Gold and Economic Freedom

Readers maybe surprised when they see who wrote this essay. It’s about promoting gold as the key element of monetary organization, written in 1966. This essay is taken from “The Liberty Dollar Solution,” edited by Bernard von NotHaus.


Since the beginning of World War I, gold has been virtually the sole international standard of exchange.

Gold, having both artistic and functional uses and being relatively scarce, has always been considered a luxury good. It is durable, portable, homogeneous, divisible and, therefore, has significant advantages over all other media of exchange.

But if all goods and services were to be paid for in gold, large payments would be difficult to execute, and this would tend to limit the extent of a society’s division of labor and specialization.

Thus, a logical extension of the creation of a medium of exchange is the development of a banking system and credit instruments (bank notes and deposits) that act as a substitute for, but are convertible into, gold.

A free banking system based on gold is able to extend and thus to create bank notes (currency) and deposits, according to the production of the economy. Individual owners of gold are induced, by payments of interest, to deposit their gold in a bank (against which they can draw checks).

Gold Standard Antagonism: Not Arbitrary

But since it is rarely the case that all depositors want to withdraw all their gold at the same time, the banker need keep only a fraction of his total deposits in gold as reserves. This enables the banker to loan out more than the amount of his gold deposits (which means that he holds claims to gold rather than gold as security for his deposits). But the amount of loans which he can afford to make is not arbitrary: He has to gauge it in relation to his reserves and to the status of his investments.

When banks loan money to finance productive and profitable endeavors, the loans are paid off rapidly and bank credit continues to be generally available. But when the business ventures financed by bank credit are less profitable and slow to pay off, bankers soon find that their loans outstanding are excessive relative to their gold reserves, and they begin to curtail new lending, usually by charging higher interest rates. This tends to restrict the financing of new ventures and requires the existing borrowers to improve their profitability before they can obtain credit for further expansion.

Thus, under the gold standard, a free banking system stands as the protector of an economy’s stability and balanced growth. When gold is accepted as the medium of exchange by most or all nations, an unhampered free international gold standard serves to foster a worldwide division of labor and the broadest international trade. Even though the units of exchange (the dollar, the pound, the franc, etc.) differ from country to country, when all are defined in terms of gold, the economies of the different countries act as one – so long as there are no restraints on trade or on the movement of capital.

Credit, interest rates and prices tend to follow similar patterns in all countries. For example, if banks in one country extend credit too liberally, interest rates in that country will tend to fall, inducing depositors to shift their gold to higher-interest-paying banks in other countries. This will immediately cause a shortage of bank reserves in the “easy money” country, inducing tighter credit standards and a return to competitively higher interest rates again.

Gold Standard Antagonism: More Free than Controlled

A fully free banking system and fully consistent gold standard have not as yet been achieved. But prior to World War I, the banking system in the United States (and in most of the world) was based on gold, and even though governments intervened occasionally, banking was more free than controlled. Periodically, as a result of overly rapid credit expansion, banks became loaned up to the limit of their gold reserves, interest rates rose sharply, new credit was cut off and the economy went into a sharp, but short-lived, recession. (Compared with the depressions of 1920 and 1932, the pre-World War I business declines were mild indeed.)

It was limited gold reserves that stopped the unbalanced expansions of business activity, before they could develop into the post-World War I type of disaster. The readjustment periods were short and the economies quickly re-established a sound basis to resume expansion.

But the process of cure was misdiagnosed as the disease: if shortage of bank reserves was causing a business decline – argued economic interventionists – why not find a way of supplying increased reserves to the banks so they never need be short! If banks can continue to loan money indefinitely – it was claimed – there need never be any slumps in business. And so the Federal Reserve System was organized in 1913. It consisted of 12 regional Federal Reserve banks nominally owned by private bankers, but, in fact, government sponsored, controlled and supported. Credit extended by these banks is in practice (though not legally) backed by the taxing power of the federal government.

Technically, we remained on the gold standard; individuals were still free to own gold, and gold continued to be used as bank reserves. But now, in addition to gold, credit extended by the Federal Reserve banks (“paper” reserves) could serve as legal tender to pay depositors. When business in the United States underwent a mild contraction in 1927, the Federal Reserve created more paper reserves in the hope of forestalling any possible bank reserve shortage.

