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* The German word 'Honig'
means 'honey' in English.
Open letter to Thomas Hoenig,
President, Federal Reserve Bank of Kansas City
Dear President Hoenig,
On January 5, 2011, you were quoted on abc NEWS as saying that "the gold
standard is a very legitimate monetary system". The quotation went on:
"We are not going to have fewer crises necessarily. You will have a
longer period of price stability or price level stability, but I don't know
that you will have lower unemployment, and I don't know that you will have
fewer bank failures."
As a student of the gold standard for the past 50 years
I welcome your statement. I would be happy to open my files and archives if
the Research Department of the Federal Reserve Bank of Kansas City (that, as
far as one can tell, has so far not been interested in gold standard
research) invited me. My files may have the answer to some of your queries.
- You are right, the gold
standard is a necessary but not a sufficient condition for achieving
lower unemployment. A necessary and sufficient condition would assume
that Adam Smith's Real Bills doctrine is also rehabilitated along with
the gold standard. The bill market is the clearing house, without which
the gold standard cannot survive. The explanation why it collapsed in
the years 1931-35 is that, when the victorious Entente powers decided to
restore the gold standard after World War I, they also decided not to
restore real bill financing of world trade or world-wide real bill
circulation. Thus the gold standard which Britain reestablished in 1925
lacked a vital organ: a clearing house. The Entente wanted bilateral (to
the exclusion of multilateral) trade for fear of German supremacy in
exports. This decision was a great setback for world trade. In effect,
it meant a return to barter. The consequence was:
beggaring-thy-neighbor, trade war, the destruction of the wage fund,
and massive unemployment world-wide.
- As pointed out by the German economist Heinrich Rittershausen in his 1930 book Arbeitslosigkeit
und Kapitalbildung (Unemployment and
capital accumulation), before World War I 'structural unemployment' was
unknown. Part of the 'float' of maturing real bills was earmarked for
payment of wages to workers producing consumer goods. This float was
what Rittershausen called the "wage
fund", out of which wages could be paid up to three months in
advance, well before the underlying consumer goods were paid for by the
ultimate, gold-paying consumer. This wage fund was destroyed by the
"Guns of August" in 1914 at the start of hostilities. The
destruction of the wage fund went unnoticed because the production of
war materiel absorbed all slack labor. After the war, a great inflation
inflicted on the world by the Fed created not only the T-bond bubble
(that burst in 1921), the Florida real estate bubble (that burst in
1925), and the stock market bubble (that burst in 1929), but it also
financed a hugely bloated production of consumer goods.
Only after the stock market bubble burst did it become
clear that there was no wage fund out of which the workers producing consumer
goods could be paid. The workers had to be laid off and the factories had to
be closed. Thus did the prohibition on real bills circulation cause the
collapse of the gold standard and the Great Depression.
My research suggests that if after World War II both
the gold standard and real bill circulation had been rehabilitated, there
would have been no serial currency turmoils and no
Great Financial Crisis. The gold standard and real bills go together like
hand and glove.
- The purpose of the gold standard is not to
stabilize prices or the price level, which is neither possible nor
desirable. Its purpose is to stabilize the interest-rate structure,
which it can do very efficiently, as history shows. There was no bond
speculation under the gold standard. Speculation was confined to
agricultural commodities, the supply of which is governed by nature
rather than bureaucrats in the Treasury and the Central Bank. Changes in
commodity prices or in the price level under the gold standard were
mild. They reflected changes in marginal productivity, not speculative
fever. Virtually all crises after the collapse of the gold standard in
the 1930's were caused by volatile changes in interest rates due to bond
speculation.
- Gold is the ultimate extinguisher of debt. The reason is that gold enters
the asset column in the balance sheet of banks but, unlike every other
asset, it has no corresponding entry in the liability column of the
balance sheet of someone else. Gold survives any consolidation of
balance sheets. Other assets are wiped out when the balance sheets of
debtor and creditor are consolidated, as in default and repossession.
- No runaway debt or derivatives tower can develop
under a gold standard. Such cancerous growths have occurred in the 21st
century because, in the absence of a gold standard, the economy is
lacking an ultimate extinguisher of debt. Total debt can only grow. It
can never contract through normal debt retirement.
