsbury, of Minneapolis–St. Paul, organizer of the world's largest flour mills. From Chicago came such business notables as Marshall Field and Albert A. Sprague, a director of the Chicago Telephone Company, subsidiary of the Morgan-controlled telephone monopoly, American Telephone and Telegraph Company.

Not to be overlooked is delegate Franklin MacVeagh, a wholesale grocer from Chicago, an uncle of a senior partner in the Wall Street law firm of Bangs, Stetson, Tracy, and MacVeagh, counsel to J. P. Morgan and Company. MacVeagh, who was later to become secretary of the treasury in the Taft administration, was wholly in the Morgan ambit. His father-in-law, Henry F. Eames, was the founder of the Commercial National Bank of Chicago, and his brother Wayne was soon to become a trustee of the Morgan-dominated Mutual Life Insurance Company.

The purpose of the second convention, as former Secretary of the Treasury Charles S. Fairchild candidly explained in his address to the gathering, was to mobilize the nation's leading businessmen into a mighty and influential reform movement. As he put it, "if men of business give serious attention and study to these subjects, they will substantially agree upon legislation, and thus agreeing, their influence will be prevailing." He concluded that "My word to you is, pull all together."

Presiding officer of the convention, Iowa's Governor Leslie M. Shaw, was however, a bit disingenuous when he told the gathering, "You represent today not the banks, for there are few bankers on this floor. You represent the business industries and the financial interests of the country." There were plenty of bankers there, too (Livingston 1986, pp. 113–15).

Shaw himself, later to be secretary of the treasury under Theodore Roosevelt, was a small-town banker in Iowa, and president of the Bank of Denison throughout his term as governor. More important in Shaw's outlook and career was the fact that he was a long-time close friend and loyal supporter of the Des Moines Regency, the Iowa Republican machine headed by the powerful Senator William Boyd Allison.

Allison, who was to obtain the Treasury post for his friend, was in turn tied closely to Charles E. Perkins, a close Morgan ally, president of the Chicago, Burlington, and Quincy Railroad, and kinsman of the powerful Forbes financial group of Boston, long tied in with the Morgan interests (Rothbard 1984, pp. 95–96).

Also serving as delegates to the second convention were several eminent economists, each of whom, however, came not as academic observers but as representatives of elements of the business community. Professor Jeremiah W. Jenks of Cornell, a proponent of trust cartelization by government and soon to become a friend and advisor of Theodore Roosevelt as governor, came as delegate from the Ithaca Business Men's Association.

Frank W. Taussig of Harvard University represented the Cambridge Merchants' Association. Yale's Arthur Twining Hadley, soon to be the president of Yale, represented the New Haven Chamber of Commerce, and Frank M. Taylor of the University of Michigan came as representative of the Ann Arbor Business Men's Association.

Each of these men held powerful posts in the organized economics profession, Jenks, Taussig, and Taylor serving on the currency committee of the American Economic Association. Hadley, a leading railroad economist, also served on the board of directors of Morgan's New York, New Haven, and Hartford; and Atchison, Topeka, and Santa Fe Railroads.On Hadley, Jenks, and especially Conant, see Carl P. Parrini and Martin J. Sklar (1983, pp. 559–78). The authors point out that Conant's and Hadley's major works of 1896 were both published by G. P. Putnam's Sons of New York. The President of Putnam's was George Haven Putnam, a leader in the new banking reform movement (ibid., p. 561, n 2).

Both Taussig and Taylor were monetary theorists who, while committed to a gold standard, urged reform that would make the money supply more elastic. Taussig called for an expansion of national bank notes, which would inflate in response to the "needs of business." As Taussig (quoted in Dorfman 1949, p. xxxvii; Parrini and Sklar 1983, p. 269) put it, the currency would then "grow without trammels as the needs of the community spontaneously call for increase."

Taylor, too, as one historian puts it, wanted the gold standard to be modified by "a conscious control of the movement of money" by government "in order to maintain the stability of the credit system." Taylor justified governmental suspensions of specie payment to "protect the gold reserve" (Dorfman 1949, pp. 392–93).

On January 26, the convention delegates duly endorsed the preliminary report with virtual unanimity, after which Professor J. Laurence Laughlin was assigned the task of drawing up a more elaborate final report, which was published and distributed a few months later. Laughlin's — and the convention's — final report not only came out in favor of a broadened asset base for a greatly increased amount of national-bank notes, but also called explicitly for a central bank that would enjoy a monopoly of the issue of bank notes.The final report, including its recommendations for a central bank, was hailed by F. M. Taylor, in his "The Final Report of the Indianapolis Monetary Commission," Journal of Political Economy 6 (June 1898): 293–322. Taylor also exulted that the convention had been "one of the most notable movements of our time — the first thoroughly organized movement of the business classes in the whole country directed to the bringing about of a radical change in national legislation" (ibid., p. 322).

Meanwhile, the convention delegates took the gospel of banking reform to the length and breadth of the corporate and financial communities. In April 1898, for example, A. Barton Hepburn, president of the Chase National Bank of New York (at that time a flagship commercial bank for the Morgan interests), and a man who would play a large role in the drive to establish a central bank, invited Monetary Commissioner Robert S. Taylor to address the New York State Bankers' Association on the currency question, since "bankers, like other people, need instruction upon this subject." All the monetary commissioners, especially Taylor, were active during the first half of 1898 in exhorting groups of businessmen throughout the nation for monetary reform.

Meanwhile, in Washington, the lobbying team of Hanna and Conant were extremely active. A bill embodying the suggestions of the Monetary Commission was introduced by Indiana Congressman Jesse Overstreet in January, and was reported out by the House Banking and Currency Committee in May. In the meantime, Conant met almost continuously with the banking committee members. At each stage of the legislative process, Hanna sent circular letters to the convention delegates and to the public, urging a letter-writing campaign in support of the bill.

In this agitation, McKinley's Secretary of the Treasury Lyman J. Gage worked closely with Hanna and his staff. Gage sponsored similar bills, and several bills along the same lines were introduced in the House in 1898 and 1899. Gage, a friend of several of the monetary commissioners, was one of the top leaders of the Rockefeller interests in the banking field. His appointment as secretary of the treasury had been gained for him by Ohio's Mark Hanna, political mastermind and financial backer of President McKinley, and old friend, high-school classmate, and business associate of John D. Rockefeller, Sr.

Before his appointment to the Cabinet, Gage was president of the powerful First National Bank of Chicago, one of the major commercial banks in the Rockefeller ambit. During his term in office, Gage tried to operate the Treasury as a central bank, pumping in money during recessions by purchasing government bonds on the open market, and depositing large funds with pet commercial banks. In 1900, Gage called vainly for the establishment of regional central banks.

Finally, in his last annual report as secretary of the treasury in 1901, Lyman Gage let the cat completely out of the bag, calling outright for a government central bank. Without such a central bank, he declared in alarm, "individual banks stand isolated and apart, separated units, with no tie of mutuality between them." Unless a central bank establishes such ties, Gage warned, the Panic of 1893 would be repeated (Livingston 1986, p. 153). When he left office early the next year, Lyman Gage took up his post as president of the Rockefeller-controlled US Trust Company in New York City (Rothbard 1984, pp. 94–95).

Any reform legislation had to wait until after the elections of 1898, for the gold forces were not yet in control of Congress. In the autumn, the executive committee of the Indianapolis Monetary Convention mobilized its forces, calling on no less than 97,000 correspondents throughout the country, through whom it had distributed the preliminary report. The executive committee urged its constituency to elect a gold-standard Congress; when the gold forces routed the silverites in November, the results of the election were hailed by Hanna as eminently satisfactory.

The decks were now cleared for the McKinley administration to submit its bill, and the Congress that met in December 1899 quickly passed the measure; Congress then passed the conference report of the Gold Standard Act in March 1900.

The currency reformers had gotten their way. It is well known that the Gold Standard Act provided for a single gold standard, with no retention of silver money except as tokens. Less well known are the clauses that began the march toward a more "elastic" currency. As Lyman Gage had suggested in 1897, national banks, previously confined to large cities, were now made possible with a small amount of capital in small towns and rural areas.

And it was made far easier for national banks to issue notes. The object of these clauses, as one historian put it, was to satisfy an "increased demand for money at crop-moving time, and to meet popular cries for 'more money' by encouraging the organization of national banks in comparatively undeveloped regions" (Livingston 1986, p. 123).

The reformers exulted over the passage of the Gold Standard Act, but took the line that this was only the first step on the much needed path to fundamental banking reform. Thus, Professor Frank W. Taussig of Harvard praised the act, and greeted the emergence of a new social and ideological alignment, caused by "strong pressure from the business community" through the Indianapolis Monetary Convention. He particularly welcomed the fact that the Gold Standard Act "treats the national banks not as grasping and dangerous corporations but as useful institutions deserving the fostering care of the legislature."

But such tender legislative care was not enough; fundamental banking reform was needed. For, Taussig declared, "the changes in banking legislation are not such as to make possible any considerable expansion of the national system or to enable it to render the community the full service of which it is capable." In short, the changes allowed for more and greater expansion of bank credit and the supply of money. Therefore, Taussig (1990, p. 415) concluded, "It is well-nigh certain that eventually Congress will have to consider once more the further remodeling of the national bank system."

In fact, the Gold Standard Act of 1900 was only the opening gun of the banking reform movement. Three friends and financial journalists, two from Chicago, were to play a large role in the development of that movement. Massachusetts-born Charles A. Conant (1861–1915) a leading historian of banking, wrote his A History of Modern Banks of Issue in 1896, while still a Washington correspondent for the New York Journal of Commerce and an editor of Bankers Magazine. After his stint of public relations work and lobbying for the Indianapolis Convention, Conant moved to New York in 1902 to become treasurer of the Morgan-oriented Morton Trust Company.

The two Chicagoans, both friends of Lyman Gage, were, along with Gage, in the Rockefeller ambit: Frank A. Vanderlip was picked by Gage as his assistant secretary of the treasury, and when Gage left office, Vanderlip came to New York as a top executive at the flagship commercial bank of the Rockefeller interests, the National City Bank of New York.

Meanwhile, Vanderlip's close friend and former mentor at the Chicago Tribune, Joseph French Johnson, had also moved east to become professor of finance at the Wharton School of the University of Pennsylvania. But no sooner had the Gold Standard Act been passed when Joseph Johnson sounded the trump by calling for more-fundamental reform.

Professor Johnson stated flatly that the existing bank note system was weak in not "responding to the needs of the money market," i.e., not supplying a sufficient amount of money. Since the national banking system was incapable of supplying those needs, Johnson opined, there was no reason to continue it. Johnson deplored the US banking system as the worst in the world, and pointed to the glorious central banking system as existed in Britain and France.Joseph French Johnson (1900, pp. 482–507). Johnson, however, deplored the one fly in the Bank of England ointment — the remnant of the hard-money Peel's Act of 1844 that placed restrictions on the quantity of bank-note issue (ibid., p. 496).

But no such centralized banking system yet existed in the United States: "In the United States, however, there is no single business institution, and no group of large institutions, in which self-interest, responsibility, and power naturally unite and conspire for the protection of the monetary system against twists and strains."

In short, there was far too much freedom and decentralization in the system. In consequence, our massive deposit credit system "trembles whenever the foundations are disturbed," i.e., whenever the chickens of inflationary credit expansion came home to roost in demands for cash or gold. The result of the inelasticity of money, and of the impossibility of interbank cooperation, Johnson opined, was that we were in danger of losing gold abroad just at the time when gold was needed to sustain confidence in the nation's banking system (Johnson 1900, pp. 497f).

After 1900, the banking community was split on the question of reform, the small and rural bankers preferring the status quo. But the large bankers were headed by A. Barton Hepburn of Morgan's Chase National Bank, who drew up a bill as head of a commission of the American Bankers Association, and presented it in late 1901 to Representative Charles N. Fowler of New Jersey, chairman of the House Banking and Currency Committee, who had introduced one of the bills that had led to the Gold Standard Act. The Hepburn proposal was reported out of committee in April 1902 as the Fowler Bill (Kolko 1983, pp. 149–50).

The Fowler Bill contained three basic clauses. The first allowed the further expansion of national bank notes based on broader assets than government bonds.

The second, a favorite of the big banks, was to allow national banks to establish branches at home and abroad, a step illegal under the existing system due to fierce opposition by the small country bankers. While branch banking is consonant with a free market and provides a sound and efficient system for calling on other banks for redemption, the big banks had little interest in branch banking unless accompanied by centralization of the banking system.

Third, the Fowler Bill proposed to create a three-member board of control within the Treasury Department to supervise the creation of the new bank notes and to establish clearinghouse associations under its aegis. This provision was designed to be the first step toward the establishment of a full-fledged central bank (Livingston 1986, pp. 150–54).

Although they could not control the American Bankers Association, the multitude of country bankers, up in arms against the proposed competition of big banks in the form of branch banking, put fierce pressure upon Congress and managed to kill the Fowler Bill in the House during 1902, despite the agitation of the executive committee and staff of the Indianapolis Monetary Convention.

With the defeat of the Fowler Bill, the big bankers decided to settle for more modest goals for the time being. Senator Nelson W. Aldrich of Rhode Island, perennial Republican leader of the US Senate and Rockefeller's man in Congress,Nelson W. Aldrich, who entered the Senate a moderately wealthy wholesale grocer and left years later a multimillionaire, was the father-in-law of John D. Rockefeller, Jr. His grandson and namesake, Nelson Aldrich Rockefeller, later became vice president of the United States, and head of the "corporate liberal" wing of the Republican party. submitted the Aldrich Bill the following year, allowing the large national banks in New York to issue "emergency currency" based on municipal and railroad bonds. But even this bill was defeated.

Meeting setbacks in Congress, the big bankers decided to regroup and turn temporarily to the executive branch. Foreshadowing a later, more elaborate collaboration, two powerful representatives each from the Morgan and Rockefeller banking interests met with Comptroller of the Currency William B. Ridgely in January 1903, to try to persuade him, by administrative fiat, to restrict the volume of loans made by the country banks in the New York money market.

The two Morgan men at the meeting were J. P. Morgan himself and George F. Baker, Morgan's closest friend and associate in the banking business.Baker was head of the Morgan-dominated First National Bank of New York, and served as a director of virtually every important Morgan-run enterprise, including: Chase National Bank, Guaranty Trust Company, Morton Trust Company, Mutual Life Insurance Company, AT&T, Consolidated Gas Company of New York, Erie Railroad, New York Central Railroad, Pullman Company, and United States Steel. See Burch (1981, pp. 190, 229). The two Rockefeller men were Frank Vanderlip and James Stillman, long-time chairman of the board of the National City Bank.On the meeting, see Livingston (1986, p. 155). The close Rockefeller-Stillman alliance was cemented by the marriage of the two daughters of Stillman to the two sons of William Rockefeller, brother of John D. Rockefeller, Sr., and long-time board member of the National City Bank (Burch 1981, pp. 134–35).

The meeting with the comptroller did not bear fruit, but the lead instead was taken by the secretary of the treasury himself, Leslie Shaw, formerly presiding officer at the second Indianapolis Monetary Convention, whom President Roosevelt appointed to replace Lyman Gage. The unexpected and sudden shift from McKinley to Roosevelt in the presidency meant more than just a turnover of personnel; it meant a fundamental shift from a Rockefeller-dominated to a Morgan-dominated administration. The shift from Gage to Shaw was one of the many Rockefeller-to-Morgan displacements.

On monetary and banking matters, however, the Rockefeller and Morgan camps were as one. Secretary Shaw attempted to continue and expand Gage's experiments in trying to make the Treasury function like a central bank, particularly in making open-market purchases in recessions, and in using Treasury deposits to bolster the banks and expand the money supply.

Shaw violated the statutory institution of the independent Treasury, which had tried to confine government revenues and expenditures to its own coffers. Instead, he expanded the practice of depositing Treasury funds in favored, big national banks. Indeed, even banking reformers denounced the deposit of Treasury funds to pet banks as artificially lowering interest rates and leading to artificial expansion of credit. Furthermore, any government deficit would obviously throw a system dependent on a flow of new government revenues into chaos.

All in all, the reformers agreed increasingly with the verdict of economist Alexander Purves, that "the uncertainty as to the Secretary's power to control the banks by arbitrary decisions and orders, and the fact that at some future time the country may be unfortunate in its chief Treasury official [has] … led many to doubt the wisdom" of using the Treasury as a form of central bank (Livingston 1986, 156; Burch 1981, pp. 161–62).

In his last annual report of 1906, Secretary Shaw urged that he be given total power to regulate all the nation's banks. But the game was up, and by then it was clear to the reformers that Shaw's as well as Gage's proto–central bank manipulations had failed. It was time to undertake a struggle for a fundamental legislative overhaul of the American banking system, to bring it under central-banking control.On Gage and Shaw's manipulations, see Rothbard (1984, pp. 94–96) and Friedman and Schwartz (1963, pp. 148–56).

The years shortly before and after 1900 proved to be the beginnings of the drive toward the establishment of a Federal Reserve System. It was also the origin of the gold-exchange standard, the fateful system imposed upon the world by the British in the 1920s and by the United States after World War II at Bretton Woods. Even more than the case of a gold standard with a central bank, the gold-exchange standard establishes a system, in the name of gold, which in reality manages to install coordinated, international, inflationary, paper money.

The idea was to replace a genuine gold standard, in which each country (or, domestically, each bank) maintains its reserves in gold, by a pseudo–gold standard in which the central bank of the client country maintains its reserves in some key or base currency, say pounds, or dollars. Thus, during the 1920s, most countries maintained their reserves in pounds, and only Britain purported to redeem pounds in gold.

This meant that these other countries were really on a pound rather than a gold standard, although they were able, at least temporarily, to acquire the prestige of gold. It also meant that when Britain inflated pounds, there was no danger of losing gold to these other countries, who, quite the contrary, happily inflated their own currencies on top of their expanding balances in pounds sterling.

Thus, there was generated an unstable, inflationary system — all in the name of gold — in which client states pyramided their own inflation on top of Great Britain's. The system was eventually bound to collapse, as did the gold-exchange standard in the Great Depression, and Bretton Woods by the late 1960s. In addition, the close ties based on pounds and then dollars meant that the key or base country was able to exert a form of economic imperialism, joined by their common paper and pseudogold inflation, upon the client states using the key money.

By the late 1890s, groups of theoreticians in the United States were working on what would later be called the "Leninist" theory of capitalist imperialism. The theory was originated, not by Lenin but by advocates of imperialism, centering around such Morgan-oriented friends and brain trusters of Theodore Roosevelt as Henry Adams, Brooks Adams, Admiral Alfred T. Mahan, and Massachusetts Senator Henry Cabot Lodge.

The idea was that capitalism in the developed countries was "overproducing," not simply in the sense that more purchasing power was needed in recessions, but more deeply in that the rate of profit was therefore inevitably falling. The ever-lower rate of profit from the "surplus capital" was in danger of crippling capitalism, except that salvation loomed in the form of foreign markets and especially foreign investments.

New and expanded foreign markets would increase profits, at least temporarily, while investments in undeveloped countries would be bound to bring a high rate of profit. Hence, to save advanced capitalism, it was necessary for Western governments to engage in outright imperialist or neoimperialist ventures, which would force other countries to open their markets for American products and would force open investment opportunities abroad.

Given this doctrine — based on the fallacious Ricardian view that the rate of profit is determined by the stock of capital investment, instead of by the time preferences of everyone in society — there was little for Lenin to change except to give an implicit moral condemnation instead of approval and to emphasize the necessarily temporary nature of the respite imperialism could furnish for capitalists.Indeed, the adoption of this theory of the alleged necessity for imperialism in the "later stages" of capitalism went from proimperialists like the US Investor, Charles A. Conant, and Brooks Adams in 1898–1899, to the Marxist H. Gaylord Wilshire in 1900–1901, and in turn to the English left-liberal anti-imperialist John A. Hobson, who in turn influenced Lenin. See in particular Norman Etherington (1984; 1982, pp. 1–36).

Charles Conant set forth the theory of surplus capital in his A History of Modern Banks of Issue (1896) and developed it in subsequent essays. The existence of fixed capital and modern technology, Conant claimed, invalidated Say's Law and the concept of equilibrium, and led to chronic "oversavings," which he defined as savings in excess of profitable investment outlets, in the developed Western capitalist world.

Business cycles, claimed Conant, were inherent in the unregulated activity of modern industrial capitalism. Hence the importance of government-encouraged monopolies and cartels to stabilize markets and the business cycle, and in particular the necessity of economic imperialism to force open profitable outlets abroad for American and other Western surplus capital.

The United States' bold venture into an imperialist war against Spain in 1898 galvanized the energies of Conant and other theoreticians of imperialism. Conant responded with his call for imperialism in "The Economic Basis of Imperialism" in the September 1898 North American Review, and in other essays collected in The United States in the Orient: The Nature of the Economic Problem and published in 1900.

S. J. Chapman (1901, p. 78), a distinguished British economist, accurately summarized Conant's argument as follows: (1) "In all advanced countries there has been such excessive saving that no profitable investment for capital remains." (2) Since all countries do not practice a policy of commercial freedom, "America must be prepared to use force if necessary" to open up profitable investment outlets abroad, and (3) the United States possesses an advantage in the coming struggle, since the organization of many of its industries "in the form of trusts will assist it greatly in the fight for commercial supremacy."See also Etherington (1984, p. 24).

The war successfully won, Conant was particularly enthusiastic about the United States keeping the Philippines, the gateway to the great potential Asian market. The United States, he opined, should not be held back by "an abstract theory" to adopt "extreme conclusions" on applying the doctrines of the Founding Fathers on the importance of the consent of the governed.

The Founding Fathers, he declared, surely meant that self-government could only apply to those competent to exercise it, a requirement that clearly did not apply to the backward people of the Philippines. After all, Conant wrote, "Only by the firm hand of the responsible governing races … can the assurance of uninterrupted progress be conveyed to the tropical and undeveloped countries" (Healy 1970, pp. 200–01).

Conant also was bold enough to derive important domestic conclusions from his enthusiasm for imperialism. Domestic society, he claimed, would have to be transformed to make the nation as "efficient" as possible. Efficiency, in particular, meant centralized concentration of power. "Concentration of power, in order to permit prompt and efficient action, will be an almost essential factor in the struggle for world empire."

In particular, it was important for the United States to learn from the magnificent centralization of power and purpose in Czarist Russia. The government of the United States would require "a degree of harmony and symmetry which will permit the direction of the whole power of the state toward definite and intelligent policies." The US Constitution would have to be amended to permit a form of Czarist absolutism, or at the very least an enormously expanded executive power in foreign affairs (Healy, pp. 202–03).

An interesting case study of business opinion energized and converted by the lure of imperialism was the Boston weekly, The US Investor. Before the outbreak of war with Spain in 1898, the US Investor denounced the idea of war as a disaster to business. But after the United States launched its war, and Commodore Dewey seized Manila Bay, the Investor totally changed its tune. Now it hailed the war as excellent for business, and as bringing about recovery from the previous recession.

Soon the Investor was happily advocating a policy of "imperialism" to make US prosperity permanent. Imperialism conveyed marvelous benefits to the country. At home, a big army and navy would be valuable in curbing the tendency of democracy to enjoy "a too great freedom from restraint, both of action and of thought." The Investor added that "European experience demonstrates that the army and navy are admirably adopted to inculcate orderly habits of thought and action."

But an even more important benefit from a policy of permanent imperialism would be economic. To keep "capital … at work," stern necessity requires that "an enlarged field for its product must be discovered." Specifically, "a new field" had to be found for selling the growing flood of goods produced by the advanced nations, and for investment of their savings at profitable rates. The Investor exulted in the fact that this new "field lies ready for occupancy. It is to be found among the semicivilized and barbarian races," in particular the beckoning country of China.

Particularly interesting is the colloquy that ensued between the Investor, and the Springfield (Mass.) Republican, which still propounded the older theory of free trade and laissez-faire. The Republican asked why trade with undeveloped countries is not sufficient without burdening US taxpayers with administrative and military overhead. The Republican also attacked the new theory of surplus capital, pointing out that only two or three years earlier, businessmen had been loudly calling for more European capital to be invested in American ventures.

To the first charge, the Investor fell back on "the experience of the race for, perhaps ninety centuries, [which] has been in the direction of foreign acquisitions as a means of national prosperity." But, more practically, the Investor delighted over the goodies that imperialism would bring to American business in the way of government contracts and the governmental development of what would now be called the "infrastructure" of the colonies. Furthermore, as in Britain, a greatly expanded diplomatic service would provide "a new calling for our young men of education and ability."

To the Republican's second charge, on surplus capital, the Investor, like Conant, developed the idea of a new age that had just arrived in American affairs: an age of large-scale manufacture and hence overproduction, an age of a low rate of profit, and consequent formation of trusts in a quest for higher profits through suppression of competition.

As the Investor put it, "The excess of capital has resulted in an unprofitable competition. To employ Franklin's witticism, the owners of capital are of the opinion they must hang together or else they will all hang separately." But while trusts may solve the problem of specific industries, they do not solve the great problem of a general "congestion of capital." Indeed, wrote the Investor, "finding employment for capital … is now the greatest of all economic problems that confront us."

To the Investor, the way out was clear:

The logical path to be pursued is that of the development of the natural riches of the tropical countries. These countries are now peopled by races incapable on their own initiative of extracting its full riches from their own soil.… This will be attained in some cases by the mere stimulus of government and direction by men of the temperate zones; but it will be attained also by the application of modern machinery and methods of culture to the agricultural and mineral resources of the undeveloped countries. (Quoted in Etherington 1984, p. 17)

By the spring of 1901, even the eminent economic theorist John Bates Clark, of Columbia University, was able to embrace the new creed. Reviewing proimperialist works by Conant, Brooks Adams, and the Reverend Josiah Strong in a single celebratory review in March 1901 in the Political Science Quarterly, Clark emphasized the importance of opening foreign markets and particularly of investing American capital "with an even larger and more permanent profit" (Parrini and Sklar 1983, p. 565, n. 16).

J. B. Clark was not the only economist ready to join in apologia for the strong state. Throughout the land by the turn of the 20th century, a legion of economists and other social scientists had arisen, many of them trained in graduate schools in Germany to learn of the virtues of the inductive method, the German Historical School, and a collectivist, organicist state. Eager for positions and power commensurate with their graduate training, these new social scientists, in the name of professionalism and technical expertise, prepared to abandon the old laissez-faire creed and take their places as apologists and planners in a new, centrally-planned state.

Professor Edwin R. A. Seligman of Columbia University, of the prominent Wall Street investment banking family of J. and W. Seligman and Company, spoke for many of these social scientists when, in a presidential address before the American Economic Association in 1903, he hailed the "new industrial order."Seligman was also related by marriage to the Loebs and to Paul Warburg of Kuhn, Loeb. Specifically, E. R. A. Seligman's brother, Isaac N. was married to Guta Loeb, sister of Paul Warburg's wife, Nina. See Stephen Birmingham (1977, appendix).  Seligman prophesied that in the new, 20th century, the possession of economic knowledge would grant economists the power "to control … and mold" the material forces of progress. As the economist proved able to forecast more accurately, he would be installed as "the real philosopher of social life," and the public would pay "deference to his views."

In his 1899 presidential address, Arthur Twining Hadley of Yale also saw economists developing as society's philosopher kings. The most important application of economic knowledge, declared Hadley, was leadership in public life, becoming advisers and leaders of national policy. "I believe," opined Hadley,

that their [economists'] largest opportunity in the immediate future lies not in theories but in practice, not with students but with statesmen, not in the education of individual citizens, however widespread and salutary, but in the leadership of an organized body politic. (Silva and Slaughter 1984, p. 103)

Hadley perceptively saw the executive branch of the government as particularly amenable to providing access to position and influence for economic advisers and planners. Previously, executives were hampered in seeking such expert counsel by the importance of political parties, their ideological commitments, and their mass base in the voting population.

But now, fortunately, the growing municipal reform (soon to be called the Progressive) movement was taking power away from political parties and putting it into the hands of administrators and experts. The "increased centralization of administrative power [was giving] … the expert a fair chance."

And now, on the national scene, the new American leap into imperialism in the Spanish-American War was providing an opportunity for increased centralization, executive power, and therefore for administrative and expert planning. Even though Hadley declared himself personally opposed to imperialism, he urged economists to leap at this great opportunity for access to power (Silva and Slaughter 1984, pp. 120–21).

The organized economic profession was not slow to grasp this new opportunity. Quickly, the executive and nominating committees of the American Economic Association (AEA) created a five-man special committee to organize and publish a volume on colonial finance. As Silva and Slaughter put it, this new, rapidly put together volume permitted the AEA to show the power elite how the new social science could serve the interests of those who made imperialism a national policy by offering technical solutions to the immediate fiscal problems of colonies, as well as providing ideological justifications for acquiring them. (Silva and Slaughter, p. 133)

The chairman of the special committee was Professor Jeremiah W. Jenks of Cornell, the major economic adviser to Governor Theodore Roosevelt. Another member was Professor E. R. A. Seligman, another key adviser to Roosevelt. A third colleague was Dr. Albert Shaw, influential editor of the Review of Reviews, progressive reformer and social scientist, and long-time crony of Roosevelt's. All three were long-time leaders of the American Economic Association.

The other two, non-AEA leaders, on the committee were Edward R. Strobel, former assistant secretary of state and adviser to colonial governments, and Charles S. Hamlin, wealthy Boston lawyer and assistant secretary of the treasury, who had long been in the Morgan ambit, and whose wife was a member of the Pruyn family, longtime investors in two Morgan-dominated concerns: the New York Central Railroad and the Mutual Life Insurance Company of New York.

Essays in Colonial Finance (Jenks et al. 1900), the volume quickly put together by these five leaders, tried to advise the United States how best to run its newly-acquired empire.

First, just as the British government insisted when the North American states were its colonies, the colonies should support their imperial government through taxation, whereas control should be tightly exercised by the US imperial center. Second, the imperial center should build and maintain the economic infrastructure of the colony: canals, railroads, and communications. Third, where — as was clearly anticipated — native labor is inefficient or incapable of management, the imperial government should import (white) labor from the imperial center. And, finally, as Silva and Slaughter put it,

the committee's fiscal recommendations strongly intimated that trained economists were necessary for a successful empire. It was they who must make a thorough study of local conditions to determine the correct fiscal system, gather data, create the appropriate administrative design and perhaps even implement it. In this way, the committee seconded Hadley's views in seeing imperialism as an opportunity for economists by identifying a large number of professional positions best filled by themselves. (Silva and Slaughter 1984, p. 135)

With the volume written, the AEA cast about for financial support for its publication and distribution. The point was not simply to obtain the financing, but to do so in such a way as to gain the imprimatur of leading members of the power elite on this bold move to empower economists as technocratic expert advisers and administrators in the imperial nation-state.

The American Economic Association found five wealthy businessmen to put up two-fifths the full cost of publishing Essays in Colonial Finance. By compiling the volume and then accepting corporate sponsors, several of whom had an economic stake in the new American empire, the AEA was signaling that the nation's organized economists were (1) wholeheartedly in favor of the new American empire; and (2) were willing and eager to play a strong role in advising and administering the empire, a role which they promptly and happily filled, as we shall see in the following section.

In view of the symbolic as well as practical role for the sponsors, a list of the five donors for the colonial-finance volume is instructive.

One was Isaac N. Seligman, head of the investment-banking house of J and W Seligman and Company, a company with extensive overseas interests, especially in Latin America. Isaac's brother E. R. A. Seligman was a member of the special committee on Colonial Finance and an author of one of the essays in the volume.

Another was William E. Dodge, a partner of the copper mining firm of Phelps, Dodge, and Company, and member of a powerful mining family allied to the Morgans.

A third donor was Theodore Marburg, an economist who was vice president of the AEA at the time, and also an ardent advocate of imperialism as well as heir to a substantial American Tobacco Company fortune.

Fourth was Thomas Shearman, a single-taxer and an attorney for the powerful railroad magnate Jay Gould.

And last but not least, was Stuart Wood, a manufacturer who had a PhD in economics and had been a vice president of the AEA.

The leap into political imperialism by the United States in the late 1890s was accompanied by economic imperialism, and one key to economic imperialism was monetary imperialism. In brief, the developed Western countries by this time were on the gold standard, while most of the Third World nations were on the silver standard. For the past several decades, the value of silver in relation to gold had been steadily falling, due to

The fall of silver values meant monetary depreciation and inflation in the Third World, and it would have been a reasonable policy to shift from a silver-coin to a gold-coin standard. But the new imperialists among US bankers, economists, and politicians were far less interested in the welfare of Third World countries than in foisting a monetary imperialism upon them.

For not only would the economies of the imperial center and the client states then be tied together, but they would be tied in such a way that these economies could pyramid their own monetary and bank credit inflation on top of inflation in the United States. Hence, what the new imperialists set out to do was pressure or coerce Third World countries to adopt, not a genuine gold-coin standard, but a newly conceived "gold-exchange" or dollar standard.

Instead of silver currency fluctuating freely in terms of gold, the silver to gold rate would then be fixed by arbitrary government price-fixing. The silver countries would be silver in name only; the country's monetary reserve would be held, not in silver, but in dollars allegedly redeemable in gold; and these reserves would be held, not in the country itself, but as dollars piled up in New York City.

In that way, if US banks inflated their credit, there would be no danger of losing gold abroad, as would happen under a genuine gold standard. For under a true gold standard, no one and no country would be interested in piling up claims to dollars overseas. Instead, they would demand payment of dollar claims in gold. So that even though these American bankers and economists were all too aware, after many decades of experience, of the fallacies and evils of bimetallism, they were willing to impose a form of bimetallism upon client states in order to tie them into US economic imperialism, and to pressure them into inflating their own money supplies on top of dollar reserves supposedly, but not de facto, redeemable in gold.

The United States first confronted the problem of silver currencies in a Third World country when it seized control of Puerto Rico from Spain in 1898 and occupied it as a permanent colony. Fortunately for the imperialists, Puerto Rico was already ripe for currency manipulation. Only three years earlier, in 1895, Spain had destroyed the full-bodied Mexican silver currency that its colony had previously enjoyed, and replaced it with a heavily debased silver "dollar," worth only 41 cents in US currency. The Spanish government had pocketed the large seigniorage profits from that debasement.

The United States was therefore easily able to substitute its own debased silver dollar, worth only 45.6 cents in gold. Thus, the United States' silver currency replaced an even more debased one, and also the Puerto Ricans had no tradition of loyalty to a currency only recently imposed by the Spaniards. There was therefore little or no opposition in Puerto Rico to the US monetary takeover.See the illuminating article by Emily S. Rosenberg (1985, pp. 172–73).

The major controversial question was what exchange rate the American authorities would fix between the two debased coins: the old Puerto Rican silver peso and the US silver dollar. This was the rate at which the US authorities would compel the Puerto Ricans to exchange their existing coinage for the new American coins.

The treasurer in charge of the currency reform for the US government was the prominent Johns Hopkins economist, Jacob H. Hollander, who had been special commissioner to revise Puerto Rican tax laws, and who was one of the new breed of academic economists repudiating laissez-faire for comprehensive statism.

The heavy debtors in Puerto Rico — mainly the large sugar planters — naturally wanted to pay their peso obligations at as cheap a rate as possible; they lobbied for a peso worth 50 cents American. In contrast, the Puerto Rican banker-creditors wanted the rate fixed at 75 cents. Since the exchange rate was arbitrary anyway, Hollander and the other American officials decided in the time-honored way of governments: more or less splitting the difference, and fixing a peso equal to 60 cents.Also getting their start in administering imperialism in Puerto Rico were economist and demographer W. H. Willcox of Cornell, who conducted the first census on the island as well as in Cuba in 1900, and Roland P. Falkner, statistician and bank reformer first at the University of Pennsylvania, and then head of the Division of Documents at the Library of Congress, who became commissioner of education in Puerto Rico in 1903. Falkner went on to head the US Commission to Liberia in 1909 and to be a member of the Joint Land Commission of the US and Chinese governments. Harvard economist Thomas S. Adams served as assistant treasurer to Hollander in Puerto Rico. Political scientist William F. Willoughby succeeded Hollander as treasurer (Silva and Slaughter 1984, pp. 137–38).

The Philippines, the other Spanish colony grabbed by the United States, posed a far more difficult problem. As in most of the Far East, the Philippines was happily using a perfectly sound silver currency, the Mexican silver dollar. But the United States was anxious for a rapid reform, because its large armed forces establishment suppressing Filipino nationalism required heavy expenses in US dollars, which it of course declared to be legal tender for payments. Since the Mexican silver coin was also legal tender and was cheaper than the US gold dollar, the US military occupation found its revenues being paid in unwanted and cheaper Mexican coins.

Delicacy was required, and in 1901, for the task of currency takeover the Bureau of Insular Affairs (BIA) of the War Department — the agency running the US occupation of the Philippines — hired Charles A. Conant for the task. Secretary of War Elihu Root was a redoubtable Wall Street lawyer in the Morgan ambit who sometimes served as J. P. Morgan's personal attorney. Root took a personal hand in sending Conant to the Philippines. Conant, fresh from the Indianapolis Monetary Commission and before going to New York as a leading investment banker, was, as might be expected, an ardent gold-exchange-standard imperialist as well as the leading theoretician of economic imperialism.

Realizing that the Filipino people loved their silver coins, Conant devised a way to impose a gold US dollar currency upon the country. Under his cunning plan, the Filipinos would continue to have a silver currency; but replacing the full-bodied Mexican silver coin would be an American silver coin tied to gold at a debased value far less than the market exchange value of silver in terms of gold. In this imposed, debased bimetallism, since the silver coin was deliberately overvalued in relation to gold by the US government, Gresham's law went inexorably into effect. The overvalued silver would keep circulating in the Philippines, and undervalued gold would be kept sharply out of circulation.

The seigniorage profit that the Treasury would reap from the debasement would be happily deposited at a New York bank, which would then function as a "reserve" for the US silver currency in the Philippines. Thus, the New York funds would be used for payment outside the Philippines instead of as coin or specie. Moreover, the US government could issue paper dollars based on its new reserve fund.

It should be noted that Conant originated the gold-exchange scheme as a way of exploiting and controlling Third World economies based on silver. At the same time, Great Britain was introducing similar schemes in its colonial areas in Egypt, the Straits Settlements in Asia, and particularly in India.

Congress, however, pressured by the silver lobby, balked at the BIA's plan. And so the BIA again turned to the seasoned public relations and lobbying skills of Charles A. Conant. Conant swung into action. Meeting with editors of the top financial journals, he secured their promises to write editorials pushing for the Conant plan, many of which he obligingly wrote himself.

He was already backed by the American banks of Manila. Recalcitrant US bankers were warned by Conant that they could no longer expect large government deposits from the War Department if they continued to oppose the plan. Furthermore, Conant won the support of the major enemies of his plan, the American silver companies and prosilver bankers, promising them that if the Philippine currency reform went through, the federal government would buy silver for the new US coinage in the Philippines from these same companies. Finally, the tireless lobbying, and the mixture of bribery and threats by Conant, paid off. Congress passed the Philippine Currency Bill in March 1903.

In the Philippines, however, the United States could not simply duplicate the Puerto Rican example and coerce the conversion of the old for the new silver coinage. For the Mexican silver coin was a dominant coin not only in the Far East but throughout the world, and the coerced conversion would have been endless.

The United States tried; it removed the legal tender privilege from the Mexican coins, and decreed the new US coins to be used for taxes, government salaries, and other government payments. But this time the Filipinos happily used the old Mexican coins as money, while the US silver coins disappeared from circulation into payment of taxes and transactions to the United States.

The War Department was beside itself: how could it drive Mexican silver coinage out of the Philippines? In desperation, it turned to the indefatigable Conant, but Conant couldn't join the colonial government in the Philippines because he had just been appointed to a more far-flung presidential commission on international exchange for pressuring Mexico and China to go on a similar gold-exchange standard.

Hollander, fresh from his Puerto Rican triumph, was ill. Who else? Conant, Hollander, and several leading bankers told the War Department they could recommend no one for the job, so new then was the profession of technical expert in monetary imperialism.

But there was one more hope, the other procartelist and financial imperialist, Cornell's Jeremiah W. Jenks, a fellow member with Conant of President Roosevelt's new Commission on International Exchange (CIE). Jenks had already paved the way for Conant by visiting English and Dutch colonies in the Far East in 1901 to gain information about running the Philippines. Jenks finally came up with a name, his former graduate student at Cornell, Edwin W. Kemmerer.

Young Kemmerer went to the Philippines from 1903 to 1906, to implement the Conant plan. Based on the theories of Jenks and Conant, and on his own experience in the Philippines, Kemmerer went on to teach at Cornell and then at Princeton, and gained fame throughout the 1920s as the "money doctor," busily imposing the gold-exchange standard on country after country abroad.

Relying on Conant's behind-the-scenes advice, Kemmerer and his associates finally came out with a successful scheme to drive out the Mexican silver coins. It was a plan that relied heavily on government coercion. The United States imposed a legal prohibition on the importation of the Mexican coins, followed by severe taxes on any private Philippine transactions daring to use the Mexican currency.

Luckily for the planners, their scheme was aided by a large-scale demand at the time for Mexican silver in northern China, which absorbed silver that was in the Philippines or that would have been smuggled into the islands. The US success was aided by the fact that the new US silver coins, perceptively called "conants" by the Filipinos, were made up to look very much like the cherished old Mexican coins. By 1905, force, luck, and trickery had prevailed, and the conants (worth 50 cents in US money) were the dominant currency in the Philippines. Soon the US authorities were confident enough to add token copper coins and paper conants as well.See Rosenberg (1985, pp. 177–81). Other economists and social scientists helping to administer imperialism in the Philippines were Carl C. Plehn of the University of California, who served as chief statistician to the Philippine Commission in 1900–1901, and Bernard Moses, historian, political scientist and economist at the University of California, an ardent advocate of imperialism who served on the Philippine Commission from 1901–1903, and then became an expert in Latin American affairs, joining in a series of Pan-American conferences.Political scientist David P. Barrows became superintendent of schools in Manila and director of education for eight years, from 1901 to 1909. This experience ignited a lifelong interest in the military for Barrows, who, while a professor at Berkeley and a general in the California National Guard in 1934, led the troops that broke the San Francisco longshoremen's strike. During World War II, Barrows carried over his interest in coercion to help in the forced internment of Japanese Americans in concentration camps. On Barrows, see Silva and Slaughter (1984, pp. 137–38). On Moses, see Dorfman (1949, pp. 96–98). 

By 1903, the currency reformers felt emboldened enough to move against the Mexican silver dollar throughout the world. In Mexico itself, US industrialists who wanted to invest there pressured the Mexicans to shift from silver to gold, and they found an ally in powerful finance minister Jose Limantour. But tackling the Mexican silver peso at home would not be an easy task, for the coin was known and used throughout the world, particularly in China, where it formed the bulk of the circulating coinage.

Finally, after three-way talks between US, Mexican, and Chinese officials, the Mexicans and Chinese were induced to send identical notes to the US Secretary of State, urging the United States to appoint financial advisers to bring about a currency reform and stabilized exchange rates with the gold countries (Parrini and Sklar 1983, pp. 573–77; Rosenberg 1985, p. 184).

These requests gave President Roosevelt, upon securing Congressional approval, the excuse to appoint in March 1903 a three-man Commission on International Exchange to bring about currency reform in Mexico, China, and the rest of the silver-using world. The aim was "to bring about a fixed relationship between the moneys of the gold-standard countries and the present silver-using countries," in order to foster "export trade and investment opportunities" in the gold countries and economic development in the silver countries.

The three members of the CIE were old friends and like-minded colleagues. The chairman was Hugh H. Hanna, of the Indianapolis Monetary Commission, the others were his former chief aide at that Commission, Charles A. Conant, and Professor Jeremiah W. Jenks. Conant, as usual, was the major theoretician and finagler. He realized that major opposition to Mexico and China's shift to a gold standard would come from the important Mexican-silver industry, and he devised a scheme to get European countries to purchase large amounts of Mexican silver to ease the pain of the shift.

In a trip to European nations in the summer of 1903, however, Conant and the CIE found the Europeans less than enthusiastic about making Mexican silver purchases as well as subsidizing US exports and investments in China, a land whose market they too were coveting. In the United States, on the other hand, major newspapers and financial periodicals, prodded by Conant's public relations work, warmly endorsed the new currency scheme.

In the meantime, however, the United States faced similar currency problems in its two new Caribbean protectorates, Cuba and Panama. Panama was easy. The United States occupied the Canal Zone, and would be importing vast amounts of equipment to build the canal, and so it decided to impose the American gold dollar as the currency in the nominally independent Republic of Panama.

While the gold dollar was the official currency of Panama, the United States imposed as the actual medium of exchange a new debased silver peso worth 50 cents. Fortunately, the new peso was almost the same in value as the old Colombian silver coin it forcibly displaced, and so, like Puerto Rico, the takeover could go without a hitch.

Among the US colonies or protectorates, Cuba proved the toughest nut to crack. Despite all of Conant's ministrations, Cuba's currency remained unreformed. Spanish gold and silver coins, French coins, and US currency all circulated side by side, freely fluctuating in response to supply and demand. Furthermore, similar to the prereformed Philippines, a fixed bimetallic exchange rate between the cheaper US, and the more valuable Spanish and French, coins led the Cubans to return cheaper US coins to the US customs authorities in fees and revenues.

Why then did Conant fail in Cuba? In the first place, strong Cuban nationalism resented US plans for seizing control of their currency. Conant's repeated request in 1903 for a Cuban invitation for the CIE to visit the island met stern rejections from the Cuban government. Moreover, the charismatic US military commander in Cuba, Leonard Wood, wanted to avoid giving the Cubans the impression that plans were afoot to reduce Cuba to colonial status.

The second objection was economic. The powerful sugar industry in Cuba depended on exports to the United States, and a shift from depreciated silver to higher-valued gold money would increase the cost of sugar exports, by an amount Leonard Wood estimated to be about 20 percent.

While the same problem had existed for the sugar planters in Puerto Rico, American economic interests, in Puerto Rico and in other countries such as the Philippines favored forcing formerly silver countries onto a gold-based standard so as to stimulate US exports into those countries. In Cuba, on the other hand, there was increasing US investment capital pouring into the Cuban sugar plantations, so that powerful and even dominant US economic interests existed on the other side of the currency reform question. Indeed, by World War I, American investments in Cuban sugar reached the sum of $95 million.

