Volume I, Number 22: Just One Wish This Christmas: a Dollar As Good As Gold
By John L. Chapman, Ph.D. Washington, D.C.
This week several millions of holiday revellers head to places far from home to be with friends, family, and loved ones. And these are indeed cherished moments in a life all too brief for most (a fate which met our Beltway acquaintance Christopher Hitchens this past week), and too grim for many. Indeed, the latter is true ever more so here in the United States eleven years into the 21st century: no net job gains in the new century although thirty more millions in population, 10% decline in real incomes in the last four years, 25 million frustrated job-seekers for whom full-time work is but a cruel apparition, $12 trillion in household capital wealth destroyed during this last recession, and consumer prices stinging fixed-income pensioners with increases above 3.5% annually when long bond yields can’t even preserve purchasing power.
Moreover the future looks to be as challenging as the recent past has been: there are significant troubles brewing in both Europe and China, and no reason to believe Japan, the other BRIC economies, Latin America or the rest of Australasia are going to see a re-igniting of growth next year. Indeed the world is awash in debt burdened-governments combating absolute declines in the value of the capital stock from which springs future wealth. And, higher inflation and interest rates are on the horizon in the United States, neither of which is helpful with respect to a much-needed recapitalization of the U.S. economy.
It is fair to ask, then, this holiday season, as the Wall Street Journal’s Vermont Royster once did, “where shall men repair unto for succour?” Or, said more colloquially, what one specific policy change would do the most good now to turn around a prospective moribund era? What would light up the U.S. economy almost immediately, and yield rapid and sustainable growth moving forward?
The list of candidates is long, from fundamental tax reform, to spending restraint, to regulatory reform or more open trade. But for those who have delved deeply into the fascinating mystery of money, the answer is unambiguous: make gold the monetary medium once again. For contained in just this one initiative would be felicitous changes following axiomatically in all these other important areas of economic policy.
Just this month we have written elsewhere in detail about the crucial functions of money in an exchange economy, why gold is superior as a monetary medium, and what a reform program for a return to gold might look like. Here we summarize the argument about why it is the single biggest “Christmas present” the world of political economy could receive at the present time. And at the outset, we would hazard predictions that induce the reader to pay close attention below: the global monetary system will see the return of gold in some fashion before 2020. This is an apodictical certainty, because of the manifest failures of competing politically-managed, or fiat, currencies, in recent decades. The bad news is, more gyrations and crises may be in the offing until such fundamental monetary reform is invoked.
What Is the Root Source of Our Present Troubles?
When President Nixon abandoned the gold link to the U.S. dollar on August 15, 1971, he could scarcely have known of or appreciated the furies he would unleash. It was the first time since at least 700 B.C. (when gold was used as money in modern-day Turkey) that the world had no tangible monetary medium, gold or otherwise; instead, currency supply was henceforth solely at the discretion of government authorities, either directly or indirectly. And what have the following 40 years brought? Inflation on a global scale, slow growth, and lower investment levels in the 1970s; periodic banking and currency crises in many Latin American countries (e.g., Mexico, Argentina), Russia, and south Asia in the ’80s and ’90s; individual episodes of volatility that caused great havoc and pain to many (e.g., Penn Square, 1987 stock market crash, the S&L crisis, Long Term Capital Management-type failures); two bubble-induced market crashes since 2000 in the United States that immediately wiped out a collective $20 trillion in capital wealth, the second one inciting a global recession as well; heightened volatility in financial markets that has poisoned the atmosphere for global trade and cross-border investment; and now most recently, a crisis in the Eurozone that some observers feel is going to lead to not only a serious downturn in Europe in the short term, but potentially affect the rest of the world as well.
The ultimate reason for all of these economic gyrations, the collective human pain of which has been large, is monetary instability, borne of governments’ political management of the money supplies of individual sovereign nations. And the reason for this, in short, is that governments are the sole and constant beneficiaries of monetary manipulation. Via fiat currency, there is easy and instantaneous credit available for desired government spending, vitiating the need for increased taxation of the citizenry which is never popular. There are seigniorage profits to be reaped from control of the money supply, and in essence borrowing real resources from the private sector and paying incurred debts back at a discount due to subsequent taxation. This of course causes a transfer of real wealth from creditor to (government) debtor, but this distortive effect is also seen in purely private transactions using fiat money. There is the potentiality, via at least short-term control of interest rates, to direct the flow of investment in the economy. And last but certainly not least, political management of the monetary system confers, as would be expected, significant benefits for the political class: Wall Street middlemen of various types become the agents of government monetary strategy, and benefit handsomely in a mutual aid arrangement that runs two ways, between Wall Street and Washington.
This is so for many reasons, two prominent ones being the primary dealing in government credit instruments and the profitability that that entails; and secondly, the leverage permitted by what is essentially an unlimited reservoir of fiat currency supply and its transmission through the banking system. All who get to play in this great game of leveraged business dealings — the investment and mortgage bankers, government bond traders, the private equity and corporate finance specialists, the bankers who can originate leveraged loans and then transfer their risk to another entity’s balance sheet, etc. in what is a very long list — are either direct or indirect beneficiaries of the government’s flood of credit creation via fiat money.
