October 14, 2002 – One of my favorite writers is Lew Rockwell, who not only is the proprietor of the eponymous www.lewrockwell.com, but also president of the Mises Institute at Auburn University in Alabama. His essays are always learned and very well-written, like the one I recently read that is entitled, “Is the Gold Standard History?”.
I highly recommend that you read it. I will excerpt some comments from his essay in order to address his question about whether the Gold Standard is indeed dead, but I would like to first provide some background information.
Few realize that the Gold Standard is one of Sir Isaac Newton’s greatest inventions. Already well recognized for his scientific achievement, he was appointed Master of the Mint in 1699 and assigned the task of dealing with the monetary turmoil prevailing within the United Kingdom. It was a matter that some of the greatest minds of the day were addressing, including for example, John Locke, who clearly understood the inseparable link between money and private property.
The monetary turmoil had been created because of the establishment of the Bank of England in 1694. Up until that time, currency existed almost exclusively of silver, and to a lesser extent, gold coin. Some paper warehouse receipts issued against coin and bullion had only recently begun circulating, which was an important technological advance keenly understood by William Paterson and his fellow promoters of the BoE. And it was this monetary process of replacing coin with paper for which they were granted a monopoly by co-regents William & Mary.
The creation of the BoE literally changed the currency used within the UK. Coin of course continued to circulate, but the convenience and ease of use made possible by paper resulted in it becoming the currency of choice in commercial transactions.
This development neatly illustrates how the history of money is actually the history of currency. It is a study of making the currency more efficient, to reduce the cost of transactions. This goal was sought because currency costs impede commerce. By reducing the cost and also enhancing the ease by which currency circulates, commerce benefits. Paper currency was an important invention because it circulated much more easily than coin, and after its formation, the BoE began to circulate its paper currency.
They were called “bank notes”, a name purposefully chosen because each note was a promise (i.e., it was a promissory note payable on demand) to pay money, namely, gold or silver coin. The bank note itself circulated as currency. It was not money, but only a money substitute. Only gold or silver can be money, because only an asset can extinguish an exchange. In other words, when you purchase a good or service, only a tangible asset can pay for that good or service. If you use a money substitute to purchase a good, the seller only completes the exchange when he uses the money substitute in another exchange to purchase some tangible good or service.
Anyway, the BoE experienced its first ‘bank run’ just two years after its creation. It had issued substantially more bank notes than it had silver or gold in the vault, a practice known as fractional reserve banking. As holders of those bank notes began to question the ability of the BoE to pay them coin as promised, they sought to redeem the notes, causing a panic, which was fueled by the fact that the coin itself had become worn and therefore debased. The panic was eventually quashed, but the lesson had been learned.
Money (silver and gold coin) was not the same as a money substitute (a promise to pay silver or gold coin). And Newton codified this reality into the Gold Standard. The Pound Sterling was linked to gold, and the BoE was taught the rules of the game about credit expansion – it would need to keep money in the vault equal to about 40% of the money substitutes it issued. If the ratio fell below this level, the BoE would undermine the confidence of those who held its bank notes. This process embedded in the Gold Standard enabled the Pound Sterling to reign supreme for more than 200 years, so that the pound had essentially the same purchasing power in 1914 as it did during Newton’s time.
Today we again face monetary turmoil. And we face these problems because the discipline of the Gold Standard has been discarded. Credit is being created at will; it is created recklessly.
As Rockwell puts it: “The case for radical monetary reform is as obvious as the need to [privatize] the post office. Every year or 18 months, the world goes through some sort of monetary convulsion. In the last ten years, we’ve seen it in Mexico, all through Asia, and now Latin America. To one degree or another, there are few problems of international economics that are not traceable to the grave limitations of a world fiat money system.” Well said. It’s an observation with which I wholeheartedly agree.
I also agree with his observation that the Austrian theory of the trade cycle capably demonstrates “that Fed-created credit is responsible for the boom and bust” evidenced in the 1990’s bubble and subsequent collapse. The expansion of credit creates bubbles, which eventually collapse when the credit expansion is no longer sustainable. The bust occurs when it is realized that much of that credit is worthless (e.g., Enron, WorldCom, Global Crossing, etc.), which is a process we are now going through.
Despite these obvious problems with credit expansion, the ability to expand credit is a very powerful force. Consequently, governments have invariably attempted to co-opt and take over the monetary process. Says Rockwell: “The federal government had long been involved in money precisely because this is one of the first areas a government likes to get its grubby hands on when it takes power. The US government was no exception, despite constitutional provisions that would appear to restrict its monetary power.”
