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The following is a transcript of an interview requested
by a gold-friendly hedge fund.
Q.: Professor Fekete, you are
known as a staunch advocate of a return to the gold standard. But mainstream
economists are saying a gold standard is not practicable and they are
fighting the idea with everything they have. How do you answer their
criticism?
A.: To say that the gold standard is not practicable is
the same to say that honesty is not practicable, and Constitutions are made
to be blithely ignored when convenient. The American Constitution, for
example, mandates a metallic monetary standard for the United States in the
clearest possible language. Opponents of the gold standard have never been
able to muster up the moral fortitude to amend the Constitution so as to
formalize the abolishing of the gold standard. Yet in 1933 president
Roosevelt confiscated the gold of the citizens, gave them irredeemable paper
in exchange, and proceeded to write up the value of gold in terms of the
paper by 75 per cent. Might makes right: if you
cannot do it fairly and legally, then you can use the strong arm of the
government to do it through chicanery, backed by the constabulary and the
jail cell.
More recently, in our own century, Switzerland changed
her Constitution in which the gold standard was also enshrined, through a
referendum. Citizens were given a week-end to debate and decide the merits or
demerits of the proposed constitutional changes. The indecent haste with
which they were railroaded through the constitutional process betrayed the
bad conscience of the authors.
One of the key principles supporting a gold standard is
that jurisprudence cannot tolerate a double standard of justice. The
government, its departments and agencies ought to be subject to the same
contract law as are citizens. There are no valid grounds to allow the
Treasury and the Central Bank to issue obligations which they have neither
the means nor the intention to honor -- while everybody else doing it will be
dealt with according to the Criminal Code. To say that the gold standard is
not practicable is the same as saying that the government should be exempted
from the provisions of the Criminal Code in its dealings with its subjects.
Q.: What would be the basic steps involved in
reintroducing a gold standard? How to proceed?
A.: Three indispensable steps are involved.
First, the government should open the Mint to gold.
This means that everybody who wants to convert his gold of the right quantity
and quality into gold coins of the realm should be able to do so at the Mint,
free of seigniorage charges, and with no limit imposed
on the amount. In other words, they would get gold back, ounce for ounce, in
coined form, and the cost of minting would be absorbed by the government, the
same way as it absorbs the cost of maintaining highways in good repair.
Conversely, owners of the gold coins of the realm must have the right to
hoard, melt down, or export them as they see fit. them
as they see fit. This is designed to vest the right to regulate the money
supply in the people, rather than in unelected bureaucrats.
Second, "legal tender protection" of paper money
must for once and all be declared unconstitutional. This is designed to
remove coercion whereby labor can be forced to accept irredeemable currency
for services rendered.
Such coercion was first legalized in France and Germany
in the year 1909, just five years before the outbreak of World War I. These
countries wanted to make sure that civil servants and military personnel
could be paid in chits, thus putting the entire labor force at the disposal
of the government -- regardless of the state of budget and collection of
taxes -- in case of war. The motivation behind the second provision is that
governments should not be able to wage undeclared and unpopular wars, as
could kings of old, but must raise taxes. World War I would have come to an
early end but for the legal tender laws. As soon as treasuries had run out of
gold, the belligerents would have been forced to make peace, unless the
electorate agreed to pay for the continuing bloodshed and destruction of
property. And the world would have been the better for it.
Third, the principle known as the "Real Bills
Doctrine" of Adam Smith should be observed. Bills of exchange drawn on
fast-moving merchandise in most urgent demand by the consumers, which mature
into gold coins within 91 days (the length of the seasons of the year), must
be allowed to enter into spontaneous monetary circulation. This would
guarantee the flexibility of the monetary system not through government
coercion, but through the voluntary cooperation of producers and consumers in
satisfying human wants.
It can be seen that the market for real bills is the
clearing house of the gold standard. In 1918, at the end of World War I, the
victorious allies decided not to allow the world to go back to multilateral
international trade. To be sure, they wanted to go back on the gold standard,
witness Great Britain's decision to make the pound sterling once more
convertible into gold at the pre-war exchange rate in 1925, but with only
bilateral trade allowed. This meant nothing less than the castration of the
gold standard: once its clearing house was amputated, it could not perform.
The allied powers did this out of spite and vengeance:
they wanted to cripple Germany over and above the provisions of the
Versailles peace treaty. Forcing bilateral trade upon Germany was equivalent
to peacetime blockade whereby the allied powers could monitor and control
Germany's imports and exports. The measure backfired. The Great Depression
and the 1931-1936 collapse of the international gold standard was due to the
forcible elimination of the multilateral financing of world trade with real
bills.
