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"The gold
standard" is the answer to a question. The question is: "How do we
create stable money?"
Until you understand the importance of stable money -- in short, until you
ask the question -- the answer won't make any sense.
July 25, 2010: The Argument for a Gold
Standard (2010 edition)
I spend most of the first chapter of my book Gold: the Once and Future
Money, and in actuality all of my book, explaining why stable money is
desirable. So, in some sense, this little essay serves as an enticement to
learn, in much more detail, why stable money works, and why unstable money
(floating currencies) do not, by reading the book. However, I don't want to just
repeat what I said in the book here, so let's go at this in a slightly
different fashion.
First of all, what is a "stable money?" It is money that doesn't
change value. Its "purchasing power" may change. For example, a
twenty-dollar bill has less "purchasing power" in downtown San
Francisco than it does in Bozeman, Montana. In other words, prices tend to be
higher in San Francisco than Bozeman. However, the value of the dollar is the
same. In the past, people discovered that gold is stable in value. So, if
their currency's value was linked to gold, then the value of their currency
would also be unchanging, or at least as stable as gold. For the most part,
this worked beautifully. But, even if you didn't take gold to be a benchmark
of monetary stability, you could still use the same principle and devise some
other system with the goal of maintaining a stable currency value. However,
historically, this never happened. There never has been, to my knowledge, a
currency system whose aim was stability of value, that used some other method
than a gold (or occasionally silver) standard.
The idea that stable money is good used to be self-evident. I say that
no economic problem in history has been caused by stable money.
Without getting into the theoretical specifics, we understand this
instinctively from daily experience. Have you ever seen this on CNBC?
Maria Bartiromo:
Peter, what's causing the economic difficulties in Anglia?
Peter Moneyshuffler: Well, Maria, it really comes down to this. The
currency is much too stable. The government needs to make the currency much
more unstable. Nothing is going to get better until this excessive stability
problem is resolved.
Maria: Norbert? What do you think?
Norbert Bigdome: This is contrary to all the known laws of economics.
Capitalism simply cannot function with a stable unit of account. An unstable
currency is one of the primary means by which speculators can appropriate the
wealth of the productive classes. The currency in Anglia has been so stable,
that speculators' profits have fallen miserably. We all know what that means
in today's speculation-based economy. Financial engineering as a percentage
of GDP has fallen to perilously low levels. Instead, the economy is focused
on producing useful goods and services, which, of course, is unproductive.
Peter Moneyshuffler: Maria, there hasn't been an asset market bubble
in Anglia in at least twenty years. During my entire professional career,
interest rates have fluctuated in a 100 basis point range. I've been reduced
to reading financial statements and researching business plans. Frankly,
Maria, for a moneyshuffler of my stature, it's embarrassing.
Maria: Let's go now to Bob Pisani, who is on the street in
Robertsburg, Anglia's capitol, where public demonstrations have broken out
criticising the government's response to the economic crisis.
Bob Pisani: Maria, it's incredible down here. People are showing their
anger at a government they call corrupt and incompetent. Let's see what they
have to say. (Turns to demonstrator.) You sir, what are you most angry about?
Demonstrator 1: We're having a currency crisis! Look, I have here a
ten-dragoon note. Ten years ago, I could buy lunch with this. Or get a taxi
ride across town. Today, I can still buy lunch with it, and taxi prices are
about the same. Can you believe that? Its value hasn't changed a bit. Not in
ten years! My gold investments have been a total disappointment.
Demonstrator 2: Our government promised us that the value of the
currency would fluctuate unpredictably, and possibly even collapse. Instead,
it has remained pegged to gold for the last fifty years. The way things are
going, it might remain pegged to gold for the next fifty years. How am I
supposed to run a business like this? What does this mean for my children? I
feel betrayed.
Never happens, does it? And yet, if you look at the present state of
understanding, almost nobody today is an advocate of stable currencies.
Everyone is the other way. They think they can solve all their problems with
currency manipulation. For the last eighty years, economists have been
building up a sort of religion of currency manipulation. This is expressed in
our present floating-currency system. There are no stable currencies today.
There isn't even a single government that attempts to create a stable
currency.
Thus, we have two different viewpoints: the stable money people, and the
funny money people.
