Page 1 of 2 Gold - the true standard
By Antal E Fekete
The following is a transcript of an interview requested by a gold-friendly hedge
fund.
Q: Professor Fekete, you are known as a staunch advocate of a
return to the gold standard. But mainstream economists are saying a gold
standard is not practicable and they are fighting the idea with everything they
have. How do you answer their criticism?
Antal Fekete: To say that the gold standard is not practicable is
the same as saying that honesty is not practicable, and constitutions are made
to be blithely ignored when convenient. The American constitution, for example,
mandates a metallic monetary standard for the United States in the clearest
possible language. Opponents of the gold standard have never been able to
muster up the moral fortitude to amend the constitution so as to formalize the
abolishing of the gold standard. Yet in 1933, president Franklin D Roosevelt
confiscated the gold of the citizens, gave them irredeemable paper in exchange,
and proceeded to write up the value of gold in terms of the paper by 75%. Might
makes right: if you cannot do it fairly and legally, then you can use the
strong arm of the government to do it through chicanery, backed by the
constabulary and the jail cell.
More recently, in our own century, Switzerland changed her constitution in
which the gold standard was also enshrined, through a referendum. Citizens were
given a weekend to debate and decide the merits or demerits of the proposed
constitutional changes. The indecent haste with which they were railroaded
through the constitutional process betrayed the bad conscience of the authors.
One of the key principles supporting a gold standard is that jurisprudence
cannot tolerate a double standard of justice. The government, its departments
and agencies ought to be subject to the same contract law as are citizens.
There are no valid grounds to allow the Treasury and the central bank to issue
obligations which they have neither the means nor the intention to honor -
while everybody else doing it will be dealt with according to the criminal
code. To say that the gold standard is not practicable is the same as saying
that the government should be exempted from the provisions of the criminal code
in its dealings with its subjects.
Q: What would be the basic steps involved in reintroducing a gold
standard? How to proceed?
AF: Three indispensable steps are involved.
First, the government should open the Mint to gold. This means that everybody
who wants to convert his gold of the right quantity and quality into gold coins
of the realm should be able to do so at the Mint, free of seigniorage charges,
and with no limit imposed on the amount. In other words, they would get gold
back, ounce for ounce, in coined form, and the cost of minting would be
absorbed by the government, the same way as it absorbs the cost of maintaining
highways in good repair. Conversely, owners of the gold coins of the realm must
have the right to hoard, melt down, or export them as they see fit. them as
they see fit. This is designed to vest the right to regulate the money supply
in the people, rather than in unelected bureaucrats.
Second, "legal tender protection" of paper money must for once and all be
declared unconstitutional. This is designed to remove coercion whereby labor
can be forced to accept irredeemable currency for services rendered.
Such coercion was first legalized in France and Germany in the year 1909, just
five years before the outbreak of World War I. These countries wanted to make
sure that civil servants and military personnel could be paid in chits, thus
putting the entire labor force at the disposal of the government - regardless
of the state of budget and collection of taxes - in case of war. The motivation
behind the second provision is that governments should not be able to wage
undeclared and unpopular wars, as could kings of old, but must raise taxes.
World War I would have come to an early end but for the legal tender laws. As
soon as treasuries had run out of gold, the belligerents would have been forced
to make peace, unless the electorate agreed to pay for the continuing bloodshed
and destruction of property. And the world would have been the better for it.
Third, the principle known as the "Real Bills Doctrine" of Adam Smith should be
observed. Bills of exchange drawn on fast-moving merchandise in most urgent
demand by the consumers, which mature into gold coins within 91 days (the
length of the seasons of the year), must be allowed to enter into spontaneous
monetary circulation. This would guarantee the flexibility of the monetary
system not through government coercion, but through the voluntary cooperation
of producers and consumers in satisfying human wants.
It can be seen that the market for real bills is the clearing house of the gold
standard. In 1918, at the end of World War I, the victorious allies decided not
to allow the world to go back to multilateral international trade. To be sure,
they wanted to go back on the gold standard, witness Great Britain’s decision
to make the pound sterling once more convertible into gold at the pre-war
exchange rate in 1925, but with only bilateral trade allowed. This meant
nothing less than the castration of the gold standard: once its clearing house
was amputated, it could not perform.
The allied powers did this out of spite and vengeance: they wanted to cripple
Germany over and above the provisions of the Versailles peace treaty. Forcing
bilateral trade upon Germany was equivalent to peacetime blockade whereby the
allied powers could monitor and control Germany’s imports and exports. The
measure backfired. The Great Depression and the 1931-1936 collapse of the
international gold standard was due to the forcible elimination of the
multilateral financing of world trade with real bills.