The reader should understand this is not an attack on these various institutions in the world of banking and finance, that indeed play a critical role in a capitalist economy in channeling credit — which represents temporary command of needed real resources — to its highest valued uses in order to optimally benefit society at large. But it is to say that unchecked leverage can and usually does cause eventual economic pain and hardship because the lack of equity — that is to say, adequate capital — either means a misdirection in the use of scarce resources (malinvestment), or the inability of the enterprise to weather the occasional headwinds that changing demand patterns in an economy can generate. In short, to take one example, the Federal Reserve injected massive amounts of credit into the economy via artificially low interest rates for some years up to the middle of 2007, and for various reasons (also dealing with errant government policy), these funds were channeled into housing. The end result has been a global disaster in which investors in many other countries around the world bought what were thought to be safe U.S. assets and then leveraged their balance sheets on top of leverage-based U.S. assets, creating what might be called a financial “house of cards.” Had the U.S. had a gold dollar for its currency, none of this, which has been tantamount to a waste of trillions of dollars of real capital around the world, would have played out anywhere nearly as badly as it has.
Why Gold?
This is because a currency based in gold takes a large measure of the ability to politically manipulate the money supply away from political (selfish) interests (we say large measure, rather than complete and total, because the institution of the Federal Reserve itself, as a tool for political interests, can still cause havoc. Political interference with the monetary system will only end with the dissolution of the central bank, a large topic for another time — and at least in the interim, gold would force the central bankers to “be more honest”). For this reason, a return to the historic medium of exchange, with its properties of durability, uniformity, and constancy in value, would bring unambiguous benefits to first the U.S. economy and then the world.
And indeed, gold has been called “sound money” or “honest money” for just this reason. Gold provides an anchor of stability in all trade and exchange relationships; the counterparties know the defined value of the medium of exchange is unchanging. The ability to calculate real profits and losses, and thus direct resources to their best uses, is greatly enhanced, and pricing of assets (including interest rates on credit) is more acutely correct (and, as we saw in the recent debacle, the inability to price assets correctly, in the sense of objective value in exchange, causes both a diminution of investment and then a freeze-up in credit markets due to opacity in real market values. The very function of money, first and foremost as a medium of exchange and instrument to promote trade, is thus eviscerated, and when trade is impaired, economic hardship and turmoil cannot be far behind).
We will defer discussion of the optimal path to a gold-based monetary reform to several publications we are developing for 2012, but will say here that the stash of gold in Fort Knox that is on the Fed’s balance sheet could “cover” more than 18% of the M1 money supply at current prices; this is more than enough to effect reform based on historical levels of fractional reserves. But the reform, say with gold setting in at a long run value of $1000 per ounce, would be electric for the U.S. economy. The demand for U.S. dollar-denominated assets would explode around the world, as the U.S. was once again seen as the ultimate safe haven, and the dollar a solid reserve currency. This would cause real interest rates to be lowered, and temper inflationary pressures that are unfortunately on the horizon. It would engender a flood of new investment into the U.S. which, along with an immediate upward valuation of U.S. equity and bond markets, would provide a one-time “positive shock” to the value of the capital stock in the U.S.
And this is precisely what the U.S. economy needs right now: ours is not a lack-of-spending problem. The main challenge to the U.S. economy right now is a lack of capital, and what is needed is a serious recapitalization of our asset base here in the U.S. and around the globe.
Gold would confer many other immediate benefits, including its return as a constant store of value for the currency, thus aiding all users of dollars — that is to say, all consumers. Real prices in an economy actually decrease over time with a strong currency. And one other happy benefit would accrue to hard-pressed American consumers and taxpayers: the federal government would have to be “more honest” and indeed, penurious, in its fiscal dealings. It would have to explicitly tax citizens for programs rather than borrow and inflate, and this alone will cut back on the hundreds of billions in waste or superfluity in Washington D.C.’s annual budgeting circus. Many of the current army of 40,000 lobbyists inside the Beltway would need to seek new employment, as the unintended transfer of wealth between creditors and debtors under the current dishonest fiat system would largely end.
Conclusion
The world is hard pressed at the moment, and challenging times will be with us for some years ahead. Another 2008-type cataclysm and financial panic cannot be ruled out, sadly. But the day draws nearer when the enormity of the problems in modern political economy, created at their core and abetted by a political class that reaps benefits from its self-aggrandizing management of the monetary system, causes a popular movement toward broad fundamental reform. And the capstone to this reform will surely be the return of a gold-linked dollar. In this season of hope, this is the brightest star in the firmament of a vague future which yet still holds boundless promise for the potential genius that is innate in free man.
For information on Alhambra Investment Partners' money management services and global portfolio approach to capital preservation, John Chapman can be reached at john.chapman@alhambrapartners.com.
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