"Stable money" is itself the answer to another question. The
question is: "What is the best way to manage a capitalist economy?"
You can make a lot of intellectual arguments regarding this topic, but I
think it is best to start with a brief overview of history. I'll do a little
handwaving and say that "capitalism," as an economic system,
emerged most recently in Europe from the end of the Middle Ages, around the
14th century. The Middle Ages were characterized by a simple agrarian system,
in which households (or, more broadly, the medieval manor), were more-or-less
self-sufficient. People grew their own food, made their own houses, and made
most of their other household goods such as clothing, using locally-available
materials, without interacting, in a commercial sense, outside of their
immediate environs. Money wasn't used much, and monetary contracts, such as
stocks, bonds, employment contracts, pensions and so forth, were rare. Then,
we have the growth of capitalism from about the Renaissance period. The early
capitalists were found mostly in Italy, in places like Florence, Venice or
Genoa. By the 17th century, Europe's most impressive capitalist powerhouse
was Holland. The 18th and 19th centuries were dominated by Britain, with
Germany, the U.S. and Japan taking a role in the later 19th century. The
United States took over the lead in the 20th century.
During this time, there were many, many experiments with all sorts of
floating currencies, devaluations, and whatnot. Hundreds and hundreds of
experiments with every sort of unstable-money system. You can read This
Time Is Different for a very brief overview of what I'm talking about.
Glyn Davies' A History of Money is
also a wonderful reference. You can even go back to the Plato/Aristotle
debates, where Plato was a soft-money guy and Aristotle was a hard-money guy.
Also, during this time, there were hundreds of experiments with stable money
systems, which, historically, has always meant a gold standard. I guess
nobody could think of a better one -- although they tried, and you can look
at the discussions in the 1870s about William Jevons' commodity basket
proposal if you like.
The point is: the great successes during the entire modern history of
capitalism over the past 600 years or so were all hard-money systems. At the
end of the day, a capitalist economy is an economy of cooperation. No
longer do we grow our own food, make our own houses, and sew our own clothes
from fabric that we wove ourselves from thread that we spun ourselves from
flax that we grew ourselves. Although this cooperation is anonymous, and
often has competitive elements, nevertheless, the way in which we produce our
goods and services is by specialization and trade. If you think of a
capitalist system as a vast network of cooperation, organized by money,
money-measurements (profit and loss), and money contracts, then it is easy to
see that if this fantastically complex system of cooperation is organized via
money, then it is important to keep this "communication system" as
clear and uncorrupted as possible. Thus, humans have always sought the most
stable money possible, and concluded that gold is the best real-world
representation of this ideal of perfect, unchanging stable money.
In short, the capitalist cooperation-system (specialization and trade) works
best with stable money. That's why all the great economic successes over the
past 600 years were those that had stable money, i.e., gold-linked money.
August 5, 2006: What is Economics About?
This was the case up until 1971, when the world left the gold standard. At
first, the dollar floated, but all major currencies remained pegged to the
dollar so exchange rates were stable. Today's floating-currency system did
not fully appear until 1973, when major currencies began to float against the
dollar. This system was never planned. There was never a great international
convention, like the Bretton Woods meeting of 1944, in which everyone
discussed the pros and cons and concluded that we should have a floating
currency system. The break with gold in 1971 was an unplanned consequence of
Richard Nixon's attempt to goose the U.S. economy with "easy money"
before presidential elections in 1972. Oops!
I'm trying to put a picture in your head: 600 years in which the biggest,
most successful capitalist industrial economies (Britain, U.S., Germany,
Japan) all had hard money/gold standard systems, against 40 years in which
we've had worldwide chaos as the consequences of the funny-money
manipulators' attempts to fix economic problems with currency games. 600
years vs. 40 years. And yet, somehow, during those 40 years, the funny-money
guys have managed to convince everyone that the previous 600 successful years
did not exist, or are irrelevant.
I like to represent this 600 years of stable money:40 years of floating money
ratio with this graph of the value of the "dollar," which was
originally a standardized European coin called the "thaler." We see
that the "dollar/thaler" didn't change in value from its inception
in 1513 until 1933, where it undergoes a single step-devaluation. The
"floating dollar" doesn't appear until 1971. It's that little
wiggle on the far right of the chart.
