The gold standard failed because
a gold standard and central bank cannot coexist. It is as simple
as that. That is particularly true when the gold standard is not
sound in the first place, which many argue it wasn't. At any rate,
when the dollar was backed by gold prior to 1933, the fiat monetary
boom (1914-1929) engendered by the Federal Reserve System resulted
in a bust sequence that in turn resulted in a series of bank panics
a few years after the stock market crash of 1929.
Oh my, bank runs are bad for the
economy, aren't they? They sure are if that means disciplining the
engine of "growth." After
all, depositors lost confidence in their banks. The system of inflation
can't work without the confidence of its participants.
Precisely. So they proceeded to withdraw
their "money," or gold. Roosevelt's bank holiday fixed them (us)
though. After the holiday was up, US citizens were fined if they
held gold assets. Hoarding was out, and spending was in. Within
a year the first "Federal Reserve" note, not backed by any amount
of gold, was issued.
Think about it. The free banking
system uses a lender of last resort to sustain a monetary boom and,
in the end, de facto defaults on its own deposit liabilities. The
citizen gets it both ways: directly in his wallet now, and over
time through consistent debasement. Without a lender of last resort
sponsoring the 1920's inflation, it could be argued that the boom
wouldn't have become so misguided in the first place. Indeed, the
gold standard in the end was the discipline, which prevented the
free banking system from continuing the inflation. Depositors voted
against banks and for their gold.
The lender of last resort is the
political connection between the banking industry and government.
It is used by the banks and paid for by the government, or its citizens
in the long run.
Anyhow, here's my point. There's
a slight wrinkle in history we need to iron out. In "Gold
and Economic Freedom," a 1967 essay (in Ayn Rand's
book Capitalism, the Unknown Ideal), Mr. Greenspan said that a free
banking system was the natural evolution of a gold standard. He
argued it much like Menger argued how money first came into being,
that a free banking system backed by a lender of last resort simply
became superior to the gold standard. Aside from the arguable fact
that sound money had already ended with the National Bank Act of
1863, the truth could probably be more accurately found in Gresham's
In the end, it was a political objection
to sound money that buried the so-called gold standard, and it arose
out of a checkmate. Depositors that wanted to protect their savings
from the "free banking system" had to choose between private property
and government help. In the end, again, they voted for government
As long as banks can lend out more
than they have, bank runs are inevitable, unless there is a lender
of last resort to sustain the (monetary) inflation.
The inevitability of the bank run
lies in theories explaining how monetary inflation affects the business
cycle, and even with some common sense. Credit expansions just cannot
go on forever. But today's society believes that they can. And they
can for what seems like forever with enough financial engineering,
political wrangling, and enormously growing derivative markets arising
out of the need to shift the growing systemic risk around to different
counterparties, like a hot potato.
If the dollar were backed by gold
today, none of this is possible. It is the reason that central banking
and the gold standard are at odds, and why they cannot coexist.
A central bank could not sustain these monetary booms to the extent
it does, if gold were allowed to function freely as money.
The free banking system is not the
natural evolution to a gold standard. It is, on the contrary, its
enemy (Mises might say that it is also simply an interruption, or
setback, in the process whereby the markets ultimately develop a
sound money). And the central
bank is a political vehicle used to undermine it as well as the
system of private property / production (or capitalism), which gold-as-money
is intended to protect.
But so long as the system of fractional
reserve credit is not recognized as flawed, in the first place,
the central bank will have a mandate. Yet, if it becomes realized
as flawed, depositors will once again be forced to choose between
economic justice and government help - which includes the burden
of hidden taxation.
So long as our policymakers continue
to perceive the cure for our economic problems (usually a manifestation
of inflation anyway) to be more credit or monetary inflation, government
and bureaucracy will grow and grow. It will have to, if only due
to the errors made by inflationist policy.
In the end, investors must choose
between exercising their Constitutional rights to private property,
something legally unique to American citizens, or more, and more,
government. The government's biggest influence today lies in its
ability to persuade us that it can stimulate the economy, through
inflation. This is its main weapon, and it stands in between the
existence of the Federal Reserve System and the investor's decision
to hoard what he or she thinks is money, in what may ultimately
amount to a political objection of central banking.
