The Gold Standard Gets No Respect

There seems to be some confusion in the papers recently (surprise, surprise) – a Washington Post writer wants to blame the Great Depression on the gold standard. Never fear, Chris Mayer sets this twisted theory straight…


There is a lot of dumb stuff written about the gold standard and the Great Depression these days. I open the paper yesterday and I read a column by Robert Samuelson in The Washington Post, “Gold’s Enduring Mystery.”

Samuelson goes on to say some things about gold’s role as money for much of recorded history. Then he gets to the Great Depression and he enters the realm of the absurd. He writes: “But the gold standard’s very rigidity led to its collapse in the Great Depression. Too little gold fostered banking and currency crises.”

The Great Depression and The Gold Standard: Winners Write History

Tsk, tsk. Poor gold! Now the blame for the Great Depression lies at your feet. Truly, the victors write history. For here is history from the view of a paper money enthusiast.

Such a view is not uncommon. Our own newly appointed Fed chief, Ben Bernanke, also holds such views. Bernanke is a Great Depression buff, just as people are Civil War buffs. It fascinates him. He studies it as a man might pick over the remains of some archeological dig. He even began a book about it.

Greg Ip’s piece in the Wall Street Journal summarizes some of Bernanke’s views on the Great Depression. On the top of the list: “Beware of outdated orthodoxies such as the gold standard.”

To the world-improver set, confident they can push the right buttons and pull the right levers, the gold standard is nothing more than a straitjacket. To those who see gold’s charms, that is precisely its chief merit. You see, the gold standard checks the creation of new money.

If every dollar must be backed by a certain amount of gold, then you cannot create money out of thin air. The gold standard says you must have the gold first. Governments find it harder to wage war, dole out entitlements and build public works with a gold standard tying them down. Banks can’t lend as much money; hence they can’t make as much money. This is why the banking interests of this country backed the creation of the Federal Reserve. They appreciated the value of a good cartel.

It’s a bit like a cash-only bar. People with little money who like to drink tend not to like cash bars.

The Great Depression and The Gold Standard: Too Many Dollars

The problem, Mr. Samuelson, is not that there was not enough gold. The problem was too many dollars. When Roosevelt ordered Americans to surrender their gold coins in the spring of ’33, he was not saving capitalism. He was burying it.

Capitalism – or free markets – depends on contracts. Contracts are nothing but promises. When contracts cannot be enforced, then you join the world of banana republics and post-Soviet style looting. The system breaks down. So it was whenever the country reneged on its promise to back its own currency with gold.

Those who gave their gold in exchange for dollars – backed by a promise to redeem in gold – were simply left with dollars. Their own government essentially stole their gold from them. Dollars, I should note, that have lost a lot of value in the ensuing seventy years.

But there’s more than this. Money unfettered by specie is the main fuel for the unsustainable booms that later turn into the panics, crashes and depressions that pock the landscape of financial history. Gold was what reigned in such excesses. It was the anchor that kept the ship in the harbor.

Just because the government frequently broke these rules does not mean the gold standard itself is at fault. (The rules were broken with finality in 1972, when President Nixon quashed the last vestige of the gold standard). A man who cannot keep his promises cannot reasonably lay the blame on the promises. Such a routine breaker of promises may be a rogue, a thief, and a scalawag. Usually, the preferred term is “liar.” Today we call such people politicians and “saviors of capitalism.”

The Great Depression and The Gold Standard: The Wrong Books

Bernanke may have studied the Great Depression, but he has read the wrong books. He should give a look at Murray Rothbard’s America’s Great Depression. Rothbard’s examination is clear and logical, without the trappings of mathematics that otherwise pollute economic texts today.

Why should paper money create unsustainable booms? I’ll attempt an answer in brief, at the risk of oversimplifying something that’s taken centuries to get right and that is still being explored and elaborated upon by economists today. (The best thing to do is read the book. Read only the first three chapters and you’ll know more about business cycles than most professional economists.)

Basically, in a free market, individuals decide how much they want to save. These savings are invested in the market – ether by the saver or through an intermediary (like a bank). The price of savings is the “natural rate” or “pure interest rate.” Just think of it as a natural market price, the result of supply and demand.

So, when you create money out of thin air you give the impression there is more savings in the economy than there really is. You distort interest rates and the natural rate does not function so well. The market’s signals are emitted through a monetary fog.

All this excess money leads to new investments and spending creating the “boom.” As Rothbard says, “the boom, then, is actually a period of wasteful misinvestment. It is when errors are made, due to bank credit’s tampering with the free market.”

