He promoted the idea of educational vouchers issued by local governments and based on taxes extracted from the public. He did not consider the obvious fact that the courts would make this the wedge by which the state would take over private education. He and I debated this in 1993.

Most of all, he promoted the idea that storing gold in government vaults to back the currency is wasteful. It wastes gold. It wastes storage space. It wastes armed guards. So, to make monetary policy more efficient, the Federal Reserve should increase money — he never said which M — by 2% to 5% per annum. He wanted central-bank-controlled fiat money.

The only critics from the fringes of academia were the Austrian School economists. We knew that an efficient government is a dangerous government. We also knew that a central bank that does not face an outflow of gold in response to its policies of monetary inflation will inflate far more than would be allowed in any gold-related economy.

I responded to this argument, which had been picked up by The Wall Street Journal, back in 1969.

Hans Sennholz responded on many occasions. So did Murray Rothbard. But we were not taken seriously. We were not part of the mainstream. Academic economists had long since abandoned any support of a gold coin standard. They did not all support Friedman’s idea of a restrained Federal Reserve. In fact, very few of them supported it. They wanted flexibility. They still do.

Once Nixon closed the gold window, there was no turning back. The monetary base grew, all of the various Ms grew, prices rose, bubbles grew and blew, and the Federal debt rose to today’s gigantic, unsustainable level — unsustainable apart from mass inflation followed by hyperinflation.

The abolition of a currency convertible on demand into gold was only one part of Dr. Friedman’s contraption. The other part was his suggestion of floating exchange rates. This deserves special consideration.

Milton Friedman’s Contraption

Friedman easily took apart the idea of fixed exchange rates. Fixed exchange rates are a form of price control. Friedman was a good enough economist to know that price controls produce shortages. The artificially undervalued currency goes out of circulation. The overvalued currency produces gluts. There will be runs on central banks.

Domestic purchasers of foreign goods say to the central bank: “Sell us the artificially undervalued foreign currency at the official price.” The central bank runs out of foreign currencies. Trade collapses. There is then a devaluation. The official prices of the foreign currencies are raised to new fixed exchange rates.

It was easy for Friedman to expose this as ridiculous. “Just float the currencies,” he said. “Let the free market set their prices.” This was good advice. Price controls do not work as promoted. They always produce gluts or shortages.

But then Friedman recommended his old favorite: pure fiat currencies. He said that these can be managed rationally by means of a fixed rule governing a predictable expansion of money. “Turn it over to the Federal Reserve. All will be well if the Federal Reserve does not tamper with the rate of growth.” As John Wayne said in The Searchers: “That’ll be the day.”

Nixon adopted Friedman’s contraption. First, there would be no more convertibility of gold for foreign official government agencies.

For a little less than two years, there were universal price controls on American goods. These controls led to shortages and a disruption of international trade. The dollar was not officially floated until December 1973.

When the price controls came off, prices rose. In 1975, Gerald Ford launched the WIN plan: Whip Inflation Now. The recession of 1975 did exactly that. Then came the worst monetary inflation in American peacetime history: 1976-80. Gold and silver soared.

Friedman’s contraption clearly was not working. Floating exchange rates were not the problem. The abolition of the gold exchange standard was the problem.

Friedman’s contraption has engulfed the whole world in monetary inflation, bubbles, and busts.

Stockman on the Contraption

In a lecture to the Mises Institute on March 12, David Stockman blames floating exchange rates and the abolition of the gold standard.

That the demise of the gold standard should have been as destructive of fiscal discipline as it was of monetary probity can hardly be gainsaid. Under the ancient regime of fixed exchange rates and currency convertibility, fiscal deficits without tears were simply not sustainable — no matter what errant economic doctrines lawmakers got into their heads.

Back then, the machinery of honest money could be relied upon to trump bad policy. Thus, if budget deficits were monetized by the central bank, this weakened the currency and caused a damaging external drain on monetary reserves; and if deficits were financed out of savings, interest rates were pushed up — thereby crowding out private domestic investment.

This is an accurate assessment of what happened. But the anchor to this was not the fixed exchange rate system, because the IMF had no real authority to enforce them. The anchor was the promise of the United States to sell gold at $35 an ounce. When the chain was cut, and the U.S. kept its gold, the international currency system was cut adrift. The anchor resides in the vault of the New York Federal Reserve Bank.

In the good old days, there was pain, Stockman observed. “Politicians did not have to be deeply schooled in Bastiat’s parable of the seen and the unseen. The bitter fruits of chronic deficit finance were all too visible and immediate.” This ended in 1971.

During the four decades since the gold window was closed, the rules of the fiscal game have been profoundly altered. Specifically, under Professor Friedman’s contraption of floating paper money, foreigners may accumulate dollar claims or exchange them for other paper monies.

But there can never be a drain on U.S. monetary reserves because dollar claims are not convertible. This infernal engine of fiat dollars, therefore, has had numerous lamentable consequences but among the worst is that it has facilitated open-ended monetization of the U.S. government debt.

The government is running a $1.6 trillion deficit. Nothing can be done politically to stop this. We are on a runaway train. The main brakes were removed in 1971. The only brake now is that of the bond vigilantes, but the Federal Reserve is the buyer of bonds today, along with Asian central banks. Stockman observed that “the Fed’s QE2 bond purchases have been so massive that it is literally buying Treasury paper in the secondary market almost as fast as new bonds are being issued.”

Is all this Friedman’s fault? Stockman lets him off the hook, to some extent.

By contrast, under the contraption that Professor Friedman inspired, trade account imbalances are never settled. They just grow and grow and grow — until one day they become the object of fruitless jabbering at a photo-op society called G-20.

In all fairness, Professor Friedman did not envision a world of rampant dirty floating. Indeed, it would have taken a powerful imagination to foresee four decades ago that China would accumulate $3 trillion of foreign currency claims or more than 50% of GDP, and then insist over a period of years and decades that it did not manipulate its exchange rate!