Thus, when Charles Conant resumed his pressure for a Cuban gold-exchange standard in 1907, he was strongly opposed by the US Governor of Cuba, Charles Magoon, who raised the problem of a gold-based standard crippling the sugar planters. The CIE never managed to visit Cuba, and ironically, Charles Conant died in Cuba, in 1915, trying in vain to convince the Cubans of the virtues of the gold-exchange standard (Rosenberg 1985, pp. 186–88).

The Mexican shift from silver to gold was more gratifying to Conant, but here the reform was effected by Foreign Minister Limantour and his indigenous technicians, with the CIE taking a back seat. However, the success of this shift, in the Mexican Currency Reform Act of 1905, was assured by a world rise in the price of silver, starting the following year, which made gold coins cheaper than silver, with Gresham's law bringing about a successful gold coin currency in Mexico.

But the US silver coinage in the Philippines ran into trouble because of the rise in the world silver price. Here, the US silver currency in the Philippines was bailed out by coordinated action by the Mexican government, which sold silver in the Philippines to lower the value of silver sufficiently so that the Conants could be brought back into circulation.It is certainly possible that one of the reasons for the outbreak of the nationalist Mexican Revolution of 1910, in part a revolution against US influence, was a reaction against the US-led currency manipulation and the coerced shift from silver to gold. Certainly, research needs to be done into this possibility.

But the big failure of Conant/CIE monetary imperialism was in China. In 1900, Britain, Japan, and the United States intervened in China to put down the Boxer Rebellion. The three countries thereupon forced defeated China to agree to pay them and all major European powers an indemnity of $333 million.

The United States interpreted the treaty as an obligation to pay in gold, but China, on a depreciated silver standard, began to pay in silver in 1903, an action that enraged the three treaty powers. The US minister to China reported that Britain might declare China's payment in silver a violation of the treaty, which would presage military intervention.

Emboldened by the United States' success in the Philippines, Panama, and Mexico, Secretary of War Root sent Jeremiah W. Jenks on a mission to China in early 1904 to try to transform China from a silver- to a gold-exchange standard. Jenks also wrote to President Roosevelt from China urging that the Chinese indemnity to the United States from the Boxer Rebellion be used to fund exchange professorships for 30 years.

Jenks's mission, however, was a total failure. The Chinese understood the CIE currency scheme all too well. They saw and denounced the seigniorage of the gold-exchange standard as an irresponsible and immoral debasement of Chinese currency, an act that would impoverish China while adding to the profits of US banks where seigniorage reserve funds would be deposited.

Moreover, the Chinese officials saw that shifting the indemnity from silver to gold would enrich the European governments at the expense of the Chinese economy. They also noted that the CIE scheme would establish a foreign controller of the Chinese currency to impose banking regulations and economic reforms on the Chinese economy. We need not wonder at the Chinese outrage. China's reaction was its own nationalistic currency reform in 1905 to replace the Mexican silver coin with a new Chinese silver coin, the tael (Rosenberg 1985, pp. 189–92).

Jenks's ignominious failure in China put an end to any formal role for the Commission on International Exchange.The failure, however, did not diminish the US government's demand for Jenks's services. He went on to advise the Mexican government, serve as a member of the Nicaraguan High Commission under President Wilson's occupation regime, and also headed the Far Eastern Bureau of the State Department (Silva and Slaughter 1989, pp. 136–37).  An immediately following fiasco blocked the US government's use of economic and financial advisers to spread the gold-exchange standard abroad. In 1905, the State Department hired Jacob Hollander to move another of its Latin American client states, the Dominican Republic, onto the gold-exchange standard.

When Hollander accomplished this task by the end of the year, the State Department asked the Dominican government to hire Hollander to work out a plan for financial reform, including a US loan, and a customs service run by the United States to collect taxes for repayment of the loan. Hollander, son-in-law of prominent Baltimore merchant Abraham Hutzler, used his connection with Kuhn, Loeb and Company to place Dominican bonds with that investment bank.

Hollander also engaged happily in double dipping for the same work, collecting fees for the same job from the State Department and from the Dominican government. When this peccadillo was discovered in 1911, the scandal made it impossible for the US government to use its own employees and its own funds to push for gold-exchange experts abroad. From then on, there was more of a public-private partnership between the US government and the investment bankers, with the bankers supplying their own funds, and the State Department supplying good will and more concrete resources.

Thus, in 1911–1912, the United States, over great opposition, imposed a gold-exchange standard on Nicaragua. The State Department formally stepped aside, but approved Charles Conant's hiring by the powerful investment-banking firm of Brown Brothers to bring about a loan and the currency reform. The State Department lent not only its approval to the project, but also its official wires, for Conant and Brown Brothers to conduct the negotiations with the Nicaraguan government.

By the time he died in Cuba in 1915, Charles Conant had made himself the chief theoretician and practitioner of the gold-exchange and the economic-imperialist movements. Aside from his successes in the Philippines, Panama, and Mexico, and his failures in Cuba and China, Conant led in pushing for gold-exchange reform and gold-dollar imperialism in Liberia, Bolivia, Guatemala, and Honduras. His magnum opus in favor of the gold-exchange standard, the two-volume The Principles of Money and Banking (1905), as well as his pathbreaking success in the Philippines, were followed by a myriad of books, articles, pamphlets, and editorials, always backed up by his personal propaganda efforts.

Particularly interesting were Conant's arguments in favor of a gold-exchange, rather than a genuine gold-coin, standard. A straight gold-coin standard, Conant believed, did not provide a sufficient amount of gold to provide for the world's monetary needs.

Hence, by tying the existing silver standards in the undeveloped countries to gold, the "shortage" of gold could be overcome, and also the economies of the undeveloped countries could be integrated into those of the dominant imperial power. All this could only be done if the gold-exchange standard were "designed and implemented by careful government policy," but of course Conant himself and his friends and disciples always stood ready to advise and provide such implementation (Rosenberg 1985, p. 197).

In addition, adopting a government-managed gold-exchange standard was superior to either genuine gold or bimetallism because it left each state the flexibility of adapting its currency to local needs. As Conant asserted,

It leaves each state free to choose the means of exchange which conform best to its local conditions. Rich nations are free to choose gold, nations less rich silver, and those whose financial methods are most advanced are free to choose paper.

It is interesting that for Conant, paper was the most "advanced" form of money. It is clear that the devotion to the gold standard of Conant and of his colleagues was only to a debased and inflationary standard controlled and manipulated by the US government, with gold really serving as a facade of allegedly hard money.

And one of the critical forms of government manipulation and control in Conant's proposed system was the existence and active functioning of a central bank. As a founder of the "science" of financial advising to governments, Conant, followed by his colleagues and disciples, not only pushed a gold-exchange standard wherever he could do so, but also a central bank to manage and control that standard. As Emily Rosenberg points out,

Conant thus did not neglect … one of the major revolutionary changes implicit in his system: a new, important role for a central bank as a currency stabilizer. Conant strongly supported the American banking reform that culminated in the Federal Reserve System … and American financial advisers who followed Conant would spread central banking systems, along with gold-standard currency reforms, to the countries they advised. (Rosenberg 1985, p. 198)

Along with a managed gold-exchange standard would come, as replacement for the old free-trade, unmanaged, gold-coin standard, a world of imperial currency blocs, which "would necessarily come into being as lesser countries deposited their gold stabilization funds in the banking systems of more advanced countries" (ibid.). New York and London banks, in particular, shaped up as the major reserve fundholders in the developing new world monetary order.

It is no accident that the United States' major financial and imperial rival, Great Britain, which was pioneering in imposing gold-exchange standards in its own colonial area at this time, built upon this experience to impose a gold-exchange standard, marked by all European currencies pyramiding on top of British inflation, during the 1920s. That disastrous inflationary experiment led straight to the worldwide banking crash and the general shift to fiat paper moneys in the early 1930s. After World War II, the United States took up the torch of a world gold-exchange standard at Bretton Woods, with the dollar replacing the pound sterling in a worldwide inflationary system that lasted approximately 25 years.

Nor should it be thought that Charles A. Conant was the purely disinterested scientist he claimed to be. His currency reforms directly benefitted his investment banker employers. Thus, Conant was treasurer, from 1902 to 1906, of the Morgan-run Morton Trust Company of New York, and it was surely no coincidence that Morton Trust was the bank that held the reserve funds for the governments of the Philippines, Panama, and the Dominican Republic, after their respective currency reforms. In the Nicaragua negotiations, Conant was employed by the investment bank of Brown Brothers, and in pressuring other countries he was working for Speyer and Company and other investment bankers.

After Conant died in 1915, there were few to pick up the mantle of foreign financial advising. Hollander was in disgrace after the Dominican debacle. Jenks was aging, and lived in the shadow of his China failure, but the State Department did appoint Jenks to serve as a director of the Nicaraguan National Bank in 1917, and also hired him to study the Nicaraguan financial picture in 1925.

But the true successor of Conant was Edwin W. Kemmerer, the "money doctor." After his Philippine experience, Kemmerer joined his old Professor Jenks at Cornell, and then moved to Princeton in 1912, publishing his book Modern Currency Reforms in 1916. As the leading foreign financial adviser of the 1920s, Kemmerer not only imposed central banks and a gold-exchange standard on Third World countries, but also got them to levy higher taxes.

Kemmerer, too, combined his public employment with service to leading international bankers. During the 1920s, Kemmerer worked as a banking expert for the US government's Dawes Commission, headed special financial advisory missions to over a dozen countries, and was kept on a handsome retainer by the distinguished investment banking firm of Dillon and Read from 1922 to 1929. In that era, Kemmerer and his mentor Jenks were the only foreign-currency-reform experts available for advising. In the late 1920s, Kemmerer helped establish a chair of international economics at Princeton, which he occupied, and from which he could train students like Arthur N. Young and William W. Cumberland. In the mid-1920s, the money doctor served as president of the American Economic Association.For an excellent study of the Kemmerer missions in the 1920s see Seidel (1972, pp. 520–45).

The defeat of the Fowler Bill for broader asset currency and branch banking in 1902, coupled with the failure of Secretary of Treasury Shaw's attempts of 1903–1905 to use the Treasury as a central bank, led the big bankers and their economist allies to adopt a new solution: the frank imposition of a central bank in the United States.

The campaign for a central bank was kicked off by a fateful speech in January 1906 by the powerful Jacob H. Schiff, head of the Wall Street investment bank of Kuhn, Loeb and Co., before the New York Chamber of Commerce. Schiff complained that, in the autumn of 1905, when "the country needed money," the Treasury, instead of working to expand the money supply, reduced government deposits in the national banks, thereby precipitating a financial crisis, a "disgrace" in which the New York clearinghouse banks had been forced to contract their loans drastically, sending interest rates sky-high. An "elastic currency" for the nation was therefore imperative, and Schiff urged the New York Chamber's committee on finance to draw up a comprehensive plan for a modern banking system to provide for an elastic currency (Bankers Magazine 1906, pp. 114–15).

A colleague who had already been agitating behind the scenes for a central bank was Schiff's partner, Paul Moritz Warburg, who had suggested the plan to Schiff as early as 1903. Warburg had emigrated from the German investment firm of M. M. Warburg and Company in 1897, and before long his major function at Kuhn, Loeb was to agitate to bring the blessings of European central banking to the United States.Schiff and Warburg were related by marriage. Schiff, from a prominent German banking family, was a son-in-law of Solomon Loeb, cofounder of Kuhn, Loeb; and Warburg, husband of Nina Loeb, was another son-in-law of Solomon Loeb's by a second wife. The incestuous circle was completed when Schiff's daughter Frieda married Paul Warburg's brother Felix, another partner of Schiff and Paul Warburg's. See Birmingham (1977, pp. 21, 209–10, 383, appendix) and Attali (1986, p. 53).

It took less than a month for the finance committee of the New York Chamber to issue its report, but the bank reformers were furious, denouncing it as remarkably ignorant. When Frank A. Vanderlip, of Rockefeller's flagship bank, the National City Bank of New York, reported on this development, his boss, James Stillman, suggested that a new five-man special commission be set up by the New York Chamber to come back with a plan for currency reform.

In response, Vanderlip proposed that the five-man commission consist of himself; Schiff; J. P. Morgan; George Baker of the First National Bank of New York, Morgan's closest and longest associate; and former Secretary of the Treasury Lyman Gage, now president of the Rockefeller-controlled US Trust Company. Thus, the commission would consist of two Rockefeller men (Vanderlip and Gage), two Morgan men (Morgan and Baker), and one representative from Kuhn, Loeb.

Only Vanderlip was available to serve, however, so the commission had to be redrawn. In addition to Vanderlip, beginning in March 1906, there sat, instead of Schiff, his close friend Isidore Straus, a director of R. H. Macy and Company. Instead of Morgan and Baker there now served two Morgan men: Dumont Clarke, president of the American Exchange National Bank and a personal adviser to J. P. Morgan and Charles A. Conant, treasurer of Morton and Company. The fifth man was a veteran of the Indianapolis Monetary Convention, John Claflin, of H. B. Claflin and Company, a large integrated wholesaling concern. Coming on board as secretary of the new currency committee was Vanderlip's old friend Joseph French Johnson, now of New York University, who had been calling for a central bank since 1900.

The commission used the old Indianapolis questionnaire technique: acquiring legitimacy by sending out a detailed questionnaire on currency to a number of financial leaders. With Johnson in charge of mailing and collating the questionnaire replies, Conant spent his time visiting and interviewing the heads of the central banks in Europe.

The special commission delivered its report to the New York Chamber in October, 1906. To eliminate instability and the danger of an inelastic currency, the commission called for the creation of a "central bank of issue under the control of the government." In keeping with other bank reformers, such as Professor Abram Piatt Andrew of Harvard University, Thomas Nixon Carver of Harvard, and Albert Strauss, partner of J. P. Morgan and Company, the commission was scornful of Secretary Shaw's attempt to use the Treasury as a central bank. Shaw was particularly obnoxious because he was still insisting, in his last annual report of 1906, that the Treasury, under his aegis, had constituted a "great central bank."

The commission, along with the other reformers, denounced the Treasury for overinflating by keeping interest rates excessively low; a central bank, in contrast, would have much larger capital and undisputed control over the money market, and thus would be able to manipulate the discount rate effectively to keep the economy under proper control. The important point, declared the committee, is that there be "centralization of financial responsibility." In the meantime, short of establishing a central bank, the committee urged that, at the least, the national bank's powers to issue notes be expanded to include being based on general assets as well as government bonds (Livingston 1986, pp. 159–64).

After drafting and publishing this "Currency Report," the reformers used the report as the lever for expanding the agitation for a central bank and broader note-issue powers to other corporate and financial institutions. The next step was the powerful American Bankers Association (ABA). In 1905, the executive council of the ABA had appointed a currency committee which, the following year, recommended an emergency-assets currency that would be issued by a federal commission, resembling an embryonic central bank.

In a tumultuous plenary session of the ABA convention in October, 1906, the ABA rejected this plan, but agreed to appoint a 15-man currency commission that was instructed to meet with the New York Chamber currency committee and attempt to agree on appropriate legislation.

Particularly prominent on the ABA currency commission were,

Arthur Reynolds, president of the Des Moines National Bank, close to the Morgan-oriented Des Moines Regency, and brother of the prominent Chicago banker, George M. Reynolds, formerly of Des Moines and then president of the Morgan-oriented Continental National Bank of Chicago and the powerful chairman of the executive council of the ABA.

James B. Forgan, president of the Rockefeller-run First National Bank of Chicago, and close friend of Jacob Schiff of Kuhn, Loeb, as well as of Vanderlip.

Joseph T. Talbert, vice president of the Rockefeller-dominated Commercial National Bank of Chicago, and soon to become vice president of Rockefeller's flagship bank, the National City Bank of New York.

Myron T. Herrick, one of the most prominent Rockefeller politicians and businessmen in the country. Herrick was the head of the Cleveland Society of Savings, and was one of the small team of close Rockefeller business allies who, along with Mark Hanna, bailed out Governor William McKinley from bankruptcy in 1893. Herrick was a previous president of the ABA, had just finished a two-year stint as Governor of Ohio, and was later to become Ambassador to France under his old friend and political ally William Howard Taft as well as later under President Warren G. Harding, also a recipient of Herrick's political support and financial largesse.

Chairman of the ABA commission was A. Barton Hepburn, president of one of the leading Morgan commercial banks, the Chase National Bank of New York, and author of the well-regarded History of Coinage and Currency in the United States.

After meeting with Vanderlip and Conant as the representatives from the New York Chamber committee, the ABA commission, along with Vanderlip and Conant, agreed on at least the transition demands of the reformers. The ABA commission presented proposals to the public, the press, and the Congress in December 1906, for a broader-asset currency as well as provisions for emergency issue of banknotes by national banks.

But just as sentiment for a broader-assets currency became prominent, the bank reformers began to worry about an uncontrolled adoption of such a currency. For that would mean that national-bank credit and notes would expand, and that, in the existing system, small state banks would be able to pyramid and inflate credit on top of the national credit, using the expanded national bank notes as their reserves.

The reformers wanted a credit inflation controlled by and confined to the large national banks; they most emphatically did not want uncontrolled state-bank inflation that would siphon resources to small entrepreneurs and "speculative" marginal producers. The problem was aggravated by the accelerated rate of increase in the number of small southern and western state banks after 1900.

Another grave problem for the reformers was that commercial paper was a different system from that of Europe. In Europe, commercial paper, and hence bank assets, were two-name notes endorsed by a small group of wealthy acceptance banks. In contrast to this acceptance paper system, commercial paper in the United States was unendorsed single-name paper, with the bank taking a chance on the creditworthiness of the business borrower. Hence, a decentralized financial system in the United States was not subject to big-banker control.

Worries about the existing system and hence about uncontrolled asset currency were voiced by the top bank reformers. Thus, Vanderlip expressed concern that "there are so many state banks that might count these [national-bank] notes in their reserves." Schiff warned that "it will prove unwise, if not dangerous, to clothe six thousand banks or more with the privilege to issue independently a purely credit currency." And, from the Morgan side, a similar concern was voiced by Victor Morawetz, the powerful chairman of the board of the Atchison, Topeka and Santa Fe Railroad (Livingston 1986, pp. 168–69).

Taking the lead in approaching this problem of small banks and decentralization was Paul Moritz Warburg, of Kuhn, Loeb, fresh from his banking experience in Europe. In January 1907, Warburg began years of tireless agitation for central banking with two articles, "Defects and Needs of our Banking System," and "A Plan for a Modified Central Bank."See the collection of Warburg's essays in Paul M. Warburg (1930; 1914, pp. 387–612). 

Calling openly for a central bank, Warburg pointed out that one of the important functions of such a bank would be to restrict the eligibility of bank assets to be used for expansion of bank deposits. Presumably, too, the central bank could move to require banks to use acceptance paper or otherwise try to create an acceptance market in the United States.When the Federal Reserve System was established, Warburg boasted of his crucial role in persuading the Fed to create an acceptance market in the United States by agreeing to purchase all acceptance paper available from a few large acceptance banks at subsidized rates. In that way, the Fed provided an unchecked channel for inflationary credit expansion. The acceptance program helped pave the way for the 1929 crash. 

By the summer of 1907, the Bankers Magazine was reporting a decline in influential banker support for broadening asset currency and a strong move toward the "central bank project." Bankers Magazine (1907, pp. 314–15) noted as a crucial reason the fact that asset currency would be expanding bank services to "small producers and dealers."

It was surely no accident that Warburg himself was the principal beneficiary of this policy. Warburg became Chairman of the Board, from its founding in 1920, of the International Acceptance Bank, the world's largest acceptance bank, as well as director of the Westinghouse Acceptance Bank and of several other acceptance houses. In 1919, Warburg was the chief founder and chairman of the executive committee of the American Acceptance Council, the trade association of acceptance houses. (See Rothbard 1983, pp. 119–23).

A severe financial crisis, the Panic of 1907, struck in early October. Not only was there a general recession and contraction, but the major banks in New York and Chicago were, as in most other depressions in American history, allowed by the government to suspend specie payments; that is, to continue in operation while being relieved of their contractual obligation to redeem their notes and deposits in cash or in gold.

While the Treasury had stimulated inflation during 1905–1907, there was nothing it could do to prevent suspensions of payment, or to alleviate "the competitive hoarding of currency" after the panic; that is, the attempt to demand cash in return for increasingly shaky bank notes and deposits.

Very quickly after the panic, banker and business opinion consolidated on behalf of a central bank, an institution that could regulate the economy and serve as a lender of last resort to bail banks out of trouble. The reformers now faced a two-fold task: hammering out details of a new central bank, and more importantly, mobilizing public opinion on its behalf.

The first step in such mobilization was to win the support of the nation's academics and experts. The task was made easier by the growing alliance and symbiosis between academia and the power elite. Two organizations that proved particularly useful for this mobilization were the American Academy of Political and Social Science (AAPSS) of Philadelphia, and the Academy of Political Science (APS) of Columbia University, both of which included in their ranks leading corporate-liberal businessmen, financiers, attorneys, and academics.

Nicholas Murray Butler, the highly influential president of Columbia University, explained that the Academy of Political Science "is an intermediary between … the scholars and the men of affairs, those who may perhaps be said to be amateurs in scholarship." Here, he pointed out, is where they "come together" (Livingston 1986, p. 175, n. 30).

It is not surprising, then, that the American Academy of Political and Social Science, the American Association for the Advancement of Science (AAAS), and Columbia University held three symposia during the winter of 1907–1908, each calling for a central bank, and thereby disseminating the message of a central bank to a carefully selected elite public. Not surprisingly, too, E. R. A. Seligman was the organizer of the Columbia conference, gratified that his university was providing a platform for leading bankers and financial journalists to advocate a central bank, especially, he added, because "it is proverbially difficult in a democracy to secure a hearing for the conclusions of experts." Then in 1908 Seligman collected the addresses into a volume, The Currency Problem.

Professor Seligman set the tone for the gathering in his opening address. The Panic of 1907, he alleged, was moderate because its effects had been tempered by the growth of industrial trusts, which provided a more controlled and "more correct adjustment of present investment to future needs" than would a "horde of small competitors." In that way, Seligman displayed no comprehension of how competitive markets facilitate adjustments.

One big problem, however, still remained for Seligman. The horde of small competitors, for whom Seligman had so much contempt, still prevailed in the field of currency and banking. The problem was that the banking system was still decentralized. As Seligman declared, "Even more important than the inelasticity of our note issue is its decentralization. The struggle which has been victoriously fought out everywhere else [in creating trusts] must be undertaken here in earnest and with vigor" (Livingston 1986, p. 177).

The next address was that of Frank Vanderlip. To Vanderlip, in contrast to Seligman, the Panic of 1907 was "one of the great calamities of history" — the result of a decentralized, competitive American banking system, with 15,000 banks all competing vigorously for control of cash reserves. The terrible thing is that "each institution stands alone, concerned first with its own safety, and using every endeavor to pile up reserves without regard" to the effect of such actions on other banking institutions.

This backward system must be changed, to follow the lead of other great nations, where a central bank is able to mobilize and centralize reserves, and create an elastic currency system. Putting the situation in virtually Marxian terms, Vanderlip declared that the alien, external power of the free and competitive market must be replaced by central control following modern, allegedly scientific principles of banking.

Thomas Wheelock, editor of the Wall Street Journal, then rung the changes on the common theme by applying it to the volatile call-loan market in New York. The market is volatile, Wheelock claimed, because the small country banks are able to lend on that market, and their deposits in New York banks then rise and fall in uncontrolled fashion. Therefore, there must be central, corporate control over country-bank money in the call-loan market.

A. Barton Hepburn, head of Morgan's Chase National Bank, came next, and spoke of the great importance of having a central bank that would issue a monopoly of bank notes. It was particularly important that the central bank be able to discount the assets of national banks, and thus supply an elastic currency.

The last speaker was Paul Warburg, who lectured his audience on the superiority of European over American banking, particularly in (1) having a central bank, as against decentralized American banking; and (2) — his old hobby horse — enjoying "modern" acceptance paper instead of single-name promissory notes. Warburg emphasized that these two institutions must function together. In particular, tight government central-bank control must replace competition and decentralization: "Small banks constitute a danger."

The other two symposia were very similar. At the AAPSS symposium in Philadelphia, in December 1907, several leading investment bankers and Comptroller of the Currency William B. Ridgely came out in favor of a central bank. It was no accident that members of the AAPSS's advisory committee on currency included A. Barton Hepburn; Morgan attorney and statesman Elihu Root; Morgan's long-time personal attorney Francis Lynde Stetson; and J. P. Morgan himself.

Meanwhile, the AAAS symposium in January 1908 was organized by none other than Charles A. Conant, who happened to be chairman of the AAAS's social and economic section for the year. Speakers included Columbia economist J. B. Clark, Frank Vanderlip, Conant, and Vanderlip's friend George E. Roberts, head of the Rockefeller-oriented Commercial National Bank of Chicago, who would later wind up at the National City Bank.

All in all, the task of the bank reformers was well summed up by J. R. Duffield, secretary of the Bankers Publishing Company, in January 1908: "It is recognized generally that before legislation can be had there must be an educational campaign carried on, first among the bankers, and later among commercial organizations, and finally among the people as a whole." That strategy was well under way.

During the same month, the legislative lead in banking reform was taken by the formidable Senator Nelson W. Aldrich, (Republican, Rhode Island), head of the Senate Finance Committee, and, as the father-in-law of John D. Rockefeller, Jr., Rockefeller's man in the US Senate. He introduced the Aldrich Bill, which focused on a relatively minor interbank dispute about whether and on what basis the national banks could issue special emergency currency. A compromise was finally hammered out and passed, as the Aldrich-Vreeland Act, in 1908.The emergency currency provision was only used once, shortly before the provision expired, in 1914, after the establishment of the Federal Reserve System.

But the important part of the Aldrich-Vreeland Act, which got very little public attention, but was perceptively hailed by the bank reformers, was the establishment of a National Monetary Commission that would investigate the currency question and suggest proposals for comprehensive banking reform. Two enthusiastic comments on the Monetary Commission were particularly perceptive and prophetic.

One was that of Sereno S. Pratt of the Wall Street Journal. Pratt virtually conceded that the purpose of the commission was to swamp the public with supposed expertise and thereby "educate" them into supporting banking reform:

Reform can only be brought about by educating the people up to it, and such education must necessarily take much time. In no other way can such education be effected more thoroughly and rapidly than by means of a commission … [that] would make an international study of the subject and present an exhaustive report, which could be made the basis for an intelligent agitation.

The results of the "study" were of course predetermined, as would be the membership of the allegedly impartial study commission.

Another function of the commission, as stated by Festus J. Wade, St. Louis banker and member of the currency commission of the American Bankers Association, was to "keep the financial issue out of politics" and put it squarely in the safe custody of carefully selected "experts" (Livingston 1986, pp. 182–83). Thus the National Monetary Commission was the apotheosis of the clever commission concept, launched in Indianapolis a decade earlier.

Aldrich lost no time setting up the National Monetary Commission (NMC), which was launched in June 1908. The official members were an equal number of Senators and Representatives, but these were mere window dressing. The real work would be done by the copious staff, appointed and directed by Aldrich, who told his counterpart in the House, Cleveland Republican Theodore Burton, "My idea is, of course, that everything shall be done in the most quiet manner possible, and without any public announcement." From the beginning, Aldrich determined that the NMC would be run as an alliance of Rockefeller, Morgan, and Kuhn, Loeb people. The two top expert posts advising or joining the commission were both suggested by Morgan leaders.

On the advice of J. P. Morgan, seconded by Jacob Schiff, Aldrich picked as his top adviser the formidable Henry P. Davison, Morgan partner, founder of Morgan's Bankers' Trust Company, and vice president of George F. Baker's First National Bank of New York. It would be Davison who, on the outbreak of World War I, would rush to England to cement J. P. Morgan and Company's close ties with the Bank of England, and to receive an appointment as monopoly underwriter for all British and French government bonds to be floated in the United States for the duration of the war.

For technical economic expertise, Aldrich accepted the recommendation of President Roosevelt's close friend and fellow Morgan man, Charles Eliot, president of Harvard University, who urged the appointment of Harvard economist A. Piatt Andrew. And an ex officio commission member chosen by Aldrich himself was George M. Reynolds, president of the Rockefeller-oriented Continental National Bank of Chicago.

The NMC spent the fall touring Europe and conferring on information and strategy with heads of large European banks and central banks. As director of research, A. Piatt Andrew began to organize American banking experts and to commission reports and studies. The National City Bank's foreign exchange department was commissioned to write papers on bankers' acceptances and foreign debt, while Warburg and Bankers' Trust official Fred Kent wrote on the European discount market.

Having gathered information and advice in Europe in the fall of 1908, the NMC was ready to go into high gear by the end of the year. In December, the commission hired the inevitable Charles A. Conant for research, public relations, and agitprop. Behind the facade of the Congressmen and Senators on the commission, Senator Aldrich began to form and expand his inner circle, which soon included Warburg and Vanderlip.

Warburg formed around him a subcircle of friends and acquaintances from the currency committee of the New York Merchants' Association, headed by Irving T. Bush, and from the top ranks of the American Economic Association, to whom he had delivered an address advocating central banking in December 1908.

Warburg met and corresponded frequently with leading academic economists advocating banking reform, including E. R. A. Seligman; Thomas Nixon Carver of Harvard; Henry R. Seager of Columbia; Davis R. Dewey, historian of banking at MIT, long-time secretary-treasurer of the AEA and brother of the progressive philosopher John Dewey; Oliver M. W. Sprague, professor of banking at Harvard, of the Morgan-connected Sprague family; Frank W. Taussig of Harvard; and Irving Fisher of Yale.

During 1909, however, the reformers faced an important problem: they had to bring such leading bankers as James B. Forgan, head of the Rockefeller-oriented First National Bank of Chicago, solidly into line in support of a central bank. It was not that Forgan objected to centralized reserves or a lender of last resort — quite the contrary. It was rather that Forgan recognized that, under the National Banking System, large banks such as his own were already performing quasi-central-banking functions with their own country-bank depositors; and he didn't want his bank deprived of such functions by a new central bank.

The bank reformers therefore went out of their way to bring such men as Forgan into enthusiastic support for the new scheme. In his presidential address to the powerful American Bankers Association in mid-September, 1909, George M. Reynolds not only came out flatly in favor of a central bank in America, to be modeled after the German Reichsbank; he also assured Forgan and others that such a central bank would act as depository of reserves only for the large national banks in the central reserve cities, while the national banks would continue to hold deposits for the country banks.

Mollified, Forgan held a private conference with Aldrich's inner circle and came fully on board for the central bank. As an outgrowth of Forgan's concerns, the reformers decided to cloak their new central bank in a spurious veil of "regionalism" and "decentralism" through establishing regional reserve centers, which would provide the appearance of virtually independent regional central banks to cover the reality of an orthodox, European, central-bank monolith.

As a result, noted railroad attorney Victor Morawetz made his famous speech in November 1909, calling for regional banking districts under the ultimate direction of one central control board. Thus, reserves and note issue would be supposedly decentralized in the hands of the regional reserve banks, while they would really be centralized and coordinated by the central control board. This, of course, was the scheme eventually adopted in the Federal Reserve System.[24] Victor Morawetz was an eminent attorney in the Morgan ambit, who served as chairman of the executive committee of the Morgan-run Atchison, Topeka, and Santa Fe Railway, and member of the board of the Morgan-dominated National Bank of Commerce. In 1908, Morawetz, along with J. P. Morgan's personal attorney, Francis Lynde Stetson, had been the principal drafters of an unsuccessful Morgan-National Civic Federation bill for a federal incorporation law to regulate and cartelize American corporations. Later, Morawetz was to be a top consultant to another "progressive" reform of Woodrow Wilson's, the Federal Trade Commission. On Morawetz, see Rothbard (1984, p. 99).

On September 14, at the same time as Reynolds's address to the nation's bankers, another significant address took place. President William Howard Taft, speaking in Boston, suggested that the country seriously consider establishing a central bank. Taft had been close to the reformers — especially his Rockefeller-oriented friends Aldrich and Burton — since 1900. But the business press understood the great significance of this public address: that it was, as the Wall Street Journal put it, a crucial step, "towards removing the subject from the realm of theory to that of practical politics" (quoted in Livingston 1986, p. 191).

One week later, a fateful event in American history occurred. The banking reformers moved to escalate their agitation by creating a virtual government-bank-press complex to drive through a central bank. On September 22, 1909, the Wall Street Journal took the lead in this development by beginning a notable, front-page, 14-part series on "A Central Bank of Issue." These were unsigned editorials by the Journal, but they were actually written by the ubiquitous Charles A. Conant, from his vantage point as salaried chief propagandist of the US government's National Monetary Commission.

The series was a summary of the reformers' position, also going out of the way to assure the Forgans of this world that the new central bank "would probably deal directly only with the larger national banks, leaving it for the latter to rediscount for their more remote correspondents" (ibid.).

To the standard arguments for the central bank: "elasticity" of the money supply, protecting bank reserves by manipulating the discount rate and the international flow of gold, and combating crises by bailing out individual banks, Conant added a Conant twist: the importance of regulating interest rates and the flow of capital in a world marked by surplus capital. Government debt would, for Conant, provide the important function of sopping up surplus capital; that is, providing profitable outlets for savings by financing government expenditures.

The Wall Street Journal series inaugurated a shrewd and successful campaign by Conant to manipulate the nation's press and get it behind the idea of a central bank. Building on his experience in 1898, Conant, along with Aldrich's secretary, Arthur B. Shelton, prepared abstracts of commission materials for the newspapers during February and March of 1910. Soon Shelton recruited J. P. Gavitt, head of the Washington bureau of the Associated Press, to scan commission abstracts, articles, and forthcoming books for "newsy paragraphs" to catch the eye of newspaper editors.

The academic organizations proved particularly helpful to the NMC, lending their cloak of disinterested expertise to the endeavor. In February, Robert E. Ely, the secretary of the APS, proposed to Aldrich that a special volume of its Proceedings be devoted to banking and currency reform, to be published in cooperation with the NMC, in order to "popularize in the best sense, some of the valuable work of [the] Commission" (quoted in Livingston 1986, p. 194).

And yet, Ely had the gall to add that, even though the APS would advertise the NMC's arguments and conclusions, it would retain its "objectivity" by avoiding its own specific policy recommendations. As Ely put it, "We shall not advocate a central bank, but we shall only give the best results of your work in condensed form and untechnical language."

The AAPSS, too, weighed in with its own special volume, Banking Problems (1910), featuring an introduction by A. Piatt Andrew of Harvard and the NMC, and articles by veteran bank reformers such as Joseph French Johnson, Horace White, and Morgan Bankers' Trust official Fred I. Kent. But most of the articles were from leaders of Rockefeller's National City Bank of New York, including George E. Roberts, former Chicago banker and US Mint official about to join National City.

Meanwhile, Paul M. Warburg capped his lengthy campaign for a central bank in a famous speech to the New York YMCA on March 23, on "A United Reserve Bank for the United States." Warburg basically outlined the structure of his beloved German Reichsbank, but he was careful to begin his talk by noting a recent poll in the Banking Law Journal that 60 percent of the nation's bankers favored a central bank provided it was "not controlled by 'Wall Street' or any monopolistic interest."

To calm this fear, Warburg insisted that, semantically, the new Reserve Bank not be called a central bank, and that the Reserve Bank's governing board be chosen by government officials, merchants, and bankers — with bankers, of course, dominating the choices. He also provided a distinctive Warburg-twist by insisting that the Reserve Bank replace the hated single-name paper system of commercial credit dominant in the United States, by the European system whereby a reserve bank provided a guaranteed and subsidized market for two-named commercial paper endorsed by acceptance banks. In this way, the United Reserve Bank would correct the "complete lack of modern bills of exchange [i.e., acceptances]" in the United States.

Warburg added that the entire idea of a free and self-regulating market was obsolete, particularly in the money market. Instead, the action of the market must be replaced by "the best judgment of the best experts." And guess who was slated to be one of the best of those best experts?

The greatest cheerleader for the Warburg plan, and the man who introduced Warburg's volume on banking reform (1911) was his kinsman and member of the Seligman investment-banking family, Columbia economist E. R. A. Seligman (Rothbard 1984, pp. 98–99; Livingston 1986, pp. 194–98).

So delighted was the Merchants' Association of New York with Warburg's speech that it distributed 30,000 copies during the spring of 1910. Warburg had paved the way for this support by regularly meeting with the currency committee of the Merchants Association since October 1908, and his efforts were aided by the fact that the resident expert for the merchants committee was none other than Joseph French Johnson.

At the same time, in the spring of 1910, the numerous research volumes published by the NMC poured onto the market. The object was to swamp public opinion with a parade of impressive analytic and historical scholarship, all allegedly "scientific" and "value-free," but all designed to aid in furthering the common agenda of a central bank.

Typical was E. W. Kemmerer's mammoth statistical study of seasonal variations in the demand for money. Emphasis was placed on the problem of the "inelasticity" of the supply of cash, in particular the difficulty of expanding that supply when needed. While Kemmerer felt precluded from spelling out the policy implications — establishing a central bank — in the book, his acknowledgments in the preface to Fred Kent and the inevitable Charles Conant were a tip-off to the cognoscenti, and Kemmerer himself disclosed them in his address to the Academy of Political Science the following November.

Now that the theoretical and scholarly groundwork had been laid, by the latter half of 1910 it was time to formulate a concrete practical plan and put on a mighty putsch on its behalf. In the book on Reform of the Currency, published by the APS, Warburg made the point with crystal clarity: "Advance is possible only by outlining a tangible plan" that would set the terms of the debate from then on (p. 203).

The tangible-plan phase of the central-bank movement was launched by the ever-pliant APS, which held a monetary conference in November 1910, in conjunction with the New York Chamber of Commerce and the Merchants' Association of New York. The members of the NMC were the guests of honor at this conclave, and delegates were chosen by governors of 22 states, as well as presidents of 24 chambers of commerce.

Also attending were a large number of economists, monetary analysts, and representatives of most of the top banks in the country. Attendants at the conference included Frank Vanderlip, Elihu Root, Thomas W. Lamont of the Morgans, Jacob Schiff, and J. P. Morgan.

The formal sessions of the conference were organized around papers by Kemmerer, Laughlin, Johnson, Bush, Warburg, and Conant, and the general atmosphere was that bankers and businessmen were to take their general guidance from the attendant scholars. As James B. Forgan, the Chicago banker who was now solidly in the central-banking camp, put it, "Let the theorists, those who … can study from past history and from present conditions the effect of what we are doing, lay down principles for us, and let us help them with the details."

C. Stuart Patterson pointed to the great lessons of the Indianapolis Monetary Commission, and the way in which its proposals triumphed in action because "we went home and organized an aggressive and active movement." Patterson then laid down the marching orders of what this would mean concretely for the assembled troops: "That is just what you must do in this case, you must uphold the hands of Senator Aldrich. You have got to see that the bill which he formulates … obtains the support of every part of this country" (Livingston 1986, pp. 205–07).

With the New York monetary conference over, it was now time for Aldrich, surrounded by a few of the topmost leaders of the financial elite, to go off in seclusion and hammer out a detailed plan around which all parts of the central-bank movement could rally. Someone in the Aldrich inner circle, probably Morgan partner Henry P. Davison, got the idea of convening a small group of top leaders in a super-secret conclave to draft the central-bank bill. On November 22, 1910, Senator Aldrich, with a handful of companions, set forth in a privately chartered railroad car from Hoboken, New Jersey to the coast of Georgia, where they sailed to an exclusive retreat, the Jekyll Island Club.

Facilities for their meeting were arranged by club member and coowner J. P. Morgan. The cover story released to the press was that this was a simple duck-hunting expedition, and the conferees took elaborate precautions on the trips there and back to preserve their secrecy. Thus, the attendees addressed each other only by first name, and the railroad car was kept dark and closed off from reporters or other travelers on the train. One reporter apparently caught on to the purpose of the meeting, but was in some way persuaded by Henry P. Davison to maintain silence.

The conferees worked for a solid week at Jekyll Island to hammer out the draft of the Federal Reserve bill. In addition to Aldrich, the conferees included Henry P. Davison, Morgan partner; Paul Warburg, whose address in the spring had greatly impressed Aldrich; Frank A. Vanderlip, vice president of the National City Bank of New York; and finally, A. Piatt Andrew, head of the NMC staff, who had recently been made assistant secretary of the treasury by President Taft.

After a week of meetings, the six men had forged a plan for a central bank, which eventually became the Aldrich Bill. Vanderlip acted as secretary of the meeting and contributed the final writing.

The only substantial disagreement was tactical, with Aldrich attempting to hold out for a straightforward central bank on the European model, while Warburg and the other bankers insisted that the reality of central control be cloaked in the politically palatable camouflage of "decentralization." It is amusing that the bankers were the more politically astute, while the politician Aldrich wanted to waive political considerations. Warburg and the bankers won out, and the final draft was basically the Warburg plan with a decentralized patina taken from Morawetz.

The financial power elite now had themselves a bill. The significance of the composition of the small meeting must be stressed: two Rockefeller men (Aldrich, Vanderlip), two Morgans (Davison and Norton), one Kuhn, Loeb person (Warburg), and one economist friendly to both camps (Andrew) (Rothbard 1984, pp. 99–101; Vanderlip 1935, pp. 210–19).

After working on some revisions of the Jekyll Island draft with Forgan and George Reynolds, Aldrich presented the Jekyll Island draft as the Aldrich Plan to the full NMC in January 1911. But here an unusual event occurred. Instead of quickly presenting this Aldrich Bill to the Congress, its drafters waited for a full year, until January 1912. Why the unprecedented year's delay?

The problem was that the Democrats swept the Congressional elections in 1910, and Aldrich, disheartened, decided not to run for reelection to the Senate the following year. The Democratic triumph meant that the reformers had to devote a year of intensive agitation to convert the Democrats, and to intensify propaganda to the rest of banking, business, and the public. In short, the reformers needed to regroup and accelerate their agitation.

The final phase of the drive for a central bank began in January 1911. At the previous January's meeting of the National Board of Trade, Paul Warburg had put through a resolution setting aside January 18, 1911, as a "monetary day" devoted to a "Business Men's Monetary Conference." This conference, run by the National Board of Trade, and featuring delegates from metropolitan mercantile organizations from all over the country, had C. Stuart Patterson as its chairman.

The New York Chamber of Commerce, the Merchants' Association of New York, and the New York Produce Exchange, each of which had been pushing for banking reform for the past five years, introduced a joint resolution to the monetary conference supporting the Aldrich Plan, and proposing the establishment of a new "business men's monetary reform league" to lead the public struggle for a central bank. After a speech in favor of the plan by A. Piatt Andrew, the entire conference adopted the resolution. In response, C. Stuart Patterson appointed none other than Paul M. Warburg to head a committee of seven to establish the reform league.

The committee of seven shrewdly decided, following the lead of the old Indianapolis convention, to establish the National Citizens' League for the Creation of a Sound Banking System at Chicago rather than in New York, where the control really resided. The idea was to acquire the bogus patina of a "grassroots" heartland operation and to convince the public that the league was free of dreaded Wall Street control. As a result, the official heads of the League were Chicago businessmen John V. Farwell and Harry A. Wheeler, president of the US Chamber of Commerce. The director was University of Chicago monetary economist J. Laurence Laughlin, assisted by his former student, Professor H. Parker Willis.

In keeping with its Midwestern aura, most of the directors of the Citizens' League were Chicago nonbanker industrialists: men such as B. E. Sunny of the Chicago Telephone Company, Cyrus McCormick of International Harvester (both companies in the Morgan ambit), John G. Shedd of Marshall Field and Company, Frederic A. Delano of the Wabash Railroad Company (Rockefeller-controlled), and Julius Rosenwald of Sears, Roebuck. Over a decade later, however, H. Parker Willis frankly conceded that the Citizens' League had been a propaganda organ of the nation's bankers.Willis's (1923, pp. 149–50) account, however, conveniently overlooks the dominating operational role that both he and his mentor, Laughlin, played in the Citizens' League. See also West (1977, p. 82).

The Citizens' League swung into high gear during the spring and summer of 1911, issuing a periodical, Banking and Reform, designed to reach newspaper editors, and subsidizing pamphlets by such proreform experts as John Perrin, head of the American National Bank of Indianapolis, and George E. Roberts of the National City Bank of New York.

A consultant on the newspaper campaign was H. H. Kohlsaat, former executive committee member of the Indianapolis Monetary Convention. Laughlin himself worked on a book on the Aldrich Plan, to be similar to his own Report of 1898 for the Indianapolis Convention.

Meanwhile, a parallel campaign was launched to bring the nation's bankers into camp. The first step was to convert the banking elite. For that purpose, the Aldrich inner circle organized a closed-door conference of 23 top bankers in Atlantic City in early February, which included several members of the currency commission of the American Bankers Association, along with bank presidents from nine leading cities of the country. After making a few minor revisions, the conference warmly endorsed the Aldrich Plan.

After this meeting, Chicago banker James B. Forgan, president of the Rockefeller-dominated First National Bank of Chicago, emerged as the most effective banker spokesman for the central-bank movement. Not only was his presentation of the Aldrich Plan before the executive council of the ABA in May considered particularly impressive, it was especially effective coming from someone who had been a leading critic (if on relatively minor grounds) of the plan. As a result, the top bankers managed to get the ABA to violate its own bylaws and make Forgan chairman of its executive council.

At the Atlantic City conference, James Forgan had succinctly explained the purpose of the Aldrich Plan and of the conference itself. As Kolko sums up,

the real purpose of the conference was to discuss winning the banking community over to government control directly by the bankers for their own ends.… It was generally appreciated that the [Aldrich Plan] would increase the power of the big national banks to compete with the rapidly growing state banks, help bring the state banks under control, and strengthen the position of the national banks in foreign banking activities. (Kolko 1983, p. 186)

By November 1911, it was easy pickings to have the full American Bankers Association endorse the Aldrich Plan. The nation's banking community was now solidly lined up behind the drive for a central bank.