- Bank failures are a consequence of unbridled
escalation of debt. The gold standard acts as a restraining force on
banks with a propensity to expand credit even after further expansion
becomes detrimental to their capital. Widespread bank failures that
presently hit the economy are an indication of destruction of bank
capital. Banks were happy to put their capital in jeopardy during the
boom as their cash flow from fees was plentiful. However, cash flow is
no substitute for capital. When the boom was over, cash flow stopped,
but bank capital was gone.
Under the gold standard banks know better. They cannot
expand credit with impunity beyond safe capital ratios. If a bank does, it
deserves to fail and should not be bailed out.
We can indeed return to a gold standard by going back
to Constitutional money. This means opening the U.S. Mint to unlimited free
coinage of gold and silver. We can return to financing production and trade
in goods demanded most urgently by the consumer through real bills, if the
Federal Reserve Banks go back to the legal provisions of the F.R. Act of
1913. That Act confined F.R. credit to real bills arising out of the
production and distribution of consumer goods, to the exclusion of
anticipation and accommodation bills as well as government debt. The solution
to the present crisis will be found in the strict observance of the monetary
provisions of the Constitution, and enforcement of the law governing Federal
Reserve credit.
ANNOUNCEMENT
New
Austrian School of Economics
Course
Two at the Martineum Academy in Szombathely,
Hungary,
from March 5 through 13, 2011. Title of the course:
ADAM
SMITH'S REAL BILLS DOCTRINE AND SOCIAL CIRCULATING CAPITAL
What
makes this course especially topical today is the fact that more and more
hints are being dropped about the possible rehabilitation and restoration of
the gold standard -- following the ignominious collapse of the irredeemable
dollar. However, a gold standard
without its clearing house, the bill market, is not viable and
itself is liable to collapse in short order -- as it did in the early 1930's.
The level of public ignorance about the necessity of a clearing house is
appalling. It is made that much worse by a tottering banking system. We have
an urgent message: only gold standard cum
real bills can restore prosperity to the world, in view of the fact that we have to write off the world's banking
system as a total loss.
This
is the second in a four-course series on Austrian Economics, a branch of
economic science based on the work of Carl Menger
(1840-1921). It is meant for those, including beginners, who are interested
in the theory of money, credit, and banking, with special emphasis on the current financial and economic crisis.
The complete program consists of four courses (10 days, 20 lectures each).
Completion of each course will earn one credit. Participants who have
accumulated four credits get a diploma signed by Professor Fekete. Course One that was given in 2010 is not a prerequisite. It is
available on DVD for purchase.
Scholarships
for students are still available.
For
further information please contact Dr. Judith Szepesvari,
e-mail: szepesvari17@gmail.com
Antal E. Fekete
DISCLAIMER AND CONFLICTS
THE PUBLICATION OF THIS LETTER IS FOR YOUR INFORMATION AND AMUSEMENT ONLY. THE
AUTHOR IS NOT SOLICITING ANY ACTION BASED UPON IT, NOR IS HE SUGGESTING THAT
IT REPRESENTS, UNDER ANY CIRCUMSTANCES, A RECOMMENDATION TO BUY OR SELL ANY
SECURITY. THE CONTENT OF THIS LETTER IS DERIVED FROM INFORMATION AND SOURCES
BELIEVED TO BE RELIABLE, BUT THE AUTHOR MAKES NO REPRESENTATION THAT IT IS
COMPLETE OR ERROR-FREE, AND IT SHOULD NOT BE RELIED UPON AS SUCH. IT IS TO BE
TAKEN AS THE AUTHORS OPINION AS SHAPED BY HIS EXPERIENCE, RATHER THAN A
STATEMENT OF FACTS. THE AUTHOR MAY HAVE INVESTMENT POSITIONS, LONG OR SHORT,
IN ANY SECURITIES MENTIONED, WHICH MAY BE CHANGED AT ANY TIME FOR ANY REASON.
Copyright © 2002-2008 by Antal
E. Fekete - All rights reserved
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