At some point, the misinvestments are exposed as unprofitable, the growth unsustainable. “The depression is actually the process by which the economy adjusts to the wastes and errors of the boom, and reestablishes efficient service of consumer desires.” In other words, the jig is up, reality sets in and the pull of the market price – the “natural rate” – start to assert itself.

It’s just like any other price controls. Set it too high or too low and there are consequences. It is unsustainable. This is why we have markets, to discover the “right” price.

There’s a lot more to this idea than I can delve into here. But the main point I want to make is this: The gold standard is not to blame for the crises of the past. They were caused by our inability to keep the promise to redeem in gold. And, secondly, that far from causing crises, the gold standard kept in check the growth in money. As a result, the gold standard served to stem unsustainable booms and avoid the necessary busts that follow.


Chris Mayer
for The Daily Reckoning

December 08, 2005

Chris Mayer is a veteran of the banking industry, specifically in the area of corporate lending. A financial writer since 1998, Mr. Mayer’s essays have appeared in a wide variety of publications, from the Daily Article series to here in The Daily Reckoning. He is the editor of CrisisPoint Trader and Capital and Crisis – formerly the Fleet Street Letter.

In addition to all of that, Chris somehow finds the to time to meet with Addison Wiggin, and the rest of the great investment minds that make up Agora Financial, once a month – and, for the first time ever, you can join the ranks of this elite crew.

We wonder how long they will put up with it. When will average Americans stop envying the rich and decide to eat them?

When it really starts to hurt, is our guess.

You’ll recall, dear reader, that the economy is said to be growing at a decent pace. But the typical family has been losing ground. Real household disposable income is going down for the sixth year in a row in 2005. Hourly wages, adjusted for inflation, have not increased for three decades, and yet, we are told, this is the world’s most dynamic economy.

Where to begin to explain this picture? The figures lie – they’ve been bent and beaten by the government’s statisticians. But even if they are straightened out, it doesn’t help America’s middle classes. GDP is not really growing as fast as reported. Most families really are getting poorer. Bankruptcies have more than doubled, for example, since the first Clinton term. Savings rate have dropped to a new record: minus 1.5% in the third quarter of this year.

Wage rates are getting globalized – good and hard. This makes some businesses more profitable; they have been able to take advantage of lower earnings in Asia. But it leaves homegrown labor struggling to make ends meet. The only way they’ve been able to put the two ends of the budget together has been with debt. It is a “plastic safety net” for America’s middle and lower classes, say economists. When they reach in their pockets and find no coin or paper, they pull out plastic. Average credit card debt has grown to $8,650 per family, say recent surveys.

Four things have enabled this growth in consumer debt: Asian lenders, the Fed’s low rates, imaginative debt mongers, and the housing bubble. None of these things are guaranteed by the Constitution. But they allowed consumers to pull $160 billion out of their houses this year alone, according to Merrill Lynch. Without that easy lucre, the ready credit, the I.O. and Neg Am mortgages, many people would be in bigger trouble than they are now.

“Although the economy has been better than expected,” write James Welsh, “the stage is set for a consumer letdown in the first half of 2006. Consumers are facing increases in adjustable-rate mortgage payments, higher minimum credit-card payments, elevated costs to heat their homes especially in the Northeast, less home-equity extraction, and lower rates of home appreciation.”

In other words, it is about to hurt. That is the problem with the plastic safety net. It only works if you bounce back quickly. The more you jump on it, the less elastic it becomes, the deeper you sink, and the harder it is to climb out, because each time, you carry a heavier burden on your back.

“There are risks in the strategy of getting by crises on plastic and mortgages,” writes Thomas G. Donlan in Barron’s. “The biggest risk is that times will get worse, and won’t get good again. Even the loosest issuers of sub-prime debt will draw the line somewhere, and the natural result is seen in that bankruptcy tally of 1.8 million families in 2004. The second biggest risk is the virtual certainty that home prices will cease to accommodate endless cash-outs of endless increases in home equity.”

Then what? We don’t know, but we have some ideas…below.

More news Aussie Joel and The Rude Awakening…


Eric Fry, reporting from Wall Street:

“Familiarity breeds contempt…but not right away. In the beginning, familiarity breeds desire, when then becomes mere comfort, then only tolerance, then resignation…and THEN contempt.”


Bill Bonner, back in España with more thoughts…

*** I bought your book and I loved it,” writes one reader. “I’m truly concerned that another 1929 crash is coming, but instead of stocks, it will be a real estate and bond bubble burst that sends this country sliding and the rest of the world to following and stocks will obviously crash as well. Greenspan’s enormous pumping of the money supply will lead to a wave of inflation and at the same time assets deflate. Stagflation will be Ben’s big battle. For now this false boom continues.”