However, 1912 and 1913 were years of some confusion and backing and filling, as the Republican party split between its insurgents and regulars, and the Democrats won increasing control over the federal government, culminating in Woodrow Wilson's gaining the presidency in the November 1912 elections. The Aldrich Plan, introduced into the Senate by Theodore Burton in January 1912, died a quick death, but the reformers saw that what they had to do was to drop the fiercely Republican partisan name of Aldrich from the bill, and with a few minor adjustments, rebaptize it as a Democratic measure.

Fortunately for the reformers, this process of transformation was eased greatly in early 1912, when H. Parker Willis was appointed administrative assistant to Carter Glass, the Democrat from Virginia who now headed the House Banking and Currency Committee. In an accident of history, Willis had taught economics to the two sons of Carter Glass at Washington and Lee University, and they recommended him to their father when the Democrats assumed control of the House.

The minutiae of the splits and maneuvers in the banking-reform camp during 1912 and 1913, which have long fascinated historians, are fundamentally trivial to the basic story. They largely revolved around the successful efforts by Laughlin, Willis, and the Democrats to jettison the name Aldrich.

Moreover, while the bankers had preferred the Federal Reserve Board to be appointed by the bankers themselves, it was clear to most of the reformers that this was politically unpalatable. They realized that the same result of a government-coordinated cartel could be achieved by having the president and Congress appoint the Board, balanced by the bankers electing most of the officials of the regional Federal Reserve Banks and electing an advisory council to the Fed.

However, much would depend on whom the president would appoint to the board. The reformers did not have to wait long. Control was promptly handed to Morgan men, led by Benjamin Strong of Bankers' Trust as all-powerful head of the Federal Reserve Bank of New York. The reformers had gotten the point by the end of congressional wrangling over the Glass bill, and by the time the Federal Reserve Act was passed in December 1913, the bill enjoyed overwhelming support from the banking community.

As A. Barton Hepburn of the Chase National Bank persuasively told the American Bankers Association at the annual meeting of August 1913: "The measure recognizes and adopts the principles of a central bank. Indeed … it will make all incorporated banks together joint owners of a central dominating power" (Kolko 1983, p. 235). In fact, there was very little substantive difference between the Aldrich and Glass bills: the goal of the bank reformers had been triumphantly achieved.On the essential identity of the two plans, see Friedman and Schwartz (1963, p. 17), Kolko (1983, p. 235), and Warburg (1930, chaps. 8 and 9). On the minutiae of the various drafts and bills and the reactions to them, see West (1977, pp. 79–135), Kolko (1983, pp. 186–89, 217–47), and Livingston (1986, pp. 217–26).On the capture of banking control in the new Federal Reserve System by the Morgans and their allies, and on the Morganesque policies of the Fed during the 1920s, see Rothbard (1984, pp. 103–36).

The financial elites of this country, notably the Morgan, Rockefeller, and Kuhn, Loeb interests, were responsible for putting through the Federal Reserve System as a governmentally created and sanctioned cartel device to enable the nation's banks to inflate the money supply in a coordinated fashion, without suffering quick retribution from depositors or noteholders demanding cash.

Recent researchers, however, have also highlighted the vital supporting role of the growing number of technocratic experts and academics, who were happy to lend the patina of their allegedly scientific expertise to the elite's drive for a central bank. To achieve a regime of big government and government control, power elites cannot achieve their goal of privilege through statism without the vital legitimizing support of the supposedly disinterested experts and the professoriate. To achieve the Leviathan State, interests seeking special privilege and intellectuals offering scholarship and ideology must work hand in hand.

This article originally appeared in Quarterly Journal of Austrian Economics, Vol. 2, No. 3 (Fall 1999), pp. 3–51. It is also reprinted in A History of Money and Banking in the United States and as a monograph.

Given this context, I am very surprised to confess that Krugman has convinced me of the virtues of currency debasement. As I was reading his blog post on the tragic fate of Ecuador, I applied Krugman's lessons to my personal life, and suddenly everything became clear. In a flash, all of my household's financial stresses were solved.

Please allow me to share Krugman's tale — and my own personal salvation — so that you too may be freed from the bondage of creditors and scarcity.

In a late October blog post titled "Fixed Rates and Protectionism, 2009 Edition," Krugman explained that the horrible trade wars of the early 1930s were the fault of — you guessed it — the gold standard. Herbert Hoover, for example, had no choice but to sign into law the Smoot-Hawley Tariff, because he stubbornly refused to let the US dollar depreciate against gold. I'll let Krugman explain:

Barry Eichengreen and Doug Irwin have a new paper challenging the conventional wisdom about protectionism in the 1930s. It wasn't about economic ignorance, or at least not about microeconomics; it was about the attempt to escape the "golden fetters" of the exchange rate. The most protectionist countries were those that tried to keep their peg to gold.

Fortunately in our times, no government foolishly pledges to pay a certain weight of a commodity in exchange for the pieces of paper it prints up and gives the force of legal tender. We've long since left behind that bit of "economic ignorance." (Phew!)

Alas, just as you kill one superstition about "hard money," another rises to replace it. For example, apparently a bunch of developing nations with histories of volatile paper currencies try to inspire faith by linking their own money to the US dollar.

In fact, some countries with very bad inflationary histories have gone so far as to literally replace their own currencies with the US dollar. Krugman has seen the awful ramifications firsthand:

I'm blogging from Quito, Ecuador. Ecuador is dollarized — no currency of its own, just US dollars. And this leaves the country with very limited room for maneuver during the current crisis. And here's what happened:

In January 2009 Ecuador announced a series of stiff import restrictions on 630 tariff lines, affecting 8.7 percent of its 'tariff universe' and 23 percent of the volume of imports. Duties were raised on 369 tariff lines and quota restrictions imposed on 271 others for a one-year period. They cover products ranging from processed foods and shoes to cars, mobile phones and sunglasses, as well as many other goods that can be manufactured in Ecuador.

Ecuador insisted that the measures it proposed were necessary to balance its widening current account deficit. GATT Article XVIII allows developing countries to impose temporary import controls to "forestall the imminent threat of, or to stop, a serious decline in its monetary reserves; or, in the case of [a Member] with very low monetary reserves, to achieve a reasonable rate of increase in its reserves."

Can you really say that Ecuador was wrong to do this, given its lack of other policy tools? At the very least, you have to say that there's a pretty good second-best case for the policy — and the WTO has reached a compromise allowing Ecuador to keep the measures in place at least for now.…

Anyway, no deep moral here, except to say that the problems that faced nations on the gold-standard in the 1930s are being replicated in countries pegged to the euro or the dollar today.

Now I have to admit, at first my knee-jerk Krugman-phobia kicked in, and I thought the above arguments were silly. First of all, the whole reason a country pegs its currency to the dollar (or better yet, gold) is to reassure investors, both domestic and foreign.

No one wants to open a factory in a distant country if there's a decent chance that a military coup will crash the currency and cut his property value in half overnight. By building up reserves in a foreign currency that is supposed to be much more reliable, the governments (or central banks) of volatile countries can allay that fear.

Since the whole point of pegging a currency is to reassure investors, Krugman's analysis ignores the downside of his proposal. Namely, investors are going to be much more cautious about exposing their wealth to a foreign government that has already burned them once by breaking its peg.

However, there's something even stranger going on in the case of Ecuador. Everything I said so far would be applicable to a country that had its own currency, but then pledged to redeem it in a certain ratio against a foreign currency like the US dollar.

After a string of trade deficits, there would be increasing pressure on the domestic currency to depreciate, which would ultimately fuel speculative attacks against the country's reserves of the foreign currency (such as the dollar). In this case, Krugman would simply be saying that if a country prints too much currency, its attempts to artificially peg that currency above market exchange rates will lead to disaster.

Yet this standard analysis doesn't seem to be applicable in Ecuador. There, as Krugman himself suggests in his blog post, the people literally use the US dollar as their currency. In other words, the people in Ecuador don't "peg their currency to the dollar," but actually walk around with US dollar bills in their pockets. (I have confirmed this fact with both a cosmopolitan world-traveling economist, and the infallible Wikipedia, so I hope it's true.)

Now in this case, Krugman's analysis seems especially nonsensical. To say that Ecuador is running trade deficits and hence running low on its "foreign reserves" of US dollars — when its official currency is the US dollar — makes as much sense as saying Governor Schwarzenegger declared a fiscal emergency because his government is running low on dollar reserves, and therefore needs to prevent Californians from spending their money on goods made in Nevada or Oregon.

I'm hoping that even Paul Krugman would recognize this as an absurd interference with trade, when the real solution would be for the California government to balance its budget. (Ha ha, a little joke there for you. Of course Krugman wouldn't say that.)

As I mentioned in the beginning of the article, I eventually came around and saw the wisdom of Krugman's analysis, but only after I applied his principles to my own life. You see, up until now I've been in a rat race: when the family budget was tight, I thought my only options were to either earn more income, or spend less money. But thinking about Krugman's analysis of Ecuador and applying it to California, I had a flash of insight.

The real problem with my household finances wasn't that we were underearning or overspending. No, the real problem was that our superstitious bank decided to peg its unit of account rigidly to the dollar at 1:1.

So, for example, if I had earlier deposited $2,000 into my checking account, then I would go around writing checks on that. But if I wrote a check for, say, 500 units of currency, then my bank would dutifully pay out at the rate of 1:1! Thus I would only have 1,500 US dollar bills left in my stockpile of reserves, which would seriously crimp my sushi purchases.

I have since forwarded a copy of Krugman's blog post to the managers of my local bank. I informed them — in case the boobs didn't already know — that Dr. Krugman not only teaches at Princeton, but is a Nobel (Memorial) laureate, for goodness' sake. Taking his advice, I henceforth want to devalue my checking account, so that when I write a check for 500 units, the bank only transfers $250 to the person whose goods I am purchasing.

This step solves so many problems; I can't believe I didn't think of it earlier. Immediately, my household's budget crisis is solved, for I now have double the effective reserves as I previously did. Making my mortgage payment is no longer a struggle!

But this isn't just about me. With my depreciated bank currency, I can spend more freely on local merchants, thus boosting business in my community. Before removing the absurd 1:1 dollar peg, my wife and I would have had to sharply curtail our consumption. This is no longer a concern, thanks to the magic of modern monetary analysis.

Thank you, Dr. Krugman! Now if only governments and central bankers would heed your words of wisdom, the worldwide recession would be ended immediately.

A careful, comprehensive response to Krugman's charges would involve an explanation of the classical gold standard, and the wonderful peace and prosperity it showered on the world. It was only after the major countries abandoned gold during World War I that major imbalances in international trade began to fester — imbalances that eventually exploded during the early 1930s.The First World War would not have lasted nearly as long had governments been forced to pay for it exclusively through taxation or borrowing. Suspending their currencies' ties to gold allowed the major belligerents (except the United States) to finance the war effort with inflation as well. (The Federal Reserve also inflated to pay for the war, though it was constrained because the United States remained on the gold standard.) As a good capitalist pig, I point the reader to my book on the Depression for the full story.

Fortunately, we can take a shortcut in the present article. Using Krugman's own graph, we can see that the case for abandoning gold — and devaluing currencies in the process — is not nearly as straightforward as he seems to think.

Here's Krugman setting up his graph. Note that the strikethrough, and accompanying text in the brackets, is from Krugman's post. What happened is that Krugman originally wrote one order of the countries going off gold, then a reader told him he was mistaken in the comments, so Krugman fixed his apparent error and explained this in brackets. I have included it as is below, because Krugman's bracketed explanation makes it crystal clear what his point is:

If there's one overwhelming lesson from the Great Depression, it is that putting a higher priority on stabilizing your currency than on domestic recovery is utterly disastrous. Barry Eichengreen pointed out years ago that major economies went off gold in the following order: Japan, Germany, Britain Britain, Germany, US, France. [screwed it up in the first draft: the correlation between going off gold and recovery is in fact perfect] And here's what happened to their industrial output….

Krugman reproduces a chart from this paper by Barry Eichengreen. This has been quite popular in the progressive blogosphere; indeed Brad DeLong features a modified version of it on the left margin of his main page. Here is the chart that apparently clinches the fact that the gold standard caused — or at least exacerbated — the Great Depression:

Inflation-Adjusted Industrial Output

(Index 1929=100, annual averages, axis notched at year's midpoint)

Before moving on, let's be clear on why Krugman thinks the above chart is so damning to the goldbugs. By 1937, if you rank the nations' industrial output relative to 1929 levels, the order is Japan, Britain, Germany, the United States, and finally France. Now if you ask, In what order did countries abandon the gold standard? Why, the answer (Krugman tells us, after making the correction to his original post) is the same! So, this is apparently decisive evidence that abandoning gold was the way to get out of the Great Depression.

The first problem with Krugman's demonstration is that he's got his dates wrong. For example, Krugman himself reproduces the following correction from economic historian Peter Temin:

Germany went off gold before the UK in 1931, in July and August, that is, before late September when the UK devalued. The story however is a bit complex because Germany went off gold by eliminating the free flow of gold. They kept the value of the mark steady all through the Nazi period (see Adam Tooze's good book), but they controlled the flow of foreign exchange. The reason that this does not show up on your graph is that the German chancellor in 1931 (Bruening) followed the dictates of the gold standard in 1931, keeping interest rates high and deflating the economy. This is what I called the gold-standard mentality in Lessons from the Great Depression (1989).

So we already see nuances in the official story. Really, it's not tying a currency to gold per se that was the problem; the real problem was refusing to devalue a currency (which the gold standard made difficult).

But then we have another problem. In the chart, Japan is the best example. They apparently go off gold first, they have an almost immediate recovery, and they end up with the highest 1937 production. So here's my problem: Why do all these various sites (e.g. here and here) from Google tell me that Japan abandoned the gold standard in December 1931 — several months after Great Britain (in September 1931)?

Now, Japan had only gone back on gold the prior year, in January 1930, so maybe that's what Krugman's dateline is based on. In other words, whoever is telling Krugman that Japan went off gold first, might be dismissing the January 1930–December 1931 period as insignificant.

Be that as it may, all five of the countries under discussion were on a gold (exchange) standard as of January 1931. Then, if you ask in what order did they sever their currencies' ties to gold, the actual ranking is: Germany, Britain, Japan, the United States, and France.

Notice that the "perfect" correlation cited by Krugman has broken down significantly. Yes, the 4th and 5th countries go off gold end up ranked 4th and 5th, respectively, in terms of industrial output in 1937. But the other three countries are now ranked as if the correlation is precisely the reverse of Krugman's original claim. That is, the 3rd country to go off gold (Japan) is ranked 1st in output, the 2nd country to go off gold (Britain) is ranked 2nd in output, and the 1st country to go off gold (Germany) is ranked 3rd in output. If we just looked at those three countries, we would conclude that "history shows" abandoning the gold standard was the way to cripple your economic recovery.

Krugman can cite other policies if he wants. That's the tack Brad DeLong takes, when he titles his version of the chart to indicate that a country needs to go off gold and start its "New Deal" for the medicine to work. I'm simply pointing out here that it seems Krugman's history concerning dates of abandoning gold is just wrong. When the "pattern" really only works for three out of five countries, it's time to drop the particular argument and find a different one to make your point.

Let's move beyond the quibbles over particular dates. If it turned out that Krugman's original ordering of historical devaluations were correct, would that give fans of the gold standard something to worry about?

Not really. Remember, the appeal of the above chart is that it seems to show that from 1929–1937, industrial output is proportional to the speed with which a country abandoned its currency's peg to gold. But what is so magical about 1929–1937? I think the only thing objective about it is that 1937 is the first year all of these countries had abandoned their peg.

If we lengthened the time frames, what would happen? After all, the Great Depression certainly wasn't over in 1937, so it's not clear that we're seeing the full story with Eichengreen's chart. I don't have convenient access to the raw figures, but it wouldn't surprise me if the ranking bounced around if you took a snapshot in 1938 or 1939. Naturally, the military situation in Europe would be relevant here — but then again, it was relevant in 1937 as well.

Even if we look at the data in the selected time frame, though, it's not obvious that abandoning gold should be credited with rescuing various countries' industrial output. Rather than simply comparing 1929 output to 1937 output, and then comparing the countries' ranking in this respect to the order in which they abandoned gold, we can use the above chart to see the allegedly beneficial effects of devaluation play out over time.

For example, Germany and the United States both experienced a significant rebound in (the annual average of) industrial output from 1932 to 1933. Krugman wants to credit the abandonment of gold with this feat. Yet France also experienced just as significant a recovery from 1932 to 1933, even though it stayed tied to gold until 1936.

So, although the chart plausibly shows the benefits to Japan and Britain for going off gold in 1931, it certainly doesn't show the benefits to the United States and Germany. Of course, Krugman could say that it was the United States and German recovery that lifted France as well — but that causality doesn't jump out from the chart itself. And Krugman was citing the chart as independent evidence of the stupidity of the gold standard.

Finally, let's look a little more carefully at the case of the United States. A critic of the gold standard looks at the chart above and concludes, "Sticking with gold drove the economy into the toilet, but once FDR freed the dollar from the peg in March 1933, it was smooth sailing."

But no, that's not what the chart above shows. Before I can make the point, though, we need to clarify something: The United States abandoned the historical gold peg at $20.67 per ounce in March 1933 when FDR seized Americans' gold at gunpoint. Then, he literally set the gold price based on superstitions like "lucky numbers." (I explain these apparently crazy claims in my book.) But in 1934, the dollar was re-pegged to gold at $35 an ounce, where it stayed until that (allegedly) conservative free marketeer Nixon truly abandoned the gold standard in 1971. See for yourself:

So, with that historical information in hand, look again at Eichengreen's allegedly damning chart. Yes, the United States enjoyed a sharp recovery in 1933 relative to 1932 output. But it also enjoyed significant growth in 1935 and 1936, well after the dollar had been tied again to gold (at a lower parity). It's not obvious at all that it was the gold standard driving the movements of US industrial output during 1929–1937.

Remember that "abandoning gold" isn't akin to shaving one's mustache. When a country dropped a peg, it effectively ripped off every investor who had been holding assets denominated in it. Thus it's not surprising that some countries could experience apparent prosperity — especially if we just look at the short run — by abandoning gold.

For an analogy, someone who just bought an expensive house with no down payment, and who doesn't plan to apply for more loans anytime soon, could definitely gain a windfall by "abandoning his mortgage" (assuming the bank couldn't seize the property). That doesn't mean it's a shot in the arm for the economy. (Though of course, all analogies break down in our current crisis. The pundits really do think "abandoning mortgages" would be a good idea right now!)

Part of what happened in the 1930s was that the countries who stayed on gold were harmed when other governments reneged on their contractual obligations. For example, one of the smoking guns in the antigold case is that the Federal Reserve had to raise interest rates (after bringing them to unprecedented lows) in 1931, in response to Great Britain's abandonment of gold. What happened was that investors around the world feared the United States would follow Britain's example, and so they began redeeming their dollars for gold, thus draining US reserves. Hence, the Fed had to hike US interest rates to stem the outflow of gold.

Another major factor is that governments in the 1930s were interfering with wages and prices more so than at any prior point in (peacetime) history. For example, after the 1929 stock-market crash, President Herbert Hoover began a series of conferences with big business and labor leaders, telling them that cutting wage rates (the standard response in previous depressions) would be disastrous, because then the workers wouldn't make enough to buy the products.

This meant that nominal paychecks fell much more slowly during the early years of the Great Depression than the general price level. Consequently, if you kept your job, you experienced a higher increase in real (inflation-adjusted) wages during the early 1930s, than during the Roaring 1920s! So, it's no wonder that unemployment reached record highs during Hoover's first and only term. If a president wants to get a huge glut on the labor market during his administration, textbook economics says to prop up wages above their market-clearing level.

Now in this context, when FDR reneged on the US government's promise to redeem dollars for gold, it allowed the Federal Reserve to flood the economy with new dollars. The falling price level turned around on a dime, as this chart indicates:

Generally speaking, printing up green pieces of paper doesn't make an economy more productive; it merely redistributes the existing property while making it harder to plan for the future. But, if the government is also preventing wage rates from falling to their new, market-clearing level, then inflating the currency has the benefit of reducing unemployment.

Of course, this observation is no justification for what FDR did. Had prices and wages been left to the market, the recovery would have been swift, just as it was in the 1920–1921 depression. Even so, fans of the gold standard need to understand why the economy apparently recovered so quickly after FDR devalued the dollar.

Intuitively, it makes no sense to say that the major dislocations of the world's economies in the 1930s could have been solved simply by printing up pieces of paper. When we closely examine the graphical evidence that apparently proves this strange claim, we see it falls apart. Krugman and Friends need to convince us, first, that their history is accurate, and second, that their charts really prove what they claim.

However, on closer examination, gold ownership in India is neither excessive nor irrational. In fact, when religious, cultural, and historical perspectives are considered, India's appetite for gold seems rather matter of fact indeed. Nonetheless, it is not lost on any Indian worth his or her salt that gold is the asset that best protects wealth and freedom.

When my father, a pediatric surgeon, wanted to buy land to construct his clinic and supplement his meager government income, he purchased the land by mortgaging my mother's jewelry. Similarly, millions of people in India have capitalized their businesses or farms, or secured their basic necessities after severe business reversals, by pledging their gold jewelry. As we shall see below, were it not for gold, the average Indian's lot through history could've been a lot worse.

India's private gold ownership is difficult to determine accurately. However, several websites, such as Gold Eagle, estimate the total private gold holdings to be about 15,000 metric tons. Compared to that figure, the Indian government owns a negligible 360 metric tons of gold.

Given that total gold mined in history is about 160,000 metric tons, India's stake then amounts to 9.6 percent of the world's total gold stock. In contrast, India accounts for just over 17 percent of the world's population. Therefore, India's large gold ownership is just a function of its large population, and its per capita gold ownership is well below average.

However, there can be no doubting Indians' desire to own this metal. Demand from India consumes some 20–25 percent of the world's annual gold output.

Much of this desire to acquire gold dates back to the Bronze Age Indus Valley civilization, in which people wore gold jewelry almost 4,000 years ago.

Gold has a rich tradition in the Hindu epics, the Ramayana and the Mahabharata. It was associated with the pomp and splendor of the gods and kings who appear in these mythological stories. The Ramayana, the earlier of the two epics, can be traced back to around 900 BC, so gold had risen above all other commodities to be associated with power, prestige, and wealth even back then.

Let me narrate a short story to illustrate how deeply gold and wealth are ingrained into the Hindu culture. The world's richest temple, at Tirupati, was built in honor of Sri Venkateswara, an incarnation of Lord Vishnu. Legend has it that Venkateswara, who was born poor, sought the hand of Princess Padmavati, the incarnate of Vishnu's celestial consort, Lakshmi.

Her father decreed that Venkateswara could marry Padmavati only if he possessed wealth comparable to the king himself. Venkateswara sought a loan of gold and jewels from Lord Kubera, the Hindu god of wealth. To help Venkateswara repay this loan symbolically, Hindu devotees donate money at Tirupati to this day.

This is but one of many thousands of stories from Hindu mythology that involve gods, kings, and wealth. Generations of Indians reared on these stories have come to associate gold with mythical qualities.

Silver coins were widely used in India during the reign of the Mauryas circa 250 BC. The first gold coins were issued widely during the Gupta dynasty around 250 AD. Interestingly, this period was also known as the Golden Age.

On the face of it, every emperor issues coins to accentuate the significance of his rule. However, there was a more practical reason for Indians to use gold as money.

India, over the past 4 millennia, was a collection of many thousands of kingdoms and fiefdoms. Every once in a while, a ruler such as Emperor Chandragupta Maurya appeared on the scene and was able to consolidate a majority of India. However, no sooner did such an able emperor pass away than his empire disintegrated.

Even with the big empires, there was always plenty of fighting, and border territories constantly changed hands. Millions of Indians could, in their lifetimes, expect to be the subjects of several different rulers and kingdoms.

Gold, being of high value, could easily be hidden during times of strife, enabling ordinary citizens to avoid being looted by marauding armies. Further, a gold coin issued by one king could serve as money under any other king as long as the weight and purity of the issued coin could be assessed. Therefore, gold was the preferred medium of exchange and store of wealth.

The history of dowry in India is almost as old as the Hindu religion itself. Dowry, before the negative connotations of today, was a gift from the bride's family to a newly married couple. It was to compensate the groom for the additional expenses he would incur taking care of his stay-at-home bride and eventually their family.[1]

Although different commodities were used to pay dowry, gold was the preferred option simply because it was easily safeguarded and widely accepted. The practice of giving gold and jewels as dowry continues to this day.

Another offshoot of the rich tradition of gold in the Hindu religion explains why Indians mark every auspicious and festive occasion with the purchase of a token amount of gold. Parents with daughters begin accumulating gold in small quantities yearly on these occasions, in anticipation of their daughters' weddings.

The above historical and cultural reasons explain the long-entrenched practice among Indians of acquiring gold. This practice continued into contemporary times despite India having a unified currency since 1857, when the British acquired complete control of the country. This was primarily because of the continued struggles for the average Indian, first under imperial Britain and then under socialist India.

Since India's independence, the country has followed a socialist economic policy, with the government running constant deficits to fund its five-year plans. Needless to say, these plans have proved very inefficient, resulting in plenty of wastage and constantly increasing prices.

India's disastrous 1962 war with China severely depleted India's foreign reserves and removed the backing for the rupee. To prevent a massive flight out of the rupee, the government established the Gold Control Act in 1962, forbidding private ownership of gold bullion and mandating the conversion of all private gold bullion into gold jewelry. This prevented the rise of an alternate currency if the rupee should flounder.

As with all government intrusions, this law had unintended consequences. Because licenses were required to hold gold bullion, many goldsmiths not connected to the establishment lost their livelihoods overnight. The prohibition also gave rise to gold smuggling and a huge black market in gold, which no doubt claimed many lives and livelihoods.

Further, in 1969, the Indian government under Indira Gandhi nationalized the banks and mandated licenses for almost everything. This was the beginning of the "License Raj" in India, which instituted rampant corruption in all levels of the bureaucracy. Since the state controlled all the banks, loans were made to special sectors just to buy votes.

The 1970s were an even more tumultuous period politically in India. A state of emergency was declared from 1975 to 1977, giving almost dictatorial powers to Indira Gandhi. When democracy was restored in 1977, Ms. Gandhi was ousted by Morarji Desai. However, the common man still couldn't catch a break, as marginal tax rates hit a scarcely believable 95 percent and the rupee's value declined steadily.

In light of these circumstances, gold was the average Indian's best friend. Due to a ban on gold, the value of gold in relation to other commodities and the rupee soared. The high marginal tax rate gave rise to a huge black market. Citizens needed a way to hide and protect their assets from the taxman, and gold was one of the two asset classes that proved effective for doing so (the other being real estate).

One last reason why extensive gold holdings are prudent in today's context is the paltry level of insurance provided to bank deposits. A fractional reserve banking system is inherently insolvent and needs government insurance to prevent a run on deposits. In India, the amount covered under deposit insurance is just Rs100,000, which is only $2,170. In contrast, federal deposit insurance in the United States was recently increased from $100,000 to $250,000.

To put things in perspective, Rs100,000 is about 5 months rent for a decent, three-bedroom apartment in Bangalore, whereas $250,000 US is four or five year's worth of living expenses for a couple in Chicago, including a mortgage or rent. In other words, Rs100,000 is an insignificant sum of money.

Print $17

Audio $25

Realizing that the banking system is shaky, because of the low level of insurance and the fractional-reserve system, many savvy consumers hedge by holding a portion of their savings in gold. Moreover, millions of people in rural India completely bypass the banking system because they don't understand it and prefer to hold their savings in gold. When in need of money in a crunch, they pledge their gold with a local money lender in return for currency.

In summation, India's ancient and deep religious traditions, combined with a plethora of historical, cultural, and practical reasons, have fostered an unflinching desire to acquire gold as a means of protecting one's wealth. In this light, one can hardly dismiss this desire as irrational. Given what's in store for the world at large when the inevitable currency crisis occurs, citizens from other countries could do worse than to take a leaf out of India's history with gold.

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[1] I'm not condoning the practice of dowry in the modern day or the atrocities associated with it, I'm only giving a historical perspective on why that custom came into existence.

As soon as an economic good is demanded not only by those who want to use it for consumption or production, but also by people who want to keep it as a medium of exchange and to give it away at need in a later act of exchange, the demand for it increases. A new employment for this good has emerged and creates an additional demand for it.

As with every other economic good, such an additional demand brings about a rise in its value in exchange, i.e., in the quantity of other goods which are offered for its acquisition. The amount of other goods which can be obtained in giving away a medium of exchange, its "price" as expressed in terms of various goods and services, is in part determined by the demand of those who want to acquire it as a medium of exchange. If people stop using the good in question as a medium of exchange, this additional specific demand disappears and the "price" drops concomitantly.

Thus the demand for a medium of exchange is the composite of two partial demands: the demand displayed by the intention to use it in consumption and production and that displayed by the intention to use it as a medium of exchange.The problems of money exclusively dedicated to the service of a medium of exchange and not fit to render any other services on account of which it would be demanded are dealt with below in section 9. With regard to modern metallic money one speaks of the industrial demand and of the monetary demand. The value in exchange (purchasing power) of a medium of exchange is the resultant of the cumulative effect of both partial demands.

Now the extent of that part of the demand for a medium of exchange which is displayed on account of its service as a medium of exchange depends on its value in exchange. This fact raises difficulties which many economists considered insoluble so that they abstained from following farther along this line of reasoning. It is illogical, they said, to explain the purchasing power of money by reference to the demand for money, and the demand for money by reference to its purchasing power.

The difficulty is, however, merely apparent. The purchasing power that we explain by referring to the extent of specific demand is not the same purchasing power the height of which determines this specific demand. The problem is to conceive the determination of the purchasing power of the immediate future, of the impending moment. For the solution of this problem we refer to the purchasing power of the immediate past, of the moment just passed. These are two distinct magnitudes. It is erroneous to object to our theorem, which may be called the regression theorem, that it moves in a vicious circle.The present writer first developed this regression theorem of purchasing power in the first edition of his book Theory of Money and Credit, published in 1912 (pp. 97–123 of the English-language translation). His theorem has been criticized from various points of view. Some of the objections raised, especially those by B. M. Anderson in his thoughtful book The Value of Money, first published in 1917 (cf. pp. 100 ff. of the 1936 edition), deserve a very careful examination. The importance of the problems involved makes it necessary to weigh also the objections of H. Ellis (German Monetary Theory 1905-1933 [Cambridge, 1934], pp. 77 ff.). In the text above, all objections raised are particularized and critically examined.

But, say the critics, this is tantamount to merely pushing back the problem. For now one must still explain the determination of yesterday's purchasing power. If one explains this in the same way by referring to the purchasing power of the day before yesterday and so on, one slips into a regressus in infinitum. This reasoning, they assert, is certainly not a complete and logically satisfactory solution of the problem involved.

What these critics fail to see is that the regression does not go back endlessly. It reaches a point at which the explanation is completed and no further question remains unanswered. If we trace the purchasing power of money back step by step, we finally arrive at the point at which the service of the good concerned as a medium of exchange begins. At this point, yesterday's exchange value is exclusively determined by the nonmonetary — industrial — demand, which is displayed only by those who want to use this good for other employments than that of a medium of exchange.

But, the critics continue, this means explaining that part of money's purchasing power which is due to its service as a medium of exchange by its employment for industrial purposes. The very problem, the explanation of the specific monetary component of its exchange value, remains unsolved. Here too, the critics are mistaken. That component of money's value which is an outcome of the services it renders as a medium of exchange is entirely explained by reference to these specific monetary services and the demand they create.

Two facts are not to be denied and are not denied by anybody. First, that the demand for a medium of exchange is determined by considerations of its exchange value which is an outcome both of the monetary and the industrial services it renders. Second, that the exchange value of a good which has not yet been demanded for service as a medium of exchange is determined solelyby a demand on the part of people eager to use it for industrial purposes, i.e., either for consumption or for production.

Now, the regression theorem aims at interpreting the first emergence of a monetary demand for a good which previously had been demanded exclusively for industrial purposes as influenced by the exchange value that was ascribed to it at this moment on account of its nonmonetary services only. This certainly does not involve explaining the specific monetary exchange value of a medium of exchange on the ground of its industrial exchange value.

Finally it was objected to the regression theorem that its approach is historical, not theoretical. This objection is no less mistaken. To explain an event historically means to show how it was produced by forces and factors operating at a definite date and a definite place. These individual forces and factors are the ultimate elements of the interpretation. They are ultimate data and as such not open to any further analysis and reduction.

To explain a phenomenon theoretically means to trace back its appearance to the operation of general rules which are already comprised in the theoretical system. The regression theorem complies with this requirement. It traces the specific exchange value of a medium of exchange back to its function as such a medium and to the theorems concerning the process of valuing and pricing as developed by the general catallactic theory.

It deduces a more special case from the rules of a more universal theory. It shows how the special phenomenon necessarily emerges out of the operation of the rules generally valid for all phenomena. It does not say, "This happened at that time and at that place." It says, "This always happens when the conditions appear; whenever a good which has not been demanded previously for the employment as a medium of exchange, begins to be demanded for this employment, the same effects must appear again; no good can be employed for the function of a medium of exchange which at the very beginning of its use for this purpose did not have exchange value on account of other employments."

And all these statements implied in the regression theorem are enounced apodictically as implied in the apriorism of praxeology. It must happen this way. Nobody can ever succeed in constructing a hypothetical case in which things were to occur in a different way.

The purchasing power of money is determined by demand and supply, as is the case with the prices of all vendible goods and services. As action always aims at a more satisfactory arrangement of future conditions, he who considers acquiring or giving away money is, of course, first of all interested in its future purchasing power and the future structure of prices. But he cannot form a judgment about the future purchasing power of money otherwise than by looking at its configuration in the immediate past.

It is this fact that radically distinguishes the determination of the purchasing power of money from the determination of the mutual exchange ratios between the various vendible goods and services. With regard to these latter the actors have nothing else to consider than their importance for future want satisfaction. If a new commodity unheard of before is offered for sale, as was, for instance, the case with radio sets a few decades ago, the only question that matters for the individual is whether or not the satisfaction that the new gadget will provide is greater than that expected from those goods he would have to renounce in order to buy the new thing.

Knowledge about past prices is for the buyer merely a means to reap a consumer's surplus. If he were not intent upon this goal, he could, if need be, arrange his purchases without any familiarity with the market prices of the immediate past, which are popularly called present prices. He could make value judgments without appraisement.

As has been mentioned already, the obliteration of the memory of all prices of the past would not prevent the formation of new exchange ratios between the various vendible things. But if knowledge about money's purchasing power were to fade away, the process of developing indirect exchange and media of exchange would have to start anew. It would become necessary to begin again with employing some goods, more marketable than the rest, as media of exchange. The demand for these goods would increase and would add to the amount of exchange value derived from their industrial (nonmonetary) employment a specific component due to their new use as a medium of exchange.

A value judgment is, with reference to money, only possible if it can be based on appraisement. The acceptance of a new kind of money presupposes that the thing in question already has previous exchange value on account of the services it can render directly to consumption or production. Neither a buyer nor a seller could judge the value of a monetary unit if he had no information about its exchange value — its purchasing power — in the immediate past.

The relation between the demand for money and the supply of money, which may be called the money relation, determines the height of purchasing power. Today's money relation, as it is shaped on the ground of yesterday's purchasing power, determines today's purchasing power. He who wants to increase his cash holding restricts his purchases and increases his sales and thus brings about a tendency toward falling prices. He who wants to reduce his cash holding increases his purchases — either for consumption or for production and investment — and restricts his sales; thus he brings about a tendency toward rising prices.

Changes in the supply of money must necessarily alter the disposition of vendible goods as owned by various individuals and firms. The quantity of money available in the whole market system cannot increase or decrease otherwise than by first increasing or decreasing the cash holdings of certain individual members. We may, if we like, assume that every member gets a share of the additional money right at the moment of its inflow into the system, or shares in the reduction of the quantity of money.

But whether we assume this or not, the final result of our demonstration will remain the same. This result will be that changes in the structure of prices brought about by changes in the supply of money available in the economic system never affect the prices of the various commodities and services to the same extent and at the same date.

Let us assume that the government issues an additional quantity of paper money. The government plans either to buy commodities and services or to repay debts incurred or to pay interest on such debts. However this may be, the treasury enters the market with an additional demand for goods and services; it is now in a position to buy more goods than it could buy before. The prices of the commodities it buys rise.

If the government had expended in its purchases money collected by taxation, the taxpayers would have restricted their purchases and, while the prices of the goods bought by the government would have risen, those of other goods would have dropped. But this fall in the prices of the goods the taxpayers used to buy does not occur if the government increases the quantity of money at its disposal without reducing the quantity of money in the hands of the public. The prices of some commodities — viz., of those the government buys — rise immediately, while those of the other commodities remain unaltered for the time being.

But the process goes on. Those selling the commodities asked for by the government are now themselves in a position to buy more than they used previously. The prices of the things these people are buying in larger quantities therefore rise too. Thus the boom spreads from one group of commodities and services to other groups until all prices and wage rates have risen. The rise in prices is thus not synchronous with the various commodities and services.

When eventually, in the further course of the increase in the quantity of money, all prices have risen, the rise does not affect the various commodities and services to the same extent. For the process has affected the material position of various individuals to different degrees. While the process is under way, some people enjoy the benefit of higher prices for the goods or services they sell, while the prices of the things they buy have not yet risen or have not risen to the same extent.

On the other hand, there are people who are in the unhappy situation of selling commodities and services whose prices have not yet risen or not in the same degree as the prices of the goods they must buy for their daily consumption. For the former the progressive rise in prices is a boon, for the latter a calamity. Besides, the debtors are favored at the expense of the creditors.

When the process once comes to an end, the wealth of various individuals has been affected in different ways and to different degrees. Some are enriched, some impoverished. Conditions are no longer what they were before. The new order of things results in changes in the intensity of demand for various goods. The mutual ratio of the money prices of the vendible goods and services is no longer the same as before.

The price structure has changed apart from the fact that all prices in terms of money have risen. The final prices to the establishment of which the market tends after the effects of the increase in the quantity of money have been fully consummated are not equal to the previous final prices multiplied by the same multiplier.

The main fault of the old quantity theory as well as the mathematical economists' equation of exchange is that they have ignored this fundamental issue. Changes in the supply of money must bring about changes in other data too. The market system before and after the inflow or outflow of a quantity of money is not merely changed in that the cash holdings of the individuals and prices have increased or decreased. There have been effected also changes in the reciprocal exchange ratios between the various commodities and services which, if one wants to resort to metaphors, are more adequately described by the image of price revolution than by the misleading figure of an elevation or a sinking of the price level.

We may at this point disregard the effects brought about by the influence on the content of all deferred payments as stipulated by contracts. We will deal later with them and with the operation of monetary events on consumption and production, investment in capital goods, and accumulation and consumption of capital. But even in setting aside all these things, we must never forget that changes in the quantity of money affect prices in an uneven way.

It depends on the data of each particular case at what moment and to what extent the prices of the various commodities and services are affected. In the course of a monetary expansion (inflation) the first reaction is not only that the prices of some of them rise more quickly and more steeply than others. It may also occur that some fall at first as they are for the most part demanded by those groups whose interests are hurt.

Changes in the money relation are not only caused by governments issuing additional paper money. An increase in the production of the precious metals employed as money has the same effects although, of course, other classes of the population may be favored or hurt by it.

Prices also rise in the same way if, without a corresponding reduction in the quantity of money available, the demand for money falls because of a general tendency toward a diminution of cash holdings. The money expended additionally by such a "dishoarding" brings about a tendency toward higher prices in the same way as that flowing from the gold mines or from the printing press. Conversely, prices drop when the supply of money falls (e.g., through a withdrawal of paper money) or the demand for money increases (e.g., through a tendency toward "hoarding," the keeping of greater cash balances). The process is always uneven and by steps, disproportionate and asymmetrical.

It could be and has been objected that the normal production of the gold mines brought to the market may well entail an increase in the quantity of money, but does not increase the income, still less the wealth, of the owners of the mines. These people earn only their "normal" income and thus their spending of it cannot disarrange market conditions and the prevailing tendencies toward the establishment of final prices and the equilibrium of the evenly rotating economy.

For them, the annual output of the mines does not mean an increase in riches and does not impel them to offer higher prices. They will continue to live at the standard at which they used to live before. Their spending within these limits will not revolutionize the market. Thus the normal amount of gold production, although certainly increasing the quantity of money available, cannot put into motion the process of depreciation. It is neutral with regard to prices.

As against this reasoning one must first of all observe that within a progressing economy in which population figures are increasing and the division of labor and its corollary, industrial specialization, are perfected, there prevails a tendency toward an increase in the demand for money. Additional people appear on the scene and want to establish cash holdings.

The extent of economic self-sufficiency, i.e., of production for the household's own needs, shrinks and people become more dependent upon the market; this will, by and large, impel them to increase their holding of cash. Thus the price-raising tendency emanating from what is called the "normal" gold production encounters a price-cutting tendency emanating from the increased demand for cash holding.

However, these two opposite tendencies do not neutralize each other. Both processes take their own course, both result in a disarrangement of existing social conditions, making some people richer, some people poorer. Both affect the prices of various goods at different dates and to a different degree. It is true that the rise in the prices of some commodities caused by one of these processes can finally be compensated by the fall caused by the other process. It may happen that at the end some or many prices come back to their previous height.

But this final result is not the outcome of an absence of movements provoked by changes in the money relation. It is rather the outcome of the joint effect of the coincidence of two processes independent of each other, each of which brings about alterations in the market data as well as in the material conditions of various individuals and groups of individuals. The new structure of prices may not differ very much from the previous one. But it is the resultant of two series of changes which have accomplished all inherent social transformations.

The fact that the owners of gold mines rely upon steady yearly proceeds from their gold production does not cancel the newly mined gold's impression upon prices. The owners of the mines take from the market, in exchange for the gold produced, the goods and services required for their mining and the goods needed for their consumption and their investments in other lines of production. If they had not produced this amount of gold, prices would not have been affected by it.

It is beside the point that they have anticipated the future yield of the mines and capitalized it and that they have adjusted their standard of living to the expectation of steady proceeds from the mining operations. The effects which the newly mined gold exercises on their expenditure and on that of those people whose cash holdings step by step it enters later begin only at the instant this gold is available in the hands of the mine owners. If, in the expectation of future yields, they had expended money at an earlier date and the expected yield failed to appear, conditions would not differ from other cases in which consumption was financed by credit based on expectations not realized by later events.

Changes in the extent of the desired cash holding of various people neutralize one another only to the extent that they are regularly recurring and mutually connected by a causal reciprocity. Salaried people and wage earners are not paid daily, but at certain pay days for a period of one or several weeks. They do not plan to keep their cash holding within the period between pay days at the same level; the amount of cash in their pockets declines with the approach of the next pay day.

On the other hand, the merchants who supply them with the necessities of life increase their cash holdings concomitantly. The two movements condition each other; there is a causal interdependence between them which harmonizes them both with regard to time and to quantitative amount. Neither the dealer nor his customer lets himself be influenced by these recurrent fluctuations. Their plans concerning cash holding as well as their business operations and their spending for consumption respectively have the whole period in view and take it into account as a whole.

It was this phenomenon that led economists to the image of a regular circulation of money and to the neglect of the changes in the individuals' cash holdings. However, we are faced with a concatenation which is limited to a narrow, neatly circumscribed field. Only as far as the increase in the cash holding of one group of people is temporally and quantitatively related to the decrease in the cash holding of another group and as far as these changes are self-liquidating within the course of a period which the members of both groups consider as a whole in planning their cash holding, can the neutralization take place. Beyond this field there is no question of such a neutralization.

This article is excerpted from chapter 17 of Human Action: The Scholar's Edition.

His name was Howard Buffett,[1] and he had just unseated Democrat Representative Charles McLaughlin in the 1942 elections. The young man's surprise was evident. After digging into his pockets for a pencil and paper, he finally admitted that "all I fixed up was [a statement] conceding my defeat."[2]

Two years later, he would again cruise to victory on the back of Nebraska's vehement anti–New Deal opinion.[3] Overall, Buffett served four terms in the US House of Representatives, fighting for a return to sound money and against federal interference in the economy and overseas. He is perhaps the best example of an Old Right politician and he deserves the attention of modern libertarians.

Upon arriving in Washington, DC, Buffett was appointed to serve on the House Banking and Currency Committee. It was not long before he took issue with one wartime creation in particular: the Office of Price Administration (OPA). Its job was to impose price controls to stabilize retail consumer prices. By 1946 the war was won but the office remained in operation. Buffett demanded hearings to look into its elimination.

He argued that the OPA had created a "spreading condition of industrial and social chaos." In particular, Buffett noted that the government's price fixing had contributed to

the lumber shortage and the dismantling of mills, accentuating the housing shortage; a steady decline in butter production and its virtual disappearance from normal distribution centers; general disappearance of soybean, corn and other grains from normal trading channels.[4]

That the OPA brought about shortages in the market is unsurprising and in direct agreement with economic theory:[5] Fixing a maximum price allows buyers to purchase a particular good or service for less than what it would sell for in the free market — otherwise there would be no need to put a ceiling on the price.

First, this increases demand for the good or service in question. With the same wealth and income, the buyer sees the lower price and decides that he can afford to increase consumption. While a lucky few will attain the good or service for less than they would have paid, the overall effect is for demand to outstrip supply. Fix the price ceiling low enough and no matter how abundant the good or service might be, excessive demand will create a shortage.

Second, price controls also impact supply as marginal, less-efficient companies are unable to earn a sufficient profit. They cut back on production or go out of business entirely. Economist George Reisman added that the "same price control that drives [the less efficient companies] out of business restricts the profits of the more efficient producers and deprives them of the incentive and also the capital required for expansion." The tendency, then, is for even the best companies to go broke.[6]

Buffett saw the elimination of the small-time producer as a direct result of the OPA's policies. The Chicago Tribune reported Buffett's charge: "Several congressmen during the debate on the extension of the life of OPA mentioned the fact that during three years [1941–1943] of rationing and price regulation 507,100 small businesses became extinct."[7]

An additional concern of those opposed to price controls was the power they gave to central governments over the economic lives of citizens. Once the price system no longer balanced supply and demand, some other mechanism had to decide who got what. Huge lines were one such mechanism: those with the time to wait end up "outbidding" others for the good or service. The other mechanism was cronyism. The well connected avoided the lines and took advantage of political control of the economy to get at supplies first.