My response: it was all Friedman’s fault, intellectually speaking. When an economist recommends a policy, he also recommends its effects. Friedman failed to see what Austrian School economists had predicted: the unleashing of fiat money, and manipulated rates — dirty floating. Dirty floating is all there is in a world run by government-licensed central banks without gold coin convertibility. But for our saying this, decade after decade, the economics profession has marginalized us.

Conclusion

Milton Friedman was always too clever by half. He advised governments to get more efficient, and they did so. They used his advice to expand their power and expand their reach into our wallets.

We told him so. He did not listen. His followers did not listen. Today, they all sit mute at the side of the road, mumbling about potentially excessive deficits and potentially excessive price inflation, but generally approving of the Federal Reserve.

The problem is the original contraption: (1) government’s monopolistic control over money and (2) central banking as such. Here, Friedman was supportive of government.

The problem was not floating exchange rates or the breakdown of Bretton Woods in 1971. Those were the inevitable results of Bretton Woods, as Henry Hazlitt warned in the late 1940s, and was fired by the New York Times for saying so.

The problem was not even the Genoa Conference of 1922, the contraption designed to solve the inflation that came as a result of the suspension of redemption in the second half of 1914, when World War I broke out.

The problem was the mass confiscation of the people’s gold in 1914: first by commercial banks, then by the central banks.

Milton Friedman’s contraption was just one more ill-fated attempt to deal with the results of the original confiscation. It was one more case of his outlook: “The government was right to confiscate the gold and end the gold standard. That was an efficient way to fight a war, just as withholding taxes are efficient, and vouchers are efficient.”

Milton Friedman spent his career defending the efficiency of the free market. But, on the really big issues, he sold his peers on the efficiency and good will of government politicians and bureaucrats. “Trust them to be efficient.”

The Austrians said the same thing, but added, following Forrest Gump’s mother, “Efficiency is as efficiency does.” The state gets more efficient only in order to tyrannize people on a cost-effective basis.

Milton Friedman’s contraption was the unchecked welfare-warfare state: unchecked by annual taxation without withholding and unchecked by the gold standard.

If that’s efficiency, include me out.

Regards,
Gary North
Whiskey & Gunpowder

March 21, 2011

Milton Friedman’s Money Machine was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

Doug: Sure. First of all, it’s because gold is actually money. It’s an unfortunate historical anomaly that people think about the paper in their wallets as money. The dollar is, technically, a currency. A currency is a government substitute for money. Gold is money.

Now, why do I say that?

Historically, many things have been used as money. Cattle have been used as money in many societies, including Roman society. That’s where we get the word “pecuniary” from: the Latin word for a single head of cattle is pecus. Salt has been used as money, also including in ancient Rome, and that’s where the word “salary” comes from; the Latin for salt was sal (or salis). The North American Indians used seashells. Cigarettes were used during WWII. So, money is simply a medium of exchange and a store of value.

By that definition, almost anything could be used as money, but obviously, some things work better than others; it’s hard to exchange things people don’t want, and some things don’t store value well. Over thousands of years, the precious metals have emerged as the best form of money. Gold and silver both, though primarily gold.

There are very good reasons for this, and they are not new reasons. Aristotle defined five reasons why gold is money in the fourth century BC (which may only have been the first time it was put down on paper). Those five reasons are as valid today as they were then. A good form of money must be: durable, divisible, consistent, convenient, and have value in and of itself.

L: Can you elaborate on that?

Doug: Yes, and from them, we can draw inferences that will help us anticipate the fate of the dollar.

First, let’s take durable. That’s pretty obvious – you can’t have your money disintegrating in your pockets or bank vaults. That’s why we don’t use wheat for money; it can rot, be eaten by insects, and so on. It doesn’t last.

Divisible. Again, obvious. It’s why we don’t use diamonds for money, nor artwork. You can’t split them into pieces without destroying the value of the whole.

L: If I paid for a new Ford GT with the Mona Lisa, what would be my change – a small canvas by Picasso?

Doug: [Laughing.] That’s right. Maybe you’d get millions of those paintings of Elvis or Jesus on velvet.
Consistent. The lack of consistency is why we don’t use real estate as money. One piece is always different from another piece.

Convenient. That’s why we don’t use, for instance, other metals like lead, or even copper. The coins would have to be too huge to handle easily to be of sufficient value.

Value of itself. The lack here is why you shouldn’t use paper as money.

Actually, there’s a sixth reason Aristotle should have mentioned, but it wasn’t relevant in his age, because nobody would have thought of it…

L: It can’t be created out of thin air.

Doug: Right. Not even the kings and emperors who clipped and diluted coins would have dared imagine that they could get away with trying to use something essentially worthless as money.

L: I think we can forgive Aristotle for the oversight.

Doug: I think so. At any rate, these are the reasons why gold is the best money. It’s not a gold bug religion, nor a barbaric superstition. It’s simply common sense. Gold is particularly good for use as money, just as aluminum is particularly good for making aircraft, steel is good for the structures of buildings, uranium is good for fueling nuclear power plants, and paper is good for making books. Not money. If you try to make airplanes out of lead, or money out of paper, you’re in for a crash.

That gold is money is simply the result of the market process, seeking optimum means of storing value and making exchanges.

But it’s not something that suits governments, because paper money is an excellent means for governments to tax people indirectly, surreptitiously, through inflation. That’s one reason central bankers love paper money, but also, phony economic theories, like those of John Maynard Keynes, hold that the government not only can but should meddle with the economy, and the ability to print paper money gives them a means to do that.

In today’s world, not only do people around the world take it for granted that paper is money, but that it should be so.
But it’s all nonsense. It’s one reason for taking a gloomy view of humanity – people will believe almost any kind of claptrap, if the story is retailed by those in authority.

After the current system collapses, as every paper money system in the past has collapsed, some form of money will have to replace it, and it’s almost certainly going to be gold.

L: There are already experiments with digital gold currencies. E-gold got taken out behind the woodshed by the feds, but GoldMoney.com seems to be doing well. Do you believe those could see widespread adoption, as paper currencies lose their credibility?