It’s nice to know that all of our urging to run out and buy your copy of Empire of Debt hasn’t fallen on deaf ears. In fact, it seems that the exact opposite has happened…we received quite a few emails along these lines:

“Ordered mine ages ago on Amazon and I am still waiting more and more impatiently!”

“It is nice you are talking so much about your book Empire of Debt. Too bad it takes two months to get it from Amazon. (I assume it is such a great seller that you must be reprinting already?) Maybe you should let people know that.”

*** And now, a campaign update (we promise we’ll make it short and sweet)…

Amidst the form letters we’ve received from members of Congress and the Senate in response to the letter and copy of Empire of Debt that we sent, there was one anomaly – a hand-written note from a living, breathing person! More on what this Congresswoman had to say tomorrow…

*** The GDP numbers hide a fraud and a shame. About the fraud we have written much – the numbers are so twisted even their own mothers wouldn’t recognize them. About the shame we have something to say today. It is a shame that America’s middle and lower classes are getting poorer. This is no one’s fault in particular; it is just an inevitable result of globalization and empire. Americans pay the immense cost of keeping a cop on the global beat – the U.S. military budget is bigger than all other countries’ put together – while hustlers all over the world rise up to compete with their own merchants and working stiffs.

What little real financial progress there is, sticks to the upper levels of American society like mud on a Mercedes fender. While the proles’ labor is marked down, the capitalists’ assets are marked up. Their work – as doctors, lawyers, developers, and promoters – is less subject to Asian price-cutting. Even at GM, upper management connives to raise its own compensation at double-digit rates while the typical wage-slave has not had a real raise since 1975.

Mass man is a loveable jackass, of course. For the moment, he is docile. He doesn’t know what is going on. He has been gulled by easy money and the property bubble. For the most part, he doesn’t begrudge the rich their fancy cars or mansions; he still believes that these gaudy treasures are not that far out of his own reach. He doesn’t set fire to his neighbor’s Mercedes, in other words, because he still thinks he might have one himself – if this property bubble continues long enough. As many as half the mortgages written in the last 18 months were drawn up based on “stated income,” rather than income that was actually checked by the lender. This makes is possible for a person to buy a McMansion, not on his income from his vocation, but his income from his prevarication. And a new car? They practically give them away!

It is too bad there are limits. If only we could live forever. If only we had two stomachs and the metabolism of a jet engine. If only we could borrow…and borrow…and borrow. But nature is against us. There comes a time when you have to borrow less, not more. When that happens, you have to spend less. And when you spend less, the people who were counting on you to buy things are disappointed, and then they have to spend less, too. Then, all those nice people who lent you money when times were good get a severe look on their faces and ask for it back!

We have no quarrel with this system, or even with nature herself. We figure she has her reasons. But neither do we have a huge mortgage on a McMansion or a bunch of credit card bills to pay. We can afford to look at the situation philosophically. We doubt Mr. Average Wage Earner will be so relaxed. Instead, he will look around for someone to blame. He will see people driving around in big Mercedes and he will resent it. He will read about people getting fat salaries and he will feel cheated.

In some tawdry office somewhere, right now, there must be an aspiring demagogue practicing his speech. He is wondering whether he should raise his arm or hammer down on the podium with his fist, when he says, “It’s just not fair that we (and here, he will stretch the facts a little to include himself among the victims of globalization) lose our jobs, our houses, our health care and our retirement benefits so that a handful of very rich people can live like pharaohs.”

He will reflect on the statement a moment, and he will decide to emend it slightly. ‘These morons won’t know what a ‘pharaoh’ is,” he says to himself. “The only pharaoh they know is at Las Vegas.”

*** Gold rose again…to $517 (Feb. contracts). Could that be right? $517?

The problem with a real bull market is that it tends to leave you behind. At first, it moves up hesitantly, reluctantly, and almost apologetically…giving you plenty of opportunities to buy on corrections. But when it reaches a more advanced stage, it races ahead. You wait for a correction, but it doesn’t come. Instead, the price roars ahead, leaving you in the dust.

Are we at that stage of this gold bull market? Have our buying target prices been made irrelevant? Will gold ever trade below $500 again in our lifetimes?

We don’t know. But we shall see.

*** Madrid is amazing. On the way in from the airport you see dozens of construction sites. The whole place is booming. There are new houses, new shops, and new cars. What happened to the country that used to be so poor? It is gone.

The Daily Reckoning