“..when you recall that one of the first moves by Lenin, Mussolini and Hitler was to outlaw individual ownership of gold, you begin to sense that there may be some connection between money, redeemable in gold, and the rare prize known as human liberty.
by DETLEV
SCHLICHTER
It is my
conviction that the central problem with the present system is the high degree
of elasticity of the money supply. A system of constant fiat money expansion,
of ongoing injections of new money into the economy via financial markets –
sometimes slow, sometimes fast – must systematically distort interest rates and
disarrange saving and investment. This will lead to capital misallocations and
the mispricing of assets. As these distortions are systematic, the resulting
dislocations are bound to accumulate over time and thus progressively
destabilize the economy. Elastic money is suboptimal, unstable and
unsustainable.
The point is not
that a gold standard is perfect or ‘perfectly efficient’ or even free of any
disturbances or disruptions. The point is simply that by fading out gold as a
fairly inelastic basis of the monetary system and replacing it with essentially
fully elastic and unlimited fiat money, as happened around the world in the
period from 1914 to 1971, we have made the financial system and by extension
our economies substantially more unstable. While the system can appear stable
on the surface for extended periods, the economy is constantly accumulating
imbalances that will finally unhinge it.
The present debacle – characterized by excessive debt, an overstretched and out-of-control financial system, overextended banks, a plethora of asset bubbles, again on a global scale – is the inevitable outcome of our decision, 40 years ago, to abandon a gold anchor completely and go for unrestricted fiat money. The system is presently being kept going by ever more aggressive money injections (in particular base money into the banking system) and other state interventions, but I firmly believe that it is in its endgame.
“Fully flexible”
and “unlimited” sound like a crazy ‘free-for-all’ but, of course, that is not
what it is. The full flexibility to create any amount of money and inject it
into the economy is a unique privilege in our post-gold-standard system that
rests with the state and that is entrusted to the central bank bureaucracy.
“The U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost…”
In moving away
from gold, we have replaced the discipline and apolitical rigorousness of hard
money that is the very foundation of a private property economy and a free
society with full monetary flexibility in the hands of the state bureaucracy.
He who has the power to print money can set interest rates, manipulate the
credit markets and influence all sorts of asset prices. In fact, he cannot not do it. It is clear that by moving from gold to
fiat money, we have abandoned a key pillar of capitalism and have adopted a
form of monetary central planning.
Looked at the
problem from this angle, my assertion that the present system will lead to
ever-larger misallocations of capital, to ever-larger economic distortions, and
that it must ultimately collapse, does not seem far-fetched at all. It is the
fate of all systems of central planning and systematic market distortions. Just
as the communist Soviet Empire collapsed under the weight of its inherent
economic contradictions so will the system of politicized fiat money.
Gold and freedom
Central planning
is not only rejected on grounds of its economic inefficiency and
unsustainability but also rightfully despised for its inherent conflict with
human liberty. Critics of paper money and central banking have always stressed
that a gold standard is not only an effective counter against excessive risk
and thus a guarantor of stability but also a guarantor of freedom.
“In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. …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 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.”
An equally
impressive document is the 1948-article by Howard Buffett, Congressman from
Nebraska, entitled “Human
Freedom Rests on Gold Redeemable Money”:
“..when you recall that one of the first moves by Lenin, Mussolini and Hitler was to outlaw individual ownership of gold, you begin to sense that there may be some connection between money, redeemable in gold, and the rare prize known as human liberty.
There is no more important challenge facing us than this issue – the restoration of your freedom to secure gold in exchange for the fruits of your labors.”
(Howard Buffett was a man of the Old Right in the US, a friend of anarcho-libertarian Murray Rothbard, and the father of billionaire oligarch Warren Buffett, who is today an outspoken critic of gold, an advocate of government bailouts and the willing poster boy for America’s tax-the-rich-more campaign.)
While my
criticism of fiat money is strictly economic and focuses on the fundamental
unsuitability of elastic money for capitalism, it is essentially congruous with
the political objection to fiat money based on considerations of human freedom.
Both aspects are two sides of the same coin. Therefore this forms one
consistent anti-fiat-money position: The present system is a system of
persistent state interventionism in markets that, very similar to socialism,
leads to grave distortions and ultimately economic chaos. It is incompatible
with a free society and a market economy.
