Going for Solid Gold
Momentum is building to get America back on a gold standard. Now the issue is, Which kind of gold standard?
On June 4, 1981, a bill was introduced into the House of Representatives that would give Americans choice in an area of their lives firmly controlled by government: the currency in which they buy and sell, make contracts, save for their retirement, and carry out any number of other financial transactions. Introduced by Rep. Daniel Crane (R-Ill.), the Free Market Gold Coinage Act is the latest in a series of bills endeavoring in one way or another to put the US monetary system back on a gold standard.
Advocates of the gold standard in America have made very little progress since the relegalization of gold ownership in 1975 and of gold-clause contracts in 1977. Those measures had managed to repeal President Roosevelt's gold prohibition—but not his fiddling with the gold standard, which culminated in President Nixon's severing of any gold-dollar relationship in 1971. But today, with a sitting president sympathetic to the cause, and a US Gold Commission established to look into the issue, many of those who have long counseled the anti-inflationary virtues of a gold-based monetary system have high hopes.
The US Gold Commission was created by a little-noticed provision passed by Congress in 1980. Its 17 members, appointed after President Reagan had taken office, are drawn from Congress, the Federal Reserve Board, the President's Council of Economic Advisors, and the general public, with the Treasury secretary joining in. It is due to issue its report in October. But will it recommend a gold standard?
How to nudge it in that direction was the subject of discussion in late March, as a nine-year-old group called the Committee for Monetary Research and Education held its annual conference at the Arden House retreat of Columbia University. At the concluding session, Howard Segermark, economic counsel to Sen. Jesse Helms (R-S.C.) and a gold maven for as long as anyone can remember, sketched a strategy for influencing the Gold Commission.
A few weeks later, another group initiated another tack in the campaign to bring back gold. At a conference held in the Capitol to explore the gold question, sponsored by Rep. Ron Paul (R-Tex.), the United States Choice-in-Currency Commission was conceived. Suggested by economist and historian Murray Rothbard, it was envisioned as an alternative voice to the official US Gold Commission.
The Choice-in-Currency Commission has a model in the Shadow Open Market Committee created a few years ago by economists Karl Brunner of the University of Rochester and Allan Meltzer of Carnegie-Mellon University. The Shadow Committee's raison d'être is to keep an eye on the Federal Reserve System's Open Market Committee—which pumps money into the US economy and causes inflation or sucks money out of the system and causes recessions—and to prod it to do right by the American people. The Brunner-Meltzer group has become quite influential in monetary policy discussions, even drawing the taciturn Federal Reserve Board into an open debate in April.
In anticipation of a delayed or even negative report from the US Gold Commission, the Choice-in-Currency Commission was conceived to launch a grassroots campaign in favor of freedom of choice in currency. It quickly enlisted the support of Congressman Paul and Lewis Lehrman (see Spotlight, REASON, July), both members of the US Gold Commission.
What's the connection between "choice in currency" and all the traditional, longstanding calls for "putting the United States back on a gold standard"? And what does choice in currency amount to, anyway? Zenith versus Sony versus RCA televisions, or a Rabbit versus a Dodge Omni versus a Chevette—these involve consumer choices; but the money people put on the line in making those choices…?
Yes, monetary units too could be open to individual choice, suggested F.A. Hayek, venerable head of the Austrian school of economics, in 1975. At a conference sponsored by the New Orleans-based National Committee for Monetary Reform (James Blanchard's one-man organization that had, along with Segermark and Senator Helms, pushed Congress to relegalize gold ownership), Hayek proposed a nearly heretical idea to all the gold bugs in attendance. The issue is not a gold standard, he implied, but letting individuals in a free market exercise freedom of choice in the monetary units they use.
Why, he asked, shouldn't the British, for example, plagued by high rates of inflation in the pound sterling, be permitted to conduct business in London in Swiss francs? Why should there be a monopoly in each nation regarding money? The idea is deceptively subtle. Hayek had discovered—or at least brought to the attention of the gold bugs—the fact that Gresham's Law works in reverse when the prices of different monetary units are free to change according to supply and demand.
Old Sir Thomas Gresham served Queen Elizabeth I in the 16th century and is given credit for Gresham's Law: Bad money drives out good money. When silver was cheap and gold was dear, the people would pass silver from hand to hand and keep their gold under the mattresses; when silver became relatively scarce, the gold came into circulation and the silver disappeared into savings and hoarding.