The gold standard did not collapse because of its "contractionist nature" - as
alleged by John Manyard Keynes. It collapsed because its clearing system, the
bill market, was blocked. Falling prices in 1930 were not the cause of the
Great Depression: they were the effect. The cause was falling interest rates.
Incidentally, falling interest rates were in turn caused by the illegal
introduction of "open market operations" by the Federal Reserve of the United
States in 1921, whereby the central bank pays bribe money, in the form of
risk-free profits, to bond speculators for bidding bond prices sky-high.
Q: To what extent should money be "covered" by gold?
AF: The Real Bills Doctrine provides the answer to that question.
There are on average 75 business days in a quarter. Therefore on each business
day, on average, one-seventy-fifth, that is, 11/3 percent of the outstanding
real bills mature into gold. Sufficient gold must be available at all times to
pay the bills at maturity; more if the discount rate is rising, less if it is
falling.
In normal times the commercial banks should have that much gold flowing to them
in the ordinary course of business, with which they can pay the maturing bills.
If times are abnormal, banks go to the bill market and sell at a discount a
sufficient amount of bills from portfolio to raise the gold. This should be no
problem: a maturing real bill is the best earning asset a commercial bank can
have. At any given time there are commercial banks somewhere in the world
overflowing with gold. They scramble to acquire earning assets. The value of
real bills increases every single day through maturity. They represent
"self-liquidating credit". Sale of the underlying merchandise to the ultimate
consumer provides the wherewithal for their liquidation.
Q: What happens if a country has no gold in its coffers?
AF: Such a country will experience a rise in the discount rate.
The appearance of a positive spread between the discount rates prevailing in
two countries improves the terms of trade in favor of the one with the higher
rate. It can offer lower cash prices on its exports, while paying lower prices
(91 days net) for its imports. This means that the country gets the gold for
its exports 91 days before its bills payable in gold for its imports fall due.
In addition, the higher discount rate will induce an inflow of short-term
capital that will help finance both exports and imports. We have to remember
that imports are financed by exports, not by gold. Gold is there to tie the
country over through temporary imbalances.
Should this help not be sufficient to meet the shortage of gold, then
consumers, if they want to eat, to keep themselves clad, shod and, in winter,
warm, will have to dig into their pockets and come up with the gold coin to pay
the bills for their imports upon maturity.
The point is that a shortage of gold need not cause privation: thanks to the
discount-rate mechanism it is a self-correcting condition.
Q: You have announced that in August you will start a school, and
call it the New Austrian School of Economics, in Budapest, Hungary. Why new?
Why Austrian? Why in Hungary?
AF: The Austrian School of Economics was started by Carl Menger
(1840-1921) of Austria-Hungary who deserves the epitaph, along with Isaac
Newton, humanis generis decus (pride of the human race). The first
members of the school, like Merger himself, were all great monetary scientists
who abhorred the idea of irredeemable currency. Keynes introduced the notion
that the gold standard is a "barbarous relic" and should be discarded. Through
bribe and blackmail academia was enlisted to rally to the new doctrine, while
the Austrian School withered.
With the intellectual bankruptcy of Keynesianism - which turned things upside
down in castigating the virtue of thrift and lionizing the vice of prodigality
- become obvious, the Austrian School has gone through a renaissance,
especially in the United States, calling for sanity and return to the gold
standard. However, the "American Austrians" are vehemently against the Real
Bills Doctrine of Adam Smith for doctrinaire reasons, as it contradicts their
holy of holies, the Quantity Theory of Money. They do not understand that real
bill circulation is spontaneous and its suppression is nothing less than
unwarranted interference in the operation of the free market. They do not see
the difference between the discount rate (yield on real bills) and the rate of
interest (yield in the gold bond).
This prompted me to start my school in Hungary where I live. It would be a
disaster if the American Austrians succeeded in making their "100% gold
standard" a reality. It would not survive the first Christmas shopping season.
Markets would seize up, and the gold standard would be given a bad name for the
second time.
Austria and Hungary used to be a dual monarchy during the days of Carl Menger,
sharing not only the monarch, but also their scientific and cultural heritage.
Q: Why a gold standard? Why not pick a basket of precious metals,
or of some other marketable commodities to serve as the standard unit of value?
AF: American money doctors are in the habit of ridiculing gold in
comparing it to frozen pork bellies that, horribile dictu, have been
trading in the same pit since gold was expelled from the monetary paradise.
This reflects a mindset suggesting that gold, at best, is just one of several
marketable commodities, and a basket of wider selection could provide a better
monetary reserve than gold.
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