had already told us why the gold standard failed. More accurately,
he hinted at why it was going to fail.
In different wording, and with regard
to the policy of hoarding gold in order to prevent commodity prices
from rising (remember, the dollar was fixed to gold at the time,
so this was really dollar policy) followed by the Federal Reserve
System between 1914 and 1924 he said:
"we might even now without undue exaggeration
say that gold has ceased to be a commodity the fluctuations
in the price of which are independent of government influence.
Fluctuations in the price of gold are nowadays substantially dependent
on the behavior of one government, namely, that of the
United States." (pp.431; Theory of Money and Credit, Chpt
20 on Money and Banking; Section 3.9 - Problems of Credit Policy
in the Period Immediately After the War)
In the underlined part of the passage
above he was effectively saying that gold no longer was a sound
money, according to the Sound Money principle, because the Federal
Reserve managed its fluctuations (uh, manipulation?).
The sound money principle does not
mean the unattainable idea of stable money. It simply means the
market decides on what money is, and what it's worth. In this way,
the Austrian School argues, money would be more stable than it is
when inflation is allowed to expand unchecked. Sound money simply
excludes government in both money and banking affairs.
At best, the gold standard can probably
be no more than a pragmatic application of the sound money principle.
At worst, it can be the wolf in shepherds clothing, or a Trojan
horse; a deceitful compromise by the powerful.
Imagine it like a front in an illicit
Only One Good Gold Standard, But
Several Bad Ones
In a recent note to my
subscribers I made the comment that the gold standard was abandoned
in 1933/34 in the United States.
Understandably, many were puzzled.
For they thought that President Nixon took America off the gold
standard in 1971 (actually, the window officially closed in 1973,
but with hindsight the case is frequently made that at the time
most people knew the 1971 suspension was probably going to be permanent).
But the gold standard that
Richard Nixon abandoned was a "gold-exchange" standard.
The 1946-1971 Bretton Woods monetary
system was modeled after the gold exchange standards that existed
in Europe between the two World Wars. Under the typical gold
exchange standard, the nation outlaws gold coinage, and restricts
For instance, Britain in the 1920's
allegedly returned to the gold standard it abandoned in 1914, but
made the pound convertible only into bullion (as opposed to coins),
so that only large traders had the privilege of convertibility.
It was a debased form of a gold standard if you will.
Moreover, it returned to the gold
standard at the prewar (overvalued) rate for the pound. Instead
of solving the attendant problems with monetary deflation, or by
applying sound money principles to increase the Pound's value:
"Great Britain persuaded the other European countries
at the Genoa Conference of 1922 to go back, not to a genuine gold
standard, but to a phony gold exchange standard. Instead of each
nation issuing currency directly redeemable in gold, it was to
keep its reserves in the form of sterling balances in London,
which in turn would undertake to redeem sterling in gold. In that
way, other countries would pyramid their currencies on top of
pounds, and pounds themselves were being inflated throughout the
1920s. Britain could then print pounds without worrying about
the accumulated sterling balances being redeemed in gold." (Rothbard;
Mystery of Banking; pp.246)
Later, when the United States abandoned
its government guaranteed gold standard, it adopted this model.
The Bretton Woods monetary system was premised on just such a recycling
(pyramiding) scheme, except with more members and the reserves this
time were Federal Reserve Notes.
The world had their currencies pegged
to the dollar, and the dollar was redeemable in gold. But what made
the Bretton Woods system a gold-exchange standard was that gold
coins weren't allowed in circulation; individuals in the United
States were restricted in owning both bullion and coins (from 1934
The same kind of centralized pyramiding
of Federal Reserve Notes goes
on today, except there isn't even a phony gold standard in place
to deceive people. It isn't necessary. For, inflation is indeed
the true opium of the people...
It's only necessary if the people
are opposed to inflation. Then you've got to fool them somehow if
you want to keep it going. Ludwig von Mises said this about the
"The gold-exchange standard, whatever argument
may be advanced in its favor, is vitiated by an incurable defect.