But when Gresham observed this phenomenon, the conversion rate (or price) between gold and silver was fixed by law. Professor Hayek simply observed that bad money does not drive out good when monetary prices fluctuate. If different types of paper money were put into mutual competition, he suggested, people could refuse bad money (money with declining purchasing power) and insist upon good money in setting prices or holding cash balances. The less-preferred units would disappear if nobody wanted to use them in commerce, and fear of this result would serve as a restraint upon inflation-prone central banks.
So now there were not just one but two proposals for ending the Fed's devastation of the economy: impose the discipline of gold, or impose the discipline of consumer choice. When the Choice-in-Currency Commission made its appearance in the spring of 1981, it planted one foot in each camp. It would call for Hayek's classic principle of competition, but that competition in the domestic US market would be between Federal Reserve dollars and gold coins.
Why not just stick with the traditional idea of a gold standard? It would try to "make the dollar as good as gold" by fixing the conversion rate between dollars and gold. To maintain the parity, the Fed would be required to hold the supply of dollars proportional to the Treasury's gold reserves—and everyone knows how likely the Fed is to follow such instructions.
Moreover, this kind of proposal has faced political difficulties because it is all-or-nothing: in accepting the classic gold standard, people must agree to a particular conversion rate. Should it be 35 dollars to one ounce of gold? 450 to one? 600 to one? Should it ever be changed? Certainly the economists have been unable to agree on an appropriate ratio, and so "the gold standard" has remained controversial.
The gold standard a la Choice-in-Currency, on the other hand, would not attempt to fix the price of the dollar in terms of gold. It would instead leave both the price and the quantity of monetary units to be determined in the marketplace. Supply and demand would govern the conversion rate, reflecting people's perceptions of the relative values of the competing currencies.
The Fed would be constrained to "keep the dollar as good as gold" by the choices of wage earners, business owners, and investors. If people were cashing in their dollars for gold and demanding payment and interest in gold, the Fed would know that it had left the printing press running too long. If people were amiably accepting either currency, it would know that equilibrium reigned.
Best of all, if the Fed did let the dollar slip in value, the people would have an alternative. Freedom of choice in currency would mean that government could no longer subject its citizens to the tyranny of inflation.
What can the Federal Reserve possibly say against the idea? That it wouldn't work? Who would believe that in a free-market economy, freedom of choice won't work? The real issue will become the Fed's monopoly of the currency.
Even Milton Friedman, who has never given his blessing to a gold standard but has instead argued for a monetarist proposal to end inflation by keeping the money supply under tight rein—won't he have to endorse the idea? Has he not written a book with the title Free to Choose and been a staunch advocate of empirical testing of economic theories? If the Fed really is as capable of controlling the monetary system as Friedman contends, then it could manage the dollar supply in such a way that the public would continue to demand dollars instead of gold coins.
One of the most persuasive arguments for the gold-coin choice-in-currency proposal is the idea of "disaster insurance." During the 1923 hyperinflation in Germany, people were able to use British pounds, French francs, and US dollars as alternative monetary units, as well as bartering with various common commodities. If the US money and banking system should collapse, however, there would be no alternative currency for Americans to use. Society would collapse economically as well as politically.
In the novel Alas Babylon by Pat Frank, the United States suffers a nuclear attack and the small Florida community that survives it undergoes a social convulsion. The local banker is one of the first to commit suicide.
Economists know that the monetary system is of central importance in a market economy, because all prices and all accounting statements are quoted in units of money. In order for the new currency to function as disaster insurance, it must be named in a way that ensures its soundness.
Where did the "dollar" come from? In the Middle Ages, there was a large silver coin of similar name valued for its quality, and people began to quote prices in its name. Prices in a free market provide information about the relative values of goods and services, and there is very little cost to obtaining this information. A high-quality physical referent for the monetary "unit-name" in which prices are quoted is important for the emergence of a free-market system.
The Spanish milled dollar was in common circulation in the 13 colonies, so Thomas Jefferson proposed that it become the standard unit for the new US decimal currency. The US government didn't invent the money of the new nation, but it did "trademark" it. Within a hundred years, the trademark had already replaced the metal coin itself as the important thing in financial dealings. The government was able to issue legal-tender greenbacks with its trademark alone, and people had to take them at their face value instead of coins.