Buffett continued to assail the notion of price fixing. Although the OPA was abolished in 1947, it reappeared under the name Office of Price Stabilization during the Korean War. The conflict was different but the economic fallacy remained the same.

Government price controls not only distorted the incentives of entrepreneurs and consumers, but failed to achieve their supposed goal: ending inflation. Interviewed by the New York Times in 1952, Buffett reminded readers that price fixing "is a fake remedy for inflation and makes inflation worse by concealing and postponing its effects. It will ultimately destroy the free market that is the base on which American freedom rests."[8]

Economic common sense, however, was not much appreciated in Washington, DC. In 1948 Drew Pearson of the Washington Post placed Howard Buffett on the "Don't Re-elect" list, calling him "a jack-of-all issues, a run-at-the-mouth politician and bedrock reactionary."[9] It would be hard to find a politician who does not "run-at-the mouth," but it seems clear Buffett had managed to ruffle a few feathers in the press.

Buffett, however, would make his mark in the Old Right talking about what he new best: money. In May 1948, the Commercial and Financial Chronicle ran an article Buffett wrote, entitled "Human Freedom Rests on Gold Redeemable Money." It is among the most cogent and concise arguments against fiat money available.

Buffett began by acknowledging that readers might think it odd to connect freedom, seemingly a political idea, with the economic idea of a gold standard. He noted, however, that "one of the first moves by Lenin, Mussolini and Hitler was to outlaw individual ownership of gold." Americans at the time no doubt quickly connected this to Roosevelt's 1933 decision to suspend private ownership of gold.

The ability to redeem paper currency into gold money, Buffett argued, gave individuals the freedom to move around the world because gold had an accepted value anywhere.[10] By going off the gold standard, a government deprived its citizens of that freedom and prevented them "from laying away purchasing power for the future. [The citizen] becomes dependent upon the goodwill of the politicians for his daily bread."

But more than an exit strategy or protector of independence, Buffett felt the gold standard provided Americans with the only effective check on budgetary excess. As long as the federal government could print as much money as it liked, no politician on earth could resist the temptation to spend.

Buffett compared politics to business. Just as any businessman would throw someone out of his office for suggesting he manufacture a product that could only be sold at a loss, so politicians resist any idea that will lose them votes. With an early appreciation for public-choice theory, Buffett wrote that

Congress is constantly besieged by minority groups seeking benefits from the public treasury. Often these groups control enough votes in many Congressional districts to change the outcome of elections. And so Congressmen find it difficult to persuade themselves not to give in to pressure groups.

Although attentive to the threat of rule by the well-organized minority, Buffett also understood the problem was more systemic. It was not enough to send the right people, people with "intestinal fortitude," to Congress to stop the spending. Fiat money meant that any person, however principled, simply lacked the necessary tools to curb budgetary growth. Buffett explained:

With a restoration of the gold standard, Congress would have to again resist handouts. That would work this way. If Congress seemed receptive to reckless spending schemes, depositors' demands over the country for gold would soon become serious. That alarm in turn would quickly be reflected in the halls of Congress. The legislators would learn from the banks back home and from the Treasury official that confidence in the Treasury was endangered.

Under a gold standard, "printing-press-paper money" can be turned into the bank in exchange for a specified amount of gold. In theory, that specified amount of gold constricts the government's capacity to print more paper money without a corresponding increase in gold. Many times, however, the government cannot resist the temptation to spend and so it bets, in essence, that no one will notice there are more paper dollars circulating than gold in the vaults — that is, no one will notice the inflation.

What Buffett recognized is that once people suspect inflation, they can go to the bank and start exchanging paper for gold. As gold flows out and paper piles up inside the banks, the politicians will have to stop their profligate ways.

While citizens could make a run on the central bank to enforce greater monetary responsibility, foreign governments tended to be the ones to do the job. Economist Murray Rothbard explained that

a country's Central Bank would generate bank credit expansion; prices would rise; and as the new money spread from domestic to foreign clientele, foreigners would more and more try to redeem the currency in gold. Finally, the Central Bank would have to call a halt and enforce a credit contraction in order to save the monetary standard.[11]

In sum, the gold standard "acted as a silent watchdog to prevent unlimited public spending."[12]

By controlling government's ability to expand the money and credit supply, the gold standard kept the inflation tax under wraps. In an address to constituents, Buffett said:

Remember the bank closings up to 1933? And all the money people lost in busted banks? For years those losses — a real tragedy — were favorite campaign oratory of New Dealers. Large as those losses were, they were peanuts compared with the losses now being forced on United States savings bond holders. During 1950 alone United States savings bonds lost $3,600 million in purchasing power. By contrast, all losses by bank depositors from 1921 through 1933 totaled $1,900 million.[13]

While there is no such thing as perfectly stable purchasing power in a dynamic, changing world, the gold standard removed control of it from the political arena. The loss Buffett referred to resulted from government printing notes and issuing credit. The greater amount of money and credit in circulation, the less each individual unit of money or credit can purchase.

The first users of the newly created financial resources benefitted at the expense of later users because they were able to purchase goods and services before their prices increased. In this way, inflation worked as a tax on those further removed from government spending.

Buffett rescued William Graham Sumner's phrase "the Forgotten Man" to describe those suffering from the inflation tax: "far away from Congress," he wrote, "is the real forgotten man, the taxpayer who foots the bill. He is in a different spot from the tax-eater or the business that makes millions from spending schemes."

Buffett made a point of referring to the "real forgotten man," because during the 1930s Franklin D. Roosevelt had stolen Sumner's idea and twisted its meaning. Instead of the taxpayer, Roosevelt used "the forgotten man" to mean the poor and unemployed. Suddenly, rather than condemning government taking the forgotten man's meager resources to finance lavish public-spending programs, Roosevelt's forgotten man justified that taking to support the downtrodden.[14]

The only way the forgotten man could protect his earnings from profligate politicians was to exchange his paper money for gold. That Roosevelt eliminated the individual's "right to protect himself" from inflation seemed to Buffett to endanger the very foundation of the country:

But, unless you are willing to surrender your children and your country to galloping inflation, war and slavery, then this cause demands your support. For if human liberty is to survive in America, we must win the battle to restore honest money. There is no more important challenge facing us than … the restoration of your freedom to secure gold in exchange for the fruits of your labors.[15]

His concern over the government's ambition to plan the economy and strip individuals' right to impose sound fiscal and monetary practices on politicians extended to the realm of foreign affairs. Buffett railed against the state's efforts to scare the citizen into submission. Recalling Mencken's warning that "the whole aim of practical politics is to keep the populace alarmed," Buffett denounced the banging of "war drums" in 1948 during the coup in Czechoslovakia.

In a letter to constituents, he maintained that "the Administration wanted to put through a draft law for compulsory military servitude. They wanted the people frightened — so that Congress could be bludgeoned into ending freedom for our young men. The scare worked."[16]

Roosevelt had signed the first peacetime conscription bill into law in 1940, establishing the Selective Service System.[17] Congress allowed it to expire in 1947, but soon found there were not enough volunteer soldiers to meet the Defense Department's needs. In response, Congress passed the 1948 draft act, to which Buffett objected.

These young men would soon be fighting and dying in Korea and Vietnam. However, in an off-the-record meeting in the spring of 1948, Admiral Hillenkoetter, Chief of the Central Intelligence Agency, had told Buffett that "signs of offensive war by Russia in the foreseeable future were completely lacking." And in public hearings in April of that same year, Senator Stuart Symington said of the selective service bill, "I have not read it very carefully … we are primarily interested in selective service because the army wants it."[18]

The Wall Street Journal criticized Buffett's letter for handing "the Russians as neat a propaganda weapon as they could contrive." The paper went on to admit that while the fears were indeed exaggerated, that fact should not diminish in anyone's eyes the real danger posed by Soviet expansionism. In particular, the Journal chastised Buffett for his "extremism"[19] and explained that his words "can only serve to weaken support for necessary defense. It just gives the Communists new ammunition to convince other peoples that the warmongers are in Wall Street."[20]

Four months later, Buffett was again trying to block America's "march into militarism." He spoke on the House floor against the Truman administration's plan for universal military training.

The Chicago Tribune noted that by committing itself to various mutual defense pacts, stationing six divisions in Europe, having 3.5 million men under arms, sending 200,000 soldiers to the Korean peninsula and requesting the largest defense budget in history (some $52 billion — $353.2 billion in 2008 dollars),[21] the United States was much further along the road to war than in 1941. It also warned that "when the leaders of a nation forge a mighty instrument for war, they do not let it rust out of idleness." [22] This was exactly Buffett's worry.

In November of 1951, Buffett decided not to seek reelection.[23] He returned to work at his investment firm in Omaha until his death in 1964. In his free time, Buffett still pushed for those policy issues dear to his heart. Two years after leaving the House of Representatives, Buffett joined the nonprofit organization For America, which promoted peace and national defense, opposed "all forms of totalitarianism," and hoped to "preserve solvency, sovereignty, freedom and independence of the United States."[24]

$24 $20

Former Sears Roebuck & Co. chairman Gen. Robert E. Wood and Notre Dame University law professor Clarence E. Manion were the founders of For America. Other members included Chicago Tribune editor Roger McCormick, a vehement anti–New Dealer, and Frank Chodorov, publisher of the monthly broadsheet Analysis and author of what would become a classic libertarian text, The Income Tax: Root of All Evil, released in 1952.[25] What is most interesting about For America is that, ten years later, Clarence Manion became the driving force persuading Barry Goldwater to run for president; and Goldwater then relied on Robert Wood for help.

Overall, in his staunch defense of economic liberty, the gold standard, and noninterventionism, Howard Buffett was an exemplary member of the Old Right.

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[1] Father of superinvestor and billionaire Warren Buffett.

[2] "Republican Prepares Speech Conceding Defeat; Wins Race," The Atlanta Constitution, November 6, 1942.

[3] Arthur Evans, "Nebraska Again is Expected to go Republican: Anti–New Deal Tide at Its Crest There," Chicago Daily Tribune, September 22, 1944.

[4] The Wall Street Journal - Washington Bureau, "Congressman Demands Price Control Hearings Be Started Immediately: Rep. Buffett Says OPA Has Created 'Social Chaos' Wants Action Before British Loan," January 21, 1946.

[5] It is important to distinguish between "shortages" and "scarcity." See George Reisman, The Government Against the Economy (Ottawa, Illinois: Jameson Books, 1979) pp. 63–64.

[6] For more, see Ludwig von Mises, Human Action: A Treatise on Economics (San Francisco: Fox & Wilkes, 1996) pp. 758–767.

[7] "Mortality of Small Business under OPA," Chicago Daily Tribune, July 12, 1945. Other than going belly-up, businesses struggling under price controls also look to evade them. One way is to manufacture an inferior product, switching to lower-quality ingredients, but sell it as the same. To this day, my grandmother complains about the difference in taste between pre– and post–World War II Hersey bars.

Another method is called a "tie-in sale": Rutgers University professor Hugh Rockoff gave the example that to "buy wheat flour at the official price during World War I, consumers were often required to purchase unwanted quantities of rye or potato flour." See Hugh Rockoff, "Price Controls," The Concise Encyclopedia of Economics (Library of Economics and Liberty, 2008).

[8] "Food Independent has Bulk of Sales: Head of Grocers' Group Puts the National Percentage at Nearly Two-Thirds," New York Times, June 24, 1952.

[9] Drew Pearson, "Don't Re-elect' List Given Voters," The Washington Post, October 26, 1948.

[10] In defining the gold standard, Murray Rothbard added an important caveat:

When [the United States] was "on the gold standard" before 1933, people liked to say that the "price of gold" was "fixed at twenty dollars per ounce of gold." But this was a dangerously misleading way of looking at our money. Actually, "the dollar" was defined as the name for (approximately) 1/20 of an ounce of gold.

Murray Rothbard, What Has Government Done to Our Money (Auburn, Alabama: The Ludwig von Mises Institute, 2005), p. 19.

[11] Ibid.

[12] Howard Buffett, "Human Freedom Rests on Gold Redeemable Money," The Commercial and Financial Chronicle, May 6, 1948 (New York: Foundation for the Advancement of Monetary Education) p. 3.

[13] William Henry Chamberlin, "Shadow and Substance: A Stable Dollar is Infinitely More Important than Cheap Money Policy, Whose Principal Victim is the Saver," Wall Street Journal, April 10, 1951, p. 6.

[14] For more, see Amity Shlaes, The Forgotten Man: A New History of the Great Depression (New York: HarperCollins, 2007).

[15] Howard Buffett, "Human Freedom Rests on Gold Redeemable Money."

[16] "Buffett's Buffeting," The Washington Post, October 29, 1951.

[17] This term is among the most egregious examples of state euphemisms. It drove Old Rightists like H. L. Mencken crazy, though perhaps George Orwell put it best in his 1946 essay "Politics and the English Language":

Such phraseology is needed if one wants to name things without calling up mental pictures of them.

[18] Albert Bofman, "Voice of the People: An Uninformed Expert," Chicago Daily Tribune, July 17, 1953.

[19] It is interesting to note the choice of the word "extremism" here, keeping in mind this is exactly how the press later labeled Goldwater during the 1964 election.

[20] "Buffett's Buffeting."

[21] Samuel H. Williamson, "Six Ways to Compute the Relative Value of a U.S. Dollar Amount, 1790 to Present," Measuring Worth, 2009.

[22] "Formula for War," Chicago Daily Tribune, February 27, 1952.

[23] "Nebraska Rep. Buffett Won't Seek Reelection," The Washington Post, November 24, 1951.

[24] "43 Prominent Citizens Join For America Policy Group," Chicago Daily Tribune, November 14, 1954.

[25] For a brief overview of Chodorov's life see Murray Rothbard, "Who is Frank Chodorov," (Auburn, Alabama: The Ludwig von Mises Institute).

Most people take it for granted that the world will never return to the gold standard. The gold standard, they say, is as obsolete as the horse and buggy. The system of government-issued fiat money provides the treasury with the funds required for an open-handed spending policy that benefits everybody; it forces prices and wages up and the rate of interest down and thereby creates prosperity. It is a system that is here to stay.

Now whatever virtues one may ascribe — undeservedly — to the modern variety of the greenback standard, there is one thing that it certainly cannot achieve. It can never become a permanent, lasting system of monetary management. It can work only as long as people are not aware of the fact that the government plans to keep it.

The alleged advantages that the champions of fiat money expect from the operation of the system they advocate are temporary only. An injection of a definite quantity of new money into the nation's economy starts a boom as it enhances prices. But once this new money has exhausted all its price-raising potentialities and all prices and wages are adjusted to the increased quantity of money in circulation, the stimulation it provided to business ceases.

Thus even if we neglect dealing with the undesired and undesirable consequences and social costs of such inflationary measures and, for the sake of argument, even if we accept all that the harbingers of "expansionism" advance in favor of inflation, we must realize that the alleged blessings of these policies are shortlived. If one wants to perpetuate them, it is necessary to go on and on increasing the quantity of money in circulation and expanding credit at an ever-accelerated pace. But even then the ideal of the expansionists and inflationists, viz., an everlasting boom not upset by any reverse, could not materialize.

A fiat-money inflation can be carried on only as long as the masses do not become aware of the fact that the government is committed to such a policy. Once the common man finds out that the quantity of circulating money will be increased more and more, and that consequently its purchasing power will continually drop and prices will rise to ever higher peaks, he begins to realize that the money in his pocket is melting away.

Then he adopts the conduct previously practiced only by those smeared as profiteers; he "flees into real values." He buys commodities, not for the sake of enjoying them, but in order to avoid the losses involved in holding cash. The knell of the inflated monetary system sounds. We have only to recall the many historical precedents beginning with the Continental currency of the War of Independence.

The fiat-money system, as it operates today in this country and in some others, could avoid disaster only because a keen critique on the part of a few economists alerted public opinion and forced upon the government cautious restraint in their inflationary ventures. If it had not been for the opposition of these authors, usually labeled orthodox and reactionary, the dollar would long since have gone the way of the German mark of 1923. The catastrophe of the Reich's currency was brought about precisely because no such opposition was vocal in Weimar Germany.

Champions of the continuation of the easy money scheme are mistaken when they think that the policies they advocate could prevent altogether the adversities they complain about. It is certainly possible to go on for a while in the expansionist routine of deficit spending by borrowing from the commercial banks and supporting the government bond market.

But after some time it will be imperative to stop. Otherwise the public will become alarmed about the future of the dollar's purchasing power and a panic will follow. As soon as one stops, however, all the unwelcome consequences of the aftermath of inflation will be experienced. The longer the preceding period of expansion has lasted, the more unpleasant those consequences will be.

The attitude of a great many people with regard to inflation is ambivalent. They are aware, on the one hand, of the dangers inherent in a continuation of the policy of pumping more and more money into the economic system. But as soon as anything substantial is done to stop increasing the amount of money, they begin to cry out about high interest rates and bearish conditions on the stock and commodity exchanges. They are loath to relinquish the cherished illusion which ascribes to government and central banks the magic power to make people happy by endless spending and inflation.

The main argument advanced today against the return to the gold standard is crystallized in the slogan "full-employment policy." It is said that the gold standard paralyzes efforts to make unemployment disappear.

On a free labor market the tendency prevails to fix wage rates for every kind of work at such a height that all employers ready to pay these wages find all the employees they want to hire, and all job-seekers ready to work for these wages find employment. But if compulsion or coercion on the part of the government or the labor unions is used to keep wage rates above the height of these market rates, unemployment of a part of the potential labor force inevitably results.

Neither governments nor labor unions have the power to raise wage rates for all those eager to find jobs. All they can achieve is to raise wage rates for the workers employed, while an increasing number of people who would like to work cannot get employment. A rise in the market wage rate — i.e., the rate at which all job seekers finally find employment — can be brought about only by raising the marginal productivity of labor. Practically, this means by raising the per-capita quota of capital invested.

Wage rates and standards of living are much higher today than they were in the past because under capitalism the increase in capital invested by far exceeds the increase in population. Wage rates in the United States are many times higher than in India because the American per-capita quota of capital invested is many times higher than the Indian per-capita quota of capital invested.

There is only one method for a successful "full-employment policy" — let the market determine the height of wage rates. The method that Lord Keynes has baptized "full-employment policy" also aimed at reestablishment of the rate which the free labor market tends to fix. The peculiarity of Keynes's proposal consisted in the fact that it proposed to eradicate the discrepancy between the decreed and enforced official wage rate and the potential rate of the free labor market by lowering the purchasing power of the monetary unit. It aimed at holding nominal wage rates, i.e., wage rates expressed in terms of the national fiat money, at the height fixed by the government's decree or by labor union pressure.

But as the quantity of money in circulation was increased and consequently a trend toward a drop in the monetary unit's purchasing power developed, real wage rates, i.e., wage rates expressed in terms of commodities, would fall. Full employment would be reached when the difference between the official rate and the market rate of real wages disappeared.

There is no need to examine anew the question whether the Keynesian scheme could really work. Even if, for the sake of argument, we were to admit this, there would be no reason to adopt it. Its final effect upon the conditions of the labor market would not differ from that achieved by the operation of the market factors when left alone. But it attains this end only at the cost of a very serious disturbance in the whole price structure and thereby the entire economic system.

The Keynesians refuse to call "inflation" any increase in the quantity of money in circulation that is designed to fight unemployment. But this is merely playing with words. For they themselves emphasize that the success of their plan depends on the emergence of a general rise in commodity prices.

It is, therefore, a fable that the Keynesian full-employment recipe could achieve anything for the benefit of the wage earners that could not be achieved under the gold standard. The full-employment argument is as illusory as all the other arguments advanced in favor of increasing the quantity of money in circulation.

A popular doctrine maintains that the gold standard cannot be preserved by a country with what is called an "unfavorable balance of payments." It is obvious that this argument is of no use to the American opponents of the gold standard. The United States [1953] has a very considerable surplus of exports over imports. This is neither an act of God nor an effect of wicked isolationism. It is the consequence of the fact that this country, under various titles and pretexts, gives financial aid to many foreign nations. These grants alone enable the foreign recipients to buy more in this country than they are selling in its markets.

In the absence of such subsidies it would be impossible for any country to buy anything abroad that it could not pay for, either by exporting commodities or by rendering some other service such as carrying foreign goods in its ships or entertaining foreign tourists. No artifices of monetary policy, however sophisticated and however ruthlessly enforced by the police, can in any way alter this fact.

It is not true that the so-called have-not countries have derived any advantage from their abandonment of the gold standard. The virtual repudiation of their foreign debts, and the virtual expropriation of foreign investments that it involved, brought them no more than a momentary respite. The main and lasting effect of abandoning the gold standard, the disintegration of the international capital market, hit these debtor countries much harder than it hit the creditor countries. The falling off of foreign investments is one of the main causes of the calamities they are suffering today.

The gold standard did not collapse. Governments, anxious to spend, even if this meant spending their countries into bankruptcy, intentionally aimed at destroying it. They are committed to an antigold policy, but they have lamentably failed in their endeavors to discredit gold. Although officially banned, gold in the eyes of the people is still money, even the only genuine money.

The more prestige the legal tender notes produced by the various government printing offices enjoy, the more stable their exchange ratio is against gold. But people do not hoard paper; they hoard gold. The citizens of this country, of course, are not free to hold, to buy, or to sell gold.This right to own gold was restored to US citizens as of January 1, 1975. If they were allowed to do so, they certainly would.

No international agreements, no diplomats, and no supernational bureaucracies are needed in order to restore sound monetary conditions. If a country adopts a noninflationary policy and clings to it, then the condition required for the return to gold is already present. The return to gold does not depend on the fulfillment of some material condition. It is an ideological problem. It presupposes only one thing: the abandonment of the illusion that increasing the quantity of money creates prosperity.

The excellence of the gold standard is to be seen in the fact that it makes the monetary unit's purchasing power independent of the arbitrary and vacillating policies of governments, political parties, and pressure groups. Historical experience, especially in the last decades, has clearly shown the evils inherent in a national currency system that lacks this independence.

This article was originally published in the Freeman, July 13, 1953.

I discovered the writings of economists such as Ludwig von Mises, F.A. Hayek, Murray N. Rothbard, and Hans F. Sennholz. I gradually found the answers I had been searching for. Even for the experts, it literally took centuries to fully understand the nature of money and the business cycle. (p. 43)

During his service in the Air Force, Dr. Paul was able to hear Mises speak, and when in Congress he met with Hayek. "I had the pleasure of hearing Hayek lecture in Washington, around 1980. Following that meeting, we had a private dinner together and spent several hours visiting." (p. 51)

But the principal economist who influenced him was Murray Rothbard.

Of all the Austrian economic greats of the twentieth century, I got to know Murray Rothbard the best.… I recall his surprise when he found out I had read his essay "Gold and Freely Fluctuating Exchange Rates."… If there's one book that the Washington establishment should read now, it's Rothbard's book America's Great Depression. In this book, he demonstrates that it was the Fed that created the late-1920s boom that led to bust, and Hoover's interventions that prolonged the Great Depression. (pp. 57–8)

The last remark begins to suggest a key reason that the Fed should be abolished. Far from being a means to maintain monetary stability, as its supporters falsely insist, the Fed, through the expansion of bank credit, is the primary cause of the business cycle.

The expansion temporarily lowers the money rate of interest below the true market rate, largely determined by people's time preference, i.e., their preference for present over future goods. Businesses, with money available, expand; but the new projects cannot be sustained. When the monetary expansion ceases (if it doesn't, we will have hyperinflation, with disastrous consequences), these new investments must be liquidated. The process of doing so is the depression.

As Dr. Paul aptly remarks,

The Fed can indeed provide liquidity in these times [of credit contraction] by a simple operation of printing more paper money to cover deposits. But if you think of the cycle as beginning in the boom phase — when money and credit are loose and lending soars to fund unsustainable projects — matters change substantially.…

When central banks push down [interest] rates on a whim, the impression is created that savings are there when they are in fact completely absent. The resulting bust becomes inevitable as goods that come to production can't be purchased, and reality sets in by waves. Businesses fail, homes are foreclosed upon, and people bail out of stocks or whatever the fashionable investment is of the day. (pp. 29–30)

Instead of the Fed and its false claim that we need an "elastic" currency, we should instead remove government entirely from the creation of money. In a free society, money would be a commodity; most likely that commodity would be gold.

In fact, I'm only observing reality: the idea of sound money in most of human history has been bound up with gold money. Can there be sound money without a gold standard? In principle, yes. And I'd be very happy for a system that would permit markets to once again choose the most suitable money, whatever that turns out to be. I'm not for government imposing any particular standard: no central bank, no legal tender, no privilege for any commodity chosen as a backing for the currency. (p. 71)

Dr. Paul has presented the Austrian view of money in a succinct, accurate, and effective way; but what justifies the claim that he offers insights available nowhere else? Are there not many excellent books and articles that explain the views of Mises and Rothbard on money; not least the works of those two economists themselves? The answer arises from Dr. Paul's many years of service in Congress. In that capacity, he has had conversations with several Fed chairmen, and one of these conversations enables us to solve a mystery.

Alan Greenspan epitomizes the control of the money supply by government. But is this not at first sight surprising? Greenspan was a follower of Ayn Rand and shared her devotion to laissez-faire capitalism. In an essay written for the Objectivist newsletter, reprinted in Capitalism: The Unknown Ideal, Greenspan offered a strong defense of the gold standard. The vital advantage of the gold standard, Greenspan explained, is that it prevents the government from manipulating the money supply:

In the absence of the gold standard, there is no way to protect savings from confiscation through inflation.… 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. (p. 81)

Greenspan, amazingly, told Dr. Paul "that he had just recently reread it [the article] and wouldn't change a word of it." (p. 86). How could Greenspan say this, while presiding over a system that embodies the government control of money that his article repudiated? Greenspan thought that he could conduct the financial system in the same way as the gold standard would operate.

I [Greenspan] think that you will find … that the most effective central banks in this fiat money period tend to be successful largely because we tend to replicate that which would have probably have occurred under a commodity standard in general. (p. 88)

In other words, we need to remove government from the money supply, unless, of course, I and people like me are in control. Greenspan's position brings to mind a Jewish tradition about King Solomon; he thought that the restrictions imposed in Deuteronomy (17: 16–17) on kings about wives and horses did not apply to him.

As the wisest of men, Solomon believed he knew the reasons for these restrictions, so he could avoid the temptations that the rules guarded against and take more wives and horses than allowed. His overweening arrogance led to disaster, and Greenspan fell victim to the same syndrome.

Dr. Paul does not regard Greenspan as the wisest of the Fed chairmen he met. "I had the most interaction with [Paul] Volcker. He was more personable and smarter than the others, including the more recent board chairmen Alan Greenspan and Ben Bernanke" (p. 48).

For Bernanke, it is clear that Dr. Paul has a deep distaste. He suspects that Bernanke has acted in secret to manipulate the price of gold, and he bristles at Bernanke's refusal to disclose his operations to Congress.

So when Bernanke quickly refuses to give us information about the trillions of dollars of credit that he recently passed out in the bailout process because that would be "counterproductive," he is really saying, "It's none of your business." (p. 174)

The book recounts remarkable conversations with others besides Fed chairmen. When Ron Paul served on the Gold Commission in Ronald Reagan's administration, he on one occasion flew by helicopter with the president to Andrews Air Force Base.

"Ron," the president told me, "no great nation that abandoned the gold standard has remained a great nation." He indeed was sympathetic, as he was to many libertarian constitutional ideas, but he was also swayed by staff pressure to be pragmatic on most issues. (p. 74)

Reagan, it is apparent, could not break with the illusion that the government needs to be in control. That illusion is avidly propagated by those who profit from it. One such was the notorious George R. Brown, a longtime backer of Lyndon Johnson. Brown displayed interest in Dr. Paul's campaign for Congress in 1976, and in one conversation told him,

"Remember, for the economic system to work, business and government must be partners." I cringed and quickly scooted out the door.… Once I was in office and after my votes and positions became known, the message was clear, and I never heard from him again. (p. 159)

Dr. Paul's fight for freedom has not been confined to the issue of sound money. He has also led the struggle against interventionist and imperialist foreign policy. But the fight for liberty is seamless, and he shows that an aggressive foreign policy depends on government control of the money supply:

It is no coincidence that the century of total war coincided with the century of central banking. When governments had to fund their own wars without a paper money machine to rely upon, they economized on resources. They found diplomatic solutions to prevent war, and after they started a war they ended it as soon as possible. (p. 63)

The book contains an abundance of other arguments against our current monetary system, e.g., that it violates the Constitution. Readers will discover Thomas Paine's poor opinion of paper money, and even how monetary debasement helped bring the Byzantine Empire to ruin. Those who have absorbed the book's message will come to a clear conclusion: End the Fed.

I choose these examples not to pick on these authors. I could have just as easily chosen a hundred other examples: the vast majority of analysts who cover the gold market focus on mine supply as one of the main drivers of gold-price forecasts. I use these examples only to illustrate the ubiquity of this view.[1] However, while analysts need something to analyze — and the mining industry provides many analytical complexities — ultimately, their efforts are wasted. Mine supply has very little influence on the price of gold.

Anyone who agrees that the gold trade is a market would accept the premise that the price depends on supply and demand. Where most analysts go wrong is to analyze gold using what I will call the consumption model. This model counts the current year's mine production plus scrap (and, in some versions, central-bank sales) as supply, and the current year's purchases of jewelry, coins, bars, and industrial gold as demand.

The consumption model is good way to forecast the price of a commodity that meets two conditions:

it is destructively consumed (or spoils), and

the annual production of the commodity is large in relation to existing, above-ground stockpiles.

Oil is a good example of a commodity that meets these conditions. It is refined and then irreversibly combusted. The oil price must enable the market to clear more-or-less current production with current consumption, buffered only by the oil sitting on tankers and in underground reserves. Reserves cannot do not hold more than a few months' supply, due to the high rate of oil consumption in relation to the storage capacity.

The consumption model does not explain price formation of a commodity where the two conditions are not met, because owners of the existing stocks own much more of the commodity than the producers bring to market. Consequently, they have far more influence over the price than do producers. Gold is the best example of such a commodity: gold is not consumed; people buy it in order to hold it; gold has the largest ratio of stock to annual production of any commodity.

In fact, it is estimated that nearly all of the gold ever mined in human history still exists. This supply grows by only 1 to 2 percent on an annual basis; or, if we look at the ratio from the other side, approximately 50–100 times the annual mine production is held in stockpiles.[2]

The consumption model would hold true if each year's gold were segregated into its own market, with no arbitrage from previous years' markets. But this is not the case: everyone who is buying, selling, and holding forms a single, integrated market. A buyer doesn't care whether he receives gold mined within the past year.[3] Gold miners are competing with all of the holders of gold stockpiles when they sell. Contrary to the consumption model, the price of gold does clear the supply of recently mined gold against coin buyers; it clears all buyers against all sellers and holders. The amount of gold available at any price depends largely on the preferences of existing gold owners, because they own most of the gold.

Looking at the supply side of the market, each ounce in someone's stockpile is for sale at some price. The offered price of each ounce is distinct from that of each other ounce, because each gold owner has a minimum selling price, or "reservation price," for each one of their ounces. The demand for gold comes from holders of fiat money who demand gold by offering some quantity of money for it. In the same way that every ounce of gold is for sale at some price, every dollar would be sold if a sufficient volume of goods were offered in exchange. While some dollar owners are not interested in owning gold at any price, those who are interested have a maximum buying price for each ounce that they might purchase. You can think of their buying prices for gold ounces as their reservation price for holding dollars.

Rothbard provides a detailed, bottom-up analysis of price formation in a market like this. I will demonstrate his model with a sequence of diagrams that show how the dollar price of gold is formed. As a first step, suppose that while gold trading had been suspended for some time, the preferences of some of the gold owners and nonowners changed. Thus, when the market opens, some of them wish to buy while others wish to sell.

Rothbard constructs supply and demand curves using the reservation prices of the individual buyers and sellers. The supply curve at each price is the total amount of gold ounces for sale by all gold owners at or above that price. The demand curve at each price is the total amount gold ounces that could be purchased with the dollars offered at that price (or below that price). The market-clearing price is that point where supply and demand are balanced.

When trading opened, the market participants would converge on market-clearing price. Once a price had been established, all of the buyers offering at or above that price would buy, and the all of the sellers asking at or below that price would sell. Trading would continue until no one wanted to exchange gold for dollars or dollars for gold. At that point in time, the market will have cleared. Supply and demand curves would be as they are in Figure 2.

After trading, everyone has adjusted gold and dollar balances to their preferred levels. The market would show two quoted prices for gold: the best bid and the best offer. The best bid is the price offered by the marginal nonbuyer of gold, and the best offer is the price asked by the marginal nonseller of gold. More trading could occur only if a buyer increased their bid price, or a seller decreased their ask price, for at least one ounce.

Suppose that, from this new starting point, one gold owner lowered his asking price for one of his ounces below the best offer of the most marginal seller. A trade would then take place between the gold owner and the marginal seller. What would the situation be after the trade? The same as before, except that the best bid and best offer prices might be different. The new prices would depend on the reservation price of the buyer of the single ounce. If his reservation price were above the best bid but below that of the next most marginal seller, then the new buyer would become the marginal seller and would set the best offer price. But his reservation price might be much higher — enough to make another one of the existing gold owners the new marginal seller.

The miner is different from other gold owners in that he produces gold, while the other owners bought their gold. But from a price-formation standpoint, it doesn't matter how or where it came from; the miner can choose a reservation price, or not. Most miners do not have a reservation price; they sell at market.[4]

The gold analysts and I agree that, in a market, the marginal buyer and seller set the prices. It is also true that the miner is always a marginal seller because they sell at market. However, the entire population of suppliers and demanders must be considered in order to identify who the marginal buyers are and the price where the trades take place. All of the demanders influence the price through their decision not to offer a higher price. All of the (nonmine) suppliers influence the price through their decision not to ask for a lower price. To sell at market means to sell at the price set largely by those buyers and sellers who do have reservation prices. The problem with the consumption model is that it ignores the influence of the majority of sellers on the price.

How does the presence of sellers selling at market affect the price? The miner's presence affects the supply curve as shown in Figure 3.

Some trades will take place below what was the best bid before the miner entered the market, as shown in Figure 4.

Once the miner has sold his stocks, we are back to the situation shown in Figure 2. What was the freshly mined gold is part of the new buyer's stockpile. There will be a new bid and ask price, which will take into account the reservation price of the person who bought the miner's gold. We cannot say what the new bid and ask will be: either could be above or below the price before the miner sold.

Now that I've explained how the price of gold is determined in the market, I will look at two of the objections I have received when I have presented the ideas above:

If gold buyers typically have long holding periods, then is gold like oil that was burned or corn that was eaten? Is it gone forever and not part of the market?

Every asset is for sale at some price. While many small gold coin and bar buyers have a reservation price that is more than $10 above today's price, they do have a reservation price. There is a point at which other assets (stocks or bonds) or consumption goods (cars or houses) would start to look more attractive than holding the marginal ounce of gold. There can be no doubt that a good many gold owners would become sellers at $5,000, $10,000, or $100,000 per ounce.

On closer examination, this is not really an argument: it is only a restatement of the definition of price. A price in a cleared market is that quantity of money below which nothing is offered for sale. While this is true, it does not provide any information about what the price will be. As discussed above, the price at which the first mined ounce is sold is set by the marginal nonseller and nonbuyers of gold.

Suppose, for example, that all of the gold owners had a reservation price of $5,000 or higher per ounce, with the buy prices of people holding dollars remaining where they are now. If that were the case, then once miners had sold their gold, gold would be offered at around $5,000 per ounce.

$20 $14

While mining doesn't have much impact on the gold price, the reverse is not true: the gold price has significant influence on the mining industry. The economics of mining explains this. The cost of getting the gold out of the ground is sensitive to several factors, including the grade of the deposit, its depth below the surface, proximity to refining infrastructure, the cost of energy, the cost of labor, and other variables. The marginal cost of mining more gold above current production rises rather sharply. It would not be profitable for the gold-mining industry to increase production enough to have much impact on the total gold supply during any given year.

The consumption model of gold pricing ignores the influence of the majority of sellers on the price of gold. It counts only a minority of the sellers. The consumption model does include "scrap sales" (sales by those sellers whose reservation price was low enough to result in a sale). But the suppliers who did not sell outnumber those who did — by a large margin — and the selling price of those who did sell was primarily determined by those who did not.

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[1] The sole exception that I can think of is a report from Credit Agricole, authored by Paul Mylchreest.

[2] You must register with the World Gold Council to download their supply and demand data. For a comprehensive set of statistics, including the total above-ground stockpiles, see Gold Market Knowledge.

[3] The time window of one year is entirely arbitrary — why not one week?

[4] Some miners sell at a predetermined price because they have entered into hedging contracts. This price could be above or below the market. Other miners (though very few) do have a reservation price. These miners stockpile gold if it is above their reservation price.

The present worldwide inflation has done, and will continue to do, immense harm. But it may eventually lead to one great achievement. It may make it possible to restore (or perhaps it would be more accurate to say to create) a full 100 percent gold standard.

That could come about in a simple manner. Our government has made it once more legal to hold gold, to trade in gold, and to make contracts in terms of gold. This makes it possible for private individuals to buy and sell in terms of gold, and therefore to restore gold as a medium of exchange. If our present inflation, as seems likely, continues and accelerates, and if the future purchasing power of the paper dollar becomes less and less predictable, it also seems probable that gold will be more and more widely used as a medium of exchange. If this happens, there will then arise a dual system of prices — prices expressed in paper dollars and prices expressed in a weight of gold. And the latter may finally supplant the former. This will be all the more likely if private individuals or banks are legally allowed to mint gold coins and to issue gold certificates.

But even of the small number of monetary economists who favor a return to a gold standard, probably less than a handful accept the idea of such a 100 percent gold standard. They want a return, at best, to the so-called classical gold standard — that is, the gold standard as it functioned from about the middle of the nineteenth century to 1914. This did work, one must admit, incomparably better than the present chaos of depreciating paper monies. But it had a grave weakness: it rested on only a fractional gold reserve. And this weakness eventually proved its undoing.

The advocates of the fractional gold standard, however, saw — and still see — this weakness as a strength. They contend that a pure gold standard was and is impossible, that there is just not enough gold in the world to provide such a currency. Moreover, a pure gold standard, they argue, would be unworkably rigid. On the other hand, a fractional reserve system, they say, is flexible; it can be adjusted to "the needs of business"; it provides an "elastic" currency.

We will come back to these alleged virtues later and examine them in detail; but first I should like to call attention to the central weakness of a fractional reserve system: it embodies a long-term tendency to inflation.

Let us begin with a hypothetical illustration. Suppose we have a world in which the leading countries have been maintaining a 100 percent gold standard, that they begin to find this very confining, and that they decide to adopt a fractional gold standard requiring only a 50 percent gold reserve against bank deposits and bank notes.

The banks are now suddenly free to extend more credit. They can, in fact, extend twice as much credit as before. Previously, assuming they were lent up, they had to wait until one loan was paid off before they could extend another loan of similar size. Now they can keep extending more loans until the total is twice as great. The new credit, plus competition, causes them to lower their interest rates. The lower interest rates tempt more firms to borrow, because the lower costs of borrowing make more projects seem profitable than seemed profitable before. Credit increases, projects increase, and there is a "boom."

So reducing the gold reserve requirement from 100 percent to 50 percent, it appears, has been a great success. But has it? For other consequences have followed besides those just outlined. Production has been stimulated to some extent by lowering the reserve requirement; but production cannot be increased nearly as fast as credit can be. So as a result of increasing the credit supply, most prices have practically doubled. Twice the credit does not "do twice the work" as before, because each monetary unit now does, so to speak, only half the work it did before. There has been no magic. The supposed gain from doubling the nominal amount of money has been an illusion.

And this illusion has been bought at a price. Lowering the required gold reserve to 50 percent has enabled the banks to double the volume of credit. But as they begin to approach even the new credit limit, available new credit becomes scarce. Some banks have to wait for old loans to be paid off before they can grant new ones. Interest rates rise. New projects have to be abandoned, as well as some incomplete projects that have already been launched. A recession sets in, or even a financial panic.

And then, of course, the proposal is made that the simple way out is to reduce the gold-reserve requirement once again, so as to permit a still further creation of credit.

Historically, this is exactly what has been happening. Space does not permit a detailed review of what has happened in one nation after another, starting, say, after the adoption in England of Sir Robert Peel's Bank Act of 1844. But we can point to a few sample changes in our own country, beginning with the Federal Reserve Act of 1913.

That act set up twelve Federal Reserve Banks and made them the repositories for the cash reserves of the national banks. The first thing that was done was to reduce the reserve requirements of these commercial banks. Under the national banking system the banks had been classified according to the size of the city in which they were located. They were Central Reserve City Banks, Reserve City Banks, and Country Banks. These were required to keep reserves, respectively, of 25 percent of total net deposits (all in the bank's own vaults), 25 percent of total net deposits (at least half in the bank's own vaults), and 15 percent of total net deposits (two-fifths in the bank's own vaults).

The Federal Reserve Act classified deposits into two categories, demand and time, with separate reserve requirements for each. For demand deposits the act reduced the reserve requirements to 18 percent for Central Reserve City Banks, 15 per cent for Reserve City Banks, and 12 percent for Country Banks. In each case at least one-third of the reserve was to be kept in the bank's own vaults. For time deposits the reserve was only 5 percent for all classes of banks.

In 1917, as an aid in floating government war loans, the reserve requirements were further relaxed, to 13, 10, and 7 percent respectively, with only a 3 percent reserve requirement for time deposits. Though the amendment also required that all reserve cash should thereafter be held on deposit with the Federal Reserve Banks, the amount of till or vault cash necessary to meet daily withdrawals was found to be small.

In addition to this lowering of the reserve requirements of the member banks, the Federal Reserve System provided for the building of a second inverted credit pyramid on top of the one that the member banks could build. For the Federal Reserve Banks themselves were authorized to issue note and deposit liabilities against their gold reserves, which were required to total only 35 percent against deposits.

As a result of such changes, if the average reserves held by the commercial banks against their deposits were taken as 10 percent, and the gold reserves held by the System against these reserves at 35 percent, the actual gold held against the commercial deposits of the System could be reduced to as low as 3.5 percent.

What actually did happen is that, between 1914 and 1931, total net deposits of member banks increased from $7.5 billion to $32 billion, or more than 300 percent in less than two decades.Money and Man, by Elgin Groseclose

These figures continued to grow. Gold reserve requirements were finally removed altogether. In August 1971, when the United States officially went off the gold standard, the money stock, as measured by combined demand and time deposits plus currency outside of banks, was $454.5 billion. The US gold reserves were then valued at $10.2 billion. This meant that the money stock of the country had been multiplied more than sixty times over that of 1914, and the gold reserve against this money stock had fallen to only 2.24 percent. Put another way, there was then $44 of bank credit issued against every $1 of gold reserves.

The situation was actually more ominous than these figures suggest. For under the gold-exchange system of the International Monetary Fund, it was not merely the American dollar, but the total currencies of practically all the nations in the Fund, that were supposed to be ultimately convertible into the US monetary gold stock. The miracle is not that this gold exchange system collapsed altogether in August of 1971, but that it did not do so much sooner.

In short, the fractional gold standard tends almost inevitably to become more and more attenuated, and while it does so it permits and encourages progressive inflation.

When the gold standard is abandoned completely and officially, inflation usually accelerates. This has been illustrated in the more than seven years since August 1971. At the end of 1978, the money stock, counting both demand and time deposits, had risen to $871 billion — nearly double the figure at which it stood in August 1971.

But what happens — as long as the fractional gold standard is being nominally maintained — is that the milder rate of inflation is less noticed, and even many monetary economists are inclined to view it with complacency. This is partly because they have a reassuring theory of what is happening. The amount of currency and credit, they say, is responding to the "needs of business." The loans on which the deposits or Federal Reserve Notes are based represent "real goods." A manufacturer of widgets, for example, borrows a six-month loan from his bank to meet his payroll and other production costs, then when he sells his goods he pays off the loan with the proceeds, and the credit is cancelled. It is "self-liquidating." The money is therefore "sound"; it cannot be overissued, because it increases and contracts with the volume of business activity.

What this theory overlooks is that while the individual loan may be self-liquidating, this is not what happens to the total volume of credit outstanding. Manufacturer Smith's loan has been repaid. But under the fractional reserve system, the bank, as a result of this repayment, now has "excess reserves," which it is entitled to relend. Of course if the bank is fully lent up, even under a fractional reserve system, it cannot extend credit further. But when a substantial number of banks are seen to be nearing this point, pressure comes from all sides — from the banks and their would-be borrowers, and from the government monetary authorities and the politicians who have appointed them — to lower the reserve requirements further. If nothing has gone wrong so far with the existing fractional reserve, indeed, there seems to be no harm in reducing the fraction further. It will permit a further expansion of credit, reduce interest rates, and prevent a threatened business recession.

In sum, to repeat, a fractional-reserve gold system, once accepted, must periodically bring about business and political pressure for a further reduction of the fractional reserve required.

We have now to examine the harm that the system does whether or not the pressure to reduce the reserve requirements is continuously successful.

Let us begin with a situation in, say, Ruritania, which has a fractional-reserve gold standard and a central bank, but in which business activity has not been fully satisfactory. The central bank then either lowers the discount rate or creates more member-bank reserves by buying government securities or it does both. As a result, business is encouraged to increase its borrowing and to launch on new enterprises, and the banks are now able to extend the new credit demanded.

As a consequence of the increased supply of money and credit, prices in Ruritania rise, and so do employment and money incomes. As a further result, Ruritanians buy more goods from abroad. As another result, Ruritania becomes a better place to sell to and a poorer place to buy from. It therefore develops an adverse balance of trade or payments. If neighboring countries are also on a gold basis, and inflating less than Ruritania, the exchange rate for the rurita declines, and Ruritania is obliged to export more gold. This reduces its reserves and forces it to contract its currency and credit. More immediately, it obliges Ruritania to increase its interest rates to attract funds instead of losing them. But this rise in interest rates makes many projects unprofitable that previously looked profitable, shrinks the volume of credit, lowers demand and prices, and brings on a recession or a financial crisis.