The populist view:
Unchecked markets are at fault
Now let’s look
at what I would describe as the conflicting, at least superficially conflicting
view of what is wrong with our financial system. This view is widespread among
the general public today, it heavily influences the discussion in the media and
it goes something like this:
Is it really
true that we have too-much state involvement in finance? Do we really have some
form of monetary central planning? Does this view not completely underestimate
the power of the big private banks? When one looks at the gigantic positions
these private banks have on their balance sheets (and the even bigger positions
they have ‘off balance sheet’), and when one looks at the outsized bonuses the
bankers pay themselves, and when one furthermore considers that most money-creation
is done by the private banks, then it appears as if ‘central planning’ or ‘the
power of the bureaucracy’ appear inaccurate descriptions of the present system.
J.P. Morgan just admitted to losing $2 billion and counting on complicated
derivative positions. How can that be the fault of central bankers or imaginary
monetary ‘central planners’? Isn’t this the opposite of central planning? Is
this not capitalism running amok? Maybe we need more regulation and more
control by the state authorities. Is the main threat to our economic wellbeing
really a too-powerful central bank, or is it not really a private banking
system that is run for the benefit of the bankers rather than the ‘real’
economy and that may collapse as a result of uncontrolled speculation? Our
system doesn’t look like grey and boring Soviet-style central planning at all
but more like flamboyant capitalism spinning out of control. And by going back
to a gold standard would we not restrict the power of the central bank to save
us from the mistakes of the bankers? Bringing back gold and restricting the
maneuvering space of central bankers will make things worse.
The way I
described the populist view here contains observations and conclusions. I
believe the conclusions to be largely incorrect. They may appear intuitively
sensible but they do not stand up to closer scrutiny, in my opinion. However,
there is no denying that many of the observations that form the basis of this
popular view are evidently correct. It is my goal with the following to show
that there is no logical conflict between these observations and the critique
of fiat money as a form of monetary central planning developed above. In fact,
all the symptoms that the populist view concerns itself with and that form the
basis of the widespread public anger – the apparent detachment of global
finance from the real economy, the outsized and uncontrollable derivatives
market, the bonus culture and the instant claims of the private banks on
unlimited bank reserves and unlimited bailouts – all have their origin in the
decision to abandon the gold standard and replace it with unlimited fiat money
under state control. And my hope is that once this connection has become clear,
more of the system’s critics will see that the cure is not more power to the
bureaucracy and more regulation and controls but simply a return to hard money
and thus a return of a system that is controlled, not by bureaucrats and
bankers, but by the consumers of financial services.
The power of the
consumer
In capitalism,
in a truly free market, the consumer decides what is being produced, how
resources are allocated, and who makes profits and who doesn’t. By buying from
some and not buying from others the consumer ultimately directs production,
economic activity and the use of scarce resources. Under capitalism the
consumer decides how capital is deployed. Our problem is that today we have no
capitalism in finance, and the reason for this is quite simply the abandonment
of a gold standard and the establishment in its place of a system of unlimited
fiat money and of central banking.
In order to
build my argument I will solicit help from an unusual source: Paul Krugman.
Paul Krugman
recently debated
Congressman Ron Paul on TV. Ron Paul
started by making the case I elaborated above, that in our system interest
rates are set by a state agency and the supply of money is determined by a
state agency; that this is some form of price fixing and economic management by
the state, which has never worked and is incompatible with a free market
system.
Paul Krugman
started very poorly. He simply claimed that “you cannot leave the government
out of monetary policy”, and that the “Federal Reserve will always be in the
business of setting interest rates”. Evidently, this is nonsense. We can
discuss whether these arrangements should prevail or not but to claim that
there is some inevitability about them is gibberish. Before 1913 there was no
Fed but yet there was interest rates and lending and borrowing and growth and
jobs and markets. To claim that in the field of money the state simply has to
set prices is hogwash, and it exposed Krugman again as a close-minded statist.