In Britain, the pound sterling is an obsolete name for a weight of silver, although from 1774, gold was the exclusive legal tender until the Bank of England's pound sterling notes displaced gold coins from most international commerce about the middle of the 19th century. People disagree about whether the banknotes were merely warehouse receipts for gold or silver on deposit or whether they represent a dishonest expansion of circulating credit with nothing to back them, but the only thing that allowed the banknotes to gain currency status was their use of the government's trademark. Similar histories can be told about the franc, the mark, the lira, etc.
Edward Gibbon wrote in The Decline and Fall of the Roman Empire that "Augustus was sensible that mankind is governed by names," and it is still very true today. The name of the monetary unit is of central importance to the new gold standard.
It is very difficult for the ordinary citizen to avoid confusion when it comes to finance, inflation, or monetary theory. John Maynard Keynes wrote: "Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose."
This is why most Americans believe that wage and price controls are a good idea. They believe that if prices rise, it is somehow the work of the merchants, not the depreciation of the familiar monetary unit. Since prices are quoted in the standard "name," it is perceived as the fixed element in the language of prices—the proper noun in the syntax of our basic economic information system. Only a little reflection shows us, though, that the real values of commodities and services are elements that change only slowly over time, as productivity improves. Yet there is something comfortable about the old "dollar" even though today it is merely the name of an electronic impulse in the computer of your bank, or the word by which you identify the ciphers on your credit card receipts.
Perhaps the central principle of a good monetary system is that stated by John Locke in 1695: The "unit was and should be a definite weight of bullion, which must not be altered." Bullion—pure, "noble" metal. Definite weight. The monetary system should emerge from the common system of weights and measures; it should not be "invented" by government as an artificial denomination of weight. It was an unfortunate historical accident that the common coin in the 13 colonies was not precisely an ounce of silver, which might have gone by the name "one ounce" without the government trademark "silver dollar."
F.A. Hayek has compared the development of a nation's monetary system to the evolution of its common language—a product of human action but not of human design; a spontaneous order. Because the "dollar" has come down through history as the unit of accounting, it may seem natural that the name-unit of the new currency should be "dollar" also. Yet, for the reasons that John Locke put forth, the idea of a "gold dollar" must be rejected.
Dollar is not a unit of weight, even though it once described a silver coin that had a fixed weight: 347.49 grains of fine silver, as defined in the coinage act of 1792. If the monetary unit is named differently from the definitive weight, specifying its weight becomes a government prerogative. Then it is easy for the government, by redefining that weight, "to debauch the currency," as Keynes noted, "in a manner which not one man in a million is able to diagnose."
Because people use the familiar name to quote prices, the government's trademark on the coinage can become the unit of accounting in lieu of a unit of weight. This is precisely the shift in meaning, however, that ought to be prevented by any modern monetary reform. If a coin is named by its unit of weight, what citizen would be fool enough not to perceive his government's skulduggery were the pound or the ounce or the gram announced no longer to amount to its former quantity? Every man in a million would scoff if the government tried to tell him that a gram of gold did not equal a gram of iron.
Any "gold dollar" currency would inevitably be afflicted by the problem of Gresham's Law. The coins would never circulate, because they would be seen as more valuable than the paper currency with the same name (and hence with a fixed price ratio). The bad money would drive out the good, and nothing would be gained by pretending that the paper was "as good as gold." This is why the United States, and the rest of the world, slipped so easily off the gold standard in 1933, due to the tendency for gold coins to remain in vaults.
To avoid the problem with government trademarking, the definite weight prescribed by Locke should be the common unit of weight. For the new gold currency, we have, therefore, two choices: grams or ounces. Which unit has a single definition? Which unit has four definitions? (Hint: gold-grams is superior in this respect.) Another consideration counting in favor of the gram is that it is the unit of weight in which every other raw material in international commerce is measured.
A gram of gold this year is worth about $15.00, which would make a 10-gram and a 5-gram gold coin about the right size for many commercial transactions. (For quick mental conversion, a gold price of $466.55/oz. would be exactly $15.00/gram.) A 10-gram goldpiece would be about the size of the US quarter dollar, and a 5-gram goldpiece would be about the size of a US penny.
