A Return to Hard Money? Let's Get It Right This Time

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The Republican platform buzz about a new Gold Commission has caused all sorts of reactions and generated a lot of commentary about the economics or workability of different variations of a return to gold-linked dollars. It is certainly understandable given the sorry state of economic affairs in 2012, but I remain more than skeptical that there is any real desire on the part of the Republican Party to address the main element. The public's desire, despite mainstream economic indoctrination against anything other than fiat money, is relatively clear when it comes to "hard" money. Hard money means stability, and that is what Americans and Europeans really want after five years of unending financial siege.

I doubt very much there is coincidence that this sort of thing seems to occur every thirty years. Life is full of cycles and economics is practically built upon them. It was only a little over thirty years ago that the "first" Gold Commission got together in March 1982. The actual idea for that commission was first proposed in 1980 under President Jimmy Carter, which tells you a lot about the circumstances that surround such gatherings.

The Great Inflation had reached its crescendo at the time of that proposal (by Jesse Helms, if I recall correctly). In terms of monetary conditions, the massive consumer price inflation inflicted on the global economy had led to more than a decade of impoverishment. Inflation's greatest contribution, if that is the right word, is exposing the weakness of the underlying economic paradigm. Think of Zimbabwe or Weimar Germany as the extreme examples that highlight this fact. Inflation of any means or scale, through ruthless and brutal imposition, is the very visible symptom that the structural or schematic framework of the financial/economic nexus is imbalanced or falsely constructed.

Typically, this kind of monetary catastrophe is required because of human nature. Apathy is as much a part of human nature as ambition. Going a little beyond "if it ain't broke, don't fix it", economic or monetary apathy is usually due to the tacit approval of the misguided idea that any economic expansion is the right economic expansion (thus the appeal to inflation by monetary science today) despite the fact the appearance of inflation indicates otherwise.

The apathy of economic appearance, then, explains partially this thirty year cycle. As the Great Inflation progressed into the double dip recessions of the early 1980's, inflation, at least in consumer prices, disappeared into the abyss of the new activism of Paul Volcker's Federal Reserve policies. As consumer inflation receded into the recesses of bad memories, so too did the appeals to hard money stability. The public could care less if stability was imposed by hard money or the centralized authority of intellectual appeals to mathematical precision. It's the economy stupid.

That was also true of the appeal to hard money thirty years prior to that 1982 Gold Commission. The 1952 Republican Party National Platform coinciding with the first nomination of Dwight Eisenhower for President featured under the sub-section "Taxation and Monetary Policy" the following plank:

"To restore a domestic economy, and to use our influence for a world economy, of such stability as will permit the realization of our aim of a dollar on a fully-convertible gold basis."

Of course, the decades preceding 1952 were full of instability in nearly every sphere of society. The Federal Reserve at that time was a secondary agency largely committed to pegging the interest rates on government debt securities (again, there are cycles to nearly everything). Inflation became quite problematic after WWII ended since the federal government now had to compete with private demand for credit which had been previously and continuously suppressed by the needs of the war. That meant loose monetary policy to maintain the government's imposed borrowing privilege.

Throughout 1947 and 1948, inflation (at least as measured by the CPI) had run up to between 8% and 10% before the economy fell into recession. With the recovery in 1950 and the looming Korean conflict, inflation was back above 9% by early 1951. The gyration in inflation was enough to put gold back into the national conversation.

Eisenhower was elected in November 1952, but by then inflation had settled back below 2%. The gold plank was discarded and forgotten.

It is, however, a little ironic that the party platform that introduced Richard Nixon to the national stage included a gold plank. It was Richard Nixon as President who ended the last remaining (though largely ceremonial) link between gold and the US dollar in 1971. That usually marks the date when conventional wisdom says the age of fiat began, but the true age of fiat began some time before that.

Between the 1952 gold plank that nominated Nixon and his unilateral decision to end convertibility in 1971, the banking system had started to innovate and evolve in ways that would end up with drastic changes to the underlying financial framework. By the mid-1960's, the eurodollar market had begun to trade and with it came proof that ledger money was viable on a global scale - not only viable but desirable for financial firms that wished to grow far beyond the frustrating constraints of real money reserves. The term "dollar" had ceased to refer to a physical quantity ages before, but by the time interbank markets had come to life and wholesale money platforms developed "depth" and "liquidity", the term "dollar" had become fully fungible - a figment of the bookkeeper's pen as Milton Friedman had referred to it (also in 1971).