The gold standard did not collapse because of its
"contractionist nature" -- as alleged by
Keynes. It collapsed because of its clearing system, the bill market was
blocked. Falling prices in 1930 were not the cause of the Great Depression:
they were the effect. The cause was falling interest rates. Incidentally,
falling interest rates were in turn caused by the illegal introduction of "open
market operations" by the Federal Reserve of the United States in 1921,
whereby the central bank pays bribe money, in the form of risk-free profits,
to bond speculators for bidding bond prices sky-high.
Q.: To what extent should money be "covered"
by gold?
A.: The Real Bills Doctrine provides the answer to that
question. There are on average 75 business days in a quarter. Therefore on
each business day, on average, one-seventy-fifth, that is, 11/3 percent of
the outstanding real bills mature into gold. Sufficient gold must be
available at all times to pay the bills at maturity; more if the discount
rate is rising, less if it is falling. In normal times the commercial banks
should have that much gold flowing to them in the ordinary course of business,
with which they can pay the maturing bills. If times are abnormal, banks go
to the bill market and sell at a discount a sufficient amount of bills from
portfolio to raise the gold. This should be no problem: a maturing real bill
is the best earning asset a commercial bank can have. At any given time there
are commercial banks somewhere in the world overflowing with gold. They
scramble to acquire earning assets. The value of real bills increases every
single day through maturity. They represent "self-liquidating
credit". Sale of the underlying merchandise to the ultimate consumer
provides the wherewithal for their liquidation.
Q.: What happens if a country has no gold in its
coffers?
A.: Such a country will experience a rise in the discount
rate. The appearance of a positive spread between the discount rates
prevailing in two countries improves the terms of trade in favor of the one
with the higher rate. It can offer lower cash prices on its exports, while
paying lower prices (91 days net) for its imports. This means that the
country gets the gold for its exports 91 days before its bills payable in
gold for its imports fall due. In addition, the higher discount rate will
induce an inflow of short term capital that will help finance both exports
and imports. We have to remember that imports are not financed by exports,
not by gold. Gold is there to tie the country over through temporary
imbalances.
Should this help not be sufficient to meet the shortage
of gold, then consumers, if they want to eat, to keep themselves clad, shod
and, in winter, warm, will have to dig into their pockets and come up with
the gold coin to pay the bills for their imports upon maturity.
The point is that a shortage of gold need not cause
privation: thanks to the discount-rate mechanism it is a self-correcting
condition.
Q.: You have announced that in August you will start a
school, and call it the New Austrian School of Economics, in Budapest,
Hungary. Why new? Why Austrian? Why in Hungary?
A.: The Austrian School of Economics was started by Car Menger (1840-1921) of Austria-Hungary who deserves the
epitaph, along with Isaac Newton, humanis
generis decus (pride of the human race). The
first members of the school, like Merger himself, were all great monetary
scientists who abhorred the idea of irredeemable currency. Keynes introduced
the notion that the gold standard is a "barbarous relic" and should
be discarded. Through bribe and blackmail academia was enlisted to rally to
the new doctrine, while the Austrian School withered.
When the intellectual bankruptcy of Keynesianism --
which turned things upside down in castigating the virtue of thrift and
lionizing the vice of prodigality -- has become obvious, the Austrian School
has gone through a renaissance, especially in the United States, calling for
sanity and return to the gold standard. However, the "American
Austrians" are vehemently against the Real Bills Doctrine of Adam Smith
for doctrinaire reasons, as it contradicts their holy of holies, the Quantity
Theory of Money. They do not understand that real bill circulation is
spontaneous and its suppression is nothing less than unwarranted interfering
in the operation of the free market. They do not see the difference between
the discount rate (yield on real bills) and the rate of interest (yield in
the gold bond).
This prompted me to start my school in Hungary where I
live. It would be a disaster if the American Austrians succeeded in making
their "100 percent gold standard" a reality. It would not survive
the first Christmas shopping season. Markets would seize up, and the gold
standard would be given a bad name for the second time.
Austria and Hungary used to be a dual monarchy during
the days of Carl Menger, sharing not only the
monarch, but also their scientific and cultural heritage.
Q.: Why a gold standard? Why not pick a basket of
precious metals, or of some other marketable commodities to serve as the
standard unit of value?
A.: American money doctors are in the habit of ridiculing
gold in comparing it to frozen pork bellies that, horribile
dictu, have been trading in the same pit since
gold was expelled from the Monetary Paradise. This reflects a mindset
suggesting that gold, at best, is just one of several marketable commodities,
and a basket of wider selection could provide a better monetary reserve than
gold.