However, then
Krugman made a statement that was interesting, essentially correct and that I
will use as the basis of my further argument. He said that money was more than
just pieces of paper with pictures of dead presidents on them, that the
distinction between money and non-money wasn’t clear but that there was a
continuum, and that we didn’t even know what money was. I think these are
important points, but if we think them through we come to conclusions that are
not in support of Paul Krugman’s monetary statism but in fact support
Representative Paul’s aversion to state paper money.
What is money?
Gold and silver
have been used as money in the form of coins for 2,500 years. ‘Modern’ finance
started with the rise of banking, roughly 300 years ago. Banks have never
really confined themselves to just taking deposits and making loans but, pretty
much from the start, have been in the business of creating money, a business
that they invented. Of course, money proper was still gold or silver, and those
could not be created by banks, but banks issued what I will call money derivatives. Think banknotes or bank deposits. As
these were not gold or silver they were not money proper but they were usually
claims on gold or silver, and they began to circulate in the economy and were
used by the public as if they were money proper. Of course, if all money
derivates in circulation had been fully backed by gold or silver in the banks’
vaults (i.e. by gold and silver that is not presently in circulation) then the
supply of what the public uses as money would not have expanded and the banks
would not have become money producers. But as we all know, banks quickly
managed to issue money derivatives that were not backed by gold or silver, or
at least not fully backed by gold or silver. To the extent that the public
accepted uncovered money derivatives as money, the banks had indeed a license
to print money, and this allowed the banks to extend more loans and make more
profits. But the operative words in the previous sentence are “to the extent
that the public accepted”. The consumer of finance, in particular the
depositor, decided to what extent bankers could become money producers. If
depositors became uncomfortable with the practices of their banker, they no
longer accepted his money derivatives but instead removed their deposits and
placed it with somebody else, or simply held physical gold and silver again.
The consumer had the power to pull the plug on the bankers.
In defense of bank
runs
What was money
and what was not money had, with the arrival of deposit banking and
fractional-reserve banking, become a somewhat fluid concept, and it has
remained such ever since. It has become subject to change. There is, in the
words of Krugman, a continuum. But under a gold standard, what was accepted as
money was ultimately decided by the public. The license to print money could be
revoked by the depositors at any time. That put the banker in a perilous
position. Being a money creator was lucrative but it placed the banker at the
mercy of a fickle public. There was always the risk of a panic and a bank run.
Now, who
would be in favor of bank runs and panics? Are they not a sign of a potentially
irrational and panic-prone public that fails to make wise decisions in its own
best interest? — That is today the generally accepted view, I guess. But the
prospect of bank runs is also without question a drastic form of consumer
power, of capitalism’s essential checks and balances. The risk of a bank run,
of the public’s sudden loss of faith in the prudence, reliability and solvency
of a banker, is a powerful check on the banker’s risk-taking and overall
business strategy. Not surprisingly, prior to the arrival of lender-of-last
resort central banks and unlimited fiat money, banking seemed to have attracted
a very different type of individual than it does today. Bankers were (because
they had to be) conservative and extremely concerned with a public appearance
of restraint, prudence and the utmost reliability. No macho-talk about ‘global
business opportunities’, of market share and high ‘return on equity’ here.
Power shifts from
the depositor to the bureaucrat
Enter the
central banks. This is what Milton Friedman and Anna Schwartz had to say in
their seminal bookA Monetary History of the United States about the
founding of the Federal Reserve:
“The Federal Reserve System was created by men whose outlook on the goals of central banking was shaped by their experience of money panics during the national banking era. The basic monetary problem seemed to them to be banking crises produced by or resulting in an attempted shift by the public from deposits to currency (currency meant specie at the time, DS.)”
This ‘attempted
shift by the public’ was none other than the sovereign consumer deciding that
there were now too many money derivatives around and that he now preferred to
hold money proper again, i.e. gold. It was apparently deemed okay for the
consumer to shift from currency (gold) to deposits, thereby widening the
definition of what was accepted as money and thus allowing the banks to create
more of it. But, so the founders of the Federal Reserve System decreed, it was
not acceptable that the consumer would ever narrow the definition of money
again and reduce the banks’ ability to place more money derivatives. The state
thus entered the scene in order to protect the banks from changing preferences
of the public, at least those changes in preferences that were bound to limit
money creation and credit expansion.