If neighboring countries are also inflating, or expanding the volume of their money and credit at as fast a rate, a crisis in Ruritania may be postponed; but the crisis and the necessary readjustment are all the more violent when they finally occur.

The fractional-reserve gold standard, in short — especially when it exists, as it usually does, with a central bank, a government and a public opinion eager to keep expanding credit to start a "full employment" boom or to keep it going — brings about what is known as the business cycle, that periodic oscillation of boom and bust that socialists and communists attribute, not to the monetary and credit system and central banking, but to some inherent tendency in the capitalist system itself.

I need describe here only in a general way the process by which credit expansion brings about the boom and the inevitable subsequent bust. The credit expansion does not raise all prices simultaneously and uniformly. Tempted by the deceptively low interest rates it initially brings about, the producers of capital goods borrow the money for new long-term projects. This leads to distortions in the economy. It leads to overexpansion in the production of capital goods, and to other malinvestments that are only recognized as such after the boom has been going on for a considerable time.

When this malinvestment does become evident, the boom collapses. The whole economy and structure of production must undergo a painful readjustment accompanied by greatly increased unemployment.

This is the Austrian theory of the trade cycle, which I need not expound here in all its complex detail because that has already been done fully and brilliantly by such writers as Mises, Hayek, Haberler, and Rothbard.In addition to larger works of these four writers that include discussions of the subject, the interested reader may consult the pamphlet, The Austrian Theory of the Trade Cycle, which contains an essay by each of them.

My chief concern in this article has been to show that in addition to being the principal institution responsible for bringing about the cycle of boom and bust that has plagued the civilized world since the early nineteenth century, the fractional-reserve standard, once its principle of "economizing the use of gold" has been fully accepted, itself encourages an inflation that has no logical stopping place until gold has been "phased out" altogether, and the world is adrift in the turbulent seas of paper money.

In emphasizing this weakness of a fractional-reserve standard, I do not intend to imply that I have solved the baffling problem of creating an ideal money — assuming that that problem is even soluble. An opportunity now exists — for the first time in a couple of centuries — to introduce a 100 percent gold reserve standard. But if sufficient new gold supplies were not regularly available, such a standard could conceivably result, over time, in a troublesome fall in commodity prices. Moreover, unless there were rigid prohibitions against it, a private no less than a government money would soon tend to become a fractional-reserve standard. And if we allowed this, would we not soon be on the road once more to a constantly diminishing fraction, and at least a constant mild inflation?

I confess I do not have confident answers to these questions. But that does not invalidate my criticisms of a fractional-reserve standard. I should like to point out, incidentally, that expanding the money supply through a fractional-reserve standard — mainly for the purpose of holding down the exchange value of the individual currency unit and thereby preventing a fall in prices — could also be accomplished under a full gold standard by constantly or periodically reducing the weight of gold into which the dollar (or other unit) was convertible. Such a proposal was once actually made by the economist Irving Fisher. I am unaware of any economist who accepts such a proposal today. But it is no different in principle from steadily expanding the money supply — under either a paper or a fractional-reserve gold standard — for the purpose of holding down the purchasing power of the monetary unit. Is this a power we would want to trust to the politicians?

As a result of what has already happened, I regret that I cannot join some of my fellow champions of the full gold standard in urging their respective national governments to return immediately to such a standard. I believe such a step at the moment to be both politically and economically impossible. Confidence in the monetary good faith of governments has been destroyed. If any one government were to attempt to return to gold convertibility, at even today's free market price for gold, it would probably be bailed out of its gold within a few weeks.

That is because holders of the currency would doubt not only that government's determination but its ability to maintain that conversion rate. People have seen their governments casually abandon the gold standard, and they are more aware of how slim and insecure the new gold backing might be against the enormous volume of credit and paper money now outstanding. Gold convertibility of an individual currency could probably now be restored only after a few years of balanced budgets and refrainment from further currency expansion.

Meanwhile, if governments would permit private individuals or banks to mint gold coins and to issue gold certificates, a dual currency system could come into existence that could eventually permit a smooth transition back to a sound gold currency.

If Ron Paul succeeds in getting the Fed audited, the consequences could be far-reaching. Assuming the audit isn't rigged to protect the guilty, as a similar bill was in 1978, the Fed will need every obfuscating Keynesian to testify and write editorials on its behalf, to reassure the public that monetary matters really are best left to the gods who rule us, such as Ben Bernanke and Timothy Geithner. Monetarists, too, would likely join the "Save the Fed" crusade, perhaps arguing that even a great free market economist like Milton Friedman considered the Fed useful for preventing and curing recessions.

But the really appetizing part of auditing the Fed is knowing what stands behind it. The Fed is a racket at heart, a con game writ large — what else can you call an organization with the exclusive privilege of printing money in the trillions and handing it over to friends? But if this is true, what does that say about the state, the organization that created and sanctions it? Is the Fed an honest mistake in the state's otherwise undying efforts to preserve our liberty, or might it be a key component of a bigger racket?

Without the power of the state, there would be no proposal to audit the Fed because there would be no Fed to audit. Like any cartel, it exists to protect its members from market retribution, and only the police power of the state can make us shoulder that burden. A bill to audit the Fed could by force of logic become a state audit, much like the investigations of the 1972 Watergate burglary exposed the grinning skull behind the government's public persona. During a Fed audit, for example, would it not be reasonable to ask why the people's elected representatives continue to support a banking system that secretly steals wealth from their countrymen and other dollar holders? Or are we to take the naïve position that most elected officials really are clueless about the Fed's policy of currency debasement and the effects such policies have had in history?

There are any number of ways a Fed audit could bring the state itself under close scrutiny, but let us sketch just one line of argument:

It is well known that banks engage in fractional-reserve lending, meaning that bankers use their deposits in lending operations, with only a part of their loans covered by money reserves. Fractional reserves expand the money supply, which, until the age of Keynes and Fisher, was called inflation. [1] It is also common knowledge that when banks extend too much credit, depositors quite naturally get nervous and start withdrawing their money.

Although fractional reserves would seemingly qualify as a form of embezzlement — the act of taking for personal use other people's property without their knowledge or consent — government court rulings have never viewed it as such. As Murray Rothbard observed, a bank that fails to meet its deposit obligations is just another insolvent, not an embezzler. Following the British ruling in Foley v. Hill and Others in 1848, US courts consider that money left with a banker is, "to all intents and purposes, the money of the banker, to do with as he pleases."[2]

This holds even if the banker engages in "hazardous speculation." Thus, according to the state, there can be no embezzlement because the money belongs to the bank, not the depositor. But was there ever a depositor who thought he was turning his money over to the banker so he could "do as he pleases" with it? Furthermore, when the banker, in loaning the customer's deposit to another party, essentially creates two claims to the same piece of property (the money deposited), there is no way he can meet his obligations to both depositor and borrower at the same time. Why does the state exempt banks from the law of contradiction?

Without a central bank, fractional-reserve banking leads to repetitive crises, as banks are incapable of meeting redemption demands. Banks that have trouble meeting their obligations need money fast, and this is one of the problems a central bank addresses. "The very existence of a fractional-reserve banking system invariably leads to the emergence of a central bank as a lender of last resort," Jesus Huerta de Soto tells us.[3]

True, but as de Soto recognizes, central banks don't emerge from open and candid discussions within the banking community, unless one regards their wish for "a more elastic currency" as an instance of brute honesty. To succeed, central banks need protection from competition; they need to be the monopoly supplier of bank notes. But monopolies in this sense don't emerge on a free market. A deal needs to be cut between big bankers and influential politicians to create a bank with legal privileges. This arrangement is then forced on us not, presented not as a special privilege but as serving the public interest. And we need to be forced to accept the privileged bank's fiat money in trade for real goods or services. It bears repeating: a central bank "is not a natural product of banking development," as Vera Smith concluded in her well-known study.[4] "It comes into being as a result of government favors." What does a government get in exchange for these favors, a Fed auditor might ask?

With a central bank, fractional-reserve banking leads to repetitive crises, but they may differ from crises without a central bank in two respects: one, because a central bank enforces a uniform rate of inflation (credit expansion), one bank can't jeopardize the rest by overexpanding more than others; consequently, the day of reckoning is delayed, and the correction needed is more severe. And two, when the crisis hits, the central bank provides a means for more monetary wrongdoing.

Since the requirement of redemption limits the inflationary potential of a central bank, governments sooner or later get around to outlawing money itself and force us to use exclusively what was formerly only a money substitute. Governments, in other words, outlaw gold and make us use their paper. Question from the auditor: how does this arrangement qualify as a free market, as so many commentators today tacitly believe when they blame the crisis on the free market?

With gold gone the central bank becomes government's genie, able to grant it almost unlimited spending. Massive spending in the '30s didn't cure the Depression, though it did make government a much heavier load for the market to bear.

Does the central bank's ability to orchestrate inflation have any connection with a government's involvement in war? Might the world wars have been far shorter and less destructive of life and property, while propagating fewer bloody shoots of their own, without the aid of central banking and a fiat-paper standard? The enormous monetary outlays of war go to politically favored firms, which thus have an incentive to foster a more belligerent and interventionist foreign policy. Is this military-industrial-congressional complex killing us? How eager will politicians be to go to war or police the world if they no longer have a printing press to pay for their adventures?

Might we all be better off with a money and banking system that is completely severed from government? And might we be better off with a government that can't feed on inflation?

Prior to passage of the Federal Reserve Act, Wisconsin Senator Robert LaFollette and Minnesota Congressman Charles Lindbergh Sr. delivered scathing speeches attacking "the money trust" for causing booms and busts. LaFollette charged that the entire country was controlled by just fifty men, a claim that a Morgan partner rejected as totally absurd. He knew firsthand the number was not more than eight.

Following Lindbergh's resolution, Congress created the Pujo Committee to investigate the big bankers, but the committee was firmly in the hands of the trust itself. During the summer of 1912, the committee scared the wits out of people with statistics and testimonies showing the power Wall Street had over the economy. To the public, Congress seemed to be doing its job by cracking down on corruption, though at no time were Lindbergh or LaFollette called to testify, nor did anyone seem to attach any significance to the fact that the biggest bankers were leading the charge for reform.

$19 $15

The committee concluded that banking reform was urgent and necessary to bring Wall Street under control, and a year later Congress and President Wilson gave the country a central bank as an early Christmas present.[5] As Rothbard notes, the composition of the first Federal Reserve Board more or less reflected the power structure of those present at the Fed's founding meeting at Jekyll Island in 1910, with Morgan man Benjamin Strong actually running the system as head of the New York Fed.[6]

Power grabs are a frequent and predictable outcome of government investigations. However, any audit that exposes the Fed's relationship to the state will be worth doing, even if the Fed's friends keep it where it is.

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[1] Jorg Guido Hulsmann, The Ethics of Money Production, Ludwig von Mises Institute, 2008, p. 85

[2] Murray N. Rothbard, The Case Against the Fed, Ludwig von Mises Institute, 1994, p. 42.

[3] Jesus Huerta de Soto, Money, Bank Credit, and Economic Cycles, Ludwig von Mises Institute, 2006, p. 638 (emphasis in original).

[4] Vera C. Smith, The Rationale of Central Banking and the Free Banking Alternative, Liberty Press, 1990, p. 169.

[5] G. Edward Griffin, The Creature from Jekyll Island: A Second Look at the Federal Reserve, American Media, 2002, pp. 443–444.

[6] Rothbard, pp. 121–125.

To first understand gold, it's first important to understand money. More importantly, we want to understand what characteristics we desire in money. Many things have served as money such as tobacco leaves, seashells and even carved sticks but these currencies failed or couldn't function well as money. Money is the common denominator of all economic activity and is intimately connected to everyone's daily lives. It should be one of the most understood items of our modern existence but it is generally one of the worst understood, as so many people seem to take it for granted. Money is a commodity in its own right, the most widely accepted and sought after commodity in fact. This is what makes it a medium of exchange. Before money coalesced out of the marketplace, people bartered, i.e., exchanged goods and services directly for other goods and services. The problem with this is that people were constantly suffering from what's called the double coincidence of wants. In a barter economy, in order to trade, I first have to find someone willing to trade his or her goods for my goods. We each need to possess something the other desires. Money eliminated this restriction by becoming the universally accepted "good" in economic transactions.

Another feature of money is that it should function as a store of value. This means that we can rely on each unit of money to have the same value in the future as we assign to it today. Unfortunately, our current money fails miserably at this task. Since the establishment of the Federal Reserve System in 1913, the dollar now has approximately $0.02 worth of its original purchasing power. To put it in another perspective, a bottle of Coke that used to cost $0.02 now costs $1.00. Since so much more Coke can be produced today, we would expect the price to actually go down, but it didn't. Such a phenomenon would never happen if our money were a true store of value.

Finally, money is a unit of account. This is really just the end result of achieving the previous two requirements. The best analogy would be a yardstick. We all conceptually know what a yard is and what it measures. Money should be the same. However if people don't accept it in trade and its value isn't reliable then it's as if the definition of a yard is constantly changing to mean different lengths. Trade can never be expected to function optimally under such circumstances. Furthermore, a stable unit of account is divisible (ex. Dollars are divided into cents) and is also fungible, meaning any one unit of money resembles every other unit of money.

Now that you know what money is supposed to be, and why our current form of money fails the test, we can move on to the best candidate for money the world has ever produced.

History is replete with examples of how gold has successfully served as money. It is also replete with examples of governments routinely attacking the soundness of the currency in order to spend without resorting to taxation. Money has sometimes been used to isolate societies from the rest of the world. Lycurgus tells us that the Spartans were banned from using gold and silver and instead used iron coins quenched in vinegar that were refused by all non-Spartans. We see the same tactic at play in the modern world when nations prevent their citizens from exchanging their paper currencies for the paper currencies of other nations, or imposing an unfavorable fixed exchange rate as seems to be the case with present-day China.

The history of money and the economy of the United States provide us with many examples of how gold produces stability and prosperity, while money created by government fiat (all current forms of money you're used to) produces short-term booms followed by busts. A brief summary of the monetary history of the United States goes as follows:

1775 — In order to fund the Revolutionary War, the Continental Congress began issuing paper money called the Continental. Wars are always expensive endeavors and on top of the estimated $12 million total money supply at the time, Congress issued $8 million in the first year, another $19 million in 1776, $13 million in 1777, $64 million in 1778 and $125 million in 1779. A total of over $225 million had been created resulting in a devaluation of the dollar by a factor of 168:1. The government resorted to price controls to try to reel in the skyrocketing prices but that only created shortages. The term "not worth a Continental" became popular in its usage and George Washington remarked, "A wagon load of money will scarcely purchase a wagon load of provisions." Furthermore, the $600 million in public debt that the United States had issued and traded on the international markets was trading at roughly 4 cents on the dollar. The nation was born in a hyperinflation.

1789 — The government begins operating under the provisions laid out in the Constitution of the United States of America. Article 1, section 8 provides Congress with the power to "coin Money, regulate the Value thereof, and of foreign Coin, and fix the Standard of Weights and Measures." Furthermore, section 10 states that the States cannot "coin Money; emit Bills of Credit; make any Thing but gold and silver Coin a Tender in Payment of Debts." In other words, only Congress had the power to coin money, made of gold or silver, with fixed and regulated weights and measures and the States could not refuse it. Furthermore, "Bills of Credit," i.e., paper money, was banned.

1792 — Congress exercises its powers under Article 1, section 8 and passes the Coinage Act. It created a coin called a "Dollar," which was to be about 371 grains of pure silver. It also established a half dollar, quarter dollar, a dime (1/10 dollar) and a half dime. The act also produced a coin called an "Eagle," which was to be about 247 grains of pure gold. There was also a half eagle and a quarter eagle. The eagle was set at a fixed exchange rate of 10:1 with the dollar.

1812 — War breaks out again between Britain and the United States. Fearing a run on their currencies due to the war, banks in the Southern states suspended gold and silver redemptions on their banknotes (exactly what Nixon would do 160 years later), effectively rendering them a floating, paper currency like we have today. The federal government also issued Treasury notes to finance the war. These notes paid interest and were declared legal tender and therefore amounted to an expansion of the monetary base. Inflation ensued. The banks of the Northern states had maintained gold redeemability of their notes and the government was soon trying to pay for Northern goods with unredeemable notes issued by Southern banks. Northern banks began to call for the redemption of Southern banknotes into gold but in 1814, the State governments to the south officially allowed the suspension of redeemability into gold.

1816–1817 — The US Treasury begins wholesale retirements of the Treasury notes that they had been issuing since 1812, effectively shrinking the supply of money. Deflation begins to set in and credit expansion by banks slows down.

1819 — Depression sets in as the growth in money supply is reversed. The easy money of the previous 7 years had found its way into the housing sector and financial sectors, creating a bubble. Once the flow of money and credit was shut off, the buying spree ended. In a letter to Richard Rush Ford, Thomas Jefferson explained that "The banks themselves were doing business on capitals, three-fourths of which were fictitious; and to extend their profit they furnished fictitious capital to every man, who having nothing and disliking the labors of the plow, chose rather to call himself a merchant, to set up a house of $5,000 a year expense, to dash into every species of mercantile gambling, and if that ended as gambling generally does, a fraudulent bankruptcy was an ultimate resource of retirement and competence."

1837 — Panic once again hits the United States as foreign banks, particularly from London, begin redeeming banknotes from US banks en masse. This situation had arisen throughout 1835 and 36, when the government was selling off vast tracts of land in order to pay down the national debt. Western banks, whose reputations for gold redemptions were spotty, were loaning vast amounts of funds to private citizens in order to buy the land. Stock prices peaked in mid-1835 and headed downward as inflation began to set in. The government, suspicious that it was being paid in unbacked notes, demanded in 1836 that all land sales be paid for in gold bullion, a decree known as the Specie Circular. By 1837 the bank run was in full tilt as others rushed to convert their notes back into gold.

1873 — After the outbreak of hostilities between the Northern and Southern States began in 1861, the government began issuing large quantities of US Notes, informally known as "greenbacks" even though this was a clear violation of the Constitution's prohibition against the emission of "bills of credit." These notes were immediately redeemed for gold, which would have put an end to the inflation. Instead, the government suspended convertibility on December 30, 1861 and the dollar became another unbacked paper currency. Issuance of these notes continued and by 1865 they had reached a devaluation of nearly 3:1. The Confederate government had responded by issuing their own paper notes and devaluing them by a factor of around 28:1. In 1865, Congress passed a resolution to begin retracting these notes and restoring the value of the dollar but this proved politically and economically unpalatable and was halted in 1868. Instead, they fixed the base money supply of the US at $656 million. Greenbacks had found themselves creating a boom in the railroad industry and when the banking system was finally loaned up to its limit and the monetary base was no longer expanding, the bubble burst, causing deflation and the resultant Panic.

1873–1900 — The fourth Coinage Act was passed in 1873, ending the coinage of silver. Other nations around the world also began abandoning silver in favor of gold. The fixed exchange rates between gold and silver on the bimetallic standard had been creating difficulties throughout the world. For instance, in America, where the gold/silver ratio was fixed at around 15:1, people would convert silver into gold and take that gold to the international markets to trade back into silver at a ratio of around 30:1, thus doubling their money instantly and causing a gold drain on the United States. In 1900, the United States formally adopted a monometallic gold standard with the Gold Standard Act of 1900.

1921 — The crash of '21 began with the United States' entrance into World War I in 1917. The United States had initially been selling war supplies to Europe since the outbreak of hostilities in 1914 and had been collecting vast sums of gold as payment. This trend reversed in 1917 and in September of that year, President Wilson prohibited all gold exports without the permission of the Federal Reserve Board and the Treasury. In 1918 this was broadened to prohibit all private hoarding of gold. The net effect of these policies was to effectively de-link the dollar from gold. In order to assist with the war effort, the Federal Reserve had pushed interest rates down, an invitation for inflation, which is what the CPI reveals. When the gold embargo ended in 1919, gold flew out of the country, a clear sign that the dollar's value had dropped significantly over the war due to the overissuance of paper notes. Eventually the Fed began contracting the supply of paper dollars, turning inflation into deflation and a drop in prices and wages of about 35% manifesting as the recession of 1920–1921.

1929 — After a period of growing prosperity throughout the '20s the United States underwent a mild contraction in 1927. This caused the Fed to create large amounts of paper reserves in the hopes of forestalling any potential shortages at banks. Moreover, the Bank of England had been holding down interest rates below the market equilibrium in an effort to expedite the recovery from WWI. Authorities reasoned that if the Fed pumped excess paper reserves in the system, interest rates in America would fall. This indeed did happen and England's gold loss was halted, but the excess reserves fueled a fantastic speculative bubble in the stock market. Fed officials tried to retract the excess reserves in an attempt to halt the boom but the end result was the crash of '29. Austrian economists Ludwig von Mises and Freidrich Hayek foresaw the crash and publicly predicted that it would be coming very shortly. In order to pay back the Fed, commercial banks and brokerages had to call in their margin loans, triggering a massive selloff in the stock market. Stock values plunged. Furthermore, rumors of the coming passage of the Smoot-Hawley Tariff Act eventually forced investors to flee the US market. The passage of the Act triggered a worldwide retaliation as other nations rushed to similarly increase their tariffs. Global trade was crippled and the Great Depression was now underway. Up until this point, the Government had taken a more or less hands-off approach to dealing with recessions and as a result they were generally short lived. However in the '30s, both Hoover and FDR instituted spending projects and interventions never before seen in all of US history. UCLA economists have now discovered that the price controls and cartelization of industry caused by these policies are the prime reason for the length and severity of the Great Depression. In order to help pay for the government's interventions, FDR issued Executive Order 6102, seizing all gold in circulation and subsequently devalued the dollar from $20.67/oz to $35/oz, where it was to remain until 1971.

1971 — Using the Great Depression as an excuse for huge Keynes-inspired spending projects such as the Marshall Plan and the Great Society; the US government was pressed into running huge budget deficits. Coupled with prolonged wars in Korea and Vietnam, the money supply increased drastically over the course of the decades after World War II. Once again, Austrian economists accurately predicted that the long-term effects of these policies would be an inflationary depression. Keynes joked that we're all dead in the long run however being flippant is no cure for excessive inflation. The world monetary system was operating under the Bretton Woods agreement, which pegged the US dollar at $35/oz and all other currencies were then pegged to that. The flaw in the system was that there was nothing preventing the Federal Reserve from increasing the supply of paper dollars in circulation. As government borrowing and overspending persisted, the gold backing behind each dollar steadily declined. Eventually the French, under Charles de Gaulle, demanded the redemption of their US dollar notes into gold. Gold began flying out of the US at an alarming rate. In order to end the loss of gold and sensing a worldwide run on the dollar, Nixon unilaterally ended the Bretton Woods agreement on August 15, 1971 by putting an end to all gold redemptions on US dollars. With no physical limit on the supply of dollars anymore the money supply and debt levels began expanding rapidly, as did America's trade deficit. Stagflation set in and once again the government resorted to price and wage controls, which only made the situation worse. Inflation was finally halted in the '80s when Fed Chairman Paul Volker set interest rates to 20%. Monetary expansion was slowed and inflation was brought back to the single digits.

Ever since 1971, the United States has had no constitutional money supply. Public and private debts have expanded to unprecedented heights and the money supply continues to grow by leaps and bounds. With so many crises caused by the manipulation of the money supply, there should be no doubt as to what caused the NASDAQ and housing bubbles of the previous 18 years.

US Government spending has been rising precipitously. World War II was the country's biggest spending project in all of history. When it was finally over and the budget cut in half in 1946, it only took the government 22 more years to reach the exact same level of spending. It doubled again in another 24 years. That brings us to 1992, and in just 16 more years government spending had reached three times the amount of WWII at its very height. This can't be good for the economy or its people. It means that the country has been spending as if it were in total war for over 40 years. It's been spending over twice that much for over 16 years. As of now, three times and it may hit four times before the end of President Obama's first term. These levels of spending are unsustainable, and have only been made possible by borrowing tremendous amounts of money from abroad or debasing the money back at home. Both of these actions have severe long-term consequences, and we may be coming face to face with them very soon. Eventually the system will run into its hard, mathematical limits. When interest payments on the national debt meet up with national income, the entire system grinds to a halt.

America once enjoyed perfect price stability. A dollar saved in 1820 had exactly the same value as a dollar in 1920, because the Coinage Act defined the dollar as a specific weight of silver or gold. A CPI reconstruction of the past 350 years, done by John Williams of Shadow Government Statistics, showed that the price index maintained a value of 5 for the vast majority of American history and only started taking off after the advent of World War II.

A more recent example of price stability under gold is seen in the chart to the left. From this, we can deduce that the skyrocketing price of a barrel of oil that was observed throughout the Bush presidency was merely an illusion. While oil prices went up 350% in dollars and 200% in Euros, prices in terms of gold have remained constant. This is because, like oil, gold requires effort to extract from the earth. It is a tangible, real good containing intrinsic value that cannot be removed or inflated away. For this same reason, gold becomes a very useful measuring stick for gauging the changes in real value of other items. Einstein said all motion is relative and the same applies to value. Before you can know the real value of an item, you need to express it in terms of another item of known value, which is assumed to be constant. Gold is the perfect candidate for this status, while fiat money clearly is not.

To drive this point home, all we need to do is take a look at the Dow Jones Industrial Average over the span of its history. In the first chart, the DJIA is expressed in US dollars from 1896 (inception) to the present day. Looking at the index through this lens seems to provide very little in terms of useful information. For instance, in 2008, was the Dow really worth several thousand times more than it was in the '40s? The answer to this is obviously no and we will find out why shortly. Also notice how the roaring '20s and the Great Depression barely even register on this scale. Because the value of the dollar is changing all the time (primarily in the downwards direction) it distorts the true shape of the DJIA. By valuing the index in gold, however, we can change the chart from this:

into this:

Considering the historical context we can now get a much better look at the real increases in value during the 1920s as well as the destruction of wealth during the 1930s. We see the beginnings of the Dow finally recovering from the Depression and WWII in 1946, the same year government spending was cut in half. We also notice something that was conspicuously absent from the previous chart, the postwar economic boom and stagflation of the 1970s. The inflation present during that period totally wiped out the changes in real value that actually did take place, as revealed by gold. Bush and Obama are on the same inflationary agenda trying to maintain asset prices at their formerly elevated levels. However, as gold clearly shows, this is a futile endeavor. By maintaining nominal asset prices, they will only succeed in raising the real prices of everything else. Welcome to the actual war on the middle class, where the vast majority of Americans are being reduced to working poor, and the working poor are reduced to destitution. Furthermore, the recovery that followed the bursting of the tech bubble is exposed as a complete fabrication. The real value of the Dow has been in a prolonged decline ever since 2001. In case you were wondering if this was a fluke, the S&P 500 gives all the same indications when valued in gold.

Anyone who still doubts the usefulness of gold as money need only look at present-day Zimbabwe. The government completely destroyed their paper currency and left the economy in shambles. Hyperinflation made the Zimbabwe dollar totally unusable. In order to compensate, the people have adopted gold as their new money. In a Zimbabwean marketplace, you can now buy loaves of bread for 0.1 grams of gold. Incidentally, at the time of the writing of this article, 0.1 grams of gold is equivalent to USD $2.88, approximately what it would cost you to buy a loaf of bread in a grocery store. Hundreds of years ago, a loaf of bread would still cost you roughly 0.1 grams of gold. This attests to gold's usefulness as a safe store of value, across geography and time, as well as its universality as a currency. Gold would stabilize prices the world over, as the example in Zimbabwe clearly shows.

Gold provides a very important and natural mechanism to stabilize world trade that would prevent a nation from running too big of a deficit and running into problems with debt. The United States had balanced trade for a very long time but only after President Nixon broke the dollar's link to gold in 1971 did the country start running deficits that grew larger and larger. At its height, not even a year ago, the United States was importing $800 billion more per year than it was exporting. The difference being paid for with borrowed or printed money.

A gold standard would prevent any trade imbalance from persisting too long and reaching such heights. If a country begins importing far more than it exports, gold is taken out of circulation in that country as the country pays for its imports. As the quantity of money in circulation declines, the price system responds by lowering the price of domestic goods and labor. This makes that same country look better to foreign companies that may want to take advantage of the cheaper labor and it also makes the goods produced in that country less expensive to foreigners. Capital will flow back into the economy, creating jobs and more goods will be produced domestically for export.

Conversely, countries exporting large quantities of goods would have the prices of their domestic labor and goods rise because of the influx of gold. This makes the same country look less attractive to import from, and less likely for international businesses to set up shop in. That country will begin to import more and export less because of the changes to domestic and foreign prices. Thus, the balance of trade between countries is maintained.

While the addition of gold to the SDR would be very welcome, it is uncertain whether or not it will actually happen. Even if it were, the SDR is still a centrally managed currency that will be prone to the manipulations of governments. This is the reason behind the failure of the Bretton Woods system and Nixon's tacit admission of national bankruptcy by declaring gold redemptions on US dollars officially over. Governments have proven beyond all reasonable doubt that they will abuse money at every opportunity. If the SDR does become the new world reserve currency, I expect that the boom-bust cycle will persist as the SDR is slowly inflated into oblivion. Over the next 25 years we will probably experience a long period of economic growth under the SDR only to wind up with another inflationary bust. Unlike our current situation, where the asset bubble was primarily located in the United States, this bubble will be worldwide and the suffering unleashed will be unimaginable even by today's standards.

As Hayek declared in a speech he delivered in November of 1977, a move towards a privately administered gold standard may be our only hope for maintaining price stability and minimizing the business cycle. The complete elimination of financial panics has turned out to be a pipe dream invented by bureaucrats and economists who clearly knew what persistent inflation would do to a people, but decided that perpetual robbery was justified in light of the fantasy of perpetual economic stability. The reality is that "monetary policy" has only served to worsen economic cycles, produce stagnation and inflation, and a slow transfer of wealth from the poor to the politically well connected. The competition produced by free banking will bring about a new class of businesses whose product is a stable currency and secure deposits. Reason and morality should compel us all towards that goal, and I look forward to the inevitable day when that becomes a reality.

I have no views as to where it will be, but the one thing I can tell you is it won't do anything between now and then except look at you. Whereas, you know, Coca-Cola will be making money, and I think Wells Fargo will be making a lot of money and there will be a lot — and it's a lot — it's a lot better to have a goose that keeps laying eggs than a goose that just sits there and eats insurance and storage and a few things like that. The idea of digging something up out of the ground, you know, in South Africa or someplace and then transporting it to the United States and putting into the ground, you know, in the Federal Reserve of New York, does not strike me as a terrific asset.

Obviously the junior high kids have been educated that inflation is coming down the pike given the massive monetary stimulus that the Federal Reserve is engineering. So it's perfectly reasonable that they would pose their question to the world's greatest investor. But Buffett doesn't understand that gold is the people's money. The yellow metal has been the free market's currency for centuries. As Murray Rothbard explained, the necessary qualities for money are that it be generally marketable (nonmonetary value), divisible, have high value per unit weight, fairly stable value, durable, recognizable, and homogenous. Gold satisfies all of these criteria. Shares of Coca-Cola and Wells Fargo don't even come close.

The famous currency crank John Law held the same view as Buffett in the early 1700s. In Law's view the shares of the East India Company were better money than silver because the shares would rise in value along with inflation, as opposed to silver specie that would decline in value as more was discovered and produced. In Law's mistaken view the capital of the East India Company was employed in productive activities, which would provide inflation protection. Law wanted his monetary system to be tied to productive assets, just as Buffett believes the productive assets of a soft drink maker and a bank will provide better protection than precious and scarce metals.

Law was given a chance to test his theory in 1716 when one of Law's partying friends, the Duke of Orléans, assumed control of the French government after Louis XIV died. Law's Royal Bank created vast amounts of paper currency, and his Mississippi Company share prices took off, which led Law to issue more shares, using the capital to refinance more of the government's debt. Ultimately, the scheme unraveled and the French people sold their shares and sought the safety of gold and silver, leading Law to outlaw precious metal possession except by goldsmiths and jewelers, effectively demonetizing the metals so that only Royal banknotes and Mississippi Company shares would circulate as money. An outraged French public ultimately forced the regent to place the once revered Law under house arrest.

Early during the same CNBC program a viewer asked Buffett if he believed what his father Congressman Howard Buffett believed, which was this: "So far as I can discover, paper money systems [like John Law's] have always wound up with collapse and economic chaos."

"Sounds like my dad, yeah," Buffett replied, "I heard that every night at the dinner table for a long time." The Oracle admits that the printing of paper money is inflationary, but being a consistent proponent of expanding government, he constantly dismisses gold and proposals to return America to a gold standard.

His father Howard understood the evils of unchecked government money printing.

"The paper money disease has been a pleasant habit thus far and will not be dropped voluntarily any more than a dope user will without a struggle give up narcotics," Congressman Buffett wrote. "But in each case the end of the road is not a desirable prospect."

The Congressman's son may have heard his father at the dinner table, but he wasn't listening. When asked if everything will turn out alright, Buffett said, "I think your kids will live better than mine, your grand children will live better than your kids. There's no question about that."

No question?

"But we can be approaching the critical stage," the elder Buffett wrote back in 1948.

When that day arrives, our political rulers will probably find that foreign war and ruthless regimentation is the cunning alternative to domestic strife. That was the way out for the paper-money economy of Hitler and others.

The current monetary inflation will end as badly as Law's, and shares of Coca-Cola and Wells Fargo will be no place to hide. Kids, start hiding some gold — carefully.

The US led embargo against South Africa, backed implicitly by the largest military in the world, highlights the gradual but steady tendency for authorities to back the failing $35 peg by forceful means. This is the inevitable route taken by any state-run financial system experiencing difficulty. Whereas in a free banking system mistakes are fixed through market discipline, competition, and failures, the state's mistakes in banking are maintained as long as its monopoly on force can keep these mistakes from destroying the system.

To recap, the Bretton Woods Agreement negotiated after World War II set the value of the dollar at 0.81 grams. This value was backed by the United States Federal Reserve's promise to convert all dollars into gold at the stipulated ratio of 0.81 grams, the more well known ratio being $35 dollars to one ounce. This promise was further enhanced by the fact that the Fed held some 21,000 tonnes of the metal, more gold than all other central banks combined. Dollar's convertibility was limited to foreign governments and central banks — private citizens in both the US and overseas who owned dollars held what was essentially inconvertible paper money.

To understand this system, it helps to compare it to a hypothetical world of private banks issuing currency in a free market. In such a system, the option that currency holders have to exercise gold convertibility forces discipline on individual banks. A bank that issues more of its branded money than the market is willing to support, say by lowering its own interest rate on loans below the market's rate, will soon face a wave of its own currency returning to it for conversion. The irresponsible bank's gold reserves will decline and it will be forced to call in loans to rebuild reserves, or increase interest rates back to at least the market rate to attract gold deposits.

In a free banking system, customers are free to choose the notes of whatever banks offer the most reserves to back up their issue, further disciplining banks that might wish to expand beyond a reserve ratio that customers prefer. At the extreme, transgressing banks are punished by run which may lead to bank failure. In that case, remaining assets are taken over by competitors, restoring balance to the system.

The US Federal Reserve operating under Bretton Woods was by no means exempt from the same pressures that individual banks in a free banking system would be subject to. As my first article pointed out, a massive US balance of payments deficit began to appear in the 1950s, driven in part by government spending overseas including military expenditures and foreign aid to a rebuilding Europe. To fund these expenditures, the Federal government issued bonds which were bought by the Fed with newly printed dollars. By 1951 the Fed held more treasury bonds on it's balance sheet than gold.

As happens in a free banking system, once the mass of dollars created by the Fed exceeded demand they began to be returned to the US for conversion into gold by foreign central banks. This process began in earnest in 1958, when US reserves plummeted by 9%. A free bank would have been forced by competitive forces to reduce money creation, call in loans, increase interest rates, and rebuild reserves. Here is where the comparison between the Fed under Bretton Woods and free banks end, because the Fed and its partner the US government have one other policy option that the free banks don't; they can resort to their monopoly on force.

Thus began the constantly escalating attempts through the 1950s and 60s to prevent the same market forces that exercise discipline on free banks from exercising discipline on the US. The monetary authority's goal was to forcibly stem the flow of US dollars overseas, reduce the gold price, and plug the rising number of conversion claims for dollars to gold on the part of foreign governments.

For instance, in 1959 Eisenhower made it illegal for Americans to buy gold overseas — extending Roosevelt's 1933 ban on American domestic holdings of gold. In 1964 a new tax was imposed by President Kennedy on foreign currency deposits to prevent Americans from investing overseas — the Interest Equalization Tax. In August 1970 President Nixon was given discretionary authority to impose wage and price controls on citizens.

Soft nanny state campaigns by the state to discourage tourism and therefore dollar outflows, including Lyndon B Johnson's comments that "We may have to forego the pleasures of Europe for a while,"The Economist, January 6, 1968. and "I am asking the American people to defer for the next two years all non-essential travel outside the western hemisphere," became common. In 1968 Johnson would also forbid all American investment in Europe and impose limits on investments elsewhere.

All this is terribly ironic as Kennedy, Johnson, and Nixon were clamping down on American economic freedoms at the same time that they were waging a war of aggression in Vietnam. By forcing the American public to spend less overseas, Kennedy and Johnson realized they would free up more room for their own overseas campaigns.

There are umpteen examples of forceful means being used to reduce the freedom of individuals in order to save the $35 peg from that era. One by one they failed, including the London Gold Pool, only to be replaced by even stronger forms of coercion. The last and probably the most overtly aggressive of these was the South Africa embargo.

Leaving off from the last article, central banks asked for the London gold market to be closed and dismantled the gold pool on March 15, 1968. Without price suppression from pool sales, the market price of gold immediately vaulted to $39 upon the market's reopening. That same day, in what became to be called the Washington accord, western central banks led by US Treasury Secretary Robert Fowler announced that the world's monetary reserves were "sufficient" and no subsequent purchases or sales by central banks in any market would be necessary.

This last seemingly innocuous statement had large repercussions. If central banks ceased buying gold, monetary demand for the metal would dry-up. South Africa, producer of some 75% of the world's gold, would suddenly find no outlet for a bulk of its new gold. After all, the lion's share of world gold demand was by central banks.

Fowler hoped that the boycott would force South Africa to funnel gold sales into the relatively small London market, dominated by jewellers, speculators, and other private parties, depressing the market price from $39 back to the official one at $35. This amounted to substituting the London gold pool, active from 1961-68, and its dampening influence on the gold price, with South African sales, the latter without South Africa's permission. Letters were sent to 95 central banks asking them to desist from all gold purchases.New York Times, January 4, 1969. The boycott had started.

From the beginning the boycott was a failure. Rather than falling the gold price steadily rose from $38 to $42. The 20% price differential between the official price of $35 and the market price put a mockery to the whole managed Bretton Woods system. In essence, the market was saying it didn't believe that the US dollar was worth the gold value that the authorities claimed. Rather than a dollar being convertible into 0.81 grams, the market was betting that, once the chips were down, the dollar was likely only convertible into just 0.67 grams.

At the same time, the price differential provided a tremendous arbitrage opportunity to central banks. To make an easy profit, all they had to do was bring their dollars to the Federal Reserve, convert them to gold at $35, ship their horde to London, and sell it for $42, further exacerbating the US's already significant gold outflows.

Despite the pressure on South Africa to sell in London, the London gold price never caved. Rather than selling gold on the market, the Reserve Bank of South Africa skirted the boycott by purchasing the gold produced by mining firms and hoarding it. By the end of 1968, South African gold reserves at the central bank had doubled from an opening balance of about $600 million to $1.2 billion.New York Times, July 13, 1969.

While this kept gold off the London market and prices high, it meant that the nation could no longer send its main export product overseas to pay for imports. Luckily, South Africa had been running a significant capital account surplus since early 1965. World equity markets had been rising since the last bear market bottomed in 1966. Foreign investors, bullish on South Africa, were flooding South Africa with foreign currency, and for the time being there was no need to sell gold.

The boycott amounted to a game of chicken between the US and South Africa. At some point the flow of investment capital into South Africa could dry up and the nation's gold reserves would have to be sold in the open market to fund imports. But before that, the differential between gold's market price and the official price could stretch even wider, weakening the resolve of the participants in the American led boycott to the point where central banks, in particular those in Europe, might start buying gold again.

Many South Africans hoped to see an official devaluation of the dollar, i.e., a rise in the official price of gold, South Africa's main source of income. With the market price of gold at $42, arbitrage profits might get so tempting that the world's central banks would converge on the US en masse to convert dollars to gold. US reserves would plummet, and a devaluation would be forced. In this game of chicken, it was a question of what happened first: South Africa being forced to sell its gold or a run on the US forcing it to give up $35 gold.

South Africa actively tried to sell some of its hoard by targeting potential boycott breakers with cheap gold prices. Portugal broke the blockade in late 1968 when its central bank bought some $150 million in gold from South Africa. They would buy another $120 million in 1969.Time, July 25 1969. Rumours persisted that other European central banks had crossed the picket line too.

The International Monetary Fund was also a potential sop for South African gold. IMF rules stipulated that the fund was required to buy all gold offered up to it by members. This, at least, was the opinion of IMF head Pierre-Paul Schweitzer and most IMF officials.New York Times, June 16, 1968. Treasury Secretary Fowler held the rather convenient opinion that the IMF had no obligation to buy anyone's gold, in particular South Africa's.

Rather than accepting a South African request to buy 1 million ounces of gold in May 1968, the IMF board of directors deferred any decision on the legality of gold purchases, thereby giving South Africa the cold shoulderNew York Times, Jun 28, 1968.. The US, with 25% of board votes, had no small part in determining this policy. This closed yet another avenue for South African gold.

Through most of 1968 South Africa would funnel small tester sales into the London market to determine the resiliency of prices. Prices fell to $38, but by year's end would be back at $42. In late 1968 three private Swiss banks agreed to buy $200-400 million worth of gold from South Africa, selling this gold on the market.New York Times, Jul 26, 1969. The South Africans were unwilling to deal with their traditional agents the Bank of England, reportedly because the Bank's close relationship with the Fed would compromise the secrecy of South Africa's sales.

With price still far above $35 in October 1968 and South Africa able to sell some of their gold, the monetary boycott was an all out failure. Henry Fowler decided to offer South Africa a compromise. He would allow the South Africans to resume monetary gold sales, but only to the IMF, not central banks. Furthermore, sales could only be made when the market price of gold was below $35 or South Africa was experiencing a capital account deficit.

This plan would set a floor for the gold price at $35. Since all South African gold would flow to the IMF once price fell below $35, the market would no longer be absorbing this rather considerable lode of metal, and price would stabilize. As they were still running a capital account surplus and the price of gold remained high, confident South African officials ignored the offer.

Around the world, the bull market in equities that had begun in 1966 was ending as markets began a downwards spiral into the 1969-70 bear market. South Africa, once attractive to investors, began to lose its shine. By the second quarter of 1969, South Africa's capital account revealed a deficit, its first in three years. Net inflows of private capital amounted to a paltry £11.7 million for the first half of 1969, down from £218 million the year prior.The Economist, Aug 30, 1969.

The pillar that had been allowing South Africa to avoid open market gold sales had cracked. To fund imports, South Africa began to sell its gold in earnest. Reserves, which had hit a peak of $1.4 billion at the end of May 1969, fell to $1.2 billion by JulyNew York Times , July 13, 1969. and $1.1 billion by August.New York Times, Aug 15, 1969. The gold price in London fell from $43.50 to $41. According to estimates, all new South African gold production, about 20 tonnes a week, was now hitting the market.The Economist, Nov 22, 1969.

The sell off turned into a bloodbath in late October. Prices broke below $40. Through November gold continued to plummet, falling into the $35 range at the end of the month. On January 16, 1970 prices touched $34.80, the lowest level since the London gold market had reopened in 1954.

At prices significantly below $35, it made sense for central banks to arbitrage gold, but no longer by drawing on US reserves. Rather, banks could buy in London at $34.80, ship the gold to the US for 10¢, and have the Fed issue dollars for gold at $35, after taking a 7.5¢ commission. This promised a sure 2.5¢ per ounce profit. The effect was that the US was now accumulating reserves. The tables had turned, and Fowler's plan had worked. The $35 peg seemed to have been saved, though at the expense of freedoms lost by everyone caught up in the endeavor.

With gold at $35, in December 1969 South Africa agreed to the US compromise offered more than a year before. Its freedom to sell monetary gold was still drastically limited — it could still only sell to the IMF, and at prices below $35 — but this was better than nothing, and at least a floor had been set below the gold price.

Newspapers and magazines were filled with fawning accounts of the US's victory. A January op-ed in the New York Times noted that: "Gold's power to disrupt the international monetary mechanism has now been greatly reduced, and possibly ended. Under Secretary of the Treasury Paul A. Volcker has voiced the hope that this latest move will dispose of gold as a 'contentious monetary problem'."New York Times, Jan 5, 1970.

This celebration would be short-lived. Even with South Africa selling most of its gold in London, the gold price steadily rose through 1970, ending the year at $37.50. By August 1971 it would be trading in the free market at $43.50, again 20% above the official price. In spring of 1971 a run on the US dollar began. Central banks lined up at the Fed's doors in ever increasing numbers to demand their gold. On August 9, the British economic representative asked to convert an astonishing $3 billion into gold, or about 2,500 tons.Peter Bernstein, The Power of Gold. Pg. 351. The South Africa gamble had been the last trick up the US's sleeve, and on August 15, 1971 President Nixon officially abandoned the dollar's $35 peg when he ended convertibility of dollars into gold.

The 1968-69 South African gold embargo is not just an interesting historical quirk. It also provides a mirror to understand the means by which governments will combat the present failure of the financial system. Like the $35 gold and Bretton Woods, much of the world's financial architecture has been designed by government technocrats. Fannie Mae, Freddie Mac and their foreign equivalents like the Canadian Mortgage and Housing Corporation dominate much of the home lending markets. The Federal Reserve and other central banks control the supply and quality of money, and agencies like the SEC, Fed, and OFHEO have monopolies on regulation.

This architecture is crumbling. In a free market, housing lenders and banks who fail at their task are taken over by more able competitors. Private regulators who do a poor job as watchdogs have their reputations crushed, to be succeeded by regulators who better understand their domain. Charities that bail out those who don't deserve help will lose funding at the expense of charities that better target aid. In this way failed architecture is renewed.