Governments understand the old and time proven adage that money is power. Consequently, the rules established by Newton were broken for good with the out-break of World War I in 1914, and eventually forgotten when the last relics of the Gold Standard were themselves jettisoned by President Nixon in August 1971. And since then, the chorus of statists with their anti-gold and anti-Gold Standard has not lessened.
Says Rockwell: “The gold standard and the issues it raises get right to the heart of the current debate concerning the future of the world economy and its reform. What the critics who denounce gold are really saying is that the government and its friends don’t like the idea of the gold standard, so therefore they are not going to favor one. Why do the government and its partisans dislike the gold standard? It removes the discretionary power of the Fed by placing severe limits on the ability of the central bank to inflate the money supply.” There is another reason not often stated in today’s world of power-hungry centralized governments. “Gold limits the power of the state and puts power back in the hands of the people.”
Central planning didn’t work in the Soviet Union. Central planning doesn’t work in the United States either. The Federal Reserve’s attempt to ‘manage’ money has been one colossal failure after another, from the Great Depression, the debilitating ongoing inflationary debasement of the dollar, and the Fed instigated credit expansion leading to the ‘irrational exuberance’ of the bubble, and now its subsequent collapse. In short: “As with all governments from the beginning of the time, they generally retard social progress and muck things up as much as possible.”
I agree with Rockwell’s view: “Once having read Mises or Rothbard or any number of great monetary theorists, you begin to realize that understanding the monetary regime is the key that unlocks the mysteries of political control in our time. The Fed was created not to scientifically manage the economy – as the journals claimed at the time – but because it met the institutional needs of both the government and the banking industry. The government sought a means of finance that didn’t depend on taxation, and the banking industry sought what Rothbard called a cartelization device. That is to say, the banking industry was seeking some way to prevent competitive pressures between banks from limiting their ability to expand credit.”
It is this banking cartel with which we must contend today. They make loans to Mexico, Brazil and Argentina and other deadbeat borrowers, and earn the profits while these loans are being serviced. When the loans default, which they invariably do, the banking cartel then asks the federal government for a bailout.
“Our experience with the federal government demonstrates that constitutions can’t restrain a government by themselves.” The reason? “It is the central bank, and only the central bank, that works as the government’s money machine, and this makes all the difference.” Rockwell goes on to say: “If a little power to inflate is good for the government and its connected banking and financial interests, a lot of power to inflate is even better.“
Consequently, many – including Rockwell – advocate doing away with central banks. I agree with that proposition, but I believe it is unrealistic to expect that central banks will be outlawed by the political process. It will never happen. Even when they screw things up, central bankers never get fired
The banks control the political process – if they didn’t, how do they always get the bailout they request? The elimination of central banks must come from outside politics. In this case, Rockwell recommends: “We must continue to state the obvious at every opportunity, that the fiat system is exactly what it is, a system of paper money backed by nothing of real value. We must continue to point out that because of this, our economic system is not depression proof, but rather highly vulnerable to complete meltdown. We must continue to draw attention to the only long-term solution: a complete separation of money and state based on the commodity that the market has always chosen as money, namely, gold.”
I couldn’t agree more. And this perspective was very much in my mind when I began to develop the ideas now embodied in GoldMoney. Says Rockwell: “…under the best gold standard, there would be no central bank, gold coins would circulate as freely as their substitutes, and rules against fraud and theft would prohibit banks from pyramiding credit on top of demand deposits. So long as we are constructing the perfect system, all coinage would be private. Banks would be treated as businesses, no special privileges, no promises of bailout, no subsidized insurance, and no connection to government at any level.
This is the free-market system of monetary management, which means turning over the institution of money entirely to the market economy. As with any institution in a free society, it is not imposed from above, dictated by a group of experts, but is the de facto result that comes about in a society that consistently respects private-property rights and encourages enterprise.”
This vision is what GoldMoney is all about, but with a twist. GoldMoney brings 21st century technology to the table. Coins were the gold currency of the 19th century. There was for all practical purposes no gold currency in the 20th century. But this is 21st century, and we have new tools available at our disposal. The greatest of these is the Internet, and digital gold currency.
It is not, in my view, the political process that will topple central banks. It is the new technology. It has been accurately stated that the Internet empowers people. And that’s what GoldMoney does. It enables people to use the gold ‘coins’ of the 21st century – GoldGrams – in preference to the dollar. It is the world’s only non-national, freemarket currency.