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