Much like the US's decision to save Bretton woods by coercing South African gold sales, today's governments will resort to ever more authoritarian measures rather than allowing their pet institutions to fail. Already the legislation governing central banks has vastly expanded in scope, federal housing agencies have had their mandates dramatically increased, and government regulators who fell asleep at the wheel are being given ever greater powers.

While this may work temporarily, much like South Africa's forced sales saved the $35 peg for one more year, the financial architecture's endemic problems will still exist. Instead of being purged, they will only crop up further down the road, more serious than ever. And when this happens you can be sure our elected officials will again try to save their pet institutions by taking away our liberties.

These are points taught to me by the life and work of Burton Samuel Blumert, one of liberty's great benefactors. He died at age 80 on the morning of March 30, 2009, after a long battle with cancer. He would deny it, but his name deserves to go down in history as a person who served as a champion of freedom during his long life.

He was born in Brooklyn, and after attending NYU and NYU Law School, and being forced into the Air Force (where the socialist regimentation made him a libertarian), Burt was a fundraiser for the American Jewish Committee and a store detective for a large retail establishment in NYC, searching out thieves. Then he was offered a promotion, and also the chance to be a traveling manager of a chain of ladies hat shops mostly based in the South, which he loved. However, the firm had a couple of stores in Northern California, and its first one at Hillsdale Mall, and Burt fell in love with the area.

Luckily, just at the time that "the evil JFK killed the hat," as he put it, Burt had the chance to buy into a business that was also his hobby, Camino Coin in Burlingame. Over the next decades, Burt built Camino into one of the most important dealers on the West Coast. Indeed, the firm became internationally known for its prices and service.

Burt was also a Silicon Valley pioneer, joining all the coins dealers in the country in their first computer network for prices and news. Xerox eventually bought the network. During all this, his libertarianism was not neglected, however, nor his opposition to inflationary fiat money and the Federal Reserve. He helped sponsor speaking engagements for such Austrian economists as Ludwig von Mises and Lenonard E. Read, and became a friend and benefactor of many libertarian scholars and activists, especially Murray N. Rothbard.

He served faithfully as chairman of the Mises Institute, succeeding Margit von Mises in that post. He was a dear friend of Murray's, and stuck steadfastly by him when others bailed out on grounds that Murray was too radical or too independent as an intellectual. Blumert saw that this genius needed support, and he provided it in every way. Indeed, in the darkest days, he made the difference.

Rothbard was only one of many who benefited from his generosity and care. Burt never wavered in his support, through thick and thin, providing excellent counsel and guidance at every step. I know that I had come to depend on his unfailing friendship and judgment in a host of areas.

His support was more than financial; he also offered his time and energy with great generosity. He provided offices, the safekeeping of books, and personal encouragement to many libertarian scholars; he linked up scholars with benefactors and publishers and employers, and even drove people to events big and small. And he played an important role as proprietor of Camino, in turning customers into benefactors of libertarian and Austrian organizations.

He had a quiet way about him that was always utterly and completely sincere. It was this feature of Burt that made him a good "salesman," and he was legendary in that respect. He loved helping people achieve financial independence. But it was about more than just business to him. He had the vision to see that ideas are more important than all the world's goods. It was this that he sought to give to the world. His gifts for friendship and hospitality were also essential.

For many years, he served as master of ceremonies for Mises Institute events. He was extremely comfortable, and successful, in asking for people's support of this cause, because he was also a supporter himself. In 2003 he was awarded the first Murray N. Rothbard Prize in celebration of his amazing contribution in a host of areas. He believed he didn't deserve it, of course. But we all sensed that Murray cheered as he accepted it: Attaboy, Burt, he often said.

Many people commented on Burt's sense of humor. It was pervasive, and unfailing in good times and bad. Have a look at his wonderful collection of observations in his book Bagels, Bonds, and Rotten Politicians. He used humor as a way of cutting through the ideological thicket created by the political moment, as a means to help people see and understand what truly matters.

It was something that many of us counted on for years. The news would be filled with reports of ominous events and threats to life and property. But Burt had a way of maintaining a refreshing distance, remembering what is important, and bringing humor to lighten the moment so that others could discern what really matters.

His political outlook was decidedly Rothbardian. He saw politicians as predictable in their scammery and racketeering. He saw the state as no more than a massive drain on society, something we could do well without. War he regarded as a massive and destructive diversion of social resources. Welfare he saw as a perverse system for rewarding bad behavior and punishing virtue. Regulations on business he saw as interventions that benefitted the well-connected at the expense of the true heroes of society, who were pursuing enterprise with an eye to independence and profitability.

His main enemy was the inflationary state, and one reason he got into the business of precious metals was to battle paper money. As a lifetime observer of the business cycle, he knew that paper-money and artificial-credit creation lead to illusions that would eventually dissipate. So it was no surprise that he saw the latest bust coming early on. As a resident of the Bay Area in Northern California, he was surrounded by illusions, but his knowledge of Austrian business-cycle theory permitted him to see through the fog.

There was a wonderful realism about his way of looking at society. He hated the state for its sheer phoniness. The paper dollar was just the beginning of it all, the most obvious symbol. To Burt, all of the state's glorious activities were an illusion, creating false booms with every action. It was the sheer hypocrisy of statecraft that struck him the most.

Private markets too have their share of crooks, but at least they didn't sail under the cover of legal legitimacy. Here is what he wrote about his favorite sport, boxing:

There is a refreshing quality about the world of boxing and the commissions that govern it: corruption is pure and unadulterated. The road to ascendancy in the world of boxing has no moral detours. For those who rise to the top, a stretch at Sing Sing is more valued than an Ivy League degree (and the alumni connections more useful). A murder indictment is equivalent to a graduate degree (see the bio of impresario Don King). There is no waste of resources in locating members for the athletic commission. The marketplace assigns a dollar value on each appointment and the only concern is that the bills are unmarked.

Burt was a wonderful friend to have, a man of extraordinary generosity and sound judgment. He was a living saint to libertarian intellectuals and a dear friend to the remnant that loves freedom. He was self-effacing to the extreme, always sincerely and quickly giving credit to others and refusing it himself. He was also a cook and host of great ability and generosity, and his home was a salon of liberty.

A longtime friend and supporter of Ron Paul, Burt chaired his 1988 Libertarian Party campaign for president, and cheered and supported his 2008 run. Burt was also the founding publisher of LewRockwell.com, and an important writer for it.

So in his death, let us say what is true about him, simply because he would never let anyone say it about him in life. Through his daily life and good works, his loyalty and indefatigability, he showed us a path forward, the very model of how a successful businessman can achieve greatness in a lifetime. His legacy can be found in many of the books you read and in the massive growth of libertarianism in our times. Signs of his works are all around us. These were his gifts to the world. And for those of us who knew him, Burt's wonderful life and outlook are gifts to us of inestimable value.

We will miss him every day, but no day will ever pass when we are not inspired by his example. May his great soul rest in peace.

A return to the gold standard, where countries peg their currencies to a given quantity of the metal and thus to one another, is a bad idea. Gold-based monetary systems are overly rigid and restrictive, possess a deflationary bias and can be volatile. They make long-term inflation dependent on the pace of mining output in places such as China, South Africa and Russia.

Let's take these one at a time. To criticize a monetary system based on gold as "rigid" only makes sense if you believe that printing green pieces of paper makes a country richer. After all, the only rigidity enforced by the gold standard is on the central bank's use of the printing press. Requiring the government to maintain a fixed dollar/gold exchange rate is "restrictive" in the same way that the Bill of Rights limits the discretionary power of the feds.

So yes, if Mr. Sesit thinks that the government does a good job centrally planning the economy with injections of new paper money, then I can see why he would consider the gold standard a bad idea. But let me ask you this: would you trust your next-door neighbor to use a legal-tender printing press "responsibly"? Now what about the people in DC? If we're going to be foolish enough to give them a printing press in the first place, don't you think it's a good idea to put some strict rules in place?

Sesit's next point is that the gold standard has a "deflationary bias." So what? That's one of its virtues, that the purchasing power of the dollar doesn't fall or might actually increase over time. Even mainstream macroeconomists — whether neoclassical or New Keynesian — have come to realize over the last few decades that long-term predictability in monetary policy has definite advantages, and that in the long run, the best thing the monetary authorities can do is provide a currency with stable purchasing power.

So you tell me: looking at the graph below of the Consumer Price Index, when was the value of the dollar stable and predictable, and when was it really volatile? In which environment could businesses and investors confidently make long-term decisions? Remember that FDR took away private citizens' right to redeem dollars for gold in 1933, and then Nixon finally removed even the ability of central banks to do so in 1971.

Remember, Mr. Sesit is warning us that under the gold standard, things were very volatile.

Let me deal with a possible objection: the opponent of the gold standard might look at the above chart and say, "Well of course the dollar-price of gold is stable under a gold standard; that's true by definition! The problem is that this enforced stability means that other parts of the economy get jerked around because of the arbitrary handcuffs placed on the central bank."

But the historical record does not support this (typical) claim. I always remind people who tout the stabilizing virtues of central banks that the Great Depression started fifteen years after the Federal Reserve opened its doors. Whether you subscribe to the Austrian theory (see this and this) that the Fed pumped up the stock market with artificial credit in the 1920s, or whether you subscribe to the Friedmanite theory that the Fed pushed on the brakes too hard in the late 1920s and then didn't inflate enough in the early 1930s, either way you are blaming the Great Depression on the botched policies of the Federal Reserve.

In contrast, throughout its previous 150 or so years, the American economy had managed to do just fine without the Federal Reserve "fine tuning" the money supply. Yes, there were occasional panics (the term they used before "depression") when the major economic powers adhered to the classical gold standard, but these business cycles paled in comparison to the Great Depression.

As for entrusting our money supply to gold miners in China, Russia, and South Africa, so what? When it comes to money, the great danger is a massive inflation. That's the only way you can really destroy an economy: through flooding it with more and more paper money so that prices start rising at runaway rates.

One of the prime virtues of using gold as money is that the annual output is a small fraction of the total world stockpile. We never need fear that prices — if they were expressed in terms of gold ounces — would rise at Zimbabwean rates. The absolute worst that could happen is that all of the major gold producers decide to stop operations in order to punish the United States. Note that they couldn't simply refrain from selling to American buyers: because gold is even more fungible than oil, the gold exporting countries would need to cut off all of their buyers if they wanted to punish Americans. Now how long could they afford to do that?

Unlike oil or other commodities intended for use in production, when gold is used as a money, a given amount can always "do the job." It's true that a sudden interruption in the growth of the world stock of mined gold would put downward pressure on prices, if those prices are quoted in gold ounces. But soon enough people would adjust, and would factor in the new trend to their expectations. There were plenty of long stretches in world history where genuine economic prosperity went hand in hand with gently falling prices. In any event, could those mischievous gold miners in Russia do anything like this to our money supply?

Sesit concludes with an odd argument:

What's more, a gold standard isn't the panacea its advocates claim. A central bank's ability to adhere to it is only as strong as the population's willingness to endure the pain associated with enforcing the system.

Countries periodically abandoned the gold standard during times of war — Britain during World War I, for example — and free-spending Latin American countries were repeatedly forced to exit the system in the late 19th century. The Bretton Woods System collapsed in 1971 when the costs associated with fighting the Vietnam War forced President Richard Nixon to suspend the convertibility of dollars into gold.

If you don't have faith in central bankers or politicians to ride herd over inflation, why would you trust them to keep a country on a gold standard for more than a short period of time?

I'm not sure how to answer this. It's true, I don't trust central bankers to stick to a gold standard; that's why I think the government should get out of the money industry altogether. Suppose we were starting in an initial state of pure laissez-faire in money and banking, and someone said, "Hey I know! Let's give this Princeton professor — what was your name, sir, was it Ben? — a printing press, but be very stern that he can't overdo it and allow the gold price to rise more than 1 percent from the day he starts. Does that sound like a good idea?" In response, I would obviously say, "No, that seems rather risky. I think we should stick to the current system, where the market determines how much new money is brought into the economy through gold production."

But that's not where we're starting. If we're going to have a central bank, it makes a lot of sense to put in place rigid restrictions on it. Notice you could use Sesit's argument for any recommendation to restrain inflation. For example, Milton Friedman famously recommended that the central bank announce a fixed rate of growth in the money stock. Well gee whiz, Dr. Friedman, if you don't trust the central bank to responsibly exercise discretionary policy, how can you trust them to stick to a fixed rate of growth?

And the same thing applies to the Bill of Rights, too. If you can't trust the politicians to respect freedom of speech, why would they respect the First Amendment?

In closing, let me admit that a hardcore libertarian really could say that it is a waste of time to defend the gold standard, or even the Bill of Rights for that matter. Maybe they really are diversions, little gimmicks that the politicians can use to fool a gullible public into thinking they are safe.

But that is clearly not what Sesit is arguing in his Bloomberg piece. No, he is arguing that the gold standard is a bad idea because it keeps the central bankers from using all the latest, cutting-edge macro models to fine-tune the economy.

Rather than his proposal, I would far prefer the classical gold standard. It's true that the government can always renege on its pledge to maintain a fixed peg to gold, but at least everybody would know exactly when the government cheated. You would at least avoid absurdities such as the present crisis, in which people are actually praising the Fed for pumping in unprecedented amounts of new money in order to "help."

Although the public has been desensitized into believing that a rising money supply is the same thing as lowered interest rates, these are actually quite distinct things. In fact, the apparently obvious connection between monetary growth and interest rates is largely an accident of the way central banks developed historically. In an economy truly based on private property, the gold miners — i.e., the producers of new money — would have no direct connection to interest rates at all. A decision by the gold miners to boost production would have very little direct impact on interest rates.

Central banks quite arbitrarily inject new money into the economy via the credit markets. Let's suppose for the sake of argument that the government should control the "money industry." Further suppose we are in a situation where the government determines that an injection of new money is needed to help the market snap out of its laissez-faire funk. Even so, there is no reason the central bank needs to choose debt securities as the point of entry for new money.

This is a crucial point so let's think it through. Right now, when the Federal Reserve engages in "open-market operations," Bernanke goes into the market and buys, say, $10 million worth of US Treasuries from a bond dealer. How does Bernanke pay for this? Why, he simply writes them a check written on the Federal Reserve.

When the bond dealer deposits the $10 million check, his bank credits his checking account with $10 million. Then the bank itself turns the check over to the Fed. Get ready, here's the fun part: when the Fed receives a check — written on itself — from Acme Bank, the Fed processes the check and increases Acme's checking balance with the Fed by $10 million. But there is no corresponding debit to any other checking balance! The total amount of member-bank reserves, held on deposit with the Fed, has magically increased by $10 million.

As everyone who didn't skip the relevant college lecture will recall, the fractional-reserve nature of our banking system means that the injection of $10 million in new reserves will actually allow up to $100 million in new money to enter the economy. But that pyramid effect is not what I want to focus on.

Instead, I want to focus on the fact that the Fed chooses bond dealers to be the first recipients of the new money. That has an enormous impact on the way the economy operates. But we don't even see this aspect of the situation, because we have come to believe it is natural.

In fact, it is horribly unnatural and causes the business cycle itself. Suppose that instead of entering the bond market, when Bernanke wanted to increase the money supply, he started adding SUVs to the Fed's balance sheet. Can you imagine how much this would disrupt the car market?

It is not unusual for the Fed's balance sheet to increase by $5 billion in a given 12-month period. (In this article I'm not even going to start to deal with the astronomical increase in Fed holdings during 2008.) That means that in the course of a year, it is entirely possible that the Fed could go on a spending spree and bulk up with $5 billion in extra bonds issued by Uncle Sam. Then, down the road, it may dump those holdings just as quickly, and not according to any predictable formula but instead largely at the whim of one man.

Now imagine if the Fed stocked up on SUVs, rather than bonds, when conducting its open market operations. It would approach car dealerships and write checks (backed up by the infinite supply of Fed electronic reserves stored in the Bernanke Phantom Zone). Then the dealership would really sell an actual vehicle to the Fed. A private customer who had had his eye on that particular SUV would have to find another vehicle, because the one he wanted was being loaded on a truck headed for the New York vault.

However, the customer could actually decide to postpone buying, hoping that the Fed would adopt a tight monetary policy. In this case — when the Fed wanted to suck money back out of the economy to contain price inflation — it would dump SUVs back on the market. When the car dealerships bought them off the auction block, they would write checks to the Fed, drawn on their commercial checking accounts, and in the process would ultimately send some of the total reserves in the banking system back to the Phantom Zone.

Although our hypothetical system would introduce extreme volatility in SUV prices, it's still obvious that the car manufacturers would love the arrangement, so long as the government generally acted as a net purchaser of SUVs. That is, as long as the government's stockpile of SUVs tended to grow over time, the manufacturers would effectively receive a roundabout subsidy, even if the government never dealt directly with the manufacturers and always bought SUVs from third-party dealerships.

The actual and potential consumers of SUVs, of course, would suffer. Not only would they pay higher prices but they would also be less certain of the availability and price of vehicles down the road, due to the sudden jumping in and out of the market by the central bank.

Similar distortions occur in the real world, but we don't notice them anymore. When the Fed "cuts interest rates," what it's really doing is creating money out of thin air and handing it over to bond manufacturers. And what is a bond manufacturer? It's simply a fancy term for a borrower.

The most privileged bond producer is of course the US Treasury. Now I'm sure it was just a pure coincidence that when the government established the Federal Reserve — the entity that in a sense controls the dollar printing press — the government required, either explicitly or implicitly, that the Fed could generally only inject that new money by buying bonds issued by the Treasury. (This pattern has changed recently, of course.) This ensures that whenever the Fed injects new money into the system, it pushes up the price of Treasury bonds. Since the Treasury is selling those newly issued bonds, the Treasury obviously benefits from this.

On the other hand, private-sector buyers of Treasury and other bonds lose out. If they had entered the market with the intention of buying a bond yielding $10,000 in ten years, they will now have to pay a higher price because of the Fed's muscling into the picture with its Phantom Zone checkbook.

Another name for private-sector buyers of debt is savers. Thus the Fed's decision to stockpile debt instruments — rather than sport-utility vehicles — subsidizes the borrowers and penalizes the savers. Its actions also cause people to save less or borrow more than they would have in a free bond market. Perhaps more serious, the Fed's behavior sets in motion the boom-bust cycle that mysteriously plagues market economies.

What people often overlook is that the Fed distorts the economy in two separate ways: first, it destroys the value of the dollar by expanding the supply of dollars year after year. But beyond raising prices in general, the Fed's actions also cause distortions because they pull up bond prices first, so that they are temporarily higher compared to other prices.

If the Fed doubles the money supply, in the long run, that will roughly double the prices of all goods and services. But if the Fed restricts the injection of new money into only the hands of a few privileged recipients, those people will be at a fantastic (albeit temporary) advantage relative to everyone else in the economy. They will get their hands on the billions in new dollars, while prices still reflect the old reality. The new money will then flow from sector to sector, pushing up prices as it ripples throughout the economy. But the last people in line receiving the new influx of twenty- and hundred-dollar bills will be much poorer than others, once prices settle down. Their paycheck was the last to rise, while they watched helplessly as more and more prices began doubling.

Now what happens when the economy is in a situation where (a) it "needs" more money, and (b) it "needs" higher interest rates? (I'm using "needs" loosely to mean "required by economic efficiency.") For example, maybe a country that was previously economically isolated has now joined the world market. Its people originally traded among themselves with their own domestic currency, but now they want to use the international money.

Under a truly free money market, gold would probably be the world commodity money. That means tons of extra gold (in the form of bars and coins) would flow into the developing country, to be added to the cash balances of its people.

But at the same time, because these people would recognize the immense jump in standard of living they would soon experience, they would also try to borrow against their future income. In other words, now that their nation was open to international trade, their productivity would multiply by a factor of ten within a few years. The switch wouldn't be overnight however, because it would take time for multinational companies to come in and build state-of-the-art factories, or to begin large-scale extraction of mineral resources.

From the point of view of the natives, they would realize that their average annual income would jump from, say, $500 to $5,000 in two years, where it would stay until their retirement. In that situation, they would naturally borrow a lot of money. Their increased demand for loans would raise interest rates, calling forth new savings from the rest of the world and rationing the available funds among other potential borrowers.

That is how a truly free market would handle a scenario where the market needs more money and higher interest rates. The rising world price of gold would induce gold miners to boost output, while the rising price of borrowing would induce savers to boost their "output." There is no reason that the actions of the gold miners would conflict with the actions of the savers.

But what happens with a central bank such as our Federal Reserve? When it tries to increase the money supply, it necessarily has to push down interest rates, at least relative to what they otherwise would have been. Therefore, in a scenario where people want to hold more cash and where they are in desperate need of more savings, the Fed can cater to one crisis only by exacerbating the other.

This is exactly where we stand during today's crisis. The tremendous uncertainty in financial markets — itself caused largely by government policies — has led everyone to seek higher cash balances. People have no idea what their income stream will be like in 6 or 12 months, and so they are trying to expand their command of very liquid assets.

At the same time, the bursting of the housing and stock bubbles revealed that many wealthy people all over the globe had not been saving nearly as much as they thought they were. The alarm needed to flood through the world: "Save more! Save more! This is an emergency! The entire structure of capital is at risk if we don't plug these holes soon!"

Tragically, the setup of central banks in today's world only allowed the governments to solve one problem. They chose to flood the markets with money, thereby pushing interest rates down to the nonsensical rate of practically zero.

Thus, at the single most crucial time in world history for interest rates to rise sharply, they were instead pushed down to zero. Just when extra saving is needed most critically, instead the governments of the world have caused lending itself to become almost pointless.

Interest rates are prices, and as such they convey real information about scarcity in the world. People talk of financial affairs spreading into the "real economy," as if the allocation of capital is some minor detail. On the contrary, the capital markets — guided by interest rates — are the single most important "governor" of the "real" market economy over time.

By flooding the credit markets with money created out of thin air, the central banks of the world are interfering with humans' attempts to communicate with each other after the housing bubble popped. It would be as if the governments used military aircraft to jam the radios of rescue workers in a region hit by an earthquake.

The politicians and bureaucrats talk as if the members of the private sector are aloof during the crisis. On the contrary, people the world over are concentrating on their finances more than ever. But the governments of the world keep drowning out the signals people are trying to send to each other.

Money and interest are distinct things. There are times when the "right" market response is an increase in the supply of money and an increase in interest rates. Because modern central banks typically inject new money only by lowering interest rates, they make financial panics much worse.

Studying Jörg Guido Hülsmann's latest book, The Ethics of Money Production, is a vastly enriching experience. After building his case for natural money on the inviolability of an individual's right to his own property, he then shows us how the state has spent the last 400 years usurping this right for the benefit of a privileged few through its protection of fractional-reserve banking.

It is the state's insatiable appetite for revenue, he argues, that is the motivation behind the various monetary schemes it imposes on us, which on an international level begins with the classical gold standard and runs through today's paper-money agreements. Although he doesn't discuss the current economic crisis directly, his observations provide a much-needed correction to government's "do something" approach.

In this essay, I will touch on some of Hülsmann's more salient points, beginning with the origin of money.

We know that in a barter economy the division of labor is primitive because trade is limited by the double coincidence of wants. A carpenter who needs shoes finds a shoemaker who needs a chair, and they enter into a mutually acceptable trade. But trade is also limited by the makeup of the goods themselves — how will the carpenter acquire a small amount of flour with the chair he has built?

Over time, market participants devised better ways to trade. Certain consumer goods were found to be highly marketable and possessed physical characteristics conducive to trade, such as homogeneity, divisibility, and portability, and came to be acquired not for consumption but to serve as media of exchange. Such goods are called money; more than that, they are natural monies because they originated through the voluntary cooperation of acting persons.

The production of natural money is ethical because it involves no violations of property rights and is the corollary of a completely free society in which private property is inviolable. The economy of such a society, Hülsmann tells us, may then be called a "free market," which would likely harbor a variety of natural monies. With this understanding, the claim that the culprit of the current crisis is the free market puts its proponents in the awkward position of having to show causality from something that doesn't exist.

Natural monies come and go; they exist because they satisfy human needs better than any other medium of exchange. When this is no longer true, market participants will stop using them and find something better. Natural money thus becomes a product of grass-roots democratic action, where people have the freedom to choose the best available monies.

"Forced money," by contrast, "owes its existence to violations of property rights." It satisfies the requirement of facilitating trade, but superior monies can't be used without exposing the user to some degree of violence.

Gold, silver, and copper have been the natural monies of many societies for thousands of years. Though they possess physical characteristics that make them superior to other commodities for use as money, they are natural monies only because they were selected through voluntary human action.

If commodity money is the best available money, why do virtually all countries today use paper money instead?

First, as Hülsmann notes, in no period of human history has paper money spontaneously emerged on the free market. "Whenever and wherever it came into being, it existed only because the courts and the police suppressed the natural alternatives."

Hülsmann also points out that no Western writer before the 18th century seemed to think paper money was even a possibility, nor did any philosopher of money ever criticize the then-existing commodity money on utilitarian grounds. For example, in The Laws, book 5, Plato wanted to outlaw natural money to make citizens more dependent on government, but he didn't say it was inadequate as a money. Neither did Aristotle, the Church fathers, or the Scholastics. Before the 16th century, furthermore, there was no problem with hoarding or sticky prices, and apparently no need to stabilize the price level, purchasing power, or aggregate demand.

Of course, none of these observations persuades the paper-money crowd. According to them, the capitalist economies that emerged during the Renaissance required a different kind of money, one whose supply could keep pace with the fast action on the market. After 1500, new theories explaining this need "swamped the world," as Hülsmann puts it — but so did the rejoinders. In other words, in the 20th century, when Rothbard observed that the supply of money, like all other goods, is best left to the free market, it was "anything but a novelty in the history of thought."

We must ask then what was the rationale for imposing paper money on the economy? Hülsmann addresses some of the most widespread errors in attempting to justify government intervention in monetary affairs.

By far the biggest fallacy is the belief that a growing economy requires a growing money supply. If an economy grows by five percent, then the money supply must grow by the same amount, the argument goes, otherwise the additional goods cannot be sold. Since a growth rate as high as five percent is exceptional for precious metals, they must be rejected as money for a modern economy. Paper money, on the other hand, can be produced in any quantity cheaply and quickly.

Economics teaches that any quantity of goods and services can be exchanged with virtually any quantity of money. If the economy grows but the money supply remains constant, prices will have a tendency to fall. It's sometimes argued that if prices fall entrepreneurs will not be able to recover their costs and will face bankruptcy. But entrepreneurs have invariably shown the ability to anticipate future price reductions and compensate by lowering their expenditures. This, in fact, is the normal state of affairs in periods of a stable or falling price level, and was the experience of Germany and the United States during the last three decades of the 19th century.

A variation of the above fallacy is the alleged need to fight deflation. Though it can be defined in several ways, deflation most frequently refers to a sustained fall in the price level. In a deflation, bank customers will have difficulty repaying their debts, and this, in turn, will reduce bank liquidity and curtail credit.

Deflation, however, does not threaten the whole of society because, as credit does not create resources, neither does a curtailment of credit destroy resources. Deflation amounts to "a redistribution of productive assets from old owners to new owners," Hülsmann writes, with the net impact on total production likely to be negligible.

If this is true, why does Ben Bernanke regard deflation as the great devil he must fight at any cost? Because deflation emphatically is a threat to those institutions responsible for inflationary increases in the money supply: fractional-reserve banks and their customers, which means "debt-ridden governments, entrepreneurs, and consumers." Deflation tends to liberate "the underlying physical resources for new employment. The destruction entailed by deflation is therefore often 'creative destruction' in the Schumpeterian sense." (William Greider noted that bankers championed "creative destruction" when it was affecting other people, but when it came knocking on their doors, the bankers were "not so accepting of their own fate.")

Stabilization of the purchasing power of money (PPM) has been another excuse for abandoning natural money for paper money. On a free market, the best monies will prevail and will have a relatively stable PPM. If the money should experience violent fluctuations, people will abandon it and switch to a different money — if they're free to do so.

Irving Fisher and others said that's not good enough; government should fine-tune the PPM, and that requires paper money. But this is another instance of putting the fox in charge of the chicken coop; the result has been a complete disaster. In the modern era, managed currencies everywhere have depreciated and fluctuated as never before in the history of monetary institutions.

Adam Smith and David Ricardo popularized the view that paper money could do the job of commodity money, only at much lower production costs. Whatever appeal this might have vanishes when one remembers that money as such is not a consumer or capital good, but a facilitator of exchanges. Increasing its quantity doesn't add to society's wealth. Its utility lies in its exchange value, and increasing its supply tends to lower that value. Thus, the higher production costs of commodity money turn out to be one of its great advantages, because it cannot be multiplied at will. Paraphrasing Hülsmann, commodity monies have built-in insurance against inflation.

Most writers today define inflation as a lasting increase in the price level. Hülsmann adopts a different definition, one that was more or less accepted up until World War II: inflation is any expansion of the money supply that violates private-property rights. Unlike natural (voluntary) money production, which is regulated by the market forces of profit and loss, inflation is always an imposed increase of the money supply. With this definition, inflation can be seen as the cause of "unnatural income differentials, business cycles, debt explosion, moderate and exponential increases of the price level, and many other phenomena." Hülsmann sets about to expose the causal connections in some detail.

People — mostly governments — inflate the money supply because they profit from it, and the history of monetary institutions is largely the history of inflationary schemes. Early owners of the new money are the winners because they buy goods and services at current prices. Later owners are the losers because they pay the higher prices that the money-supply increase creates.

Inflation began as the debasement of coins, or what Hülsmann refers to as the falsification (counterfeiting) of money certificates physically integrated with the monetary metal. The counterfeiter could either reduce the precious metal content of the coins or imprint a higher nominal figure on the coins.

Compared to fractional-reserve banking and paper money, debasement was a crude method of counterfeiting. Using debasement, English kings could only inflate the money supply by a factor of 0.3 over a 500-year period (1066–1601). When they had access to the advantages of fractional-reserve banking during the subsequent 200 years, however, that factor jumped to 16. And American monetary maestros pumped up the money supply by a factor of 5 in a mere 30 years (January 1973–January 2003) by feeding the fractional-reserve monster.

There were other differences between inflation then and now. When princes of old debased their coins, their subjects considered it a cheat. When today's leaders debauch their currency, they proclaim it as wise and necessary monetary policy, and until recently most people believed them. It has taken the hocus-pocus of massive "stimulus " solutions to begin to shake their faith, though the new messiah is trying to restore it.

The grip of government on our lives cannot be adequately explained without reference to fractional-reserve banking, paper money, and the laws protecting these institutions. Hülsmann provides a compelling explanation of the relationship between government growth and modern banking.

As he tells us, banks developed as money warehouses in northern Italy beginning in the late 16th and early 17th centuries and soon became fractional-reserve banks, meaning they issued certificates in excess of the actual money they had in reserve. Unlike warehouse banks, fractional-reserve banks cannot meet all their obligations at once and are subject to the perpetual nemesis of all fractional-reserve schemes: the bank run.

The usual explanation for the corruption of warehouse banking into fractional-reserve banking is the simple one of bankers' giving in to temptation. While true, this is not the sole cause. Fractional-reserve banking was in part a defense against government confiscation. When Charles V was robbing the reserves of banks in Seville in the mid-1500s, for example, the bankers decided to evade the plunder by loaning a large portion of their deposits to commerce and earning a profit. The threat of confiscation somewhat diminished the bankers' guilt.

In an ethical society, laws would punish counterfeiting as an instance of fraud and theft, and, once the false certificates were discovered, market participants would abandon their use and switch to alternatives.

But governments can legalize certain kinds of counterfeiting. This can be accomplished in several ways. One method is for government to spin language in such a manner that certificate imprints can take on any contractually binding meaning. For example, the courts might see nothing wrong with a gold coin marked "one ounce of gold" that in fact has less gold or no gold at all. Legalization here means that the government refuses to enforce the laws against bank counterfeiting. Legalizing false money certificates is the foundation of all other monetary privileges, such as legal monopolies and legal-tender laws.

But even when it holds a monopoly on the supply of coins and banknotes, the government cannot yet open the inflationary floodgates; market participants are still free to evaluate the coins and banknotes and can switch to other monies if their local monopoly supplier is irresponsible. Legal monopoly reduces the range of options and diminishes the full use of one's property, but it does not eliminate choice per se, and that remaining choice continues to keep the government in check.

From the government's perspective, legal-tender laws solve this problem. They attack choice at the root by overruling any contractual agreement a person might make with respect to money.

There is another sense in which legal tender corrupts choice. If the unhampered market can be thought of as assigning "votes" to money users — one penny, one market vote, as Frank Fetter wrote in 1905 — then the imposition of fractional-reserve banking through legal-tender laws creates votes out of nothing and assigns those votes to the first users of the new money: bankers and government. A privileged money creates a privileged society.

Historically, legal-tender laws usually established a fiat equivalence between the privileged money and other monies. If gold and silver are legal tender, and gold is decreed to trade with silver at 1/20, but will trade at 1/15 on the market, the undervalued silver will gradually disappear from daily transactions. Legal-tender laws inflate the legally privileged money and deflate the others.

With silver scarce, its purchasing power rises, and it becomes difficult to make small purchases. People will be inclined to rely instead on fractional-reserve banknotes and demand deposits, which can be created quickly. If government then makes its notes legal tender, along with gold, the notes increase in demand because no one wants to pay in real money (gold). Notes are consequently redeemed less often, which increases bank reserves of gold. In the fractional-reserve system, this enables banks to issue more banknotes.

For the government, fractional-reserve banknotes are a godsend. It was fairly easy for laymen to distinguish debased coins from sound coins. Paper certificates, though, circulate without any distinctions.

Privileged banknotes entail a "race to the bottom" of worthlessness, but as long as they're redeemable in gold there is a limit to how much they can be inflated. Removing that limit converts them into pure paper money.

Banknotes become paper money through progressive infringements on private property and through breaches of contract perpetrated by central banks. When government grants a monopoly legal-tender status to the notes of a fractional-reserve bank, then allows the bank to suspend the contractually agreed-upon redemption of its notes, it turns those notes into paper money.

Paper money, by its very nature, is a form of fiat inflation: it is always and everywhere in greater supply than it would be on the free market, where it could not sustain itself at all. The banknotes of the world became paper money on August 15, 1971 when the United States declared it would no longer redeem its dollars in gold.

While the threat to gold miners is bankruptcy, the threat to paper-money producers like the Fed is hyperinflation. There's really no limit to how much paper money it can produce. As a privileged central bank, it cannot go bankrupt, and neither can the government that appoints the Fed's leaders go bankrupt.

In December 2002, Alan Greenspan claimed that "a prudent monetary policy maintained over a protracted period can contain the forces of inflation." But even "prudent" central bankers can't avoid economic crises. As Hülsmann argues, "the mere possibility of inflating the money supply creates moral hazard" (emphasis added). Users of commodity money do not speculate on the sudden availability of gold and silver miraculously emerging from the mines. By contrast, people do speculate on the "good will" of the paper-money producers, and they're right most of the time.

Inflation's standard definition is too narrow to provide an appreciation of the extent of its harm; it is far more than a deterioration of the currency's purchasing power. It's also much more than a "hidden tax." Government's perennial fiat inflation is a subtle WMD. Consider the following:

In funding wars, it allows government to ignore the fiscal resistance of its citizens.

It benefits the central government at the expense of secondary and tertiary governments.

It turns moral hazard and irresponsibility into an institution, and guarantees recurring economic crises.

By making credit cheap, it encourages businesses to finance their ventures through borrowing rather than equity. Because of market competition, few firms can resist the offer of low credit, making them more dependent on banks. As Pius XI noted in 1931, it puts a dictatorship in the hands of lenders who regulate the lifeblood of the entire economic system.

Fiat inflation drives people to invest in capital markets where few will have the expertise, time, and inclination to monitor their investments properly. In former times people could save simply by holding gold and silver coins.

Under a perennially increasing price level, the average citizen finds his best strategy is personal debt, which weakens self-reliance and independence.

Under chronic fiat inflation, people will tend to choose their employment based on monetary returns. Money then becomes the prime or only consideration for personal happiness.

Perennial inflation deteriorates product quality. Industries that cannot compensate for inflation with technological innovation turn to other means, such as producing an inferior product under the same name. Lying, which is bound up with fractional-reserve banking, tends to spread like a cancer over the rest of society.

By fueling the exponential growth of the welfare state, fiat inflation fosters the decline of the family. Families become degraded into "small production units that share utility bills, cars, refrigerators, and especially the tax bill." The welfare state drives the family and private charities out of the "welfare market."

As Hülsmann concludes, "fiat inflation is a juggernaut of social, economic, cultural, and spiritual destruction."

The myth that governments are servants of their people is fully exposed in the history of money production. From antiquity to the present day, governments have always sought to steal from their citizens through manipulation of the money supply. In modern times, this has taken on the trappings of a science. To oppose it now means to oppose virtually the entire economics profession, most of whose members happen to be on the government payroll in one way or another.

The classical gold standard was ushered in following Germany's victory over France in 1871. Libertarians and monetary conservatives often hail this period as a halcyon era we need to resurrect. But while that standard had desirable results, such as boosting the international division of labor, it was still an imposed standard. As such, it demonetized silver and thus brought about a strong fiat deflation, which in turn reinforced fractional-reserve banking throughout the banking hierarchies.

As Hülsmann makes clear, the inherent fragility of fractional-reserve banking is well known to bankers and motivates them to devise means of postponing the crisis it inevitably produces. The classical gold standard was one such scheme. It was not imposed as a means of limiting inflation. It served as a pretext for national governments to bring the monetary systems of their countries under their control. Rather than "a bulwark of liberty," it was a "breakthrough for the societal scourge of our age — omnipotent government."

The onset of World War I in 1914 killed the classical gold standard before it could collapse on its own. An international arrangement called the gold-exchange standard replaced it in 1925 and lasted until 1931. Under the classical standard, the central banks kept their entire reserves in gold, while the commercial banks kept their reserves mostly in central banknotes. The gold-exchange standard took this pooling arrangement to an international level, with the Fed and the Bank of England remaining true central banks and, as the holders of gold, serving as the central banks of the world. Other central banks kept a large portion of their reserves in US and British notes. The gold-exchange standard collapsed following the 1929 Crash when various governments turned to protectionism or imposed foreign-exchange controls. It died in September 1931, when the Bank of England suspended payments.

The world suffered through a period of fluctuating exchange rates until the end of World War II, when the Bretton Woods system was adopted. As Hülsmann explains, it amounted to "a gold-exchange standard writ large." Under the classical system, gold was pooled in each nation's central bank; under the gold-exchange standard, the number of pools was cut to two — and under Bretton Woods, one. All the arrangements were devised to facilitate the "flexibility" of banknotes, and each was far more expansionary than its predecessor.

Under Bretton Woods, the participating nations agreed to pool the world's gold reserves at the Fed, which already had the largest gold supply in world history. The Fed continued to redeem its notes in gold to other governments and central banks, which in turn redeemed their own notes in dollars. To a great extent, participants were dependent on the good will of the Fed, which alone had the power to allocate the world's banknotes — dollars — at its discretion.

"Restraint was not part of its mission," Hülsmann tells us, "and the very anchor of the system — the Fed — was particularly ruthless in its inflation of the dollar supply." When it collapsed in 1971, the gold reserves of the Fed were nearing exhaustion. Bretton Woods thus concluded 100 years in which three "cartels of central banks had flooded the western world with their banknotes without nominally abandoning the gold standard."

When the United States suspended payment of gold, it converted the world's banknotes to paper money. It also created the horror of fluctuating exchange rates that weakened the international division of labor and brought "misery and death" to millions. Yet paper-money standards have emerged. How is this possible?

We need to consider what government wants — more power and revenue — and the means available to attain it. The easiest way for governments to get additional revenue over and above taxes and debt is to encourage foreigners to make investments in their countries. But to do so they must provide sufficient financial safeguards. A government seeking investors, for example, might float bonds denominated in the paper money of a country whose investments it seeks. The issuing of government bonds denominated in US dollars or euros is today a widespread practice.

The territories with the largest capital markets will be the ones whose paper money will be adopted as international standards, and, in the 30 years following the fall of Bretton Woods, those territories have been Europe, Japan, and the United States. Consequently, the euro, the yen, and the dollar are the three most important monetary standards today.

As Hülsmann notes, the standard money producers cooperate with one another to maintain their positions. In a dollar crisis, for instance, the euro producers will commit to stabilizing the dollar-euro exchange rate so that dollar countries won't switch standards. And since paper-money producers know they can count on their competitors to help them out, they have a strong incentive to collude and expand their production.

Would a single global paper money such as the one Keynes proposed at Bretton Woods avoid the pitfalls of competing paper monies? Absolutely not, Hülsmann answers. All paper monies, whether national or global, are subject to moral hazard. They will either collapse in hyperinflation or invite increasing government control over all economic resources.

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We need to sweep aside privileged money and let the market work. It might seem an impossible goal, but history provides some encouragement. As the author notes, China used paper money for 500 years and suffered from hyperinflations and other monetary problems. When political leaders stopped suppressing silver and copper coins, monetary sanity returned. In US history, the framers repudiated the inflationism of the country's past in the Constitution's very first article; and Andrew Jackson defeated his inflationist foes during his presidency.

An ideal order of natural money production based on a universal respect for private property could exist today, he says, "technically at a moment's notice." With it so close at hand, it remains only to convince others that it should exist. Students of Hülsmann's book will find it a rich resource for such an undertaking.

[bio] See his [AuthorArchive]. Comment on the blog.

An MP3 audio file of this article, read by Floy Lilley, is available for download.

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Libertarians tend to be an intense lot. After all, with government making a mess of things economically and constantly infringing on our freedoms, what is there to laugh about? It's a full-time job being outraged. Who has time for anything else? But the dictators and their apparatchiks come and go, and the days, months, and years still march on. Everyone has a life to live and fighting the good fight for liberty while having a laugh or two is the way to a happy, fulfilling existence.

Burt Blumert has been fighting that good fight for decades, all the while poking fun at the government thugs, societal decay, political correctness, the medical-industrial complex, the persecution of Barry Bonds, and anything else that has slid under his skin. Burt's the kind of guy who seems like he was born wise. Thus, it's no surprise that, as David Gordon writes, "He knew almost everyone important in the libertarian movement, as well as in the hard money community of which he was a leading member." Up until Lew Rockwell persuaded Burt to put his views of the world on LewRockwell.com, only Burt's friends and customers benefited from his keen and funny insights.

Thankfully, since November 1, 1999, LRC readers have had the benefit of reading about the world through Blumert's eyes. Bagels, Barry Bonds, & Rotten Politicians is a compilation of Burt's missives, published by the Mises Institute, of which Burt is chairman of the board.

Burt captures the outrage of anyone who must fly frequently, with his piece written just after 9/11, "Revisiting The Friendly Skies." "It was like a WWII newsreel: the endless line of defeated people pushing their luggage," he begins, "inching toward the inevitable checkpoint." Seven-plus years later, the punk economy has made the lines shorter, but we now have a beefed up TSA workforce outfitted in snappy new blue uniforms. And as if metal detectors weren't bad enough, soon all passengers will be electronically strip-searched insuring that only the best and brightest will continue to seek employment with the TSA.

"Adjusting is part of the human condition," Blumert writes in a piece celebrating the TV remote-control device, poking fun at the nonsense that's on television, and skewering various TV personalities such as Wolf Blitzer, Bill O'Reilly, and Bill Maher. Ironically, the leftist Maher has often provided a forum on his show for Burt's pal Ron Paul since Paul ran for president in 2008.

There is probably no more revered profession than doctors. After all, doctors are thought to know everything — just ask them. But an entire section of Burt's book is devoted to why he hates doctors, or at least most of them. In one piece he recounts a story that a friend and medical editor told him about a doctors' strike in Israel. Undertakers protested and stopped the strike because their business was being harmed.

For those who haven't fallen for the siren's call of party politics, but are considering it, Burt's articles on third parties, conventions, and delegates are a must. He has been there and done that, serving on the Libertarian Party National Committee from 1987–89. He was treasurer of the 1984 Libertarian Party presidential campaign and was Ron Paul's campaign chairman in 1988. "Delegates to political conventions rank amongst the lower forms of animal life," Burt writes. "They are mindless adherents who fit Lenin's description of movement followers as 'the swamp.'"

Blumert spent some of his formative years at the racetrack and watching baseball. And while he vigorously defends Barry Bonds, the beloved horse Seabiscuit is no champion in Blumert's view. While Bonds is "true baseball royalty," Seabiscuit "doesn't rate in the top 50." Seabiscuit's match race victory over War Admiral was "more hype than history."

For those having an interest in buying gold, Burt owned and operated Camino Coins for decades, and, as you would expect, a number of the essays in the book concern the yellow metal. Besides providing plenty of good advice, Burt gives a historical perspective to buying gold that precious-metals newbies may not be aware of. It has only been since 1974 that gold ownership has been legal. "Many of the products we handle today would have sent you to prison then," Burt explains. "Markets were rigidly controlled and the gold police were always lurking."

Burt also writes skillfully about movies, books, and the deficiencies of modern culture, but my favorite pieces are about Murray Rothbard. It was my great fortune to have studied under and been friends with Murray, and I am equally blessed to know and be friends with Murray's close friend Burt Blumert. Murray was more aware than anyone of the ongoing evils perpetrated by government and he was never given the proper recognition in academia. But he was constantly happy and loved to laugh. Now I know Murray wasn't a joyous libertarian by himself; he had help from his smart, wickedly funny best friend Burt.

This review originally appeared on LewRockwell.com.

I am tired of hearing economists argue that government and the Fed should expand credit for the good of the economy. Sometimes an analogy clarifies a subject, so let's try one.

It may sound crazy, but suppose the government were to decide that the health of the nation depends upon producing Jaguar automobiles and providing them to as many people as possible.

To facilitate that goal, it begins operating Jaguar plants all over the country, subsidizing production with tax money. To everyone's delight, it offers these luxury cars for sale at 50% off the old price. People flock to the showrooms and buy.

Later, sales slow down, so the government cuts the price in half again. More people rush in and buy. Sales again slow, so it lowers the price to $900 each. People return to the stores to buy two or three, or half a dozen. Why not? Look how cheap they are! Buyers give Jaguars to their kids and park an extra one on the lawn. Finally, the country is awash in Jaguars.