This position is false. Gold is no frozen pork bellies
-- wishful thinking of the American money doctors notwithstanding. The reason
is that the marginal utility of the former declines more slowly than that of
the latter. In fact, the marginal utility of gold declines more slowly
than that of any commodity (or a basket of any commodities) known to man.
That's what makes gold what it is: the monetary metal par excellence.
That's what makes gold the only monetary asset that has no counterpart as a
liability in the balance sheet of someone else.
Incidentally, there are only two monetary metals: gold
and silver. Other precious metals such as platinum and palladium are not
monetary metals. What sets monetary metals apart from other precious metals
is their stocks-to-flows ratio. They are a high multiple for the monetary
metals, but a small fraction for other precious metals.
* * *
Q.: Critics say that historically, under the gold
standard, the world economy languished, trade was sluggish, technological and
therapeutic innovation was unexciting, in a word: the gold standard has never
worked well. How do you answer that?
A.: This allegation is just the opposite of the truth. The
heyday of the gold standard was during the 100 years' period between 1815
(the end of the Napoleonic wars) and 1914 (the start of World War I). This
was the age of transcontinental railways, intercontinental shipping, when all
the key inventions were made that ushered in the age of electricity, of the
internal combustion engine, of aviation, of wireless telecommunication, of
the X-ray, etc. Financing these discoveries and their applications in
transportation, telecommunication, and therapeutics would have not been
possible without the gold standard and the accumulation of capital that it
facilitated.
Q.: Introducing a gold standard hardly seems possible
today, in view of the gigantic injections of new currency into the economy
world-wide. How could the gold standard handle that?
A.: It wouldn't. The new gold standard would let the
regime of irredeemable currency run itself aground and boil in its own juices
of excess fiat money. When it can no longer handle the task of delivering
food and other necessities to the people, when it can no longer provide
employment to the majority of the population, the gold standard will spring
back to life spontaneously. People have to eat, and they also have other
necessities. They must have work to be able to earn a living. It will dawn on
the world, maybe unexpectedly for the majority, that gold has a place
underneath the Sun. Gold is that hard core of capital that can be destroyed
neither by inflation nor by deflation, that will survive any consolidation of
balance sheets. Gold is at the heart of the healing process of the world
economy that makes survival possible.
Q.: Is a gold standard the ultima
ratio to cure the human weakness, the belief that you can multiply wealth
by printing money without limits? Is it not true that no central bank could
ever stand up to do-gooder politicians?
A.: Friedrich Hayek, the Nobel-laureate Austrian economist
thought so. He said that there would be no need for a gold standard but for
the propensity of governments to spend beyond their means.
I don't believe that. I see gold everywhere,
independently of the government's spending propensities. Even without a gold
standard, gold has a role to play in forming prices, wages, rents, the rate of interest. It helps to find the balance between
short- and long-term satisfaction; it determines the
marginal productivity of capital and labor. It is like air, we don't see it
yet it's there and, without it, there is no life.
You need a yardstick to measure value. Gold is the raw
material of which that yardstick is made.
Q.: In the past states also went bankrupt, some
repeatedly, e.g., ancient Athens, Rome, or France in the 17th and 18th
centuries. This shows not only that such occurrences are possible under a
gold standard, but also that the powers-that-be could always circumvent
limitations put on coining money and restrictions on banking whenever the
idea of scarcity of gold takes hold. What makes you think that a future gold
standard may be more successful, and could endure for a long period of time?
A.: There is no hard-and-fast limit on the amount of
self-liquidating credit that can be safely built on the unit weight of gold.
Improvements in clearing techniques, such as those in telecommunication,
freight-forwarding and warehousing will increase the amount of credit
outstanding while there is no corresponding increase in gold bearing that
credit. It is this property that makes gold the ultimate extinguisher of
debt. It is simply not true that restrictions put on the economy by the gold
standard are "contractionist", and that
the "powers-that-be" are justified in breaking those fetters.
Gold is not scarce: in terms of its stocks-to-flows
ratio gold is the most abundant substance on earth. But for the gold standard
to endure man has to have confidence in the promises of government to pay
gold. If this confidence is impaired, gold tends to go into hiding and then
the system may break down. The answer to the problem is that the government
must keep faith with its subjects without fail.
* * *
Q.: What is your opinion of the governments' handling
the great financial crisis, the Greek crisis, the crisis of the Euro, and the
other currency crises brewing? How long can they contain the
"debt-firestorms"? Will they be able to extinguish it with a shower
of new debts?