The Free Market Gold Coinage Act introduced by Rep. Dan Crane proposes 10-gram and 5-gram gold coins. Crane, in his second term in the House of Representatives, has supported other gold standard bills and was enthusiastic about a gold coinage proposal. (His brother, Philip Crane, had been a leader in advocating the legalization of gold ownership.) As Dan Crane said in introducing the bill:
Some people advocate a gold ounce coinage, and others advocate a metric coinage based on the gram of gold. I don't like the metric system myself, but in the spirit of giving people the freedom of choice the "Free Market Gold Coinage Act" has allowed for two metric coins: The "Jefferson 10-gram Goldpiece" and the "Adam Smith 5-gram Goldpiece." Thomas Jefferson and Adam Smith are two early advocates of a hard-money system for the free market. These two coins are intended to honor these great men who wisely forewarned us that paper money can lead to inflation.
In addition, the bill proposes two other gold ounce coins in anticipation that these weights may be popular with Americans. One is a troy-ounce coin because the gold coin market in the United States has grown up around Krugerrands, and the other a US-ounce coin.
Crane says he decided to put John F. Kennedy's profile on the troy-ounce coin to challenge liberal Democrats to support the bill. Since he comes from downstate Illinois, Abraham Lincoln seemed well suited for the US-ounce coin, especially if the copper penny is eventually discontinued.
The first section of the Gold Coinage Act proclaims that "it shall be the policy of the United States to promote the free coinage of gold at a free market price." The idea is that private mints, like the Gold Standard Corporation in Kansas City, ought to be encouraged to produce free-market coins and not be displaced by the US Treasury's coinage.
Why should the government manufacture and issue coins at all? Wouldn't a free-market gold coinage most properly come entirely from private sources instead of from the US Mint? Nobody can quarrel with the logic here, but in practical terms it is important to get the gold bullion out of Fort Knox and into private hands—and there is enormous political opposition to the selling of bullion in large quantities for depreciating dollars.
The development of central banking and legal-tender laws in England during the period of laissez-faire for everything else should be instructive to us if the objective of the new gold standard is to prevent an eventual remonopolization of the currency by government. In England, following the Napoleonic wars, the Bank of England had all the gold. For reasons of physical convenience and safety, nobody saw any problem with this de facto monopoly.
After 1844, the law specified a 100 percent reserve for each Bank of England note (but not for the loans the Bank of England would make against the banknotes); so the practice of central banking seemed like a natural monopoly. In retrospect, we now can see why this was a dangerous political arrangement. The gold in a central vault might be most secure from petty robbery, but it is most vulnerable to grand, political larceny.
Moreover, the most important element in the gold-coin standard is the existence of the coinage, so that people can quote the coins as price units for goods and services. Relatively few gold coins would have to be issued by the US Treasury before the coinage would begin to be used to denominate some kinds of transactions. Given the famous inefficiency of the Post Office and other government service agencies, there is every reason to believe that private mints would supply most of the actual gold coins in circulation unless the coins were marketed to the public as an alternate source of funding for the federal budget deficit.
The process of quoting prices in terms of gold coins is the fundamental thing about a gold-coin standard. The creation of myriad private caches of coins is an important part of the "disaster insurance" scenario, and this can be partially satisfied by "unofficial" coins; but the gold-coin standard will not have taken root in the economic life of the nation until people quote prices in terms of it. This is the basic reason why an official coinage needs to be created. This would open the way for the most logical use of a gold coinage by the free market—in the long-term capital markets.
As a tool in the market, money facilitates "indirect exchange" by providing something that a seller of goods can accept with some confidence that other sellers will accept it from him later. Any indirect exchange, however, that skips over several, perhaps lengthy, periods of time—as in the long-term bond market—exposes the bond buyers (lenders) to a uniquely dangerous kind of risk.
The main risk in modern times is not so much "default risk" but "inflation risk"—will the monetary units in which the debt is to be repaid be worth as much in the future? A bond expert can evaluate the degree of default risk and classify a bond as Aaa or Baa and recommend a higher interest rate for the lower-graded bonds; but how can anyone tell you what the link is between the "1981-dollar" and the "2001-dollar"?
Since 1977 there has been no restriction on the use of gold clauses in contracts, so hypothetically the process should emerge; but it hasn't yet to any noticeable degree. Why not? Could the reason be that nobody trusts gold clauses so long as the basic language of prices is still the "dollar"? If dollars are the exclusive legal tender, what would prevent some future abrogation of gold clauses?