Alas, sales slow again, and the government panics. It must move more Jaguars, or, according to its theory — ironically now made fact — the economy will recede. People are working three days a week just to pay their taxes so the government can keep producing more Jaguars. If Jaguars stop moving, the economy will stop. So the government announces "stimulus" programs and begins giving Jaguars away. A few more cars move out of the showrooms, but then it ends. Nobody wants any more Jaguars. They don't care if they're free. They can't find a use for them. Production of Jaguars ceases.

It takes years to work through the overhanging supply of Jaguars. The factories close, unemployment soars and tax collections collapse. The economy is wrecked. People can't afford repairs or gasoline, so many of the Jaguars rust away to worthlessness. The number of Jaguars — at best — returns to the level it was before the program began.

The same thing can happen with credit.

It may sound crazy, but suppose the government were to decide that the health of the nation depends upon producing credit and providing it to as many people as possible.

To facilitate that goal, it begins operating credit-production plants all over the country — called Federal Reserve Banks, Federal Home Loan Banks, Fannie Mae, Sallie Mae, and Freddie Mac, all subsidized by monopoly powers or government guarantees — to funnel credit to the public through banks. To everyone's delight, banks begin reducing collateral requirements and thereby offering credit for sale at below-market rates. People flock to the banks and buy.

Later, sales slow down, so banks cut the price again. More people rush in and buy. Sales again slow, so lenders lower the price to 1% with no collateral and no money down. People return to the banks to buy even more credit. Why not? Look how cheap it is! Borrowers use credit to buy houses, boats, and an extra Jaguar to park out on the lawn. Finally, the country is awash in credit.

Alas, sales slow again, and government and banks start to panic. They must move more credit, or, according to its theory — ironically now made fact — the economy will recede. People are working three days a week just to pay the interest on their debt to the banks so the banks can keep offering more credit. If credit stops moving, the economy will stop. So the government announces "stimulus" programs and begins giving credit away, at 0% interest. A few more loans move through the tellers' windows, but then it ends. Nobody wants any more credit. They don't care if it's free. They can't find a use for it. Production of credit ceases.

It takes years to work through the overhanging supply of credit. Banks close, unemployment soars and tax collections collapse. The economy is wrecked. People can't afford to pay interest on their debts, so many IOUs deteriorate to worthlessness. The value of credit — at best — returns to the level it was before the program began.

See how it works?

Is the analogy perfect? No. The idea of pushing credit on people is far more dangerous than the idea of pushing Jaguars on them. In the credit scenario, debtors and even most creditors lose everything in the end. In the Jaguar scenario, at least everyone ends up with a garage full of cars. Of course, the Jaguar scenario is impossible, because the government can't produce value. It can, however, reduce values.

A government that imposes a central bank monopoly, for example, can reduce the incremental value of credit. A monopoly credit system also allows for fraud and theft on a far bigger scale. Instead of government appropriating citizens' labor openly by having them produce cars, monopoly banking and credit machines do so clandestinely by stealing stored labor from citizens' bank accounts by inflating the supply of credit, thereby reducing the value of savings.

Twentieth-century macroeconomic theory — both Keynesian and monetarist — championed the idea that a growing economy needs easy credit. But this is a false theory. Credit should be supplied by the free market, in which case it will almost always be offered intelligently, primarily to producers, not consumers.

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Would lesser availability of consumer credit mean that fewer people would own a house or a car? Quite the opposite. Only the timeline would be different. Initially it would take a few years longer for the same number of people to save enough to own houses and cars — actually own them, not rent them from banks. Prices would be lower because credit would not be competing with money to bid up these goods. And, because banks would not be appropriating so much of people's labor and wealth, the economy as a whole would grow much faster. Eventually, the extent of home and car ownership — actual ownership — would eclipse that in an easy-credit society. Moreover, people would keep their homes and cars because banks would not be foreclosing on them. As a bonus, there would be no devastating across-the-board collapse of the banking system, which, as history has repeatedly demonstrated, is inevitable under a system of central banking and other government-created credit factories.

Jaguars, anyone? More credit? Here's a better idea: let's go back to using real money.

[bio] See his [AuthorArchive]. Comment on the blog.

The original version of this article appeared in the February 20, 2004 issue of The Elliott Wave Theorist, a year before the housing-credit bubble burst.

An MP3 audio file of this article, read by Dr. Floy Lilley, is available for download.

You can subscribe to future articles by this author via this [RSSfeed].

The $35 price was an integral part of the Bretton Woods Agreement negotiated after World War II. Bretton Woods specified a system of fixed parities between the US dollar and other industrialized currencies, and the convertibility by foreign central banks of US dollars into gold at $35 an ounce. In other words, each dollar paid out around .03 ounces of gold, or 0.888671 grams.

This was not like the classical gold standard of the 1800s but a pseudo gold standard foisted on the world by central planners. Convertibility could not be exercised by private individuals, only central bankers, and most currencies were not redeemable in gold; only the dollar was. Again, gold charts show a flat line through the Bretton Woods era of the 1940s, '50s, and '60s at $35.

The problem with these flat lines is that they imply that monetary authorities were able to keep the actual gold price fixed at the precise level they specified, and conversely, that the purchasing power of the dollar remained constant. This was not the case, as the market price for gold often differed from the official $35 price, sometimes quite significantly, and the dollar actually lost value against most goods, even though it was officially fixed versus gold.

When doing research for a gold chart project of my own, I spent several weeks nosing through old papers and magazines for market data from the era of $35 gold. I hope to bring back into public memory the divergence of gold's market price from the official price, a data set that has been forgotten.

Our chart begins in 1954 with the reopening of the London gold market, which, prior to being closed at the outbreak of World War II, had been the world's largest venue for trading the metal. Through the 1950s the London price fluctuated between $34.85 and $35.17. These upper and lower limits were set by arbitrage and the threat thereof. Foreign central banks, as stipulated in Bretton Woods, could go to the Federal Reserve in New York and convert their dollars into gold or gold into dollars at $35 plus 8.75¢ commission. The cost of shipping and insuring gold from New York to London and vice versa was 8¢ to 10¢ per ounce.The Economist, October 22, 1960.

Thus, when the London price traded down to $34.82 or so, it made sense for central banks to buy gold in London, ship it to New York for 8¢, then sell it to the US Treasury at the $35 official price less 8.75¢ commission, earning arbitrage profits of around 1¢ an ounce. Conversely when gold rose to $35.18 in London, it made sense to buy gold from the US Treasury at $35.0875, ship it to London for 8¢, sell it at $35.18, and earn arbitrage profits of 1¢.

In the mid to late 1950s the balance of payments between the United States and the rest of the world grew ever more dramatically in the latter's favor. This was due to growing US military expenditures overseas, corporate investment outflows, and foreign aid to a rebuilding Europe. As a result, European and Japanese central banks accumulated continuously growing US-dollar reserves.

Nineteen fifty-eight marked the first year in which foreign central banks exercised their convertibility rights in significant amounts and returned their dollars for gold. US gold reserves fell 10% from 20,312 metric tons to 18,290 that year, another 5% in 1959, and 9% in 1960. At the same time, the US Federal Reserve continued to increase notes in circulation, resulting in dollars being backed by ever smaller amounts of gold. Since this threatened future potential convertibility, rumors grew that the United States would be forced to devalue the dollar to staunch the outflow.

The US government tried to prevent gold from leaving by twisting the arms of foreign central banks to keep their dollars, and, later, setting travel limits on American tourists overseas and US private investment in Europe. By 1958, London gold was trading closer to its $35.18 upper limit rather than the bottom limit at $34.82, which it touched in 1957. Participants in the London market — increasingly dominated by throngs of private investors and speculators — were ever more certain that the United States' plunging gold reserves would force it to dramatically devalue the dollar.

In September 1960, the United States experienced its largest weekly decline in reserves since 1931Globe and Mail, September 23, 1960. as foreign central banks went to New York for the metal. At the same time it was becoming evident that presidential challenger John F. Kennedy would win that fall's election. Kennedy's promises to lower interest rates and increase government spending convinced many that gold outflows would only increase. The Dow Jones Industrial Average plunged 12% from the end of August to October 25, hitting its lowest point since 1958.

In this context, London gold prices rose above $35.20 for the first time in September 1960, and on October 20 hit $36, far above the ceiling implied by arbitrage. The next week, a speculative gold rush touched off and the price soared, briefly hitting $41 before closing at a high of $38. With London trading at an impressive 17% premium to the official price, the world's monetary architects had lost control of the market price of gold.

Gold's market premium to the official price was no small matter as it questioned the very fundamentals of the planned monetary system. After all, if an ounce of gold was trading at a premium over dollar claims to that same ounce of gold, then the validity of those dollar gold claims was being challenged by the market. Furthermore, by giving foreign central banks even more incentive to exchange dollars for gold at $35 in New York in order to sell it in London at $36 to $38, the premium would exacerbate the United States' gold drain.

At the eleventh hour, the New York Federal Reserve cut an informal deal with the Bank of England to resupply said bank with any gold it spent, at its own discretion, in suppressing the gold price. Prices soon began to fall as the Bank of England sold. As one of his last acts as president in 1960, Eisenhower tried to suppress gold demand further by making it illegal for Americans to buy the metal overseas — an extension of Roosevelt's 1933 ban on American domestic holdings of gold. By March 1961, the gold price had been strong-armed back to $35.10.

Fearing another gold rush in October 1961, Western central banks formalized a plan by which they pooled together several hundred million dollars worth of gold, this stock to be mobilized to control the London gold price. Thus was born the famous London gold pool. The pool became an active buyer of gold when the London price fell below $35.08 an ounce and a seller at $35.20.The Economist, February 16, 1962. In its first test — the week of the Cuban Missile Crisis in October 1962 — the pool effectively supplied the London market despite demand for the metal being greater than the 1960 gold rush. Prices could not penetrate $35.20. The pool's reputation strengthened: gold would stay benign and near $35.08 for the next few years.

In 1963 and 1964, the United States would lose only small amounts of gold reserves to foreign central banks, and the London pool bought gold to support its price rather than suppressing it. Bretton Woods, the dollar, and the $35 fix seemed safer than ever. But with the Gulf of Tonkin incident in late 1964 and the acceleration of the Vietnam war in 1965, US foreign military spending exploded. This was compounded by President Lyndon B. Johnson's expensive Great Society project, paid for in part by the Federal Reserve issuing new money to buy government debt.

The balance-of-payments deficit grew ever faster, and the United States lost more gold reserves to dollar-laden foreign central banks exercising convertibility and through gold-pool sales in London. US gold reserves resumed their downward trajectory, declining by 9% in 1965. At the same time, speculators were buying gold in record numbers in London, forcing price up to $35.20, the London pool's line in the sand.

Things only got worse with the exit of the French from the gold pool in early 1967, tensions in the Middle East, and the collapse of the British pound in November 1967. The Tet offensive of early 1968 indicated the US commitment to Vietnam would only grow. Speculators bought en masse in London through the remainder of 1967 and into March 1968. By March 14, the members of the gold pool, having sold about $2.75 billion worth of gold to protect the $35.20 ceiling, or about 10% of the member's total reserves since the pound's devaluation, had had enough.The Economist, March 16, 1968. They asked the Queen of England to close the London market the next day and dissolved the once-feared gold pool. When London reopened two weeks later, without suppression, prices immediately vaulted up to $38 and would soon rise to $42.

Reviewing this period in gold's history makes evident the extreme difficulties experienced by the monetary authorities in controlling the price of gold. The typical flat $35 line on charts gives the illusion that the dollar was a stable store of value. In actuality, market prices diverged from $35 — and dramatically so in 1960. The attempt to fix the dollar at 0.888671 grams and gold at $35 — this while the dollar's purchasing power had declined versus all other goods — was a losing battle carried out at great expense. The United States and its allies would sell huge quantities of gold at prices below what a free market would have borne. In 2009, amidst some of the largest central-bank rescues and bailouts in history, let the 1960 gold rush and the eventual collapse of the London gold pool in 1968 stand as a reminder to us that central planning of monetary matters is doomed to fail.

What I noticed is that from the time it opened its doors in November 1914, all the way through 1931, the New York Fed charged its record-low rates at the very end of this period. The "discount rate" was the interest rate the Fed banks would charge on collateralized loans made to member banks. For the New York Fed, rates had bounced around since its founding, but they were never higher than 7 percent and never lower than 3 percent, going into 1929.

This changed after the stock-market crash. On November 1, just a few days following Black Monday and Black Tuesday — when the market dropped almost 13 percent and then almost 12 percent back to back — the New York Fed began cutting its rate. It had been charging banks 6 percent going into the Crash, and then a few days later it slashed by a full percentage point.

Then, over the next few years, the New York Fed periodically cut rates down to a record low of 1 ½ percent by May 1931. It held the rate there until October 1931, when it began hiking to stem a gold outflow caused by Great Britain's abandonment of the gold standard the month before. (Worldwide investors feared the United States would follow suit, so they started dumping their dollars while the American gold window was still open.)

So far my story doesn't sound unusual. "Everybody knows" that the Fed is supposed to slash rates to ease liquidity crunches during a financial panic. It helps to ease the crisis, and provides a softer landing than if the supply of credit were fixed.

But guess what? Throughout the period we are considering, the highest the New York Fed ever charged banks was 7 percent. And the only time it did that was smack dab in the middle of the 1920–1921 depression.

Although you've probably never heard of it, this earlier depression was quite severe, with unemployment averaging 11.7 percent in 1921. Fortunately, it was over fairly quickly; unemployment was down to 6.7 percent in 1922, and then an incredibly low 2.4 percent by 1923.

After working on these issues for my book, it suddenly became obvious to me: the high rates of the 1920–1921 depression had certainly been painful, but they had cleaned the rot out of the structure of production very thoroughly. The US money supply and prices had roughly doubled during World War I, and the record-high discount rate starting in June 1920 was a pressure washer on the malinvestments that had festered during the war boom.

Going into 1923, the capital structure in the United States was a lean, mean, producing machine. In conjunction with Andrew Mellon's incredible tax cuts, the Roaring Twenties were arguably the most prosperous period in American history. It wasn't merely that the average person got richer. No, his life changed in the 1920s. Many families acquired electricity and cars for the first time during this decade.

In contrast, during the early 1930s, the Fed's rate cuts "for some reason" didn't seem to do the trick. In fact, they sowed the seeds for the worst decade in US economic history.

Now let's be clear, I am not merely arguing from historical correlations. There is a perfectly good theoretical explanation for why the record-high rates in the early 1920s were the right policy, while the record-low rates in the early 1930s were the wrong policy. We quote from Lionel Robbins, who wrote from a 1934 vantage point and applied the Mises-Hayek business-cycle theory to the world collapsing before his eyes:

Now in the pre-war business depression a very clear policy had been developed to deal with this situation. The maxim adopted by central banks for dealing with financial crises was to discount freely on good security, but to keep the rate of discount high. Similarly in dealing with the wider dislocations of commodity prices and production no attempt was made to bring about artificially easy conditions. The results of this were simple. Firms whose position was fundamentally sound obtained what relief was necessary. Having confidence in the future, they were prepared to foot the bill. But the firms whose position was fundamentally unsound realised that the game was up and went into liquidation. After a short period of distress the stage was once more set for business recovery.

It's actually easier to see if you forget about a central bank, and just pretend that we were living in the good old days when banks would compete with each other and there was no cartelizing overseer. Now in this environment, when a panic hits and most people realize that they haven't been saving enough — that they wish they were holding more liquid funds right this moment than their earlier plans had provided them — what should the sellers of liquid funds do?

The answer is obvious: they should raise their prices. The scarcity of liquid funds really has increased after the bubble pops, and its price ought to reflect that new information. People need to know how to change their behavior, after all, and market prices mean something.

But in more modern times, thanks not just to Keynes but, more important, to Milton Friedman, central bankers now think that during the sudden liquidity crunch, they are supposed to shovel their product out the door. But in order to do that, of course, they have to water down its potency. It's as if a wine dealer suddenly has a rush of customers for a rare vintage of which he only has 3 bottles, and his response is to put the vintage on sale but then dilute it with 9 parts water to 1 part wine. That way he can sell to all the eager customers and not pick their pocket at the same time.

Now I know there is a big dispute in the Austrian-libertarian academic world over whether banks in a legitimately free market would have 100% hard-money reserves in the vault, or if banks would be allowed to lend out some of their customers' checking-account deposits to other customers. I'm not taking a stand on that here.

What I am saying, though, is that if we decide banks ought to be able to engage in fractional-reserve lending — so that the total supply of credit can be expanded if the banks want to stretch their reserves thinner — then we still agree that the unit price of that expanded credit issue ought to be higher.

If the owner of a trucking company experiences a huge rush for his services, he might decide to postpone essential maintenance on his fleet, to take advantage of the unprecedented demand. But during this period he will be charging record shipping prices to make it worth his while to deviate from the normal, "safe" way of running his business. He will only be willing to bear the extra risk (either to the safety of his drivers or just the long-term operation of the trucks) if he is being compensated for it.

The same is true for the banks. Just as every other business during a recession wants to bolster its cash reserves, so too with the business that rents out cash reserves. If there's a hurricane, the stores selling flashlights and generators should raise the prices on those essential items, to make sure they are rationed correctly. The same is true for liquidity — the moment after the community realizes they are in desperate need of it.

It was a good thing for Americans that Herbert Hoover — regardless of his other disastrous policies — did not want the United States to abandon the gold standard. Because its gold reserves were plummeting, the Fed had no choice but to reverse its disastrous course in late 1931. The next two years were awful, but that was because so much capital had been squandered in the boom and then in the easy-money collapse.

FDR was sworn into office in March 1933. Had he followed the same pattern as Warren Harding and Calvin Coolidge — i.e., had he basically kept the federal government out of it — Americans might have looked back at the Great Interruption, referring to the three-year gap between the Roaring Twenties and the Zooming Thirties.

Switching to today, the sad fact is that Ben Bernanke and the other central bankers of the world do not have any feedback on their behavior. There is no dwindling stock of gold reserves to signal to them that they are doing something horribly wrong. Like all central planners, they are groping in the dark, as Mises said.

Although the dollar is no longer tied to gold, that will not stop the dollar price of gold from exploding when more investors realize that no one, not even a sharp guy like Ben Bernanke, ought to hold the fate of the world's economy in his hands.

During the current crisis, however, financial systems all over the world are increasingly struggling, and the end of the experiment seems closer. In fact, the Federal Reserve System has used up much of its "ammunition" for monetary interventions in an attempt to keep the experiment going, lowering its target interest rate almost to zero. Other central banks are also quickly approaching the "zero limit" for interest rates.

During these inflationary decades, economic structures have developed that can only survive with falling interest rates. As the world approaches a zero interest rate, it appears that finally there might be a full adaptation of the structure of production to the demands of consumers, and the experiment might come to an end.

Yet, has the Fed really "run out of ammunition"? First of all: what is the Fed shooting at? It is trying to artificially stimulate the economy with its monetary policy, thereby it is also unwittingly shooting at the value of the currency. Through its monetary policy, the Fed is trying to bail out an insolvent and illiquid banking system to maintain an unsustainable structure of production. As long as the currency is not totally destroyed, the Fed will never run out of ammunition. In order to assess the ammunition left, one should have a look at the balance sheet of the Federal Reserve — especially at the assets the Fed can still obtain. The Fed's balance sheet also gives insights on the condition or quality of the dollar.

Since the crisis broke out, the Fed has continuously weakened the quality of the dollar by weakening its balance sheet. In fact, the assets the Federal Reserve holds have deteriorated tremendously. These assets back the liability side of the balance sheet, which mainly represents the monetary base of the dollar. The assets of the Fed, thereby, hold up the value of the dollar. At the end of the day, it is these assets that the Fed can use to defend the dollar's value externally and internally. Thus, for example, it could sell its foreign exchange reserves to buy back dollars, reducing the amount of dollars outstanding. From the point of view of the buyer of the foreign exchange reserves, this transaction is a de facto redemption.

In the first stage of the crisis that lasted until September 2008, the Federal Reserve did not increase its balance sheet. Instead, the Fed changed its balance sheet's structure. These changes are very important for the value of the currency. Imagine that the Fed announces tomorrow that is has sold all its gold and has bought Zimbabwean government bonds with the revenues. The Fed would explain this move by arguing that the stability of the Zimbabwean economy would be crucial for the US economy and the welfare of mankind. This action by itself would not change the quantity of money at all, which shows that concentrating exclusively on the quantity of money is not sufficient to evaluate the condition of a currency. Qualitative issues can be even more important than mere quantities. In fact, an asset swap from gold to Zimbabwean government bonds would mean a strong deterioration of the quality of the dollar.

While this example might sound extreme, something similar happened during the first stage of the sub-prime crisis. The Fed weakened the composition of its balance sheet not in favor of the Zimbabwean economy but in favor of the US banking system. The Federal Reserve sold good assets in order to acquire bad assets. The good assets were not gold but mainly the still highly-liquid US treasury bonds in the category of "securities held outright." The bad assets were not Zimbabwean government bonds but loans given to troubled banks backed by problematic and illiquid assets. This weakened the dollar.

As can be seen in the chart, starting in August 2007, the lower-quality assets increased. They grew especially in the form of repurchase agreements and, later, new types of credits such as term-auction credits — through the Term Auction Facility (TAF) — starting in December 2007. As the Federal Reserve did not want to increase its balance sheet, it sterilized the increasing amount of bad assets by selling good assets to the troubled banking system. Swapping good assets for bad assets can in fact be considered a bail out of the banking system on a gigantic scale. Moreover, the Federal Reserve started lending securities (good assets) to banks in the so-called Term Securities Lending Facility (TSLF). This measure provided the banks with high-quality assets they could pledge as collateral for loans. As a consequence, the amount of securities decreased via selling and lending, as can be seen in the following chart.

Thus, the average quality of the Federal Reserve balance sheet deteriorated in the first stage of the crisis and continues to do so as shown in the following compositional graph.

In the second stage of the crisis, which started with the Lehman bankruptcy, it became clear that the policy of merely changing the balance-sheet structure was coming to an end. The Fed was running out of Treasury bonds. Moreover, this policy did not allow for the strong liquidity boosts that the Fed deemed appropriate in this situation. Hence, the Fed started to increase its balance sheet. It no longer "sterilized" the additional loans it granted with the sale of good assets. In fact, it would not have had enough good assets left to sell. In our imaginary example, the Fed would run out of gold. It would stop selling gold and keep on buying Zimbabwean government bonds. Of course, the Fed did not buy Zimbabwean government bonds but other assets of low quality, mainly loans to an insolvent banking system. As a consequence, the sum of the balance sheet has nearly tripled since June 2007.

The increase of the balance sheet in favor of the financial system required some unconventional policies. Thus, the Fed has invented new credit programs with a tendency for longer terms, such as the aforementioned TAF. It has granted special loans to AIG and bought Bear Stearns assets that J.P. Morgan did not want. It has allowed primary dealers to borrow directly from the Federal Reserve in the Primary Dealer Credit Facility (PDCF). In addition, the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility (AMLF) was created. This facility allows depository institutions to borrow from the Fed with collateral of asset-backed commercial paper.

Later the Fed decided to supplement the AMLF with the Commercial Paper Funding Facility (CPFF). Now unsecured commercial paper is also eligible as collateral. (Unsecured commercial paper is not backed by specific assets but only by the name of a company.)

Furthermore, the Fed has set up the Money Market Investor Funding Facility (MMIFF), which allows money market mutual funds to borrow from the Fed via special purpose vehicles. Three characteristics of these policies can be found:

Despite of all these efforts, credit markets still have not returned to normal. What will the Fed do next? Interest rates are already practically at zero. However, the dollar still has value that can be exploited to keep the experiment going. Bernanke's new tool is the so-called quantitative easing. Quantitative easing is when a central bank with interest rates already near zero continues to buy assets, thus injecting reserves into the banking system. In fact, quantitative easing is a subsection of qualitative easing. Qualitative easing can be defined as the sum of the policies that weaken the quality of a currency.

But what new assets is the Fed acquiring? The Fed has already started buying the debts of Fannie Mae, Freddie Mae, and the Federal Home Loan Banks. It has also bought mortgage-backed securities issued by Fannie Mae, Ginnie Mae, and Freddie Mac. Bernanke is also considering buying other securities backed by consumer loans, credit card loans, or student loans. Long-term government debt is also on the list of assets that the Fed might buy.

In the analysis of the Fed balance sheet and the condition of the dollar, another detail is extremely important. The equity ratio in the Fed balance has fallen from about 4.5 to 2%.

This figure implies an increase of the Fed's leverage from 22 to 50. As we have seen there are large new positions of dubious quality on the Federal Reserve balance sheet. More specifically, should only 2% of the Fed's assets go into default — or if there is a loss in value of 2% — the Fed becomes insolvent.

Only two things can save the Fed at this point. One is a bailout by the federal government. This recapitalization could be financed by taxes or by monetizing government debt in another blow to the value of the currency.

The other possibility is concealed in the hidden reserves of the Fed's gold position, which is only valued at $42.44 per troy ounce on the balance sheet. A revaluation of the gold reserves would boost the equity ratio of the Fed to 12.35%.At a market value of $810 per troy ounce, January 15, 2009. 

It is ironic that in troubled times a revaluation of the "barbarous relic" could save the Fed from insolvency. Yet, this would only be an accounting measure and would not change the fundamental problems of the paper dollar. While shooting its last bullets and weakening the dollar, the Fed is outmaneuvering itself. The end of the experiment is getting closer.

Nevertheless, the response has been unprecedented in its own right. Government debt held by the public was $5.51 trillion when September began; by the end of 2008, it had risen to $6.37 trillion. The more than $1 trillion expansion in Treasury borrowing surely partially serves to offset the $438 billion budget deficit. But what about the additional half a trillion dollars?

On September 17, the Treasury announced the creation of the "Supplementary Financing Account" in the Federal Reserve. This is a capital reserve in the Fed financed by the Treasury selling new debt, but its excess capital is "trapped" and does not immediately reach currency in circulation. As of January 2, $259 billion is in this cash pool and $365 billion counting the Treasury's "General Account." The capital itself is money borrowed by the public, so its immediate net effect is deflationary.

On top of that, the Fed in an unprecedented gesture has started incentivizing excess bank-reserve deposits by issuing interest on these holdings, trapping liquidity. The Fed is essentially issuing debt, and banks are engaging in what amounts to a dollar-based Fed vs. interbank carry trade. Banks borrow money from the Fed, deposit it back into the Fed, and profit from the differential between the federal-funds and overnight rates. Less than $40 billion a year ago, the excess reserve deposits held by the Fed have ballooned to $860 billion. These deposits comprise another huge pool of excess liquidity on the Fed's balance sheet that doesn't immediately affect circulated currency.

Another Fed-induced cash trap has been in the form of increased reverse repurchase agreements, which are up to $88 billion. Reverse repurchase agreements are the offering of collateral in exchange for a cash loan. The Fed has utilized reverse repurchase agreements in its liquification of banks. It buys off toxic defaulting assets in exchange for cash and immediately reclaims the cash by selling the banks' T-bills. The Fed printed money to pay for these T-bills, so there is excess liquidity that is trapped in time-sensitive debt.

The Fed's risk transfer to the taxpayer is only worsened by its lack of transparency in doing so. The $2 trillion in lending is going to unknown places in exchange for unknown collateral. This leads me to believe the Fed has been busy buying up all of the toxic assets held by banks. This explains why it let the congressional bailout funds be used for equity purchases and not toxic debt. It hides the huge toxic-asset purchases — which it paid for with printed money — in its balance sheet's opacities. Bloomberg recently made a Freedom of Information Act request for details on bailout fund appropriations, but the Fed refused to comply and is being sued. This secrecy by the Fed in its appropriations of taxpayer money and the most-likely worthless collateral it exchanged it for represents inflationary risks the Fed is attempting to conceal.

The Fed's balance sheet suggests it has been cranking the printing presses like mad. Fed liabilities have expanded to $2.26 trillion, up over 140% since September. However, currency in circulation is up only 7% in that same time period. Where is this "trapped" $1.37 trillion? The answer is it's confined in temporary cash pools, whether in the Supplementary Financing Account or excess reserve deposits or in time-sensitive T-bills. The Federal Reserve seems to be sequestering all of this cash to buy time for the Treasury to finish its funding activities.

But who is going to keep funding this expansion of Treasury debt issuance? The American public is broke and cannot offer its capital in return for terrible yields. Foreign nations don't have the means or will to continue financing our debt. Commodity prices have collapsed, cutting deeply into foreigners' export revenues. Oil is down from highs around $150/barrel this past summer to around $40/barrel now.

In November, China announced a $585 billion economic stimulus package to be fully invested by the end of 2010. The Chinese government agreed to provide only $170 billion of the funds. How will China raise the other $415 billion for continuous use until the end of 2010? Surely, local governments and private banks and businesses can't finance such a large package in the midst of a historic recession.

The only reserve China can tap into to finance its stimulus package is its $1.9 trillion foreign exchange reserves, $585 billion of which is in US Treasury securities. Financing its stimulus package would require selling Treasury securities, but becoming a net seller of US debt could have disastrous economic, political, and even militaristic consequences for China, so it will be interesting to see how events unfold. What seems certain, however, is that China can no longer purchase more American debt to finance the US Treasury (and consequently the Fed).

This is a problem echoed by the rest of the big creditor nations. After China, the biggest holders of American debt securities are Japan, the United Kingdom, Caribbean banking centers, and OPEC nations. Japan is facing enormous headwinds as its quality-focused exports are suffering massive demand destruction as its consumers abroad lose wealth at epic proportions. Japan was a net seller of US Treasuries in 2008 and it is highly unlikely it will switch to being a net buyer anytime soon. The British demand for American debt represented Middle Eastern oil-financed investment, but with oil prices collapsing, it will be next to impossible for this proxy demand from the UK to rise and finance additional debt. The demand for US debt by Caribbean banking centers is because of their tax laws but as the credit crunch leads to liquidity destruction in Caribbean banks, these banking centers will no longer be able to buy additional debt. OPEC nations' US debt demand, similar to the UK's, is tied to Middle Eastern oil revenues financing American consumption (of their oil exports). As oil prices tank, so will OPEC nations' economies and they too will have no wealth to buy up more American debt.

Bernie Madoff is well recognized as the perpetrator of the biggest Ponzi scheme in history, at $50 billion. I beg to differ with that assessment. The United States has financed debt with debt since the late 1980s, when its external debt/GDP broke the 0 mark. Since then, it has risen to over 100% of its GDP (which in itself is quite artificially inflated because of manipulated hedonics-adjusted inflation figures), and now stands at $13 trillion. That is what's called a debt bubble. Bernie who?

But the debt bubble appears ready to collapse. The pyramid scheme is finally running out of investors, and many Treasury ETFs (like SHY, TLT, IEF, and IEI) are showing classic parabolic topping patterns and the next few weeks should confirm or deny my suspicions. Interest rates are at an obvious floor at zero, so there is nowhere to go but up. That means bond prices have nowhere to go but down, and the falling prices will cascade into more selling until the debt bubble deflates and all the spending is financed by quantitative easing. Judging by gold backwardation (discussed later) and the bearish charts on the bubbly debt ETFs, I think the debt monetization and dollar devaluation will begin within the next six weeks. The ProShares UltraShort Lehman 20+ Year Treasury Bond ETF (TBT) and ProShares UltraShort Lehman 7–10 Year Treasury Bond ETF (PST) are good ways to play this debt-market collapse.

With an insolvent public and no foreign demand for Treasuries, the Federal Reserve will monetize debt to finance its continued bailouts and economic stimulus. This is purely created capital pumped right into the system. This is not anything new for the Fed — for the past two decades, it has kept interest rates artificially low and created massive artificial wealth in the form of malinvestment and debt financing. In the past, the Fed has been able to funnel the inflationary effects of its expansionary monetary policy into equity values with its low rates, which discourage saving, causing bubble after bubble. The excess liquidity was soaked up by the stock market, which gave the appearance of economic growth. With inflation being funneled into equity and real estate over the last two decades, illusory wealth was created and the public remained oblivious to the inflationary risk and the great disparity between real returns and nominal.

Now that the "artificial-wealth bubble" of the past two decades is finally collapsing, one of two scenarios can occur: capital destruction or purchasing-power destruction. Capital destruction occurs when the monetary supply decreases as individuals and institutions sell assets to pay off debts and defaults and savings starts growing at the expense of consumption, otherwise known as deleveraging. This is deflation and the public immediately sees and feels its effect, as savings accounts, equity funds, and wages start declining. Deflation serves no benefit to the Federal Reserve, as declining prices spur positive-feedback panic selling and bank runs, and debt repayments in nominal terms under deflation cause real losses.

Purchasing-power destruction is much more desirable by the Fed. Its effects are "hidden" to a certain extent, as the public doesn't see any nominal losses and only feels wealth destruction in obscure price inflation. It breeds perceptions of illusionary strength rather than deflation's exaggerated weakness. The typical taxpayer will panic when his or her mutual fund goes down 20% but will probably not react to an expansion of monetary supply unless it reaches 1970s price-inflationary levels. In addition, the government can pay back its public debt with devalued nominal dollars, which transfers wealth from the taxpayers to the government to pay its debt. Inflation is essentially a regressive consumption tax, which the government wants and the Fed attempts to "hide." Not only is the Treasury's debt burden reduced but the government's tax revenues inherently increase.

The Fed, in an effort to minimize inflationary perception, has for the last two decades supported naked COMEX gold shorts to keep gold prices artificially low. The Fed, as well as European central banks, unconditionally supported these naked shorts to deflate prices and stave off inflationary perception, as gold prices stay artificially low. This caused gold shorts to be "guaranteed" eventual profit, by Western central banks offering huge artificial supply whenever necessary, causing long positions in gold to be wiped out by margin calls and losses.

Now that the economy is contracting, the Fed won't be able to funnel the excess liquidity into equities or other similar assets. It also can't allow the unprecedented excess liquidity of today to be directly injected into the economy, as that would be immediately very inflationary, with more than three times the money chasing the same amount of goods, technically leading to 300% price inflation. These figures are strictly based on monetization of the Fed's current liabilities, not including any future deficit spending (which is sure to dramatically increase, especially with Barack Obama's policies), the American external debt, or unfunded social programs that need payment as Baby Boomers retire.

In order to funnel the excess liquidity into a less harmful asset, the Fed appears to be abandoning its support for gold naked shorts, causing shorts to suffer their own margin calls and cause rapid price expansion in gold. On December 2, for the first time in history, gold reached backwardation. Gold is not an asset that is consumed but rather stored, so it is traditionally in what is called a contango market, meaning the price for future delivery is higher than the spot price (which is for immediate settlement). This is sensible because gold has a carrying cost, in the form of storage, insurance, and financing, which is reflected in the time premium for its futures. Backwardation is the opposite of contango, representing a situation in which the spot price is higher than the price for future delivery.

On December 2, COMEX spot prices for gold were 1.99% higher than December gold futures, which are for December 31 delivery. This is highly unusual and it provides strong evidence for the theory that the Fed is abandoning its support for gold shorts. Backwardation represents a perceived lack of supply (in this case, the artificial supply the Fed would always issue at strategic times no longer exists), causing investors to pay a premium for guaranteed delivery. I consider gold's backwardation as a leading indicator to a dramatic increase in prices. In fact, crude began its most recent backwardation in August 2007 at around $75/barrel and increased dramatically over the next nine months to $133/barrel at contango levels.

But why would the Fed abandon its support for naked COMEX shorts? The unique nature of gold and precious metals provides its desirability in this Fed operation. Gold has little utility except as a store of value, unlike most commodities (like oil, which is consumed as quickly as it's extracted and refined), so its supply/demand schedule has unusual traits. Most commodities and assets go down in price as the public loses capital, because the public has less to consume with and that is reflected in demand destruction that leads to price deflation. Gold is not directly consumed and has much less industrial use than most other commodities.

As a result, gold is relatively "recession-proof," as evidenced by its relative strength in 2008. Gold prices rose 1.7% last year, which is quite spectacular considering equity values went down 39.3%, real estate values went down 21.8%, and commodity prices went down 45.0% in the same period (as determined by the S&P 500, Case-Shiller Composite, and S&P Goldman Sachs Commodity Indices, respectively). Because gold is not easily influenced by consumer spending, highly inflationary gold prices don't do any direct damage to the public and are a good way to funnel excess liquidity without economic destruction.

Federal Reserve Chairman Ben Bernanke is a staunch proponent of devaluing the dollar against gold and is very supportive of President Franklin D. Roosevelt's decision to do so in 1934. In the past, manipulating gold prices to artificially low levels was beneficial because it prevented capital flight into a nonproductive asset like gold and kept production, investment, and consumption high (even if it was malinvestment and unfunded consumption).

Bernanke's continued active support for gold-price suppression would lead to widespread deflation that would collapse equity values and cause pervasive insolvencies and bankruptcies. Insolvency in insurers removes all emergency "backups" to irresponsible lending and spending, which would surely ruin the economy. Bernanke's plan seems to be to devalue the dollar against gold with huge monetary expansion, causing nominal equity values to rise. I've heard estimates of 7500 and 8000 in the Dow Jones Industrial Average as being minimum support levels that would cause insurers and banks to realize massive losses, causing widespread insolvencies in them and other weak sectors like commercial real estate that would irreversibly collapse the economy.

This gold-price expansion, set off by the massive short squeeze, will continue until gold prices reflect gold supply and Federal Reserve liabilities in circulation. The "intrinsic" value of gold today (called the Shadow Gold Price), calculated dividing total Fed liabilities by official gold holdings, is about $9,600/oz, compared to the actual spot price of around $850/oz today. This gold-price calculation essentially assumes dollar-gold convertibility, as is mandated by the US Constitution and was utilized at various periods of American history.

The US dollar's strength as the equity and commodity markets collapsed was due to deleveraging and an effect of the Fed's temporary sequestration of dollars, taking dollars out of supply. That is over. Oil seems to be putting in a bottom on strong volume, no one is left to buy any more negative real-yield securities the Treasury is issuing, and gold has started looking very bullish.

But a good speculator always considers all situations. Even if deflation is to occur, which I see as next to impossible, the price of gold should still rise to $1,500/oz levels next year, because it has shown relative strength as one of the most viable assets left to invest in. In addition, the short squeeze occurring in gold will provide substantial technical price expansion, even in the absence of dollar devaluation. A rise in nominal values in deflation represents an ever greater rise in real values, so I think gold's price ascent in real terms will be nearly identical in inflation or deflation.

I see the market breaking down from these levels to about the November lows, with commercial-real-estate stocks like Simon Property Group (SPG), Vornado Realty Trust (VNO), and Boston Property Group (BXP) leading the way, as well as retailers like Sears Holdings (SHLD). I recommend short positions (including leveraged bear ETFs) against these stocks for the very near term. If the market indeed breaks down but shows bouncing/strength around 7500–8000 in the Dow Jones, that would confirm to me that the Fed is able and willing to inflate its way out of this crisis and I will sell my bearish positions and buy into bullish gold positions.

Because in inflation the dollar is devalued, I am a proponent of owning bullion and avoiding gold ETFs, but I do believe gold and gold-miner stocks will provide great returns over the next few years. Royal Gold (RGLD), Iamgold (IAG), Jaguar Mining (JAG), Anglogold Ashanti (AU), Newmont Mining (NEM), Randgold (GOLD), Goldcorp (GG), and Barricks (ABX) are among my favorite gold equities at this early stage in the process.

$74 $63

I leave you with this, a quote from Fed Chairman Ben Bernanke about President Franklin D. Roosevelt's 1934 Gold Reserve Act, which was the greatest theft of wealth I'm aware of in American history:

The finding that leaving the gold standard was the key to recovery from the Great Depression was certainly confirmed by the U.S. experience. One of the first actions of President Roosevelt was to eliminate the constraint on U.S. monetary policy created by the gold standard, first by allowing the dollar to float and then by resetting its value at a significantly lower level … With the gold standard constraint removed and the banking system stabilized, the money supply and the price level began to rise. Between Roosevelt's coming to power in 1933 and the recession of 1937–38, the economy grew strongly.

My predictions: gold at $2,000/oz by the end of the year and $10,000/oz by 2012 and silver at $30/oz by the end of the year and $130/oz by 2012.

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the elimination of central banks as lenders of last resort (which will be unnecessary if the first principle is applied, and harmful if they continue to act as financial central-planning agencies); and

the privatization of the current, monopolistic, and fiduciary state-issued money and its replacement with a classic gold standard.

This radical, definitive reform would essentially mark the culmination of the 1989 fall of the Berlin Wall and real socialism, since it would mean the application of the same principles of liberalization and private property to the only sphere — finance and banking — that has until now remained mired in central planning (by "central" banks), extreme interventionism (the fixing of interest rates, the tangled web of government regulations), and state monopoly (legal-tender laws, which require the acceptance of the current, state-issued fiduciary money) — circumstances with disastrous consequences, as we have seen.

I should point out that the transition process designed in the above-mentioned chapter of my book could also permit, from the outset, the bailing out of the current banking system, thus preventing its rapid collapse, and with it the sudden monetary squeeze that would be inevitable if, in an environment of widespread broken trust among depositors, a significant volume of bank deposits were to disappear.

This short-term goal, which, at present, western governments are desperately striving for with the most varied plans (the massive purchases of "toxic" bank assets, the ad hominem guarantee of all deposits, or simply the partial or total nationalization of the private banking system), could be reached much faster and more effectively, and in a manner much less harmful to the market economy, if the first step in my proposal for reform (page 792 in my book) were immediately taken: to back the total amount of current bank deposits (demand deposits and equivalents) with cash, bills to be turned over to banks, which from then on would maintain a 100% reserve with respect to deposits. As I explain in chapter 9, chart IX-2, which shows the consolidated balance sheet for the banking system following this step, the issuance of these bills would in no way be inflationary (since the new money would be "sterilized," so to speak, by its purpose as backing to satisfy any deposit withdrawals).

Furthermore, this step would free up all banking assets (toxic or not) that currently appear as backing for demand deposits (and equivalents) on the balance sheets of private banks. On the assumption that the transition to the new financial system would take place under "normal" circumstances, and not in the midst of a financial crisis as acute as the current one, I proposed in my book that the freed assets be transferred to a set of mutual funds created ad hoc and managed by the banking system, and that the shares in these funds be exchanged for outstanding treasury bonds and for the implicit liabilities connected with the public social-security system (pp. 796–797).

Nevertheless, in the current climate of severe financial and economic crisis, we have another alternative: apart from canceling "toxic" assets with these funds, we could devote a portion of the rest, if desired, to enabling savers (not depositors whose deposits would already be backed 100 percent) to recover a large part of the value lost in their investments (particularly in loans to commercial banks, investment banks, and holding companies). These measures would immediately restore confidence and would leave a significant remainder to be exchanged — once and for all and at no cost — for a sizeable portion of the national debt, our initial aim.

I conclude with an important final warning: naturally (and I must never tire of repeating it) the solution I propose is only valid in the context of an irrevocable decision to establish a free-banking system subject to a 100% reserve requirement on demand deposits. Any of the reforms noted above, if adopted in the absence of a prior, firm conviction and decision to change the international financial and banking system as indicated, would be simply disastrous: a private banking system that continued to operate with a fractional reserve (orchestrated by the corresponding central banks), would generate — in a cascading effect, and based on the cash created to back deposits — an inflationary expansion like none other in history, one which would eventually finish off our entire economic system.

However, politicians and central bankers the world over are taking great efforts to hide this truth and its full consequences from the public's attention by taking recourse to even more far-reaching market interventionism.

Central banks provide commercial banks with any amount of base money needed to prevent them from defaulting on their payment obligations. The Federal Reserve, for instance, keeps expanding the monetary base at the highest rate seen since 1919 (see graph below).[1]

The Federal Reserve has started monetizing various types of paper assets. As a result, the Fed's balance sheet volume rose from US$909 billion to US$2,189 billion from the end of August 2007 to the middle of November 2008, much of it reflected by a considerable rise in deposits held by depository institutions, the US Treasury, and others with the Fed (see graph below).

What is more, not only the Federal Reserve but virtually all other major central banks have cut interest rates sharply to cheapen funding costs for commercial banks and borrowers in general (see graph below). By pushing official interest rates down, central banks hope to unfreeze credit markets, support asset prices, and keep the economies on an expansion path.

However, the lowering of short-term central-bank interest rates has (so far) not succeeded in bringing down credit costs, which have risen considerably following the turmoil in credit markets. In fact, corporate bond yields have continued to edge up. This holds true for risky as well as for less risky corporate bond yields in the United States, for instance (see graph below).

The yield differential between central-bank short-term interest rates and corporate bond yields — that is, the yield spread, which can be interpreted as a measure of (default) risk — has been rising strongly in recent months. US yield spreads have reached the highest level since the Great Depression period (see graph below).

Despite growing concern about rising defaults in credit markets, depositors and investors in commercial-bank debentures seem to have remained reasonably confident that emergency measures taken by governments will be successful in preventing bank failures on a grand scale.

People seem to believe that governments will, should commercial banks run the real risk of defaulting, expropriate taxpayers (particularly the future generation via raising government debt) on their behalf to make good any potential losses.

Such a belief might have been instilled in particular by government bank-rescue packages — including capital injections for ailing banks, guaranteeing banks' liabilities, and taking over (part of) their bad assets.

Meanwhile, however, the gigantic financial burden heaped upon (future) taxpayers has led to growing concern about government defaults, as evidenced by the edging up of the so-called credit-default-swap (CDS) spreads (see graph below); the latter can be interpreted as the market price for insurance against losses from investing in government bonds.

Politicians, central bankers, and the public at large may hope that by announcing banking-sector-support measures confidence can be restored, so that financial-market participants will lose their risk aversion and return to business as usual — that is, to lend and borrow as they did before the turmoil started in autumn 2007.