Economic apathy in these intervening years between bouts of dollar instability was not a neutral proposition, however. Ben Franklin famously decreed that those that trade liberty for security deserve neither. In the 20th century, the American population traded power over the banking system for the appearance of economic stability and growth, and it might be fairly said we as a society of free individuals deserve the current results. That's not to say that all economic growth in the 20th century was ephemeral, but as the decades rolled on the proportion of financial-driven growth became exponentially more central to the real economy's appearance, and thus the human apathy toward the mechanisms or drivers of that growth.

What the gold commissions and gold planks failed to project or describe is that gold as money is as much a discussion of political power as economic agent. With true hard money as the basis for the financial and monetary system, banks are far more closely aligned with the needs and wishes of the general population. A depository bank that pyramids actual money into credit is totally dependent on that depositor base for its continued existence. That means the bank must be responsive to the demands and perceptions of depositors, or it will face a run and extinction.

The modern system, beginning in 1913 with the Federal Reserve system, is designed to override that public authority with centralized money elasticity. Banks under pressure from fickle depositors would be given an outlet to remain afloat - they could "borrow" from the Federal Reserve to tide them over until depositors regained their senses. And that is how this modern system is set up and even described. Since bank panics are supposed fits of illogical emotion, the people need to be saved from themselves, so a central political authority is imposed with monopoly ability.

That was one of the prime lessons, for mainstream economics anyway, of the Great Depression. Milton Friedman himself, the father of modern monetarism, acknowledged and lamented that the monetary failure of the Federal Reserve in the early 1930's was all the worse because so many "good" banks were flushed with the "bad" banks. Those illogical depositors did not have the good sense enough to distinguish and discern, and thus crashed the entire financial system and nearly the whole economic and political system because of unchecked emotion. Clearly, if one is predisposed to think in this manner, people need to be separated from the authority over money, with an altruistic agency as the means to that end.

Once the professional political class obtained that power, and the public willingly acceded given the scale of economic and political instability, the rise of the inflationary periods was inevitable. Political agents had been prevented from acquiring authority over money precisely because it was obvious, and historical, that they could not be trusted with it - there is no altruism when it comes to money and politics. The urge and tendency toward government domination "financed" by inflation was always and everywhere too irresistible, no matter the political affiliation. Interbank wholesale money markets are merely the latest expressions of this age-old central authority. Monetary policy is carried out in the Fed funds market and not through the actual printing of dollar bills or minted coins. As I have said before, there is no money in monetary policy today.

The modern financial system is the height of centralized financial power. Even the pretense of "good" bank/"bad" bank is gone into the abyss of the political urge toward artificial stability. Bank access to the Discount Window is fully collateralized for a reason; it was this notion that good banks under undue stress from depositor rubes could pledge good assets to the Federal Reserve for funding to remain afloat until the storm of emotion receded. If a bank had collateral in good standing available to pledge, it must be a good bank worth saving.

So where does emotion, particularly fear, lie in the power balance of today's banking system? Collateral restrictions have been eased over and over again, the latest on June 22 of this year (both the ECB and the Bank of England). In 2008, the Federal Reserve created all manner of funding bypasses around the Discount Window, afraid of the "stigma" banks would receive for appealing to that monetary power program. What really happened was that the biggest banks had junk for collateral, forcing the Fed to create new programs to sidestep existing monetary rules pertaining to this sifting mechanism.

A bank full of junk or failed credit assets and loans is really a "bad" bank, deserving of brutal market discipline. What is truly ironic about this modern system is that such a judgment was not rendered in 2008 by the dumb or unsophisticated herd of public depositors, but by the banking system itself. These "bad" banks were threatened by other banks cutting off funding in those very same wholesale markets - the collateral they possessed was not even fit for the private marketplace on any terms. From that point on the central bank authorities, through their monopoly power over money, have conspired to keep nearly all of these banks whole and in business in sharp contrast to their own monopoly justifications.