Likewise, if you
have two countries with currencies pegged to gold, then of course the two
currencies have stable exchange rates. I don't think people today believe me
when I say that exchange rates used to be stable and unchanging. This chart helps:
That's the way it's supposed to work. The way capitalism is supposed to look.
The funny-money guys all try to convice you that if you adopt a gold
standard, your head will explode. How is it, then, that Britain, which
has one of the greatest records of currency stability in the world, 233 years
of a gold standard at the same parity (1698-1931, with some lapses), became
in the 19th century:
The world's
leading industrial economy
The world's leading financial center
The source of the world's premier international currency
The center of an empire that spanned the globe
British 5-pound gold coin.
After 1931, Britain descended into Keynesian money manipulation, with a
series of devaluations between 1931 and 1971. Britain's industrial
leadership? Poof! Premier international currency? Kaput! World-spanning
empire? Gone! It is still a leading financial center, although that may be in
part because The City is not quite the same as Britain.
The baton was handed to the United States. The U.S. has perhaps the
second-best record of hard-money stability in the world, with 182 years
(1789-1971, with some lapses) on the gold standard with just one permanent
devaluation in 1933. As a result, in the 20th century, the U.S. became:
The world's
leading industrial economy
The world's leading financial center
The source of the world's premier international currency
The center of an empire that spanned the globe
Wow, what a coincidence! The same action produces the same results! Yes,
people, it really is that obvious. Guess what: their heads didn't explode.
Instead they became a world-spanning colossus.
The U.S. has been able to hold onto its top-dog position despite leaving gold
in 1971, because the dollar has been the most stable currency in a
world of worse options.
The U.S. middle class used to be an amazing story of ever-increasing wealth
and prosperity. However, the middle class hit the wall exactly when we went
from hard money to soft money, in the early 1970s.
June 21, 2010: What Happened to the Middle Class?
Wow, what a coincidence! Soft money produces economic stagnancy and decline, exactly
like the hard money guys have been saying for six hundred years!
The
same action produces the same results!
"Soft money" usually means a currency that declines in value.
Sometimes there is a persistent rise, as Japan experienced in the 1985-2004
period. But that is very, very rare. Sometimes there is a period of
fluctuation within a range, as was the case in the U.S. in 1982-2004. This
causes a persistent ill-health and underperformance. However, in the
long-term picture, "soft money" inevitably means "easy
money" during a period of economic weakness, and this ultimately leads
to declining currency value.
When a currency loses value, then obviously nominal wages paid in that
currency also lose value. Wages may rise to offset this currency devaluation,
but they usually do not rise anywhere near the degree that the currency
declined, so on balance wages fall in real, devaluation-adjusted terms, which
in practice means in terms of gold. This makes perfect sense from a
productivity standpoint as well. Most any economist will tell you that wealth
is a direct function of productivity. You can't enjoy more goods and services
unless you make more goods and services. Where would they come from
otherwise? Outer space? Since unstable money distorts and corrupts the
capitalist cooperative system of specialization and trade, we can see that we
cannot generate more productivity from making a mess of the system that makes
productivity possible. In short, productivity will also decline as a result
of currency instability, which is why that although nominal wages may rise in
response to the currency devaluation, they do not reach their old peaks,
except perhaps after a few decades of recovery.
To summarize: soft money = lower wages. Obviously, if wealth/productivity/economic
health and vigorousness is represented by higher wages, then a method
that produces lower wages isn't going to get you there, is it?
These are "weekly wages of production workers," excluding
management, income from capital, healthcare costs, etc.
Or, as they used
to say: "You can't devalue yourself to prosperity."
Just as currency instability/devaluation results in poorer workers, it also
results in poorer corporations. Here's the Dow Jones Industrial Average, as
measured in real money -- gold.
We're back at a
mid-1920s level!
Whoops!
April 15, 2007: The Value of Today's Dollars
in 1854 Dollars
Traditionally, the hard money guys have run into difficulties when faced with
a recession. They tend to want to stand around and "do nothing."