For those of us bullish on gold today,
this is the Gold market's ultimate challenge.
We're looking for a three to five
year bull market in gold that should begin sometime this year, if
it hasn't already. This bull market in gold, we contend, will be
all about overcoming the State's global monopoly on money. For gold
to win, in the end, will require the utmost moral conviction on
the part of every single individual who holds the power to vote
for the system of private property… to veto the government, if you
will. Long-term global prosperity depends on it.
If you accept this argument then
it isn't difficult to imagine the world's central banks all have
a common goal. Everyone must by now know they are the ones engaged
to replace gold, after all:
"In summary, then, although information
technology by its very nature has lowered risk, it has also engendered
a far more complex international financial system that will doubtless
bedevil central bankers and other financial regulators for decades
to come. I am sure that nostalgia for the relative automaticity
of the gold standard will rise among those of us engaged to replace
it." - Alan Greenspan, sometime in 1999.
So now that you know who "they"
are, it's funny that the Bundesbank is talking about diversifying
out of its bullion holdings and into equities, on the premise that
over the long run stocks outperform. The fact that central bankers
are natural opponents of gold-as-money is small in comparison to
how grave the situation must be for them. After all, their money
is only good so long as there is confidence in stock and bond markets.
Unfortunately, today there is this valuation problem in those markets.
Effectively, what Bubba is saying
is not different from what is said in any other market crisis by
the main players supporting the market. It isn't much different
than what promoters do or say to control their markets. The difference
is they're allowed to do it. Unfortunately for them, that's the
only difference. For both the promoter and central bank ultimately
succumb to the laws, or discipline, of markets.
This week was a tough week for gold.
Bubba came out on top as commodity prices blew off, by Monday, after
a two-month gain of better than 11% in the main indexes.
Oil prices ended the week back to
where they started, after meeting some technical objectives, probably
influenced by the bearish sentiment on Wall Street, in the other
commodities, and finally egged on by what seemed like Bush's final
attempt at peace in the region. Early in the week, Iraq and Iran
threatened oil embargos against any supporters of Israel's reportedly
increasing aggression in the region. The Saudis and Kuwait rejected
the notion of an embargo, probably since Bush was promoting their
peace plan for the resolution of the conflict between Israel and
Arafat, the Palestinian authority.
Palladium prices fell because analysts
discovered that Ford Motor Company invented a technology that reduced
the amount of palladium they needed. Ford disclosed that it would
reduce its inventory of palladium by half. Palladium prices fell
Falling stock and commodity prices
provided impetus to bullish bond trade, however. The long bond was
up about 3% on the week by Friday, and Wall Street noticed. The
Dow was able to bounce, a little. The other averages weren't. They
ended at their lows for the week, as well as only slightly above
support levels that could seriously extend the bearish argument
The dollar ended down marginally,
on the week. We are of the opinion that it is going to suffer badly
as a consequence of shifting priorities in global trade, and as
a consequence of an eroding investment premium related to the dwindling
of prospects for returns on dollar denominated financial assets.
But we are also going to suggest
that global trade is breaking down because there is no valid common
global medium of exchange. We would like to propose that trade has
been deteriorating as a consequence of the erosion of confidence
in the dollar as a sound common medium of exchange.
If that is true then Bush's shift
in trade policy is reactionary, and the fall in the value of the
dollar is just around the corner.
Whatever happens in Japan, it's bullish
for gold. If the Yen and Nikkei fall apart, it is bullish for gold.
If the Yen and Nikkei go up, it is bullish for gold, because the
dollar will be going down. Only, investment demand for gold will
grow in the US instead of Japan.
The Australian dollar is still trending
up, but the RBA's decision to hold rates steady pressured it against
the greenback this week, which kept the US dollar's decline in check,
generally. Softness in the Aussie is bullish for gold demand. Still,
the chart of the Aussie, as well as those of most currencies, continues
to build bullish bias.
I think this week will be very bearish
for US/European stock markets, bearish for the US dollar, bullish
for gold (including equities), the yen, and maybe the Nikkei.
Anything can happen in the oil markets,
but we expect most surprises to happen on the upside, and stay generally
bullish on oil and other commodity markets. But this week, the focus
should be on Wall Street, the dollar, and Gold.