It offers to governments an easy opportunity to embark upon inflation
unbeknown to the nation. With the exception of a few specialists,
nobody becomes aware in time of the fact that a radical change
in monetary matters has occurred. Laymen, that is 9,999 out of
10,000 citizens, do not realize that it is not commodities that
are becoming dearer but their tender that is becoming cheaper."
(Mises in the Theory of Money & Credit; pp. 494 on the Return
to Sound Money)
We call such gold standards clunky
government rig jobs. Or I like to call them the Trojan Horses. Awarding
the government the ability to regulate money and to award banking
monopolies is as Gary North (popular contemporary Austrian economist)
recently put it:
"a government-guaranteed gold standard is
to money what government-guaranteed health inspection is to prostitution.
Both guarantees are subsidies to the providers. Both guarantees
create the illusion of decreased risk. Finally, the operations
of both systems are best described by the same verb" - Gary
North; Two Kinds of Gold Standard - July 25th, 2003
In his essay, however, North didn't
differentiate between the classical gold standard (which existed
in the US between 1896 and 1933) and the gold exchange standard
(which the Bretton Woods system effectively was).
He differentiated between a market
determined gold standard and a government guaranteed gold standard.
If I may be so bold, the world has rarely, if ever, been witness
to the former.
The classical gold standard in the
United States was a government guaranteed (or traditional) gold
standard. It differed from the gold-exchange standard, but it also
differed from the ideal free market established gold standard.
Consider Gary North's conclusion:
"The State's gold standard is a preliminary
to eventual confiscation or debasement. The State's promise
of redemption on demand should not be trusted.
A gold coin standard by profit-seeking storage
organizations can be trusted with less risk, but not if the
storage is offered for free. There are no free lunches. Someone
will eventually pay for free services. When it comes to fractional
reserve banking, that someone is always the late-coming depositor.
This is why any call by conservatives for
the State to adopt a gold standard is futile. No one will
listen. Even if voters understood the case for a limited State,
they would not be able to limit the State by a State-run gold
standard. A State-run monetary system, with the exception
only of Byzantium, becomes a debased standard.
This is why the free market is the only
reliable source for the re-establishment of a gold standard.
Honest money begins with these steps: (1) the revocation of
legal tender laws that require people to accept the State's
money; (2) the enforcement of contracts; (3) laws against
fraud, which fractional reserve banking is. The free market
can do the rest."
Thus, while I often refer to the
traditional gold standard in America (1896-1933) as the last gold
standard, I only mean to differentiate between the traditional gold
standard and the gold-exchange standards. By no means do I mean
to imply that particular gold standard was sound.
On the contrary, as North says, and
as history has shown: "The State's gold standard is a preliminary
to eventual confiscation or debasement. The State's promise of redemption
on demand should not be trusted."
Legal Tender Laws, Central Banking
are Obstacles to Sound Money
To understand how a market
would determine the gold standard (and how it determines money)
one needs only to understand how a market works free from intervention.
But to understand why the State's
gold standard fails Sound Money doctrine and leads to confiscation/debasement,
I think the reader needs to
understand that the real conflict is
between free decentralized banking and monopoly / centralized banking,
as both Mises and Rothbard showed, rather than simply a matter of
discipline. The State, through granting legal tender privileges
(i.e. the government decides what constitutes a legal unit of
account, which means that all creditors and merchants are legally
forced to accept a specific fiat currency in exchange for their
labor, goods, and/or in settlement of all debts), always endorses
the latter. And the latter is inflationary.
Mises argued that:
"The real obstacle in the way of an unlimited
extension of the issue of fiduciary media is not constituted by
legislative restrictions of the note issue, which after all, only
affects a certain kind of fiduciary medium, but the lack of a
centralized world bank or of uniform procedure on the part of
all credit-issuing banks." (on Peel's Act - Chpt 20: Money
and Banking; pp. 411, Section 2.2 in the Theory of Money and Credit)
Murray Rothbard, a Mises student,
went on to write several books on the subject of money and banking.
He discussed this conflict (centralized versus decentralized) at
great lengths. He built on what Mises discovered.