Doug: Sure. You know, in the 19th century, the “paper money” you carried in your wallet was called bank notes. Why? Because they actually were notes from your bank representing a specified amount of real money on deposit. People carried these things because they were much more convenient for large amounts of money than chests of gold. Dollars today say “Federal Reserve Note,” not “XYZ Bank Note” on the back, because they aren’t redeemable for anything besides more Federal Reserve notes. That’s why today’s paper money substitutes are called fiat currencies; they have zero intrinsic value and are not redeemable for anything, but are accepted because the government will put you in jail if you don’t. It’s a fiat accomplished by force, not real value recognized by those who accept the notes.

Things like GoldMoney.com are simply modernized, updated versions of bank notes. They are basically transferrable warehouse receipts that represent amounts of gold you have on deposit someplace. I do recommend GoldMoney.com, incidentally, because it allows you to hold your gold in digital form, outside the U.S. And to my understanding, these accounts are not reportable under current U.S. rules. It’s an excellent alternative to storing large amounts of gold in a safe deposit box.

L: But will people believe in them? Will the public accept them so they can be used in everyday transactions, as paper money is used now? Hundreds of years ago, people accepted bank notes because they knew the reputations of the banks issuing them (when you traveled, you went to a reputable local bank, which knew the reputation of the bank that issued your notes, and the local bank could issue you new notes in local currency, etc.). There was no central authority to certify these notes. But today, people don’t think that way. They think it takes a government to assure the value of money.

Doug: You’re quite correct on that – a sea change in thinking will have to take place. Of course, anyone in Zimbabwe can tell you a government’s guarantee is not necessarily worth anything. A collapse of the dollar – the worlds’ de facto reserve currency – could spark such a change in that way of thinking. With GoldMoney.com or the Perth Mint – another worthy alternative – it’s a question of predicting the solvency of an actual company, and we have tools for that. I believe this is exactly what is going to happen in the future. As far as I’m concerned, either of these outfits is more reliable than, say, Citibank. And gold is far more desirable than the dollar. So I’d rather have a thousand ounces of gold stored with GoldMoney.com than a million dollars deposited at Citibank.

The dollar will be phased out of the world economy, because everyone can see that it’s a hot potato. This Chinese have two trillion of them. They want to get rid of them because they aren’t stupid, and they can see what the ultimate fate of the dollar is. This is true of every country around the world at this point; their central banks know they are sitting on hot potatoes, and they are going to want to unload them.

What’s going to happen is that one or more countries are going to institute a sound, stable, gold-backed currency. Ten years ago, Mahathir Mohamad of Malaysia tried to get Islamic countries to return to hard money, adopting the gold dinar and the silver dirham, which are defined in the Koran as specific weights of gold and silver. It didn’t work because of mistrust between the players; the governments of Muslim countries are, as a group, almost universally corrupt. But I think it’s entirely possible, nonetheless, that something like that might arise in the Islamic world. After all, they believe that the Koran is the actual word of Allah, and there is a resurgence of Islamic fundamentalism everywhere.

According to press reports, the Chinese government is actually encouraging Chinese people to accumulate gold at this point. They might go for a gold-backed yuan – it would put them on the map as an international monetary leader. The press also reports that the Russian government has been consistently buying large amounts of gold. We might even end up with a gold-backed ruble.

Meanwhile, the U.S. government is creating trillions more dollars per year. This could result in the entire world monetary system being overturned. But there’s no reason for anyone to trust any of these other governments more than they trust the U.S. government. And rightly so; they shouldn’t trust any currency that doesn’t come with a guarantee of redemption for something specific. And as Aristotle and history have shown us, gold is the best choice.

L: So the question now boils down to, what is gold really worth in terms of today’s dollar? How do we compute that?

Doug: Well, aside from a few Spanish galleons at the bottom of the sea and dentures returned to the earth after a lifetime of use, pretty much all of the gold ever mined and refined is still sitting on the surface of the earth somewhere. Nobody really knows how much that is, but the most reasonable estimates I’ve seen are something like six to eight billion ounces. That happens to work out to about one ounce of gold for every human being on the planet at this time.

Out of this, the U.S. government reports that it has 265 million ounces of gold in its treasury. If we divide the money supply by the number of ounces the U.S. could back its paper with – and here we’d have to decide what measure of money supply we want to use. Nobody, including the Federal Reserve, actually knows how much money they have floating around out there. It would seem that there are about six trillion dollars outside the U.S. alone. Let’s estimate that M0 in the U.S., the narrowest measure of money supply that consists of just notes and coins, amounts to one trillion. So, 265 million into seven trillion gives you about $26,420 dollars per ounce of gold.

Now, if we add in the total obligations of the U.S. government, which it will either need to print more money to meet, or it will have to default on – that’s about 100 trillion. If those dollars are printed, that would give us $377,430 per ounce. The same ratio for M1 would give you about $6,226 per ounce and M2 would give you $31,320 per ounce.

All of these numbers are far, far above the current level of roughly $1,000 per ounce. And that’s the answer to the question you started this interview with. Why gold? Because it’s got only one way to go: up. It seems to me that everyone should have a very significant portion of their wealth in gold.

That’s not just for safety, security, and prudence, though those are reasons enough, but because gold is cash in its most basic form. Better yet, even though it’s quadrupled since its bottom in 2001, it’s also still an excellent speculation. I can see somewhere between three and ten times your investment in current capital. And there’s no limit to the upside in dollars, depending on how rapidly the government destroys the currency.

To my view, that offers an exceptional combined opportunity; by buying gold, you protect your wealth but also have enormous speculative upside.

L: Plus, as you like to say, gold is the only asset class that is not also simultaneously someone else’s liability.

Doug: Absolutely right. And in a world as financially unstable as today’s, you just don’t want to hold on to someone else’s liabilities any more than you have to. Especially if that’s a liability of an entity like the U.S. government.

L: Got it. You should own gold because it’s money, because of its security, and because it’s an excellent speculation. In our publications, we’ve been telling readers that they should have as much as 1/3 of their portfolio in gold, 1/3 in cash, and 1/3 in investments that could do well in times of crisis, including gold stocks, commodities, certain kinds of real estate, etc. Do you think those are still the right proportions? That worked out very well for our readers last year. Those who actually followed our advice would have had 1/3 in gold and 1/3 in cash, so even if they lost 50% of their remaining third, they would still have only been down 16.67% by the end of the year. But that was then, and there were signs of short-term price deflation, and now things are different. How should we be deployed today?