You may say it
was good of the Fed to reduce the risk of bank runs and make banking safe. That
is the standard interpretation today. (By the way, the Fed has neither made the
economy more stable nor banking safer, as George Selgin demonstrates nicely in this
excellent presentation.) However, the
good economist does not just look at the immediate and most obvious
consequences of policy but also at the long run consequences. There is no
escaping the fact that the establishment of a central bank as a backstop for
the banks’ production of money derivatives was the starting point of a process
of disenfranchisement of the depositor as ultimate controller and arbiter of
what is money, of how much there should be of it, and of what makes good and
prudent banks. The power of the depositor, the consumer of banking, was
weakened, and the power of the central banker, the bureaucrat, as ultimate
judge of what is money and what is good banking was strengthened. The bond
between banker and depositor was starting to be replaced with the bond between
banker and central banker.
It is clear that
the interests of banker and bureaucrat were closely aligned and both pointed
toward ever more money production. The banker wanted to conduct the lucrative
business of creating and placing money derivatives with the public without the
risk of sudden changes in consumer preferences. The state officials wanted to
encourage monetary expansion as this was deemed to be good for business and
because the state itself was of course an important borrower. It is hardly
surprising that with the advent of central banking and later unlimited fiat
money, state borrowing began to expand.
The score at
this point: Bankers/bureaucrats 1 – Consumers 0
There is no such
thing as a free lunch. While that is a famous and very fitting quote of Milton
Friedman’s (1912-2006), it is Ludwig von Mises (1881-1972) who the bankers and
central bankers of the 1920s and 1930s should have listened to. The
money-induced credit boom of the 1920s ended in the crash of 1929, and although
the public had accepted more money derivatives during the boom as these now
came with a government backstop from the young Federal Reserve (and this had
made the extended boom possible in the first place), when the bust started the
consumer definitely wanted to hold money proper again, and that was still gold.
Bank runs still ensued and now were much worse than they ever had been in the
pre-Fed era, simply because the Fed had by now encouraged the issuance of
vastly more money derivatives. Although the country was officially on a gold
standard and the banks had promised their depositors repayment in gold as part
of their strategy to place their money derivatives with the public, the state
decreed that the banks would collectively default on this promise and that they
could still continue as going concerns. The state also decreed that money
derivatives were now the new money proper and in order to leave the public no
choice whatsoever – and no say in what was money or not -the state confiscated
all previous money proper (that is gold) via executive order of the president
in 1933. (In the United States of America private ownership of gold remained
severely restricted until 1974.)
History is
always written by its victors, and the victorious money statists, central
bankers and Keynesian economists claim – to this day – that this was all for
the better. It ended monetary contraction (true) and ended the Great Depression
(not quite true but it probably provided a break). But – oh those long run
consequences!
The money
consumer had been disenfranchised. What bankers could do and not do, how much
money there was in the economy and what interest rates were – none of this was
any longer a give and take between profit-seeking bankers and their banking
consumers, and thus identical in its dynamics to the relationship between any
entrepreneur and his customer, but it was now the outcome of policy. In 1953
the Chamber of Commerce of the United States published a pamphlet entitled The Mystery of Money that roundly stated: “Money
is what the government says it is.”
The bankers, by
and large, embraced this change. It was better to be in bed with the state than
the fickle public. The state had unlimited resources (almost) and could make
laws. And most important, the state was interested in constant monetary
expansion – a magnificently lucrative proposition for the bankers as money
derivative producers.
The score:
Bankers/bureaucrats 2 – Consumers 0
Closing another
loophole
Were all money
consumers disenfranchised? – No, there were still those pesky foreigners who
got hold of various forms of money derivatives through trade but who had no use
for them in their own local economies. Under the post WWII arrangements
(Bretton Woods, which was, unlike the gold standard, not a system that had
evolved spontaneously but one that was designed by the bureaucratic elite, only
to be then undermined by the same elite – sound familiar?) these foreigners
could of course hold on to their paper dollars if they so wished, or they could
send them back to the issuers and demand payment in gold. These foreigners were
therefore still in a position similar to domestic depositors prior to 1933.
They could still threaten a ‘run’ if they felt that the money producers were
using their license to print money too liberally.