Rothbard argued that central banking
began in England in the 17th century as a "crooked deal between
a near-bankrupt government and a corrupt clique of financial promoters,"
and specifically that it wasn't the product of a natural market
In the Mystery of Banking, he says,
"On the contrary, it was the result, as Bagehot put it, 'of an
accumulation of legal privileges on a single bank.'"
Rothbard too focussed on Peel's Act
as a pivotal moment in the conflict.
Peel's Act was a controversial restrictionist
measure; controversial because Sir Robert Peel and his clique were
from the leading opposition to Inflationism, yet the act simply
awarded the Bank of England more legal power over note issue.
As Rothbard said:
"In a praiseworthy attempt to end fractional
reserve banking and institute 100% money, the Peelites unfortunately
decided to put absolute monetary power in the hands of the very
central bank whose pernicious influence they had done so much
to expose. In attempting to eliminate fractional reserve banking,
the Peelites ironically and tragically put the fox in charge of
the proverbial chicken coop." (pp188 -- Mystery of Banking)
The other main Rothbard-Misesean
criticism of Peel's Act was that the British Currency school (dominated
by Peel at the time) stubbornly refused to acknowledge demand deposits,
or anything but the central bank's notes as money. So banks were
able to issue demand deposits beyond the restrictions, and inflation
The sound money principle was upended.
The failure of Peel's Act became
the academic world's example of why a man made restrictionist
policy can't work to check inflation, and in the more extreme interpretation,
why central banking can't work. But in reality it became the pivotal
point inducing the unbridled growth of central banking, and the
abandonment of sound money doctrine, which as many Austrian School
economists argue occurred in the late 19th century.
The reason restrictionist measures
can't work in the context of a centralized banking system is,
"a monopoly bank privileged by the State could not, in practice,
be held to a restrictive 100% rule. Monopoly power, once created
and sustained by the State, will be used and therefore abused."
Forget about theory. That's the reality of it all.
Several times after Peel's Act was
enacted, the Bank of England suspended it (1847, 1857, 1866, and
1914) when the inflation induced booms busted, and its banks didn't
have enough cash reserves to settle redemption demands.
What this means in lay terms is that
any claims by a central bank that it could restrict the growth of
money has been proven absurd by the failure of one of the strictest
attempts in recent history, let alone events of the recent past.
A central bank's reputation as a regulator of a free banking
system is ironically limp, or outright deceptive at worst. Its
independence from the government is not even theoretically valid
so long as it is the government which grants it its monopoly.
Yet there are those who argue that
a central bank is the product of the natural evolution of a free
banking system. For, everywhere there was free banking, there is
now a central bank!
Rothbard pointed out two things
in the "Mystery of Banking."
First, banking in Scotland was free
between 1727 and 1845 - until it ended when the British Government
ratified Peel's Act in 1845. Second, he made the controversial contention
that banking in the United States even before the Civil War was
never really free (i.e. decentralized).
Since we're not discussing the Fed's
origins we'll put aside the second point except to the extent the
reader understands my main point here: the Federal Reserve was not
the creation of a free decentralized banking system. On the contrary,
Rothbard showed it was a State system, which led to the National
Bank Acts after the Civil War, which resulted in the centralized
banking structure that in the end required a lender of last resort.
Free Banking in Scotland, however,
was free in the sense that it was decentralized, and each bank checked
the other by calling on it to redeem in each others notes. Rothbard
In contrast to the English banking system, the
Scottish, in its 120 years of freedom from regulation, never evolved
into a central banking structure marked by a pyramiding of commercial
banks on top of a single repository of cash and bank reserves.
On the contrary, each bank maintained its own specie reserves,
and was responsible for its own solvency. The English “one-reserve
system,” in contrast, was not the product of natural market evolution.
On the contrary, it was the result, as Bagehot put it, “of an
accumulation of legal privileges on a single bank.” Bagehot concluded
that “the natural system—that which would have sprung up if Government
had left banking alone—is that of many banks of equal or not altogether
unequal size.” Bagehot, writing in the midnineteenth century,
[p. 187] cited Scotland as an example of freedom of banking where
there was “no single bank with any sort of predominance.”
In a footnote he added:
Walter Bagehot, Lombard Street (Homewood, Ill.:
Irwin, 1962), pp. 3233; White, “Free Banking,” pp. 42-43. Furthermore,
Scottish free banking was never plagued by any problem of counterfeiting.