Doug: That’s still a good balance, but if you start really thinking of gold as cash, and the dollar as a merely temporarily fashionable means of exchange, you’ll find yourself loading your portfolio with much more gold and gold proxies. That will protect you against the very rapid loss of value the dollar faces in years to come. Inflation is going to truly get out of control.

The only reason to hold any dollars at all right now, other than what you need for a few months’ living expenses if you live in the U.S., is that there is still a possibility of a very short-lived but catastrophic deflation. That could make the silly things worth more in the short term and give you liquid capital to deploy quickly into other asset classes. But certainly within one year, I would start moving more money out of dollars and into gold and other investments, possibly including well-positioned real estate and stocks that could benefit from the destruction of the dollar.

And once again, I want to emphasize, especially for Americans, that it’s not just a question of what you have and what you’re doing in the market, but where you’re keeping these things. Everyone, not just Americans, should try to have half of their gold, cash, and investments outside of their countries of citizenship and/or residence. You don’t want all of your assets within easy reach of whatever government considers you its milk cow.

L: Good reminder. Well, we’ve talked a long time again, but briefly, what are the best ways to own gold?

Doug: I prefer gold coins to bars. They are more recognizable and convenient. You can walk into a coin shop in many places around the world, and they will recognize your Gold Eagles, Krugerrands, Philharmonics, etc. Dealers, or the public, may not recognize the hallmark of some bars.

For larger amounts, I like GoldMoney.com, as I mentioned above, and I believe Kitco offers secure and convenient accounts accessible online. I also think highly of the Perth Mint Certificate program, especially for those who feel more secure with some sort of government backing (though government involvement is a reason to run in the opposite direction, in most cases). And, of course, there are various banks that will store gold for you in vaults in London or Zurich, that sort of thing. We cover these sorts of things in Casey’s Gold and Resource Report.

L: Okay, then, one last question: how about the gold stocks – where do they fit into this picture?

Doug: That’s a whole new conversation. For now, I’ll sum it up with three words: leverage to gold.

L: Very well then – I look forward to our next conversation. Thank you for your time.

Doug: A pleasure, as always.

December 29, 2009

Why Gold Really Is Money was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

In order for there to be a restaurant at all some entrepreneur has to put his money and vision on the line and open it. He has a thing called “overhead,” which is irreducible on-going expenses whether he has any customers at all or not. The rent, utilities, taxes, staff, laundry, raw ingredients, and so forth are constants. He is harried by assorted inspectors, frequently with conflicting demands.

In order for a meal to be put on the table once Joe Entrepreneur reaches that point the cooks have to prepare it and somebody has to serve it.

The diner has to have both the inclination to eat there and the wherewithal to pay for the meal and tip the waiter.

When government becomes the restaurant the system flies apart in many ways. Governments do not worry about overheads; indeed, it is an essential function of government to grow. The gang in DC has no concept of being able to “afford” the expenses they occasion. Money isn’t real to them. Other people’s money rarely is. They print some more any time they want to knowing that it reduces the value of the dollars we hold. They hire staff which always turns out to be permanent with reckless abandon.

Back in the real world government makes everything more expensive and more difficult. In our example, the minimum wage concept makes labor more expensive for the business owner. He has his choice of taking less profit, reducing staff, not expanding, or cutting quality. All of those will damage his enterprise. For over two decades I have been listening to small business owners say that they had the business to expand, but that between ludicrous restrictions, regulations, and taxes it simply was not worth their while to do so.

Cap and Trade will make energy far more expensive, and do so by design. Does the restaurateur reduce the fourteen ounce Angus strip to ten ounces? Raise prices? Charge for parking? Use frozen french fries instead of hand cut ones from fresh potatoes? It does not matter which unpleasant choice he makes he will be obliged to offer less to customers who are under the same constraints with their work and family expenses. Every time one of them decides that dinner out is an expense he cannot justify the restaurant suffers.

The waiters are damaged by the harm done by government to the owner and the customers, and so is the cook, so is the busboy, and so is the bartender.

The diner, at least, still has the choice of whether or not to patronize the restaurant, although he has to eat somewhere, whether at home or out. This is where we get into taxation policies.

Statists and, indeed, politicians in general, rarely know anything about where money comes from. They seem to think that “made,” “earned,” “produced,” and “printed” all mean the same thing. They really cannot tell the difference between a US savings bond and gold. They think borrowed money is real and does not actually have to be paid back.

They appear to believe that incomes are immutable, that if you make $200,000 this year that you will continue to make at least that much every year until you retire no matter what else changes. They speak blithely of your electrical bill doubling, not seeing that as causing you to spend less elsewhere because you have a ludicrous fondness for heat and light in your home. They even think you should run automobiles on the stuff. Some of them probably even believe that you can charge the ten thousand dollar battery on a Volt with twenty-five cents’ worth of electricity, as advertised.

They think that burger-flippers will always flip burgers, and their lot will improve only if Congress mandates higher wages for them.

Governments understand only fear, force, and how to use the public treasury to buy votes. Congress fails to grasp the very simple fact that everything is interconnected. In one sense it does not matter who, other than those with Pelosi-like incomes, has his or her light bill doubled, the money that will be allocated for electricity can no longer be spent in another area. If Hal’s discretionary income is $500/month and he has to give $167 of that to Brazos Power and Light, one out of every three dollars that he had previously to spend in restaurants, or to have carpets cleaned, or to buy a new fishing rod is gone forever, vanished into the insatiable maw of government. If Susie, the single mom teacher loses a third of her discretionary income, she will have to do without a washing machine, painting her house, or as many school clothes for her child. There is no way, short of a second job, to replace the money which has been stolen by government action, or that stolen by inflation which was caused by printing of fiat money.