This defies capitalism and a democratic republic. The healthy economic system decries bad decisions and wasted resources while a true democratic republic abhors centralized or monopoly authority. Entrepreneurs that have bad ideas that don't work over the longer term fail and their resources are re-allocated back into the marketplace at clearing prices (steep discounts). The system as a whole incorporates not just that "value", but also a good deal of information content as well. This is where economic progress originates, and is as true for the productive/real economy as it is for the financial economy. Dispersed opinions of markets offer far more information content than can ever be discerned by centralized mathematical and statistical modeling.

Under a gold or physical system, the "market" decides productive and unproductive. In the case of a questionable financial firm, the bank's depositors collectively come to a consensus, gleaned from the dispersed opinions of market actors, and decide whether to maintain deposits of real money or to convert deposit liabilities and reclaim that real money. That is the ultimate political authority over the banking system, and it forces the bank to at least consider and check any tendencies toward recklessness as it intermediates its own assets and liabilities. This is not foolproof or a guaranty over behavior, but an alignment of the goals and operating regimes of banks with the general population. Disalignment is checked by the collective will of the people.

That is the anathema of the political urge to use money to create artificial stability. Banks that are dependent on the perceptions of depositors for their very existence are far more insulated from these political pressures. Banks that are aligned with public desires for stable money do not conform to the political will of imposed artificial stimulation - which is all that economic management and central planning consists. Proponents essentially appeal to some specialized knowledge and institutionalized professionalism as the basis for subverting public will, but they miss the central point just as the past appeals to gold money have done.

Of course good banks were extinguished with bad banks in the early 1930's. Banks that could have survived absent so much emotion were driven out of business by a deposit base, the political holders of monetary power, that was reacting on a systemic level. The larger recoil of emotion was not due to individual or idiosyncratic circumstances (though there were plenty) but the growing market-based consensus that money had been debased too far in the preceding years. The public, rightfully, expressed a vote of no confidence in the monetary affairs of the banking system and acted upon that vote with the full power vested in it by the option of hoarding the "money" (gold and physical Federal Reserve Notes) that formed the tip of the bank reserve pyramid. It was a systemic rebuke of the artificial growth of the 1920's and all the monetary intervention that accompanied it, an ultimate appeal to true stability. That the resulting economic contraction was severe is not a symptom of dispersed power or the ability to enforce that rebuke, but an all too belated recognition of just how dangerous economic apathy can be.

It is obvious that the previous two appeals to a gold standard by the Republican Party came during periods when consumer inflation was considered the primary economic issue, and thus the primary appeal to a store of value. The gold standard gives the public the ability to impose the store of value upon the banking and monetary system by taking away the option for financial firms to survive through the unfettered expansion of credit. What is really noteworthy about the 2012 appeal to gold is the relatively new and growing recognition of the very real downside to the economic apathy created by asset inflation and the artificial growth that accompanies it.

What the gold standard debate and any gold commission are really about is who has ultimate authority to decide the course of monetary instability. Should the people be restored that authority or should it remain as a centralized agent of the banking cartel and government? In so many ways central banks have already abused that political authority, not just in the artificial stability and growth of the past few decades, but in violating their own rules and philosophies that they themselves use for the very justifications for their own power grab. If the people are to lose their power over money because they supposedly cannot distinguish good banks from bad banks, what are we to say about an unaccountable government/banking agency that refuses to do exactly the same? These were the same professional classes and political intellectuals that were supposed to offer a better monetary alternative, and even they recoiled at the debasement and dysfunction.

It was a long and slow transformation that was often unnoticed under the growing cover and opacity of technological complexity, but Ben Franklin was exactly right. The artificial economy and the insidious perversions of asset inflation generated more than enough apathy, a form of anesthesia really, to allow the financial economy, with full approval of the political and economic authority elite, to dominate. The big banks just got bigger and more prevalent, but as long as 401k's were doubling or tripling and house prices were allowing HELOC's to function as ATM's no one cared; even stagnant real wages failed to arouse the people from the debased stupor as fungible ledger money lifted away the last vestiges of dispersed control over money and finance. Now that monetary authority is fully gone, we have only one option to return to true stability since central banks continually demonstrate their preference for intentional instability: reclaim that monetary authority. But we must be serious and resolved this time or we will end up in another thirty years agreeing how Einstein was right about insanity.


Jeffrey Snider is the Chief Investment Strategist of Alhambra Investment Partners, a registered investment advisor. 

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