Counterfeiting is generally a function of the length of time any
given note remains in circulation, and the average Scottish bank
note lasted a very brief time until a competing bank would return
it to the issuing bank through the clearinghouse for redemption.
Emmanual Coppieters, English Bank Note Circulation 1694-1954 (The
Hague: Martinus Nijhoff, 1955), pp. 64-65; White, “Free Banking,”
Scottish bank notes became so prominent
that they were frequently used in the North of Britain in the early
19th century, while the British notes never made it into circulation
The structure of the Scottish banking
system wasn't centralized.
So what happened. How did they fall
prey to this debauchery? Or are the central bankers right? Is central
banking simply the natural progression of a free banking system?
Rothbard said of the Bank of England's
new powers in Scotland at the time:
"One interesting point is the lack of any protests
by the Scottish banks at this abrogation of their prerogatives.
The reason is that Peels 1845 Act suppressed all new entrants
into Scottish note banking, thereby cartelizing the Scottish banking
system, and winning the applause of the existing banks who would
no longer have to battle new competitors for market shares." (Mystery
When people become rich and successful,
I suppose it's just human instinct for them to want to protect their
livelihoods. That's what seemed to happen here. The Scottish bankers
that survived the discipline of the market no longer wanted to compete.
They were seduced by the Bank of England. They were offered a cartel.
It's the same in any industry. Few
people want market discipline today, yet that's our only real challenge
in society. To serve the market!
There can be no discipline in banking
so long as there is a central bank, awarded the power to issue notes
at will. And there can be no free banking so long as governments
can enforce legal tender laws (which support the centralized structure).
Free banking means every bank has
to keep appropriate quantities of "specie reserves," and is subject
to "calls for redemption in specie by other, competing banks
as well as by the general public." It is a decentralized form
of banking, as opposed to today's "centralized banking system,
able to inflate the supply of money and credit in a uniform manner."
Smarter people than me say so. The
problem today is the modern financial man refuses to believe that
the subject of money is as simple as disciplining banks and governments
through a market determined gold standard.
Indeed, the traditional gold
standard is no more viable than Peel's Act was in its aim, so
long as the banking system retains its monopoly over money; so long
as it remains centralized.
Thus, legal tender laws are the main
barrier to a viable gold standard because they are responsible for
creating the need for a centralized structure to begin with. A
centralized structure is needed to ensure the inflation is controlled.
In this regard, Rothbard noted that
the Federal Reserve System was not simply a lender of last resort,
but a powerful, proactive engine of inflation, as its creation was
the last piece of the centralized structure in America's banking
system put in place:
"The new Federal Reserve System was deliberately
designed as an engine of inflation, the inflation to be controlled
and kept uniform by the central bank." (Mystery of Banking)
Controlled and uniform.
It is the key advantage of a centralizing
banking system. Not to prevent inflation. But to "inflate the
currency in a smooth, controlled, and uniform manner throughout
That might help you understand what
they mean today when they say "inflation is under control."
They realize they can't say there isn't any inflation, so they say
things like that, or that deflation risks are larger than inflation
risks, or they discuss inflation expectations, or they redefine
inflation as the rate of change in certain prices.
But they never say there is no inflation
in money and credit. At least
I've never heard them say it that way. The main point is that the
repeal of legal tender laws would in all likelihood lead to a decentralized
free banking system, one which a gold standard could more easily
Will They Confiscate Gold This
Diane Francis wrote an
article for the Financial Post, and she ended it asking, if gold
threatens to rise, and in doing so threatens our economic system,
why wouldn't the government confiscate it again as it did in 1934?
The answer to this question is simple:
they can't blame the gold standard this time around.
You see, gold isn't the problem.
Inflation is. When gold is going up, it simply means the public
is losing confidence in the State's money.
The problem is that capitalism can't
work well when the inflation alters the economy's price structure.