I suppose I sound as though I am speaking to a sixth grade civics class, although most kids have allowances or parents who utter the foulest three words in the English language, “We can’t afford…” One wonders if the constantly increasing out of control “budgets” at local, state, and national levels are caused in part by a system that requires great wealth to be elected to public office, and great dependence on funds gathered by those who demand political favors in return. I live near Bryan, a town of 55,000 people. Can someone explain to me why Bryan needs to spend nine million dollars a year? All of it extorted from local property owners?

You may wonder why I am covering anything this basic here on Whiskey & Gunpowder! Surely you Shooters, of all others, understand the basic principles of business, budgets, and von Mises. One would have thought so–right up to the point where the Editor was deluged with letters asserting that pie in the sky “health care” is a “right” and expressing their sentiments in language unbefitting ladies, gentlemen, and civilized debate. If you understand why we cannot have “single payer” health insurance, fine, pass this on to some child who needs to know.

The basic fact is that there is only so much “money” in the world, when we see “money” as a medium of exchange, which it is. I need a better way to induce the cobbler to make me a pair of shoes than offering him twenty dozen eggs he can’t eat before they spoil, although we might agree that I would deliver a dozen a week until the debt was paid. He, in turn, needs cow hide to make shoes, and I have cows, but I don’t want to skin one just to get shoes…at any rate, it worked better when we all exchanged little slugs of silver or gold for each others’ labor and production. The balance gets destroyed when the government creates “fiat” money and expects us to accept their fairy not-gold at the same value as shimmering silver ingots. We won’t do it. We also know that every time more money is cranked out of thin air every dollar we have is worth less because there is no way to differentiate between the dollar we had when there were only ten in the world and that same dollar when suddenly there are a hundred.

The Statists’ theory is that there is no limit to how much money they can “create,” just as there is no limit to how much milk the cow can give. There really are limits to how much moo-juice Bossy will produce, including her heritage, her age, how good her feed is, and whether or not she has had a calf recently. Even cows want a break after being milked for 300 days. It takes nine months to produce another calf and “freshen,” or begin producing more rich, creamy milk.

My darling Charles and I sent Asia, our Segundo, off to pick up a cow and her week old bull calf today. Mathilda, as we have named her, is three-quarters Jersey and a quarter Black Angus, both animals are black, and they will fit in beautifully with the Black Dexters. Mathilda will handle our milk and cream needs for the next three hundred days, more time than it takes for the goats to reproduce (210 days.) The funny part is that the owner didn’t want to milk her so he has been underfeeding her deliberately so that she won’t produce more milk than the calf can drink! How about that, Shooters, when a “simple farmer” in “flyover country” knows that to get less out of the cow you provide less sustenance than she needs. (We gave her a whole bale of first class hay and a big container of clear water for tonight.) Why can’t all those Ivy League economists and lawyers see that when they take too much of our money we produce far less taxes?

There really are practical limits to how many taxes can be extracted from most of us. Particularly in a land where nearly half of the people pay no taxes at all and a lot of them get “earned income credits” for doing one day’s work a year. There is a large class of people that is paid to do one simple chore: vote for the Statists. I suppose it is nice work if one can stomach it. I don’t know, since no government has ever bought my food, shelter, utilities, and medical care. Given my choice I would prefer to be a slum landlord, but the government beat me to it.

There are two points here that the DC gang had better grasp quickly. The first is that no matter how you jigger the figures, jobless people aren’t making money and they aren’t paying taxes on the money they didn’t earn. Just because they aren’t counted officially doesn’t mean that they aren’t out there, as increased robberies, claims for unemployment, and appeals to churches show. Those who are losing more of their income to higher taxes and utility bills are not purchasing as much, which means that the stores they once patronized are no longer making as much money, so they don’t pay as many taxes.

The Statist solution is automatic: “Oh, we’ll just tax the rich!” “Rich” is a relative term but our dear leader defines it at a quarter of a million dollars a year. Their problem is that if they confiscate all of the earnings of every person in America who makes $250,000 a year or more it won’t be more than a drop in the bucket they have to fill to cover their expenditures. It can’t be done. According to the most recent analysis available, 2006, the “richest” ten per cent. paid fifty-five per cent. of all taxes. Statists think that is “fair,” but what they had better start thinking is that pulling that much money out of those who produce jobs, start new businesses, invest in others, or even play the stock market slows everything down. Charity? When you filter money through the government over ninety per cent. of it is spent as salaries and overhead or disappears from graft or theft. Good private charities more than reverse that ratio.

How many families do you suppose there are with incomes of two hundred thousand dollars a year or more? I’ll tell you, since Newsweek kindly told me: 3.4%. That is 34 out of 1000 families, or 340 out of 10,000 families, or 3400 out of 100,000 families, or 34,000 out of a million families. Those are the ones who pay more than half of the taxes. I’m not among them, but I understand the frustration and annoyance such a state of affairs must cause.

The really fun statistic is this one: those 3.4% do 14% of the consumer spending and they are the ones who create and sustain businesses, which is where jobs come from. When the top five per cent. bears the greatest burden of onerous taxes, sooner or later not only does commerce decline but at least some of them ask why they are bothering. That is one of the difficulties with the proposed health “care” legislation, the bizarre proposition that doctors will submit to a 15% pay cut at the government’s whim. No, they won’t. Those who are old enough will retire. Young people who were planning on enrolling in medical school will think of something else to do.

The best solution I can see is to do the John Galt thing. Quit. If you cannot afford to quit your job literally, stop your consumer spending to the greatest extent that you can.