More disastrous, however, was the Federal Reserve’s attempt to assist Great Britain, who had been losing gold to us because the Bank of England refused to allow interest rates to rise when market forces dictated (it was politically unpalatable). The reasoning of the authorities involved was as follows: If the Federal Reserve pumped excessive paper reserves into American banks, interest rates in the United States would fall to a level comparable with those Great Britain; this would act to stop Britain’s gold loss and avoid the political embarrassment of having to raise interest rates.

Gold Standard Antagonism: Destroying the World Economy

The “Fed” succeeded: it stopped the gold loss, but it nearly destroyed the economies of the world in the process. The excess credit which the Fed pumped into the economy spilled over into the stock market – triggering a fantastic speculative boom. Belatedly, Federal Reserve officials attempted to sop up the excess reserves and finally succeeded in braking the boom. But it was too late: By 1929 the speculative imbalances had become so overwhelming that the attempt precipitated a sharp retrenching and a consequent demoralizing of business confidence.

As a result, the American economy collapsed. Great Britain fared even worse, and rather than absorb the full consequences of her previous folly, she abandoned the gold standard completely in 1931, tearing asunder what remained of the fabric of confidence and inducing a worldwide series of bank failures. The world economies plunged into the Great Depression of the 1930’s.

In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value. If there were, the government would have to make its holding illegal, as was done in the case of gold.

If everyone decided, for example, to convert all his bank deposits to silver or copper or any other good, and thereafter declined to accept checks as payment for goods, bank deposits would lose their purchasing power and government-created bank credit would be worthless as a claim on goods. The financial policy of the welfare state requires that there be no way for the owners of wealth to protect themselves.

This is the shabby secret of the welfare statists’ tirades against gold. Deficit spending is simply a scheme for the “hidden” confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights. If one grasps this, one has no difficulty in understanding the statists’ antagonism toward the gold standard.


Alan Greenspan


Don’t ask. Don’t tell.
Bill Bonner

The San Francisco Chronicle notes that neither candidate has mentioned “the U.S. debt disaster.”

No bigger threat faces the nation…except perhaps the menace of ruining itself in military adventures.

And yet, in this great “nation of courage,” none of the leading politicians has had the gumption to say anything about it. Faithless, gutless…they throw about empty phrases and hollow promises, alternately flattering the voters or bribing them, while cheating the next generation and hoping no one will say anything.

Candidate Kerry has pledged that he will not cut Social Security benefits. Yet the Social Security Board of Trustees has come up with a new measure of the unfounded “fiscal gap” between what the federal government can expect to receive in revenues and what it has promised to pay. The number – $72 trillion – comes to nearly seven times the size of the nation’s annual GDP and nearly 50% more than the value of all the assets tucked away in every burg and backwater in the entire country. In technical, accounting terms…as the Great Mogambo might say…the whole freakin’ country is broke…busted…no bread…like nuthin’…

But who cares? Who complains? Who worries?

Not us! We’re buying gold every time the metal drops below $400 and enjoying the show. Don’t worry about us, dear reader. We’ll be all right.

But what about the poor lumpen? What about the poor schmucks who actually take George Bush, Alan Greenspan, John Kerry – or practically any other public figure – at his word? What about the poor boobs who took the advice of one Fed governor and bought a new SUV gas guzzler – just as oil prices began to rise? What about the poor fellows who, lured by Alan Greenspan’s extraordinarily low lending rates, went out and bought a bigger house than they could actually afford? What about the million of ordinary Americans who count on Social Security for retirement?

Laurence Kotlikoff figured that Social Security benefits would have to be cut by 45% – “immediately and forever” – in order to close the fiscal gap. What will the poor lumpen do?

We don’t know. But what troubles our sleep are the whispers of the dead. “Watch out,” they remind us. “Ruin the middle class…and bad things will happen.”

In America today, a curious and disgraceful conceit has arisen. America is “good”…no matter what it does. America will always be “good”…no matter what it does. Good things will always happen to good nations.

“When America was created, the stars must have danced in the sky,” said Dick Cheney, full-time Vice President…and occasional astronomer.

When Dick Cheney was created, the gods must have laughed… for no sooner does a people come to believe that it enjoys some special grace…some special dispensation from the laws of Nature, Gravity, and Morality…then bad things begin to happen.