In the thirties, the banks and government could have blamed the
gold standard because it failed to check the inflation. But they
probably realized that it really failed because they didn't want
the market's discipline. So instead,
they blamed the gold standard for restricting their ability to stimulate
Today, there is only central banking
to blame. Diane Francis might be more correct to ask, why wouldn't
we abandon central banking?
The Demise of Private Property
and America's "Potential" Decline
It should be clear to the
student of money that Legal Tender laws are the main impediment
to honest money and social progress. It's through such laws that
history's most notorious central bankers have been able to sanction
their banking and money monopolies, and thus to perpetrate the crimes
of inflation - as against capitalism, of morality, and social justice.
I believe when way future historians
look back on mankind's current struggles they'll say something like
For millenniums mankind struggled
to overcome tyrannical rule by other men, but failed to see how
easy it really was. They needed only to understand how such despotic
inroads into their individual freedoms would never be possible had
they subjected their kings, governments, and banks to the same kind
of market discipline most all other businessmen were. In other words,
they only needed to understand how inflation undermines the institution
of private property. With inflation gone and out of our lives forever
now, we have ingeniously eradicated the one factor most responsible
for social injustices, capital depravation/decumulation, moral decay,
unemployment, growing taxes, too much government, financial volatility,
and even war. There's been peace for over 2000 years since the great...
I know, my optimism knows no bounds.
Congressman Paul is an optimist too
(press release below). But he's also a true warrior for liberty.
His aim is correct: to repeal the legal tender laws. His timing
may be premature. But if only there were more like him, America
could one day recover its powerful economic position in the world,
rather than succumb to the decline marked by all other empires through
See, gold bugs aren't pessimists.
We would be if we believed the world will be subject to inflation
forever. Maybe then gold would be dead. The thing is, I left the
concluding futuristic remark above open because it seems
that throughout history, progress was only made after great tragedies...
after a crisis materialized.
So where will the Inflationists take
us exactly this time?
Paul introduces new legislation: "The Honest Money Act,
HR 2779". From last week's press release:
intervention through legal tender laws, individuals acting
through the market decide what they will use as money. Historically,
the free market has chosen some combination of gold and silver
whenever they were available. As Dr. Edwin Vieira, the nation’s
top expert on constitutional money, stated: “A free market
functions most efficiently and most fairly when the market
determines the quality and the quantity of money that’s being
used.” When government creates fiat money out of thin air,
the purchasing power of existing dollars falls. Fiat money
erodes the value of savings, and is especially harmful to
those living on fixed incomes. Paul believes centralized planning
in monetary affairs is as harmful as centralized planning
in economic affairs.
“Fiat money is widely
accepted only because of legal tender laws,” Paul stated.
“Throughout the 20th century, the legal tender power enabled
politicians to fool the American public into believing the
dollar no longer meant a weight of gold or silver. Instead,
the government told the people that the dollar now meant a
piece of government-issued paper backed up by nothing except
the promises of the government to maintain a stable value
of currency. Of course, history shows that the word of the
government (to protect the value of the dollar) is literally
not worth the paper it is printed on.”
Obviously, our lesson hasn't been
learned despite the many wars such polices have arguaby caused over
the past 200 years alone.
When historians write the rise and
fall of the American Empire (I sincerely hope they never do; I'm
just roughing readers up a little), I hope they get it right: that
people didn't realize how the sound money principle was the most
effective way to protect their property from confiscation, and their
freedom from tyrants.
Maybe America won't ever end up with
a tyrant. Maybe the bureaucracy will just keep growing, like it
has in Canada, or Japan. Socialism surely will grow.
But then, the Austrian School has
shown how socialism has often led to fascism in the modern progressive
era. I don't want to make that argument though. Indeed, my main
point is that it could very well be different this time, but it
probably won't be good.
If the institution of private property
is at root the best explanation for America's relative prosperity,
the demise of the sound money principle is the best explanation
for its fall. And it began more than 100 years ago.
Either our generation is going to
make the sacrifice voluntarily, or the next generation, our children,
or theirs, will live our legacy of moral turpitude. Certainly, there
is great cost involved in going to a gold standard today. But the
cost of rejecting one grows as each decade passes.
Please don't mistake me for an expert
or guru. I'm merely a passionate student of money.
Edmond J. Bugos