This remaining
constraint on money creation was removed in August 1971 when Nixon closed the
gold window. Another group of externals, of finance-consumers outside the
state-bank alliance that had some power to pull the plug on the money monopoly,
was silenced. Now nothing stood in the way of the growing financial-political
complex to expand the issuance of money derivatives further. The government
could run budget deficits continuously; the banks could expand their balance
sheets and issue money derivatives, which now were the new money proper even
globally, to their heart’s content without having to worry too much about a
fickle public. Keynesian economists were on hand to explain to the public that
this was all to its benefit. Under the new PhD-standard (Jim Grant),
enlightened bureaucrats would guide the financial system to constant and smooth
expansion, a prospect that contrasted favorably with the official history
version of early banking when bankers had to constantly live in fear of their
irrational depositors.
Bankers/bureaucrats
3 – Consumers 0
These
institutional changes have persistently widened the definition of what is
money, they have made the supply of money ever more elastic and they have led
to a constant expansion of the money supply, naturally beyond what the public
truly demands. The vast amounts of new money could only be placed with the
public at an ever-lower purchasing power of every new monetary unit. If the
public really demanded to hold that much money, the price of money, i.e. the
exchange value of each unit of money, would not have had to decline so much.
Since 1933 the dollar has lost 94% of its purchasing power according to
official government statistics. Since 1971 82%.
Of course, I am
not claiming that the public was entirely powerless. The public can always
reduce its money-balances and keep more wealth in gold. These shifts are
particularly pronounced whenever the state-bank alliance uses its
money-printing privilege particularly brazenly, such as during the 1970s or
recently, 2001 to today, leading to drastic depreciations of paper money versus
gold. Since the closing of the international gold window in 1971, the price of
gold as measured in paper dollars has gone from $35 to $1585.
Fiat money =
disenfranchisement of the public
However, the key
point of this essay is not inflation or not even the ever-larger economic
dislocations that must result from constant monetary expansion, which is the
topic of Paper Money Collapse. The focus here is who
controls banking and finance. Who is the ultimate arbiter of banking practices
and even the size and scope of the financial industry? Again, in a proper free
market it is the public, the consumer, who decides what products are being
produced and where resources go and who makes profits. But for this to happen
in banking and finance the public needs to be in control of banking’s raw
material. That is no longer the case in our complete fiat money system, in
which the raw material is no material at all but unlimited funny money at the
full discretion of the central banking bureaucracy.
Gold means
consumer power and banking discipline. The official demonetization of gold has
severed the link between depositor as banking consumer and ultimate regulator
of banking activity and the bankers. The banker is no longer at the mercy of a
risk-averse depositor who funds the banker’s business but can demand repayment
in gold. The banker does not have to explain the soundness of his operations to
the public. As long as he can convince his superiors at the central bank that
what he does deserves the generous funding with fiat reserves, or if he
astutely figures out which assets the central bank will gladly monetize with
its printing press, or if he can simply make the case that if he goes out of
business he will hurt a lot of innocent bystanders so he is deserving of more
reserve money, he is in business. And the bankers know that the bureaucrats
will always tend to support them, to always lean toward a further expansion of
the banking industry as that means credit growth. And the state itself has
become totally dependent on persistent credit expansion to fund the welfare
state and to keep the voters happy. The state bureaucracy is a junkie who is
asked to regulate the activities of his own drug dealer.
That is why the
Occupy-movement gets it so wrong. The culprit is not capitalism because we
largely removed banking and finance from the normal discipline of a capitalist
system. In a
remarkable article for zerohedge, entitled The Real Debate on Gold and Money,
Jeff Snider, President and CIO of Atlantic Capital Management, provided a brilliant
description of the bizarre shape that our financial system has adopted:
“As long as a bank can pledge some kind of financial collateral with a central bank, that bank will remain in business, regardless of how its depositors (the public) feel about its recklessness. Indeed, most of the credit production accomplished during the past thirty years (encompassing the whole of the Great Moderation) was done by banks that have no depositors whatsoever. The Great Moderation would be more appropriately called the Great Financialization, where securities overtook the role of “reserves”, and central banks committed to unlimited funding of those reserves (to achieve a specified interest rate target, meaning a zero or near-zero interest rate target can lead to the possibility of unlimited reserve creation, but, again, the effective restraint being the supply of “quality” collateral, as defined by central banks themselves).”