This is not an easy political sell even when it is the right thing to do, but
it is even worse when it leads to a sort of obliviousness about economic
developments. The Classical economists' solution to the exploding worldwide
trade war set off by the Smoot-Hawley Tariff in the U.S. in 1930 (with
preparations in 1929), was: do nothing! When this was followed by an
even more destructive trend around the developed world toward soaring
domestic tax hikes, exemplified by the 1932 Hoover tax hike, their response
again was: do nothing! Even in less dramatic times, economists need a
better solution than: do nothing. In fact there is quite a bit a government
can do instead of "easy money." I've listed a few options:
June 27, 2010: U.S. Tax Hikes of the 1930s
September 14, 2008: Depression Economics
October 12, 2008: Effective Bank
Recapitalization 2: Three Examples
October 5, 2008: Effective Bank Recapitalization
September 28, 2008: Every Crisis is Like All
the Others
January 27, 2008: Crisis Management
November 10, 2008: "Austerity"
November 2, 2008: "Stimulus"
January 18, 2009: "Austerity" and
"Stimulus" 2.0
June 24, 2010: Stimulus, Austerity, and the Spiral of Decline
December 9, 2008: Preventing Bubbles
April 6, 2008: Liquidationists vs.
Interventionists
May 2, 2010: Thoughts on Greece
May 30, 2010: The Flat Tax in Russia
The soft-money guys really come into their own when politicians are looking
for solutions to their problems. This might be something minor, like Nixon's
re-election plan, or something major, like the Great Depression. The soft-money
guys have a zillion proposals, although they all boil down to the same
proposal: "easy money." Combined with government
"stimulus" spending, it's their one-size-fits-all soution for every
kind of economic event. Politicians fall for this time and time again,
because, often, it works! For at least a short time, it seems like the
economy is improving, although as we've seen before this never seems to
persist in any sort of "long run." It's all illusory. Plus, it
doesn't seem to cost anything, seems to bypass the difficulties of the
democratic legislative process, seems like it can be implemented immediately,
and generally flatters politicians' Master of the Universe fantasies as they
imagine themselves to be "macro fine-tuners" of some sort. When the
inevitable long-term results appear -- economic stagnation and decline -- it
is hard to attach blame on the soft-money managers, who are always ready with
a blizzard of confusing nonsense to cloud the issue.
July 28, 2008: "Why Not the Gold
Standard?"
April 26, 2009: Two Monetary Paradigms
March 23, 2010: China Vs. U.S.: Clashing Monetary Paradigms
Another very real problem with "hard money" today is that hardly
anybody knows how to make it happen. Someone can say "oh, it would be so
wonderful if we had a proper stable money/gold standard system," but if
they don't know how to implement it, then the result could be a disaster.
Most of the "hard money" proposals I've seen in recent years would
almost certainly create a disaster. Unfortunately, noble sentiment alone is
not enough. You need to have some technical competence to go with it. One
reason that people cling to today's soft-money system is that at least it is
the Devil We Know. Thus far, from 1982 to the present, it seems to be
tolerable enough, the "Great Moderation," although that era is
surely slipping by as we embark on a new phase of currency devaluation today.
It won't be until the Devil We Know is getting to be so horrible that people
are willing to chance a turn at the ignorance and stupidity of today's
hard-money guys -- the Devil We Don't -- that things may change. It would all
be a lot easier if we just learned how to play this game properly, and then
the transition could be an occasion of celebration.
January 3, 2010: The GLD Standard
November 23, 2008: Redeemability and
Reserves
August 26, 2007: How To Operate a Gold
Standard
August 19, 2007: Gold Standard Fallacies
June 2, 2008: World Without Paper Money
May 6, 2008: The Key to Managing Currencies
Nathan
Lewis
Nathan
Lewis was formerly the chief international economist of a leading economic
forecasting firm. He now works in asset management. Lewis has written for the
Financial Times, the Wall Street Journal Asia, the Japan Times, Pravda, and
other publications. He has appeared on financial television in the United
States, Japan, and the Middle East. About the Book: Gold: The Once and Future
Money (Wiley, 2007, ISBN: 978-0-470-04766-8, $27.95) is available at
bookstores nationwide, from all major online booksellers, and direct from the
publisher at www.wileyfinance.com or 800-225-5945. In Canada, call
800-567-4797.
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