A.: The governments of the industrialized countries bear
full responsibility for bringing the world to the brink of this crisis -- the
greatest financial and economic crisis ever. They should have resigned in
admission of their guilt, and let new governments armed with a better
economic theory take over and work out the remedy. Instead, they doggedly
cling to power. Their analyses of the causes of the malady are faulty; the
remedial measures they have recommended are the old nostrums, incredibly
inept, nay, counter-productive.
Take the example of the runaway growth of the debt
tower. The great financial crisis, the Greek crisis, and all the currency
crises still at the brewing stage, are part of the same problem, namely, the
debt problem. It goes back to the year 1971. On August 15 of that fateful
year the U.S. government defaulted on its international gold obligations. By
now the debt tower threatens with toppling, and burying the world economy
under the debris.
The reason for the exponential growth of debt in the
world is that the international monetary system has been lacking an ultimate
extinguisher since 1971. Total debt in the world can only grow, never
contract. We should do well to remember that, since time immemorial, gold has
successfully acted as the ultimate extinguisher of debt -- until it was
forcibly removed from the international monetary system in 1971. Paying debt
in gold extinguished the debt, period. Since 1971 governments have pretended
that paying debt in U.S. dollars extinguished it, too. But in fact it did
not. Debt was merely transferred from the debtor to the U.S. government and
kept accumulating. Transferring debt is not the same as extinguishing it.
Debt accumulation has a natural limit. This limit has now been reached.
Your description of the debt-tower as a firestorm is
apt. Governments of the leading industrialized countries will not be able to
contain the firestorm they have started. They are just pouring oil on the
fire.
Q.: How will the current situation unfold? Do you think
resolution will come in the form of hyper-inflation or deflation?
A.: One has to be careful with these terms. Both inflation
and deflation mean destruction of wealth through destroying the value of
obligations; the former through depreciation, the latter through default. It
is also possible to have a mixture of both simultaneously.
But if you insist on my answering your question, chalk
me up in the deflation column. Signs of deflation are all around us. Rivers
of new money are unable to turn receding prices and interest rates around.
Confidence in promises to pay is evaporating. Banks do not trust one another
with overnight money. Paper gold is being pushed down the throat of those
wanting physical gold. Worse still, vanishing confidence has reached the
stage of contagion. Paper wealth is disintegrating before our very eyes. The
domino-effect is spreading: the collapse of one firm brings down two other.
Most frightening is the shrinking of employment. It is leading to a
break-down in law-and-order. Governments are completely unprepared and think
that it is just a matter of printing more money, for which they are superbly
equipped, to prevent further contraction.
Q.: Your answer to my next question would certainly
interest our readers very much. Are you invested in gold, silver, and other
precious metals? Would you still buy them at these elevated prices?
A.: I take exception to your use of the word
"investing". To my way of thinking holding monetary metals is not
investing but more like taking out an insurance policy. I don't think the
other precious metals (or stones, for that matter) make good investment. As
far as the monetary metals, gold and silver, are concerned, you would be
well-advised to buy some more every month routinely, regardless of the price.
You should look at your holdings as you look at your fire insurance policy.
If you never need to collect, well, so much the better.
At the optimum, you would track the value of your
assets not at their dollar price but at their gold equivalent. In other
words, you would carry your balance sheet, both on the asset and the liability
side, not in dollar or euro units, but in gold units (ounces or grams). It
takes self-discipline to do that, but this is the only way to avoid the
pitfall of always looking at your own face in a curved mirror. The torsion of
the image may easily translate into torsion of the mind.
Q.: I come to my final question, if I may. What do you
think the gold price will be in terms of U.S. dollars or euros in 3 to 5
years' time?
A.: I am sorry, but I am not a practitioner of
clairvoyance. I think I would compromise my reputation as a scientist if I
ventured to answer this question. Besides, I don't think I am very much
interested in knowing. Guesses at the future price of gold are dime a dozen.
A more appropriate -- and interesting -- question may
be whether the dollar and the euro will still be around in 3 to 5 years. I am
not sure about the euro, but I think the dollar will definitely be around 3
years from now. 5 years -- maybe not, but I wouldn't be surprised if the staying
power of the dollar extended beyond 5 years.
It is dangerous to underestimate the strength of the
poison you have to live and work with.
Interviewer: Thank you for your time to talk to us.
Professor Fekete: Thank you
for the opportunity to express my views.
* but were afraid to ask.
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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