Put the money into commodities for your family’s use or into chunks of silver. Some of you may shake your heads in bewilderment and ask, “Isn’t that consumer spending?” Well…yes, and no. If you spend a hundred dollars taking your family out for pizza and a movie, that money (minus taxes) goes back into the economy to be taxed again and again in every hand that holds it, and you have nothing to show for it beyond a few memories. If you buy a case of MREs (ugh), your money has gone to an individual who will do whatever with it, but you have taken it out of circulation. You are storing value in the form of food that you can eat during the coming Greater Depression. If you wear the clothing you have now and do not visit Macy’s or Dillards, the shock of what you do not spend ripples through the economy. A nice blouse costs a couple of hundred dollars and you may wear it two years. That money goes to pay those who manufactured, shipped, and sold the blouse. If you turn that money into a dozen ounces of silver you have pulled that value out of circulation. You are richer for having “savings” that cannot be lost through devaluation. You have turned the value of your fiat dollars at present into a metal which will preserve it. You have also hit the tax-and-spenders where they live…

A great many stores and firms are going out of business and this trend will gain momentum. You’re smart. You can figure out for yourself which businesses will not make it through a deepening depression and what you should stock now. Only the big, the smart, and the connected will survive, and the myriad choices you have now will be a distant dream perhaps five years from now. Perhaps in less.

Big government turns you into lunch. Most of us cannot afford to be the owner. Our choice is whether to be the waiter, who may lose his job and will surely see his customers and his tips diminish, or to be the diner. It isn’t too late to do the Joseph thing and stock up for the future, and emulating John Galt and Midas Mulligan will shorten the time until the whole rotten system collapses. Too many carpenter ants have been nibbling at the foundations of our financial structure.

John Galt said to withdraw our minds. The current system doesn’t want those and doesn’t want us to use them. Take away what they do want, an endless stream of tax revenues.

Cordially,
Linda Brady Traynham

September 4, 2009

Free Lunches, Money from Nothing and Limits to Government Theft was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

“Maestro…you hardly look yourself. It looks like twenty years have dropped from your face. It must be liberating not to have to worry about inflation anymore.”

“What’s inflation?”

“Ah yes. About that. Why haven’t we seen it yet? You’ve seen massive fiscal stimulus plans the world over, a huge increase in the monetary base, and lower interest rates. But no inflation. Bond traders don’t seem especially worried either. They are not demanding higher interest rates because they fear future inflation. And gold? Well, it’s plodding along. But shouldn’t it be going much higher as the supply of fiat money explodes?”

“You’re thinking is so old fashioned. It’s true. Or at least it used to be true. In the days when we had a gold standard, it was a great defense against government monetary fraud (that’s what I used to call inflation, before I became a central banker).”

“Oh. What do you mean?”

“If each unit of paper currency in your hand is redeemable for gold, then each holder of paper units has the power to hold the government accountable for its fiscal and monetary policy. If the government prints too much money to pay for its spending programs, unit holders can redeem their paper for gold. This draws down the governments stores of real gold, forcing it to either reduce the supply of paper money, or lose all its gold.”

“Why would it worry about that if it could just print more paper?”

“Because paper is not money. And your trading partners will not accept your paper if it is not backed by either real money or the ability to collect taxes from your people.”

“I’m not sure I follow. Back up a bit for me.”

“Okay. Back when everyone was on a gold standard, before the Great Depression, international accounts were settled in gold. It wasn’t just citizens who could demand gold for their units. Nation states could do it to. Governments who ran up fiscal imbalances would see international holders of their currency redeem those paper units for real gold. This encouraged a kind of competition among nation states, or at least a kind of accountability. If you ran up deficits and borrowed a lot of money, gold flowed out to pay your creditors and to pay for your exports. Your inflationary monetary policy cost you your national inventory of gold and silver.”

“So what happened?”

“My you ask a lot of questions.”

“Hurry up. I think I have to wake up soon.”

“Well, under a gold standard, governments are forced to manage their monetary system for the benefit of their people. You get a stable price level because the value of the money is not fluctuating constantly with changes in the money supply. Governments want to avoid causing a run on their gold supply that would result from fiscal and monetary mismanagement.”
“Why did the world go off the gold standard if it was so good? What changed?”

“Lots of things. For example, with a gold standard, governments and people must live within their means. This is deeply unpopular with politicians, who must bribe populations with bright new shiny things to get elected. Gold makes it harder to bribe your people and win an election.”

“Okay. What else?”

“For whatever reason, perhaps because it is in their nature, governments like to take their people to war. It keeps them distracted from other problems, usually caused by the government. But war is expensive. To pay for a war you must increase taxes or borrow money. If you increase taxes (directly or indirectly) you risk alienating your population and causing a tax revolt (and sending a lot of economic activity underground, out of the view of the tax collectors). So you have to borrow. It’s the only way to greatly expand spending without raising taxes to punitive or socially disruptive levels.”

“Ah. I see. Under a gold standard, you couldn’t borrow excessively without causing a run on your nation’s gold. So…a gold standard was a natural constraint on a nation’s ability to make war.”

“Yes. That doesn’t mean nations didn’t go to war before there was a gold standard. It just means that if you had to pay for your war with real money, it made it an expensive proposition. And if it undermined the value of the currency your citizens held, they were unlikely to support you. In a monarchy or dictatorship, that doesn’t matter so much. But in a democracy, it matters a lot.”

“If what you’re saying is correct, Maestro, then there’d be a clear connection between the creation of fiat money which is not backed by gold at all, and war between nation states.”

“There might be. But you’re still thinking too small.”

“What do you mean?”

“It’s true that most nations suspended the gold standard upon entering World War I. This allowed them to run up ruinous debts to private bankers. They tried reinstating it, but then the Great Depression hit. And more than ever, governments needed the ability to print money to pay for domestic ‘wars’ on poverty and unemployment.”

“Right. And then World War Two-which was partly a consequence of the ruinous debt and reparations Germany could not repay-came along and you saw a huge explosion in government debt, this time mostly through bonds.”

“That’s right. Which brings us back to inflation today. When the government finances exploding debts through the issuance of new bonds, investors typically demand higher interest rates to compensate for the inflation that results from the increase in the money supply. But today, in a kind of conundrum, bond investors are not demanding higher interest rates.”

“Why not?”

“Who knows? For one, they don’t see inflation. They see falling prices that come with a collapse in global demand. But it could be that they fear the worldwide recession more than they fear inflation. The contraction in global trade and national GDPs has investors fleeing for the safety of bonds. This allows governments to print money and expand the monetary base with apparent impunity.”

“Apparent?”