The public has
been so far removed from a controlling function in finance that during the
crisis the bureaucracy went to extreme measures to keep it outside. Remember
that the US government forced private banks to accept the TARP bailout funds,
even if these banks felt they did not need government assistance and that
accepting it might tarnish their reputation with their customers. Recently,
when some European banks made it known that they had not taken any of the ECB’s
emergency LTRO funds, they were rebuked sharply by ECB president Mario Draghi.
When gold was money and the state was outside finance, the depositor was in
charge and the banker went to great length to distinguish himself from his
peers in terms of solidity and reliability. In the new Orwellian world of
government-controlled finance, all pigs are equal.
Or so we are to
believe. That the truth is different we all know. But I guess it is a case of
“You want the truth? You can’t handle the truth!” The bureaucracy knows what is
best for us.
The depositor
has still one important weapon at his disposal. He can withdraw his funds and
by using cash can remove his financial affairs from the banking system. Not
surprisingly, this last remnant of consumer power in finance is already under
heavy attack from the state. Not only has it become fairly inconvenient in
today’s world to use cash, mainly because of high nominal prices as a result of
decades of monetary debasement, but also because the state is erecting ever
more legal and regulatory barriers to the public’s transacting with the state’s
own paper money. In many countries, legal limits on cash transactions have been
implemented or are being debated. The official reason is cracking down on tax
evasion, drug dealing or terrorist funding. But once we move to a cashless
society, not only will every transaction be recorded and the state be able to
monitor every individual better, but the inability to transact outside the
established and government-controlled banking system will make the bank run
impossible. Total disenfranchisement of the finance consumer will have been
achieved.
The delusions of
bankers and bureaucrats
We, the public,
no longer know which banks are sound or even if any sound banks are left. We do
not know what interest rates would really reflect the public’s true propensity
to save and thus the real availability of resources for long- term investing.
We do not know what assets out there are still supported by voluntary saving.
We do no longer know what the proper prices of any assets are. All of these
aspects of our economies are manipulated by the ever-growing banking-bureaucracy
cartel. We know that this cartel works toward an ever-larger state-finance
complex, and we are supposed to believe that this vast complex is still being
controlled in our own best interest.
Calls for more regulation are missing the point.
Regulation only shifts power from banks to state within the anti-market
state-bank alliance but do not bring back the public and the finance consumer
as ultimate power broker into the equation. Those who only see ‘greedy bankers’
and a decline in business morals behind our present financial malaise take a
too superficial view of things. Human decency is important but the most
powerful check on greed and the most effective enforcer of sound business
practice is still the prospect of loss, which in a market economy is the result
of not serving your customers adequately. When gold was the basis of the
monetary system the depositor was the most powerful banking customer. Gold
anchored the financial system in the real economy. It was an enforcer of
discipline and of sound banking practices. In our system today, the fate of
banks, the prices of financial assets and the structure of the finance industry
are largely determined by monetary policy and the various interventions of the
financial bureaucracy. Ironically, whenever cracks appear in this new system of
monetary central planning, they lead to more intervention and thus to a further
removal of the system from the regulating forces of the market.
Bureaucrats and
bankers are equally deluded if they believe that they can continue managing
this system to their advantage, or even that this system will be sustainable.
The bankers believe they can extend the house of cards of ever-bigger balance
sheets and ever-bigger derivative positions forever with the help of zero-cost
central bank funding and limitless bailouts if things go wrong. They seem to
think that they can continue to combine the state-guaranteed security of the
post office with compensation-packages that would be suitable only for
free-market entrepreneurs. The bureaucrats believe that they can control this
overstretched edifice of debt with their various policy tools, and that by
tweaking yield curves, by massaging some asset prices higher and some interest
lowers, they can continue manipulating the real economy forever. Both are
wrong. A system that is based on central planning, on price fixing and
persistent market manipulation must ultimately collapse. Signs that this system
has already checkmated itself are accumulating everywhere around us.
In the meantime,
the debasement of paper money continues.
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