“Germans are not bad people,” the dead whisper. But when bad things happen…few people have the courage to stand against them. What set Germany off on its course toward complete destruction in the 1930s was President Wilson’s disastrous conclusion to World War I, which humiliated and bankrupted Germany…followed by the hyperinflation of the 1920s. The middle class was disillusioned by the war…and then ruined by hyperinflation. The old verities – hard work, saving, integrity, religious faith – were shaken…and fell. Germans began to look for new verities. What they found – the master race – was preposterous, but very popular.

And now the news from Tom:


Tom Dyson, from Charm City…

– “I really believe we have a disaster scenario in the making,” said a high-ranking economist in The New York Times yesterday. “As soon as the markets see these unsustainable levels of debt, the dollar could very well crack.”

Today’s doomsayer is C. Fred Bergsten, the director of the Institute for International Economics. His gloomy prediction was prompted by the release of the latest current account data.

Trade and capital flows between the United States and the rest of the world reached a record deficit of $166.2 billion last quarter, according to the Commerce Department. “This is a far larger share of GDP than we’ve had in the past,” said an economist at the Economic Policy Institute. “This just can’t go on.”

Investors didn’t care and pushed the Dow to a sneaky 3-point gain, closing out a fourth winning session at 10,318. The Nasdaq gained too, adding 5 points, to 1,915.

Meanwhile, gold continues to lurk. Yesterday, it climbed $1.40, closing at $405.10. Today, it’s back down again, losing 50 cents.

The blame for such a large deficit can be laid squarely on currency valuations, say economists. They say the dollar is overvalued – particularly against currencies in the East – and that encourages U.S. consumers to spend beyond their means when they should be saving.

Here at The Daily Reckoning, we wouldn’t argue with that logic, and we’d agree that the dollar might be overvalued relative to other international currencies – although if you lived in the Midwest, you’d never know it. “Here, each time we order breakfast, we get far more than we can eat at a price that seems preposterously low. If the dollar is too high, you can’t tell it by food prices. Or by the price of gasoline. Or just about anything else,” wrote Bill last month, from Farmington, N.M.

The Bush administration, reports The New York Times, has a different explanation. They blame the rest of the world for selling their wares too cheaply. “The Bush administration interpreted the current account deficit as a sign that other countries were lagging behind the United States and needed to pump up their economies,” says a government spokesperson. “The deficit actually makes the country more attractive to foreign investors.” More attractive like a swimsuit model with a beard…

The dollar seemed uninterested in the news, but then again, why should it be? The dollar’s floating rate should reflect all the millions of routine transactions occurring every day. An invoice arrives from South Korea for a batch of clock radios, a Japanese exporter hedges the dollar exchange rate on a shipment of new cars in transit to Vancouver.

Showing little regard for politicians, economists or the fundamental laws of gravity, this year the dollar has strengthened, but not by much. Against the euro, the dollar has gained about 5 cents, to 1.2152, its current level. And in Japan, the dollar has gained almost 4 yen, from 107.5 at year-end 2003 to its current level of 110.32.

We suspect hedge funds may have played a hand.

These days, the currency markets are extremely sensitive to movements in the expected level of short-term interest rates. Hedge funds entered the carry trade so aggressively…the “Greenspan Put” offered them the keys to a moneymaking machine: a carte blanche to buy long-dated Treasurys covered through the leveraged sale of short-term T-bills at a 300-basis point spread. The unwinding of this transaction, it could be asserted, has more bearing on the dollar than any other dynamic.

But that was last year. Making money in 2004 hasn’t been quite so simple. “After several years of rich pickings, 2004 has been an annus horribilis for many hedge funds specializing in the currency market,” begins an article in the FT. “Many funds will have entered the year with short-dollar positions in the belief that the greenback would continue to slide in 2004. However, the dollar has firmed since January.”

“Hedge funds are getting chopped to pieces in the forex markets,” says another currency strategist.


Bill Bonner, back in London:

*** “Did you notice that the volatility index hit a record low,” asked colleague Dan Denning. “You know what that means. People have never before been so complacent. They’re sure that nothing much will happen.”

Meanwhile, investors, speculators, homeowners, politicians, consumers…all seem to be working overtime piling straws on the poor camel’s back. As long as the beast stands, people believe they have nothing to fear. And the longer he stands, the more sure they become.