“Yes. Why, there in Australia where you’re sleeping, the government is going to announce a budget in May which may include a $50 billion deficit. This is a country that had a surplus just a short time before.”

“That’s not as bad as my home country. In the U.S., the government is going to run a trillion dollar deficit this year. And it’s told everyone that number will double. But it doesn’t seem to have dented demand for U.S. bonds yet.”

“No, it hasn’t. And that’s because without a gold standard, governments don’t have to compete for capital as fiercely as they used to. They can all sell bonds to investors to finance deficits, provided the deficits aren’t too jaw-dropping and provided they can continue to collect taxes to pay interest on the debt. Plus, they’re colluding with one another to eliminate tax competition among countries, which gives them an even stronger grip on your wealth.”

“I’m with you Maestro. But I don’t see where this is going.”

“Let me show you. Governments can only raise direct taxes (income taxes) so much before it negatively affects the economy (and social cohesion), which in turns lead to falling tax revenues as real economic activity slows. So a sure sign of governments that are getting desperate for revenue is an increase in indirect taxes.”

“You mean like the alcopops tax here in Australia?”

“I’ve never heard of that. But if it’s a tax that the supplier of a good or service passes on to the consumer then yes, that’s exactly what I mean. It’s an efficient way for the government to raise revenue without looking like it’s being grubby, desperate, or just plain greedy. It can also claim the taxes are being raised to discourage socially undesirable behavior, but this is generally just a lie to disguise the need to raise revenues.”

“Ah. I see. You know the alcopops tax is illegal anyway, by the way. The government collected revenue on a tax using a law that hadn’t been properly been passed by the Parliament. How is that possible? What about the Rule of Law?”

“What about it?”

“Never mind. You need to finish your lecture before I wake up. When will inflation result from the large increase in the monetary base?”

“I have no idea, my boy. You see at its core, fiat money greatly accelerates the rate at which scarce resources are depleted. Land, labour, capital, and raw commodities are allocated based on a demand that isn’t sustainable. If you do that long enough-let’s say for the last seventy years or so-you get an entire global economy (and population) that exists because of the increase in credit. That’s the world we live in. And it’s all falling apart with the credit depression you’ve been writing about.”

“Wait a second Maestro. Are you saying that the scope and scale of this economic contraction is a lot greater than anyone expects because the fiat money system itself is failing?”

“You said it. Not me. But it does make sense to say that the last twenty years or so of building national economies around the growth of residential real estate and the finance sector has greatly hastened us to a day of reckoning, as your friend Bill Bonner might say. We will find out if all that investment made by banks is merely ‘temporarily impaired,’ or if it represents an enormous misallocation of our collective resources and has made us poorer for years to come.”

“So what should we do?”

“This is your dream. You decide.”

Regards,
Dan Denning

April 16, 2009

Dreams of the Maestro, Gold and Inflation was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

First, let’s consider a bit of history. Money was originally just coinage rather than currency, as the root of the word (and of the word mint) is Moneta, from the name of a temple that was used as a mint in ancient Rome. Coins throughout history have mostly been made of silver and gold. These have natural qualities that are appropriate for money, being durable, divisible, universally recognizable, of high rarity and of high intrinsic value due to their attractiveness for artifacts. It was only later when rulers got strapped for cash, they started producing ‘money’ that was not made from silver or gold – pretend money if you like. The paper versions were, in effect, credit notes for proper money, or currency. This word comes from the Latin currere, meaning to run or flow. And how it does run and flow nowadays – off the printing presses and down the fibre-optic cables! Of course it may simply refer to the way currency facilitates the flow of trade. Paper currencies are described as fiat, deriving from ‘an official sanction or decree’, from the Latin ‘let it be done’. Meaning that it’s worth something because the Government or ruler says it is. Its inherent worth is negligible, and so its value is entirely dependent on confidence and acceptance by the populace. In fact it is mostly dependent on the confidence of a few currency traders, and how they react to unfolding events. Fiat currencies are always over-printed, so they are not a very sound basis for an economy in a mature civilization. So what are the options after the dollar is worth only pulp and scrap value?

The obvious option is partial backing of one currency with gold, as with the dollar before 1971, when 25% of the money supply was allegedly backed. The new reserve currency would not necessarily be the dollar, because after a dollar crash people probably wouldn’t want anything to do with them, and America would not be seen as economically reliable. The Euro, Renminbi, or perhaps a new currency issued by the IMF are possibilities. Whichever currency it was, a problem with partial backing is that it allows room for sliding – why not 20%, or 15%, ‘just to get us through these hard times’? And without policing, we could not be sure that too much money was being printed compared to the gold reserves. Backing of only one currency perhaps gives the relevant country too much power and influence, as we have seen with the dollar, which even with its unbacked reserve status has allowed America to rack up huge debts at the expense of other countries. Having only one currency backed by gold, or indeed other precious metals, is that the other currencies are still at risk of having to be revalued and of being over-printed. Partial backing also allows uncertainty in the event of a collapse in confidence, as not all holders of the currency could redeem their money for precious metals.

100% backing would get round these problems, rather like the ‘Liberty Dollar’ currently in use in America, which is 100% backed by silver. This system does not allow the kind of over-lending and inflation problems that we have seen in recent years. Hardly anyone, except in times of economic crisis, would in reality bother redeeming their currency for metals, apart from those needing them for some practical use – the important thing is that the metals are there to back the currency. Having all currencies fully or even partially backed would bring more global stability, but this would need policing, and it would be difficult for countries starting off with small reserves of metals. This system would also tie up most of the world’s precious metals in bank vaults, creating shortages for their many real-world uses.

If all currencies were 100% backed by precious metals, you’d have to wonder why you were bothering, and why you didn’t cut out the middleman and just use the precious metals directly. This is the most honest and trustworthy system, and no doubt would be welcomed by many people whose wealth during a future meltdown had been destroyed by inflation. However, using precious metals directly is not without its drawbacks.