There seems to be an underlying process in the free market, or more particularly in the price system, that causes trade to gravitate toward the common unit of accounting—because that is what the courts would rely on if the contract had to be enforced. Similarly, many civil actions in court don't involve contracts under which the parties might have protected themselves with a gold clause. When someone smashes your car or disrupts your business through negligence, you don't have a contract—yet you might ask a judge to assess damages. Sometimes a judgment can take years of litigation. The main change in existing law made by the Free Market Gold Coinage Act is the principle that individuals in court, and in their dealings with the government itself, should have the right to use the unit of weight of gold to denominate the value at stake.
The real key to the freedom of choice in currency movement is the basic human right to choose and use gold coins recognized by statute. Congressman Crane's bill, the Free Market Gold Coinage Act, is just one specific proposal that meets all the criteria. It is really less of a coinage act than it is a "monetary constitution" for official transactions. In the process of creating a coinage, the bill would simultaneously provide a numeraire for longterm capital transactions and eliminate the monopoly of the Federal Reserve System over the currency.
In contrast, the traditional gold-standard proposals, which would legislate a "gold cover" for the Federal Reserve System—or to fix the quantity of dollars it issues based on the Treasury's holdings of gold—is very much antithetical to the choice-in-currency idea. First, because a "gold cover" would not put gold coins into circulation, it would not satisfy the disaster-insurance requirement; and second, because the expansion of the money supply would still be a monopoly of the government, there would be no genuine halt to price-index inflation.
When the British adopted Peel's Act in 1844, requiring 100 percent gold backing for Bank of England notes, they nevertheless had to suspend the act in 1866. Walter Bagehot reported in his classic Lombard Street (1873): "Three times since 1844 the Banking Department has received assistance, and would have failed without it." Whoever believes that the 19th-century Bank of England model is a good example of the gold standard is playing games with words.
It is hardly an accident that the 19th-century gold-backed currency and banking systems evolved into central bank monopolies, because they were heavily restricted and warped by government finance issues that do not concern our 20th-century economic system. The institutions that were created, like the Federal Reserve System, have survived to perform a different purpose—macroeconomic planning, with monopoly authority. Our legacy from the past is inflation, the boom-and-bust cycle, and sky-high interest rates because there is no underlying connection between the 1981-dollar and any future currency units.
The financial revolution that would result from a successful choice-in-currency campaign would be one of the major transformations in monetary history. By enacting the Free Market Gold Coinage Act, for example, a sovereign government will have voluntarily surrendered its monetary monopoly. Impossible? Popular movements have achieved more startling changes, such as the 17th Amendment to the Constitution allowing for popular election of senators.
Best of all, like other technological revolutions (for example, the development of telecommunications), all progress would be made at the margin as individuals and companies adopted the new procedures for denominating values. On the first day of enactment of the "Free Market Gold Coinage Act," there would be no visible change at all. Yet by the 10th year or the 50th year afterward, the present system of money and credit might be fully transformed into one based on the gram of gold as the "unit of account"—the proper noun in the syntax of the free-market price system.
The report of the US Gold Commission is due on October 1, 1981. Whether or not the commission will recommend a return to a gold standard, and whether or not their recommendation will look like the 19th-century Bank of England system, is very much up in the air.
What the "shadow" Choice-in-Currency Commission will be able to achieve is uncertain. Surveys of public opinion in monetary and fiscal matters reveal a depth of misunderstanding and emotionalism that staggers the imagination. Indeed, due to public ignorance, the "choice in currency" process might be the only way to create a new gold standard, because "information costs" and "transactions costs" alone will prevent any widespread agreement on a particular kind of system. We do not live in a classic, small-group Greek democracy.
Yet, from the international system of weights and measures, provided a vocal minority insists upon it, the fundamental unit of a new gold coin standard can be created. This alone, along with the official recognition of the unit in courts and in all dealings with the government itself (for example, paying taxes and customs duties; receiving tax refunds; etc.) is sufficient, on economic grounds, to transform our financial system and rebuild it on a firm, noninflationary basis that is well suited for the new kinds of electronic payment-systems that the free market is even today creating.
Joe Cobb is director of economic analysis for the Washington-based Council for a Competitive Economy.