But eventually, without warning…and when everyone has stopped worrying about it – which is to say, when the volatility index has hit a record – the creature’s legs buckle. In a second, he has collapsed. Where once he stood, there is nothing but a cloud of dust.

“Yes, that’s the problem,” Dan continued. “It can happen so fast…once you see it, it’s too late to do anything about it.”

*** A reader comment, with “notes from a China tourist”: “Our first visit to China was in 1984. Even then, it was clear to me that China was destined to become an economic giant. The cities were still pretty dirty and pretty basic. The people went to the market every morning and could be seen carrying home a live chicken for dinner, because they had no refrigeration.

“The milkman rode a three-wheeled bike with a flatbed on which there were wooden cases with milk in 8 oz. bottles, again because of no refrigeration. The public got around on bicycles and buses. Medical facilities (the reason for our visit) were basic, except for an occasional piece of high-tech equipment, and the docs were pretty good and trying to get better.

“Nanjing Road in Shanghai was a dirty, tree-lined boulevard lined by shops offering little or no merchandise for sale. The arrival point at the airport in Shanghai was a two-story block building into which one walked from the plane, across the tarmac, to deal with the officials. The bus ride downtown was through several miles of small farms. “Fast-forward to 2000. The Shanghai airport is as modern as any in the United States. The little building from 1984 is still there, but not in use. The road to town is an expressway traversing a totally urban landscape all the way to downtown.

“Nanjing Road is an elegant blocks-long pedestrian mall lined by multistory stores offering merchandise competitive in every way with any Western department stores, often the Western merchandise itself, and the people are buying. In contrast to 1984, when they usually had two outfits, one on their backs and one in the laundry, they are well dressed.

“Not only do the Chinese now have refrigerators, they have color TV, stereos, computers, and their apartments have air conditioners hanging out of the windows. The old Russian-built hotels have been beautifully updated. Cell phones are visible everywhere. Cars have replaced bicycles, resulting in horrendous traffic. A futuristic city has risen across the river from the Bund in Shanghai, where there was a swamp 16 years earlier.

“And the modern airport? It was closed two weeks after our visit in 2000 to be replaced by a totally new facility in another location. “I don’t think it is going to take anything like 40 years for China’s economy to draw even with ours, and then pass us.” *** A reader comments on “faith”:

“I do take issue with your belief that people of “faith” also think everything is OK. In some conservative religious circles, pastors and churchmen have been predicting the end of the United States for quite some time, often with much more negativity than is seen in this e-letter.”

“In particular, some have pointed out that due to the sinful nature of modern North America, a negative end is virtually assured. A return to the ‘gold standard’ will have no effect on this spiritual issue at all. In fact, there is a hint in the Bible that near the end, gold may actually become temporarily worthless (Isaiah 2:20).

“In reality, the minds of many (but not all) modern men have become corrupted due to their sinful nature, and as a result, God cannot bless them.

“Nor are they likely to make wise choices, especially with their finances. Two Bible statements, one from the Old Testament (Deut 28:15-68) and another from the New Testament (Rom 1:18-32), seem to indicate that this (among other things) will be one of the problems near the end. *** And another on the faithful:

“I’m the guy who wrote you the alien comment several weeks ago. Thanks for printing it – word for word – the world needs to know…THEY’RE HERE!” “Hey…the pastor who said you were negative all the time and that things will eventually work out…well, I work at a church…I’m the janitor and maintenance man…I know all about how a pastor’s mind works…

“How many times over the years, I would have liked to smash his ‘rose colored glasses’ on the floor! “Well…just wait…someday the American people are going to find out the truth about this country’s secret programs…boy, will their faith be smashed to pieces. “The USA already has the secrets to free abundant energy, anti-gravity craft (which we are flying around now), super-weapons (they will even shoot down alien UFOs, which we have done several times already…the Russians have these also) and possibly time travel! It’s hard to believe, isn’t it? This country is spending $1.7 trillion per year funding these super-secret programs. No wonder the Treasury’s printing presses are working around the clock. “America’s faith will evaporate when the truth comes out someday! “We better all go buy an assault weapon while the ban is temporarily off. You should also buy a RPG weapon while you’re shopping around. Lots of ammo and food and clothing and survival gear are also needed…

“Go bury it in the woods for safe keeping. “An extremely dangerous world is about to unfold…”

The Daily Reckoning