There is the age-old problem of forgery. In this day and age it would be no doubt be possible to produce highly convincing coin forgeries to pass off in everyday use. However, coin weighing machines are already widely in use, and it should not be too difficult to make these a little more sophisticated so that they can measure density and determine whether or not coins are genuine, and for every outlet to use one for all transactions. Measuring of electrical conductivity to a high degree of accuracy might also be informative. And in any case, it’s not as if paper notes can’t be forged is it?

There is also the problem of fluctuation in the value of the metals, which in the past has led to coins going out of the country, but this is a problem only if other countries are not using precious metals as currency and buy up your good coins with their rubbish. In any case the exchange rate should reflect the value of the metals. A more difficult problem is if the relative values of silver and gold move substantially, then people start hoarding the more valuable coins, or selling them for scrap. This can be got round by just using one precious metal directly – obviously silver – or effectively having separate currencies in the different metals. This would mean that you would not have a fixed relationship between different metals as in the past, such as 1 gold unit equaling 30 silver units equaling 3000 copper units. The relative values would change with the markets, so prices of goods would be in a combination of metals such as 5 silver 650 copper. If you required change the retailer would have to check the latest relative market prices of metals before knowing how much to give you, and this could be automated on tills of course. Actually, for practical purposes you would probably need to use an alloy rather than pure gold in coins, to make them more hard-wearing – as is current practice. This would complicate any valuations, but again it could be automated.

Another problem, or rather inconvenience, is the weight and bulk of coins as opposed to notes – but  a benefit is that this also makes money more difficult to steal. And you would still have cheques, bankers’ drafts, credit and debit cards and electronic transfers for convenience. You could even have a hybrid system of large-denomination notes, fully backed by reserves of metals of course. The trend is in any case for most transactions to be done by card – it would just mean the banks would periodically have to physically send bullion to each other to settle up.

Notwithstanding the above, the big problem with any system involving precious metals is that in the 38 years of free-for-all since the gold standard was abandoned, the money supply has grown astronomically. Replacing fiat notes and electronically-recorded currency would show up how little these are worth in terms of the precious metals reserves of the issuing country, and would require extremely small gold or silver coins for buying everyday items. Let’s take the dollar as an example. In 2006 the figure for the M3 dollar supply was $10.3 trillion, but since then the Fed has stopped publishing figures on this to try and hide how much money it is printing. However, others have been keeping tabs on it, and reckon it is now about $15 trillion. America probably had a sneaking suspicion that it would eventually have to go back to a gold standard, as it has hung onto reserves of 8,133.5 tonnes (261.5 million Troy oz). This is much more than any other country, but doubts have been expressed as to the veracity of the figure. Anyway, this is worth only about $250 billion at today’s prices (gold is at $950 as I write). For the national gold reserves to be worth the current M3 figure, gold would have to be worth about $1844 per gram or $57,361 per ounce! Put another way, each dollar is backed by just 542 millionths of a gram (micrograms, or µg) of gold. A few grains of gold dust. You could even argue that US Dollar Bonds, Treasury Bills and Notes all represent real dollars, so should be counted. These would take the ‘money’ supply many trillions higher, and push the gold price into the stratosphere.

Ignoring this, even with the M3 figure, the dollar would have to be drastically devalued in order for gold or silver coins to be usable for everyday items. The smallest usable silver coin would weigh about 2g and be about ? of an inch across, and at current prices ($13) it would be worth about 84 cents. However, if the price of silver were to rise in line with gold as above, i.e. sixty-fold, a 2g coin would be worth about $50 in today’s money. The modern dollar coin weighs 8.1g (0.26 Troy oz), and to have a silver version at the same weight at the increased value it would be worth about $204. A Silver Eagle, (which has a face value of a dollar, so is probably what we should be aiming for!) weighs 31.1g (1 Troy oz), and would be worth about $780 in today’s money. A sixty-fold devaluation of the dollar against precious metals is an indication of how false its current value is, but far worse things have happened in pre-war Germany and in modern Zimbabwe. And this is conservative, because silver could be expected to rise faster than gold as it would be the more affordable investment, probably eventually reflecting its 15:1 ratio of rarity to gold in the Earth’s crust. As for gold coins, gold is currently about 70 times the price of silver. It is about 80% denser than silver so the smallest coin would have to be about 3.5g with a value of about a hundred re-valued dollars. Base-metal coins would make up denominations of less than a dollar of course.

If we were looking at just backing the M3 with the gold reserves rather than directly using the gold as coins, the basic unit of money would have to be as low as a milligram of gold. As all of the world’s economies and currencies would be devastated by a dollar meltdown, a fresh start might be needed, and the Gold Milligram could potentially become the standard world currency. It would currently be worth $1.84 on the basis of it being fully backed by the stated US gold reserves. As a milligram of gold is impractical to handle there would presumably have to be a minimum value of currency, say a gram, that could be redeemed for gold!

Of course, if one or more Governments sought to back their currencies with gold, they would seek to increase their gold holdings dramatically so that they could maximize the value of each unit of currency. The price would rocket, and we would see the widespread melting-down of less important artifacts, and no doubt the passing of laws, ‘in the national interest’, like Roosevelt’s 1933 Gold Confiscation Order banning the private holding of gold for investment purposes. Gold mines would be nationalized. Prices would be so astronomical that the other precious metals – silver, and possibly platinum and palladium – would be dragged along too, and might also come into use as standards. Even copper’s status and price could be elevated. However, the rise in precious metal prices could mean no more catalytic converters, gold fillings and wedding rings. The cost of electronics would rocket due to all the silver electrical contacts that they need. These are good reasons for having just one strong currency backed just by gold, with the other currencies pegged to it. However, this would still leave leeway for the other countries to grow their money supplies and cheat people. Ultimately it’s difficult to shake off the attractiveness of money just being simple and incorruptible gold, silver and copper coins everywhere in the world. Indeed, after a dollar crash it might be a long time before people trust paper money again.

However, it’s also difficult to see Governments giving away ‘their’ hoarded gold to people they see as peasants in exchange for their worthless fiat notes, so my money is on a cosy agreement between Governments for the IMF to create a new fiat currency that everybody has to use. How they would allocate it is another matter.

Sincerely,
David McCabe

April 7, 2009

After the Dollar was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.