However, any such optimism is naïve, especially as much more is now at stake. Ludwig von Mises, one of the leading scholars of the Austrian School of economics, was aware of the dangers to freedom when the government-sponsored credit-and-money system runs into trouble. Mises wrote that

all isolated measures of government interference with market phenomena must fail to attain the ends sought. If the interventionist government wants to remedy the shortcomings of its first interferences by going further and further, it finally converts its country's economic system into socialism of the German pattern. Then it abolishes the domestic market altogether, and with it money and all monetary problems, even though it may retain some of the terms and labels of the market economy.[2]

Mises clearly saw that a monetary fiasco would not be ascribed to state interventionism in monetary affairs, but that it would compromise capitalism: people would ascribe the ensuing evils — such as job losses, falling income, etc. — to the machinations of the free market. What is more, they would call for more government intervention, convinced that such action would lead the way out of calamities. Mises noted,

The boom produces impoverishment. But still more disastrous are its moral ravages. It makes people despondent and dispirited. The more optimistic they were under the illusory prosperity of the boom, the greater is their despair and their feeling of frustration. The individual is always ready to ascribe his good luck to his own efficiency and to take it as a well-deserved reward for his talent, application, and probity. But reverses of fortune he always charges to other people, and most of all to the absurdity of social and political institutions. He does not blame the authorities for having fostered the boom. He reviles them for the inevitable collapse. In the opinion of the public, more inflation and more credit expansion are the only remedy against the evils which inflation and credit expansion have brought about.[3]

The causes of the current monetary fiasco can indeed be traced back to the government-controlled fiat-money system. Under such a regime, commercial banks, with the support of the central bank, increase the money supply whenever they extend loans to nonbanks (private households, firms, and public-sector entities) or buy assets from them.

Such an arrangement, which allows commercial banks to create money out of thin air, spells trouble, as banks decouple the money supply from the economy's real savings. Bank credit supply (and the corresponding additional money supply in the form of fiduciary media) in excess of the economy's real savings is what Mises called circulation credit.

Savings are the part of people's current income that are not consumed but invested. As such, savings represent present goods that are exchanged (in the time market) for future goods; the latter are simply goods that are expected to become — after emerging from the production process — present goods in the future.

In the United States, for instance, people's savings have declined strongly relative to their income in the last decades. The personal saving rate has fallen from a range of around 8–10%, which prevailed from the 1950s to the middle of the 1980s, to just 1.1% in the third quarter 2008 (see graph below).

The finding of a declining savings rate has been accompanied by bank-credit expansion increasingly outstripping income since around the middle of the 1980s (following the scrapping of the last remnants of the gold standard at the start of the 1970s), a process that has even gained momentum since the middle of the 1990s.

That said, a chronically declining savings rate accompanied by bank credit supply increasingly outstripping income points towards great doses of circulation credit, a process that puts the economy on an unsustainable path, according to the Austrian monetary theory of the trade cycle.

Initially, the rise in money supply via circulation credit leads to more investment, employment, and overall output. However, any such upswing is ill-fated from the start, as the economy lives beyond its means. Sooner or later it becomes obvious that the monetary demand outstrips the economy's real resources.

Production, stimulated by an artificially lowered interest rate, becomes increasingly roundabout, causing disequilibria in peoples' desired consumption-saving relation. As people scale back their purchases of investment goods, the boom turns to bust, and jobs created during the boom are destroyed.

When the economy slows down (due to a cluster of errors), people call for government support — particularly in the form of lower central-bank interest rates. A lowering of interest rates may do the trick (at least for a limited number of cases), reversing the bust into boom. However, such a policy causes rising disequilibria over time.

This is because a monetary policy of manipulating interest rates downwards keeps alive unsustainable consumption patterns and unproductive investments. Borrowers of economically wasteful spending projects do not need to liquidate and repay their debt. On top of that, artificially lowered interest rates encourage new investments.

That said, a monetary policy of repeatedly fending off cyclical downturns by cutting interest rates via expanding the credit-and-money supply risks resulting in ever-higher levels of debt for consumers, firms, and governments relative to their incomes.

At some point, private owners of commercial banks might no longer wish to put their money at risk, especially when they fear that borrowers could default on their debt loads. Commercial banks will reduce their credit-risk exposure, and the process of deleveraging, or derisking, starts.

When commercial banks stop making new loans and demand their borrowers to pay down their debt, the economy's credit-and-money supply contracts. At this point inflation — the increase in the money stock through circulation credit — turns into deflation.

Deflation corrects misallocations (malinvestments) that were caused by inflation. The ensuing decline in output, employment, and prices may be painful for those who have benefited from inflation (borrowers), but it will reallocate resources to those who have economically suffered from previous inflation (lenders).

A free-market economy could certainly deal with the correcting effects of deflation. However, the coercive apparatus of government cannot: its very existence rests in great part on ever-higher amounts of credit and money, in particular to finance cascading amounts of public debt at low interest rates.

This might explain why governments do everything they can think of to keep the current system churning out credit and money: by increasing the base money supply, cutting interest rates, spending (future) taxpayers' money on an unprecedented scale, or nationalizing the banking sector.

However, these measures will not solve the problem brought about by circulation credit. As Mises noted,

The boom can last only as long as the credit expansion progresses at an ever-accelerated pace. The boom comes to an end as soon as additional quantities of fiduciary media are no longer thrown upon the loan market. But it could not last forever even if inflation and credit expansion were to go on endlessly. It would then encounter the barriers which prevent the boundless expansion of circulation credit. It would lead to the crack-up boom and the breakdown of the whole monetary system.[4]

Ever-higher doses of government intervention will not solve the trouble brought about by government intervention in monetary affairs. Any attempt to do so would increasingly erode what little is left of the free societal order — already greatly damaged by the consequences of a government-sponsored monetary regime.

One strategy to prevent complete disaster — the destruction of the currency — would be returning money to the free market, as put forward by Mises and developed further by Murray N. Rothbard, one of Mises's most brilliant students. According to Rothbard's blueprint, the outstanding money stock should, in a first step, be linked to the gold stock in the hands of central banks. [5]

Money holders would, by law, receive a property right to redeem commercial bank money on demand in gold, with the money defined as a unit of weight of gold.[6] Such a change would leave commercial banks solvent. Commercial banks could, at any one time, redeem their obligations in gold (100%-reserve system).

While such a scheme would (arbitrarily) freeze the status quo brought about by inflation (bygones are bygones), it nevertheless has a great deal of political charm. First, bankruptcies among banks would no longer reduce the money stock, thereby preventing the widely feared economic and political consequences of deflation. Second, it would prevent losses for borrowers and lenders on a grand scale, thereby reducing the political incentive for starting the printing press.

In a second step, the banking sector could be privatized, and the government's grip on the money stock would be abolished. It would then be up to the free market to decide what medium will serve as the universally accepted means of exchange; maybe gold, silver or both (bimetallism) would emerge as the money standard. The central bank would be closed down. The interest rate would become a free-market phenomenon, free of government manipulation.

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However, it would be misleading to hope that governments and their central bankers would induce any such change. The golden way out of the monetary fiasco can only come with a change in public opinion. People must relearn that free-market money, or sound money, as Mises put it, is the indispensable element for preserving the free societal order. As Mises wrote,

It is impossible to grasp the meaning of the idea of sound money if one does not realize that it was devised as an instrument for the protection of civil liberties against despotic inroads on the part of governments. Ideologically it belongs in the same class with political constitutions and bills of rights.[7]

Thorsten Polleit is Honorary Professor at the Frankfurt School of Finance & Management. Send him mail. Comment on the blog.

[1] The increase in the stock of base money was largely due to higher bank reserves holdings, most of it in the form of excess reserves (rather than an increase in peoples' holdings of coins and notes). Banks' required reserves with the Fed stood at US$39.7 billion in August 2007 and US$50.5 billion in November 2008.

[2] Mises, L.v. (1996), Human Action, 4th ed., Fox & Wilkes, San Francisco, p. 474.

[3] Ibid., pp. 576.

[4] Ibid., p. 555.

[5] See, for instance, Rothbard, M.N. (1983), The Mystery of Banking, 1st ed., Richardson & Snyder, pp. 263. In this context it might be of interest to note that according to statistics provided by the Austrian National Bank, all euro-area central banks held a total of 350.63 million fine ounces of gold at the end of September 2008, the US 261.5 million and Japan 24.6 million.

[6] Of course, one could discuss the inclusion of the stock of coins and notes outstanding in the money stock redeemable in gold. What is more, one should also discuss the option of linking the commercial banking sectors' total liabilities (possibly excluding equity capital) to the central bank's gold reserves.

[7] Mises, L.v. (1912), The Theory of Money and Credit, p. 454.

Weighing in at a light sixty-eight pages, the book nonetheless packs a wallop. It is well-researched and — most surprising for a history book — full of laugh-out-loud moments. One-hundred-plus years have done nothing to diminish the effect of Dr. White's prose.[1] Only in the author's method of referring to the numbers involved — numbers that then seemed so fantastic yet are commonplace today — does the book show any signs of dating. This leads you to read, for example, "twenty eight hundred millions" instead of $2.8 billion — billions likely being beyond the thought process of the people of his time.

Not beyond ours, though; we're up to a trillion.

The issue of paper will show that gold is not necessary.

–Mirabeau, French politician (1790)

Wisdom comes and goes; lessons are learned hard then hardly remembered. Mankind's endless stupidity on the subject of paper money surely ranks up there in the realm of the sublime. We are forever like Charlie Brown, trying and trying to kick Lucy's football. Generation follows generation, each refusing to learn one of life's more important lessons — nobody must be allowed license to counterfeit. Fiat Money Inflation in France uses as its lesson plan the tragedy of France in the 1790s and Dr. White moves the tale along at a steady clip.

His prose is pointed but polite, and makes no bones about giving credit where credit is due. On the plus side of the ledger, he notes that France was not plunged into a decade-long economic pit by wild-eyed fools, but rather by calm, well-educated ones. The smartest guys in the room whose ideas brought about the tragedy "were universally recognized as among the most skillful and honest financiers in Europe" (p. 47).

Because France in 1789 was in an economic downturn, the idea that the difficulties were due to a lack of money — and that more of it would be nice — caught the imagination of many people. France boasted its own Bernankes, Paulsons, and Greenspans, and when not misthinking, they were off making the rounds of Parisian salons, talking peoples' ears off about how fiat money, despite its disastrous history, could work if only done better — and better is what they intended.

Fiat money, declared the experts, was a means of "securing resources without paying interest" (p. 2). The idea promised that from nothing there would be something — or, as Keynes would later put it, from stone there shall be bread. Nobody was thinking this one through.

Soon the doctrine wormed into the ears of the French politicians who, upon having it explained to them that the plan called for them to print money whenever they wanted, were quickly convinced the whole thing was a splendid idea.

France in 1790 was on a gold standard, with the livre being the unit of measure, but the government would now issue paper money, too. It was to be backed not by gold but by church land stolen specifically for the purpose, and under the authority of The Will of the People. While France had just experienced a harsh lesson in paper money not too long before the coming madness — with John Law's 1720 paper-money schemes — members of the French central government insisted that John Law's paper notes did in fact bring prosperity, "and the ruin they caused resulted from their over-issue, and that such an over-issue is possible only under a despotism" (p. 4).

"We don't live under a despotism!" everyone agreed, and promptly voted to issue $400 million livres' worth of paper money, backed by the stolen church land and paying interest to the holder at three percent annually. Not five months later, $800 million more were printed, the notes not bearing any interest at all. With the currency now nice and elastic (before it all collapsed in 1796), the French politicians were madly printing money in secret, running the printing-press workers at a very un-French-like fourteen hours per day.[2] In less than six years, the French politicians printed over $45 billion in irredeemable paper — and that was when $45 billion was a lot of money.

It is where Dr. White outlines the effects of all this inflation on France that the book reads like today's paper. Prices rose as the value of the currency endlessly fell; savings dwindled while debt loads rose; a spirit of gambling took hold, and bribery flourished. I just Googled those terms plus "America," and we're four for four.

Dr. White created the book from a series of lectures given during his time at Cornell University and the University of Michigan. Judging by how the book reads, he must have been quite the speaker. Describing Mirabeau's impassioned 1790 speech in support of paper, he writes of its oratorical beauty, of how it was frequently interrupted by applause, yet how listening to the opinion of a man who never studied the subject he's yammering about (Mirabeau knew nothing of economics) "was like summoning a prize fighter to mend a watch" (p. 18).

And that went for the rest of the French Assembly, too, bursting with plans to "fix" the economy but full of "men who had never shown any ability to make or increase fortunes for themselves (yet) abounded in brilliant plans for creating and increasing wealth for the country at large" (p. 17). They soon would fall back to the politician's more natural road to wealth, as their newly found power to dispense endlessly available money made them obvious candidates to bribe for legislative favors. Dr. White tries to see the bright side by writing "it is some comfort to know that nearly all concerned were guillotined for it" (p. 30).

What is best about the book is that it is, at its base, a plea for the poor — an appeal to grant them the protection afforded by gold. Dr. White shows a progressive mind in his concern for the less fortunate, always the ultimate victim of inflation, which "creates on the ruins of the prosperity of all men of meager means a class of debauched speculators, the most injurious class that a nation can harbor" (p. 5).

Don't we know it.

On whom did this vast depreciation mainly fall at last? Men of small means.

–Andrew Dickson White (1896)

Using the French monetary collapse of 1796 as a lesson to teach a greater point — to warn against fiat currency — the book is unabashedly supportive of a gold standard. At the time of its publication in 1896 this position was not only respected; it was mainstream — proponents of paper money were the kooks. Now the shoe is firmly on the other foot: polite people do not talk about a gold standard. Maybe they should start.

The purpose of a gold standard — what makes it so indispensable to a system of economic justice — is that it takes the power to create money and credit at will out of the politicians' hands — in fact, out of anyone's hands. No man, no matter how virtuous and saintly, can long resist the call of the money machine; and the political world, where virtue and saints are always in meager supply, is a particularly dangerous place for it to reside.

The removal of the gold standard from our lives, Robert Samuelson recently noted, has "created an entirely new situation…inflation would no longer control itself." With Nixon's repudiation of the US dollar's remaining link to gold in 1971, we've all taken a time machine back to 1790s France, and so far it's been a less-than-excellent adventure.[3]

We have substituted for the steady, disinterested hand of gold the arbitrary, rapacious vagaries of the politician; yet we wonder why prices do nothing but float upward, year after year, until grandma is eating cat food. Whenever and wherever paper money has been introduced, from France in the 1790s to America in 2008, a steadily debased currency and a steadily debased economy have followed, as "there is a natural law of rapidly increasing emissions and depreciation" (p. 21).

Inflation as a deliberate policy is fit for nobody but street junkies; it is a method of short-term, artificial pleasure at the certain cost of long-term pain. But "long term" is a misleading, soothing term meant to calm nerves. The "long term" always inevitably morphs into "right now," and towards the foolish he's a vicious bastard. A glance at America's money-supply growth since 1971 — and since the Federal Reserve's creation in 1913, for that matter — gives notice that many have been fools.

The French of the late 1790s, like so many people in so many times, believed in "the doctrine that all currency…derives its efficiency from the stamp it bears" (p. 22), and therefore we can print as much of that currency as we please. Dr. White identifies that flawed doctrine as the root cause of the disaster.

In France during 1790 to 1796 the economic dislocations gained steam as the currency dove towards zero, leading politicians to pass a desperate intervention, followed in time by another even more desperate; and soon Marat, one of the most powerful men in French politics, was openly calling for the people to murder the shopkeepers and plunder their inventory. (That was his economic stimulus package.) The price inflation rent the fabric of French civilization; just the attempt alone to enforce price controls had the guillotines chopping steadily.

As much as the French of the 1790s, we too wished to be "delivered by this grand means from all uncertainty and from all ruinous results of the credit system" (p. 8), and now, also like the 1790s French, we have discovered that where "commerce was dead; betting took its place" (p. 27). We too sat at dinner parties and prattled on about how our hedge fund — the one we told you all to invest in — is up 46% year to date; and now we find ourselves staring at an empty 401(k) with the same dumbfounded "what happened?" look on our face.

What is amazing about America circa 2008 is not the citizens' money illusion — history has seen that aplenty — but the utter lack of resistance to it. From near to far, from MTV to CNBC to cocktail parties, the doctrine of fiat money is so pervasive that the thought of life without it is beyond our comprehension. Maybe it shouldn't be.

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Niall Ferguson recently asked why the West was so "blinded by money illusion." He asks the question as if we're over the illusion, as if we now see paper money for what it is. We don't. We, like the French of 1795, still blame "every cause except the right one" for our troubles.

On a Paris morning in February 1796, with great melancholy all the apparatus for printing paper money was "solemnly broken and burned" in that city's Place Vendome (p. 53). It took the French six years to figure it out; it's taken us 37 and counting.

Dr. White's excellent book can move us a step closer to "solemnly" breaking and burning the root of our problem. Even if it doesn't, Fiat Money Inflation in France is still a great read.

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[1] Case in point: "All that saved thousands of laborers in France from starvation was that they were drafted off into the army and sent to be killed on foreign battlefields."

[2] Being French, they of course went on strike.

[3] My mother-in-law now lives with me. Her savings have been depleted by the dollar’s steady debasement. Thank you, Mr. Greenspan. You’re the best.

When a little over two years ago, at the second Lausanne Conference of this group, I threw out, almost as a sort of bitter joke, that there was no hope of ever again having decent money, unless we took from government the monopoly of issuing money and handed it over to private industry, I took it only half seriously. But the suggestion proved extraordinarily fertile. Following it up I discovered that I had opened a possibility which in two thousand years no single economist had ever studied. There were quite a number of people who have since taken it up and we have devoted a great deal of study and analysis to this possibility.

As a result I am more convinced than ever that if we ever again are going to have a decent money, it will not come from government: it will be issued by private enterprise, because providing the public with good money which it can trust and use can not only be an extremely profitable business; it imposes on the issuer a discipline to which the government has never been and cannot be subject. It is a business which competing enterprise can maintain only if it gives the public as good a money as anybody else.

Now, fully to understand this, we must free ourselves from what is a widespread but basically wrong belief. Under the Gold Standard, or any other metallic standard, the value of money is not really derived from gold. The fact is, that the necessity of redeeming the money they issue in gold, places upon the issuers a discipline which forces them to control the quantity of money in an appropriate manner; I think it is quite as legitimate to say that under a gold standard it is the demand of gold for monetary purposes which determines that value of gold, as the common belief that the value which gold has in other uses determines the value of money. The gold standard is the only method we have yet found to place a discipline on government, and government will behave reasonably only if it is forced to do so.

I am afraid I am convinced that the hope of ever again placing on government this discipline is gone. The public at large have learned to understand, and I am afraid a whole generation of economists have been teaching, that government has the power in the short run by increasing the quantity of money rapidly to relieve all kinds of economic evils, especially to reduce unemployment. Unfortunately this is true so far as the short run is concerned. The fact is, that such expansions of the quantity of money which seems to have a short run beneficial effect, become in the long run the cause of a much greater unemployment. But what politician can possibly care about long run effects if in the short run he buys support?

My conviction is that the hope of returning to the kind of gold standard system which has worked fairly well over a long period is absolutely vain. Even if, by some international treaty, the gold standard were reintroduced, there is not the slightest hope that governments will play the game according to the rules. And the gold standard is not a thing which you can restore by an act of legislation. The gold standard requires a constant observation by government of certain rules which include an occasional restriction of the total circulation which will cause local or national recession, and no government can nowadays do it when both the public and, I am afraid, all those Keynesian economists who have been trained in the last thirty years, will argue that it is more important to increase the quantity of money than to maintain the gold standard.

I have said that it is an erroneous belief that the value of gold or any metallic basis determines directly the value of the money. The gold standard is a mechanism which was intended and for a long time did successfully force governments to control the quantity of the money in an appropriate manner so as to keep its value equal with that of gold. But there are many historical instances which prove that it is certainly possible, if it is in the self-interest of the issuer, to control the quantity even of a token money in such a manner as to keep its value constant.

There are three such interesting historical instances which illustrate this and which in fact were very largely responsible for teaching the economists that the essential point was ultimately the appropriate control of the quantity of money and not its redeemability into something else, which was necessary only to force governments to control the quantity of money appropriately. This I think will be done more effectively not if some legal rule forces government, but if it is the self-interest of the issuer which makes him do it, because he can keep his business only if he gives the people a stable money.

Let me tell you in a very few words of these important historical instances. The first two I shall mention do not refer directly to the gold standard as we know it. They occurred when large parts of the world were still on a silver standard and when in the second half of the last century silver suddenly began to lose its value. The fall in the value of silver brought about a fall in various national currencies and on two occasions an interesting step was taken. The first, which produced the experience which I believe inspired the Austrian monetary theory, happened in my native country in 1879. The government happened to have a really good adviser on monetary policy, Carl Menger, and he told them, "Well, if you want to escape the effect of the depreciation of silver on your currency, stop the free coinage of silver, stop increasing the quantity of silver coin, and you will find that the silver coin will begin to rise above the value of their content in silver." And this the Austrian government did and the result was exactly what Menger had predicted. One began to speak about the Austrian "Gulden", which was then the unit in circulation, as banknotes printed on silver, because the actual coins in circulation had become a token money containing much less value than corresponded to its value. As silver declined, the value of the silver Gulden was controlled entirely by the limitation of the quantity of the coin.

Exactly the same was done fourteen years later by British India. It also had had a silver standard and the depreciation of silver brought the rupee down lower and lower till the Indian government decided to stop the free coinage; and again the silver coins began to float higher and higher above their silver value. Now, there was at that time neither in Austria nor in India any expectation that ultimately these coins would be redeemed at a particular rate in either silver or gold. The decision about this was made much later, but the development was the perfect demonstration that even a circulating metallic money may derive its value from an effective control of its quantity and not directly from its metallic content.

My third illustration is even more interesting, although the event was more short lived, because it refers directly to gold. During World War I the great paper money inflation in all the belligerent countries brought down not only the value of paper money but also the value of gold, because paper money was in the large measure substituted for gold, and the demand for gold fell. In consequence, the value of gold fell and prices in gold rose all over the world. That affected even the neutral countries. Particularly Sweden was greatly worried: because it had stuck to the gold standard, it was flooded by gold from all the rest of the world that moved to Sweden which had retained its gold standard; and Swedish prices rose quite as much as prices in the rest of the world. Now, Sweden also happened to have one or two very good economists at the time, and they repeated the advice which the Austrian economists had given concerning the silver in the 1870s, "Stop the free coinage of gold and the value of your existing gold coins will rise above the value of the gold which it contains." The Swedish government did so in 1916 and what happened was again exactly what the economists had predicted: the value of the gold coins began to float above the value of its gold content and Sweden, for the rest of the war, escaped the effects of the gold inflation.

I quote this only as illustration of what among the economists who understand their subject is now an undoubted fact, namely that the gold standard is a partly effective mechanism to make governments do what they ought to do in their control of money, and the only mechanism which has been tolerably effective in the case of a monopolist who can do with the money whatever he likes. Otherwise gold is not really necessary to secure a good currency. I think it is entirely possible for private enterprise to issue a token money which the public will learn to expect to preserve its value, provided both the issuer and the public understand that the demand for this money will depend on the issuer being forced to keep its value constant; because if he did not do so, the people would at once cease to use his money and shift to some other kind.

I have as a result of throwing out this suggestion at the Lausanne Conference worked out the idea in fairly great detail in a little book which came out a year ago, called Denationalisation of Money. My thought has developed a great deal since. I rather hoped to be able to have at this conference a much enlarged second edition available which may already have been brought out in London by the Institute of Economic Affairs, but which unfortunately has not yet reached this country. All I have is the proofs of the additions.

In this second edition I have arrived at one or two rather interesting new conclusions which I did not see at first. In the first exposition in the speech two years ago, I was merely thinking of the effect of the selection of the issuer: that only those financial institutions which so controlled the distinctly named money which they issued, and which provided the public with a money, which was a stable standard of value, an effective unit for calculation in keeping books, would be preserved. I have now come to see that there is a much more complex situation, that there will in fact be two kinds of competition, one leading to the choice of standard which may come to be generally accepted, and one to the selection of the particular institutions which can be trusted in issuing money of that standard.

I do believe that if today all the legal obstacles were removed which prevent such an issue of private money under distinct names, in the first instance indeed, as all of you would expect, people would from their own experience be led to rush for the only thing they know and understand, and start using gold. But this very fact would after a while make it very doubtful whether gold was for the purpose of money really a good standard. It would turn out to be a very good investment, for the reason that because of the increased demand for gold the value of gold would go up; but that very fact would make it very unsuitable as money. You do not want to incur debts in terms of a unit which constantly goes up in value as it would in this case, so people would begin to look for another kind of money: if they were free to choose the money, in terms of which they kept their books, made their calculations, incurred debts or lent money, they would prefer a standard which remains stable in purchasing power.

I have not got time here to describe in detail what I mean by being stable in purchasing power, but briefly, I mean a kind of money in terms which it is equally likely that the price of any commodity picked out at random will rise as that it will fall. Such a stable standard reduces the risk of unforeseen changes in the prices of particular commodities to a minimum, because with such a standard it is just as likely that any one commodity will rise in price or will fall in price and the mistakes which people at large will make in their anticipations of future prices will just cancel each other because there will be as many mistakes in overestimating as in underestimating. If such a money were issued by some reputable institution, the public would probably first choose different definitions of the standard to be adopted, different kinds of index numbers of price in terms of which it is measured; but the process of competition would gradually teach both the issuing banks and the public which kind of money would be the most advantageous.

The interesting fact is that what I have called the monopoly of government of issuing money has not only deprived us of good money but has also deprived us of the only process by which we can find out what would be good money. We do not even quite know what exact qualities we want because in the two thousand years in which we have used coins and other money, we have never been allowed to experiment with it, we have never been given a chance to find out what the best kind of money would be.

Let me here just insert briefly one observation: in my publications and in my lectures including today's I am speaking constantly about the government monopoly of issuing money. Now, this is legally true in most countries only to a very limited extent. We have indeed given the government, and for fairly good reasons, the exclusive right to issue gold coins. And after we had given the government that right, I think it was equally understandable that we also gave the government the control over any money or any claims, paper claims, for coins or money of that definition. That people other than the government are not allowed to issue dollars if the government issues dollars is a perfectly reasonable arrangement, even if it has not turned out to be completely beneficial. And I am not suggesting that other people should be entitled to issue dollars. All the discussion in the past about free banking was really about this idea that not only the government or government institutions but others should also be able to issue dollar notes. That, of course, would not work.

But if private institutions began to issue notes under some other names without any fixed rate of exchange with the official money or each other, so far as I know this is in no major country actually prohibited by law. I think the reason why it has not actually been tried is that of course we know that if anybody attempted it, the government would find so many ways to put obstacles in the way of the use of such money that it could make it impracticable. So long, for instance, as debts in terms of anything but the official dollar cannot be enforced in legal process, it is clearly impracticable. Of course it would have been ridiculous to try to issue any other money if people could not make contracts in terms of it. But this particular obstacle has fortunately been removed now in most countries, so the way ought to be free for the issuing of private money.

If I were responsible for the policy of any one of the great banks in this country, I would begin to offer to the public both loans and current accounts in a unit which I undertook to keep stable in value in terms of a defined index number. I have no doubt, and I believe that most economists agree with me on that particular point, that it is technically possible so to control the value of any token money which is used in competition with other token monies as to fulfill the promise to keep its value stable. The essential point which I can not emphasize strongly enough is that we would get for the first time a money where the whole business of issuing money could be effected only by the issuer issuing good money. He would know that he would at once lose his extremely profitable business if it became known that his money was threatening to depreciate. He would lose it to a competitor who offered better money.

As I said before, I believe this is our only hope at the present time. I do not see the slightest prospect that with the present type of, I emphasize, the present type of democratic government under which every little group can force the government to serve its particular needs, government, even if it were restricted by strict law, can ever again give us good money. At present the prospects are really only a choice between two alternatives: either continuing an accelerating open inflation, which is, as you all know, absolutely destructive of an economic system or a market order; but I think much more likely is an even worse alternative: government will not cease inflating, but will, as it has been doing, try to suppress the open effects of this inflation; it will be driven by continual inflation into price controls, into increasing direction of the whole economic system. It is therefore now not merely a question of giving us better money, under which the market system will function infinitely better than it has ever done before, but of warding off the gradual decline into a totalitarian, planned system, which will, at least in this country, not come because anybody wants to introduce it, but will come step by step in an effort to suppress the effects of the inflation which is going on.

I wish I could say that what I propose is a plan for the distant future, that we can wait. There was one very intelligent reviewer of my first booklet who said, "Well, three hundred years ago nobody would have believed that government would ever give up its control over religion, so perhaps in three hundred years we can see that government will be prepared to give up its control over money." We have not got that much time. We are now facing the likelihood of the most unpleasant political development, largely as a result of an economic policy with which we have already gone very far.

My proposal is not, as I would wish, merely a sort of standby arrangement of which I could say we must work it out intellectually to have it ready when the present system completely collapses. It is not merely an emergency plan. I think it is very urgent that it become rapidly understood that there is no justification in history for the existing position of a government monopoly of issuing money. It has never been proposed on the ground that government will give us better money than anybody else could. It has always, since the privilege of issuing money was first explicitly represented as a Royal prerogative, been advocated because the power to issue money was essential for the finance of the government-not in order to give us good money, but in order to give to government access to the tap where it can draw the money it needs by manufacturing it. That, ladies and gentlemen, is not a method by which we can hope ever to get good money. To put it into the hands of an institution which is protected against competition, which can force us to accept the money, which is subject to incessant political pressure, such an authority will not ever again give us good money.

I think we ought to start fairly soon, and I think we must hope that some of the more enterprising and intelligent financiers will soon begin to experiment with such a thing. The great obstacle is that it involves such great changes in the whole financial structure that, and I am saying this from the experience of many discussions, no senior banker, who understands only the present banking system, can really conceive how such a new system would work, and he would not dare to risk and experiment with it. I think we will have to count on a few younger and more flexible brains to begin and show that such a thing can he done.

In fact, it is already being tried in a limited form. As a result of my publication I have received from all kinds of surprising quarters letters from small banking houses, telling me that they are trying to issue gold accounts or silver accounts, and that there is a considerable interest for these. I am afraid they will have to go further, for the reasons I have sketched in the beginning. In the course of such a revolution of our monetary system, the values of the precious metals, including the value of gold, are going to fluctuate a great deal, mostly upwards, and therefore those of you who are interested in it from an investor's point of view need not fear. But those of you who are mainly interested in a good monetary system must hope that in the not too distant future we shall find generally applied another system of control over the monetary circulation, other than the redeemability in gold. The public will have to learn to select among a variety of monies, and to choose those which are good.

If we start on this soon we may indeed achieve a position in which at last capitalism is in a position to provide itself with the money it needs in order to function properly, a thing which it has always been denied. Ever since the development of capitalism it has never been allowed to produce for itself the money it needs; and if I had more time I could show you how the whole crazy structure we have as a result, this monopoly originally only of issuing gold money, is very largely the cause of the great fluctuations in credit, of the great fluctuations in economic activity, and ultimately of the recurring depressions. I think if the capitalists had been allowed to provide themselves with the money which they need, the competitive system would have long overcome the major fluctuations in economic activity and the prolonged periods of depression. At the present moment we have of course been led by official monetary policy into a situation where it has produced so much misdirection of resources that you must not hope for a quick escape from our present difficulties, even if we adopted a new monetary system.

F.A. Hayek (1899–1992) was a founding board member of the Mises Institute. He shared the 1974 Nobel Prize in Economics with ideological rival Gunnar Myrdal "for their pioneering work in the theory of money and economic fluctuations and for their penetrating analysis of the interdependence of economic, social and institutional phenomena." His books are available in the Mises Store. Comment on the blog.

This lecture was delivered at the Gold and Monetary Conference, New Orleans, Louisiana, November 10, 1977. It made its first appearance in print in the Journal of Libertarian Studies, Volume 3, Number 1.

Today we stand at a point in time that is the beginning of the end of an economic era when the US dollar dominated the global economy. The dollar still dominates world financial markets and many currencies around the world are still linked with the dollar, including China. However, the dollar has now ceased to gain additional influence in the world economy and it now has two new competitors, the Euro and the Chinese Yuan.

Gold has now exceeded $1,000 per ounce and our trading partners are growing worried, both about the inflation we are exporting to them, as well as the value of their own central bank holdings of US government securities.

As we enter the era of decline for the dollar all sorts of reforms will be used to address this decline and the economic instability it causes. However, reforms designed on Wall Street or in Washington will not work and will amount to nothing more than rear guard action by the moneyed interests that control the government.

The only true path to reform is monetary freedom. We have gone from a situation where money was entirely free from government intervention to one that is completely dominated by government. Instead of privately minted coins made from precious metals we now have a system of government-printed paper fiat currency. We have gone from a system of private banking that provided bank notes and checks for demand deposits to one where banks are completely regulated by the central bank and a host of other regulatory bodies. The idea that our current financial mess resulted from a lack of regulation is truly laughable. Of course this process has taken centuries to complete. By giving up our monetary freedom—particularly over the last one hundred years—we have given government the ability to grow in size and scope and to achieve unthinkable levels of power. Every step forward towards government control of money has resulted in social chaos and economic destruction. The real economy only grows in the interludes when monetary mischief is at a minimum.

We are now at a point in time when the US government is bankrupt. It cannot pay its bills, it cannot pay off its debt, and it has future unfunded liabilities with a current value in excess of $60 trillion dollars—and that was before all the current bailout packages!

Given that the political parties have done nothing to solve the government's financial mess or to even reduce its magnitude, and given that everything they have done including the prescription drug benefit, the war in Iraq, and the bailouts of Wall Street only makes the problem worse, I can only conclude one of two things. Either they "plan" to resort to hyperinflation to pay for this mess, or they are collectively dumb as a sack of horse manure. Remember, hyperinflation is not just very high prices; it is social chaos and the breakdown of social order. At a basic level our lives are built on a structure of prices that we ourselves co-determine, but in a hyperinflation there is no solid basis for prices and therefore our lives are thrown into chaos. Society becomes more violent and criminal. Government, too, becomes more violent and criminal towards its own citizens.

Given all this, monetary reform is of the utmost importance and knowing the proper path of reform is more important than ever. I will begin by noting

There are some reforms that we obviously do not want and that will not work. For example, we don't want the supply-sider solution of the Federal Reserve targeting the price of gold—that would be very dangerous. We clearly do not want a "new Bretton Woods System," whatever that would amount to; it would surely leave government with too much power. The old Bretton Woods System did not work and was doomed to failure as predicted by Mises, Hazlitt and Rothbard.

We also do not want to return to a gold-exchange standard where governments are in charge of most of the gold and emit paper notes for people to use. This approach is unnecessary and inevitably harmful when too many notes are issued not matched with a corresponding amount of gold.

We actually do not even want to return to a gold standard system which still leaves government too much room for manipulation. In fact, we want no standard at all. "Standards" in money imply government regulation. Such a regulatory role resulted in the problems of bimetallism where government establishes a fixed ratio of gold to silver. As soon as reality deviates from the plans of government bureaucrats, either gold or silver money virtually disappears from circulation.

When Britain overvalued silver vs. gold, all but the most worn silver coins left the market and the British people were left without money for everyday exchanges and payments. This was the beginning of the gold standard, pretty good compared to today's "standard," but still the unnatural result of government control. I urge you to read George Selgin's brand new book which gives the history of how the market came to the rescue and prevented the derailing of the industrial revolution in England by producing the much needed coin money privately.

The list of things we do not want in our monetary system is short. First, we do not want the Federal Reserve—the central bank—in any form, including Federal Reserve notes. Any legitimate roles it now plays, such as serving as a clearinghouse for checks, can be and in many cases already is handled by the private sector. We do not want government control—in any form—over money, banking, interest rates and the money supply.

Second, we do not want Federal deposit insurance. This creates a moral hazard that puts the taxpayers at risk for the bad decisions of bankers. Deposit insurance is a natural moral hazard and therefore bank deposits are not an insurable risk. Banks and depositors can overcome this problem simply by being certified as holding 100% reserves against all their demand deposits. In a market economy, depositors pay fees to have their money deposited in banks and to write checks on those deposits.

The list of things that we do want in our monetary system is also short. First, we know that money emerged on the market and was produced by the market. After the world had achieved substantial integration, gold, silver, and copper emerged as money. Their most useful form as money was coins and the dominant form of money was silver coins. The most obvious thing we want is a return to silver coin money denominated by weight. This is the money that the world used as a basis of economic prosperity and higher standards of living because it enhanced trade and economic calculation. Checks, debit and credit cards, and everything else can be adapted to gold and silver. We need the freedom to hold our money in both gold and silver forms with no fixed government ratio between.

The first step is to repeal legal tender laws which would begin to eliminate the monopoly that government and the Federal Reserve has on the money we use. This would give us back our right to decide what money we will offer in transactions and what money we would be willing to accept in transactions.

Second, we must begin to allow other monies to compete with Federal Reserve notes, such as privately minted gold and silver coins, by taking away any hindrance to the use of gold and silver as money, such as the application of the capital gains tax on gold profits.

These two moves would go a long way to reducing the Fed's ability to inflate the money supply and manipulate the economy. Any inflation by the Fed would eventually result in higher dollar prices of goods, lower gold prices of goods, and more people switching their accounts from paper to gold.

Ultimately we need to send the Federal Reserve into a receivership process whereby Federal Reserve assets including the US gold hoard at Fort Knox and all other depositories, as well as the Fed's real estate portfolio should be used to satisfy the holders of Federal Reserve notes. This process would be conducted by accountants and lawyers just like they do in any bankruptcy process with Austrian economists serving as consultants as to what exactly would be redeemed. Rothbard offers a specific plan in his Mystery of Banking. The dollar would henceforth just be a name of a monetary unit that represented a very small amount of gold.

The restoration of monetary freedom would also force a sharp reduction in the size and power of government. The Federal government would immediately have a hard time borrowing money and would be forced to cut expenditures. Just as government control of money allowed government to expand, monetary freedom would force government to contract. New spending would have to be paid for by new taxes because borrowing and the inflation tax would not be an option. Balanced budgets would force Congress to start making tough decisions. For example, the invasion of Iraq would have never been contemplated; neither would the prescription drug benefit legislation and a whole host of other spending programs. Budget cutting would be put on an even keel with spending, if not at an advantage, and politicians would become more open to shutting down entire programs and selling government assets.

Mises wrote that the era of inflation will come to an end once people realize that the process of inflation is ongoing with no end in sight. At that point people will stop holding dollars and dollar-denominated assets. Individuals who understand inflation should be in a process where they convert their dollars and dollar-denominated assets into non-dollar assets. For example, you can effectively put yourself onto your own personal gold standard by holding gold and silver as your savings, rather than dollars.

In conclusion: What we need is monetary freedom and we must tear down and destroy its opposite, the Federal Reserve. To celebrate the return of monetary freedom in the US, a giant bonfire should be used to destroy all existing Federal Reserve Notes.

My choice at the moment would be a legislated rule instructing the monetary authority to achieve a specified rate of growth in the stock of money. For this purpose, I would define the stock of money as including currency outside commercial banks plus all deposits of commercial banks. I would specify that the Reserve System should see to it that the total stock of money so defined rises month by month, and indeed, so far as possible, day by day, at an annual rate of X per cent, where X is some number between 3 and 5. The precise definition of money adopted and the precise rate of growth chosen make far less difference than the definite choice of a particular definition and a particular rate of growth.Friedman, Milton, Dollars And Deficits, Prentice Hall, 1968, p. 193.

Now if economic fluctuations or boom-bust cycles are caused by fluctuations in money supply, then it makes a lot of sense to eliminate such fluctuations in the rate of growth of money. So in this sense, the fixed-money rate-of-growth rule is the perfect solution.

Contrary to Friedman however, we suggest that the boom is not just about an increase in the rate of growth of the money supply; it is also about various nonproductive activities that spring up on the back of the expanding money-supply rate of growth. Furthermore, we maintain that an economic bust is not about a fall in the rate of growth of the money supply; it is about the elimination of various nonproductive activities on account of the decline in the rate of growth of the money supply.

An increase in the money supply out of thin air sets in motion the so-called "counterfeit effect." It lays the foundation for nonproductive activities, which consume and add nothing to the pool of real funding or real wealth. These activities divert real funding from wealth generators, thus weakening their ability to grow the economy.

The diversion occurs once various individuals that are the early receivers of newly printed money are able to push the prices of goods higher. Wealth generators that didn't receive the newly printed money discover that they can now secure fewer goods than before.

A fall in the money supply out of thin air undermines various nonproductive activities. Their ability to divert real funding from wealth generators is curtailed.

Note that, since nonproductive or bubble activities do not generate any real wealth, they cannot secure the goods they require in an honest way without the support from money out of thin air.

A major problem with the Friedman rule is that we are still going to have an expansion in the money supply out of thin air. (Remember, Friedman advocates the expansion of money at a constant percentage.) This in turn means that various nonproductive activities will be generated.

Once the percentage of nonproductive activities out of all activities starts to increase, this raises the likelihood of an increase in banks' bad assets. Consequently, banks' expansion of credit is likely to slow down and this in turn will weaken the rate of growth of money supply.

A fall in the rate of growth of money will undermine various nonproductive activities. This will set in motion an economic bust.

From this we can infer that, because of banks' conduct, it is not possible to sustain a constant-money rate of growth. This means that Friedman's rule cannot be implemented. Indeed, the Federal Reserve tried to implement Friedman's rule in the early '80s but was unsuccessful.

Let us, however, make the unrealistic assumption that the central bank is successful in maintaining the money-supply rate of growth at a fixed number. Will this lead to economic stability as suggested by Milton Friedman?

We have seen that printing money always creates false nonproductive activities. So if the fixed-money rule were to be enforced, over time it would lead to the expansion of false nonproductive activities. This, as we have seen, is going to weaken the wealth generators and thus undermine the real economy.

The longer that Friedman's rule is implemented, the worse it is going to be for wealth generators and hence for the foundations of the economy. At some stage, once the percentage of false activities surpasses the 50% mark, the economy is going to collapse.

We can thus conclude that Friedman's monetary rule is another way of tampering with the economy; it cannot lead to economic stability.

The better solution—offered by the Austrian School of economics, aims at bringing back the market-chosen money, which is gold.

But even if we bring back the gold standard, the money-supply rate of growth is going to fluctuate. Remember that fluctuations in money supply are associated with fluctuations in economic activity. From this, one may be tempted to conclude that even on the gold standard boom-bust cycles can't be eliminated. But is it true that increases in the supply of gold will generate similar distortions that money out of thin air does? We suggest that this is not the case. Here is why.

Let us start with a barter economy. John the miner produces ten ounces of gold. The reason why he mines gold is because he believes there is a market for it. Gold contributes to the well-being of individuals. He exchanges his ten ounces of gold for various goods such as potatoes and tomatoes. Note that the fact that John can exchange his gold for other goods means that gold offers benefits to the buyers. (For instance, people use gold for making jewelry.)

Now people have discovered that gold, apart from being useful in making jewelry, is also useful for some other applications. They now assign a much greater exchange value to gold than before. As a result, John the miner can exchange his ten ounces of gold for more potatoes and tomatoes.

Should we condemn this as bad news because John is now diverting more resources to himself? This, however, is just what is happening all the time in the market. As time goes by, people assign greater importance to some goods and diminish the importance of some other goods. Some goods are now considered as more important than other goods in supporting one's life and well-being.

Furthermore, people now discover that gold is useful for another use such as to serve as the medium of exchange. Consequently they lift further the price of gold in terms of tomatoes and potatoes. Gold's most prominent  demand currently is for its services as a medium of exchange. The demand for its other services—e.g., for ornaments—is now much lower than before.

The benefit that gold now supplies people is by providing the services of the medium of exchange. In this sense, it is a part of the pool of real wealth and promotes people's life and well-being. When John the miner exchanges gold for goods he is engaged in an exchange of something for something. He is exchanging wealth for wealth.

Let us see what happens if John increases the production of gold. One of the attributes for selecting gold as the medium of exchange is that it is relatively scarce. This means that a producer of a good who has exchanged this good for gold expects the purchasing power of his effort to be preserved over time by holding gold.

If, for some reason, there is a large and persistent increase in the production of gold, the exchange value of the gold will be subject to a persistent decline versus other goods, all other things being equal. As the supply of gold starts to increase, its role as the medium of exchange is likely to diminish, while the demand for it for some other uses is likely to be retained or to increase.

So in this sense, the increase in the production of gold adds to the pool of real wealth. (People might abandon gold as a medium of exchange but still find it useful for other applications.) Note that the increase in the supply of gold is not an act of embezzlement or fraud. The increase in the supply of gold doesn't produce an exchange of nothing for something.

Contrast all this with the printing of gold receipts, i.e., receipts that are not backed 100% by gold, i.e., money out of thin air. This is an act of fraud, which is what inflation is all about; it sets a platform for consumption without making any contribution to the pool of real wealth. Empty certificates set in motion an exchange of nothing for something, which in turn leads to boom-bust cycles.

Again in the case of the increase in the supply of gold no fraud is committed here. The supplier of gold—the gold mine—has increased the production of a useful commodity. So in this sense we don't have here an exchange of nothing for something. Consequently, we also don't have an emergence of bubble activities. Again the wealth producer, because he has produced something useful, can exchange it for other goods. He doesn't require empty money to divert real wealth to him.

On the gold standard an increase in the rate of growth of money, which is gold, will not set in motion the emergence of bubble or false activities, i.e., an economic boom. A fall in the money rate of growth is not going to trigger an economic bust—no bubble or false activities were created that are going to be busted by a slower money rate of growth.

Note that the disappearance of money out of thin air is the major cause of an economic bust. The injection of money out of thin air generates bubble activities while the disappearance of money out of thin air destroys these bubble activities.

On the gold standard this cannot take place. On a pure gold standard, without the central bank, money is gold. Consequently, on the gold standard, money is unlikely to disappear since gold cannot disappear unless it is physically destroyed. We can thus conclude that the gold standard, if not abused, is not conducive to boom-bust cycles.

The famous economist Milton Friedman observed that fluctuations in the rate of growth of money supply could be an important factor behind boom-bust cycles. He suggested that central banks should aim at stabilizing the money rate of growth at some percentage, and keep it at this number for an indefinite time. Friedman held that by maintaining the money-supply rate of growth at a fixed percentage, the Fed could keep the economy on a path of stable growth without boom-bust cycles. Friedman's money rule however is still about printing money, and in this sense it is going to generate the same effect as any money printing does, i.e., boom-bust cycles. We have shown that only a pure gold standard is immune to boom-bust cycles.