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On Returning to the Gold Standard

by Michael Nystrom
June 20, 2007

This article also appeared on Bull! Not bull 

There were a couple of interesting pieces yesterday on TheStreet.com about the possibility of a return to the gold standard. The article: Ditch the Fed, Go Back to Gold made the front page, and embedded within the article was a link to a video interview with the author, Simon Constable. Gold has obviously come a long way in the last decade in terms of public awareness. Rising inflation has generated considerable interest in the so-called “barbaric metal.”

At first blush, both the article and the interview appear to give the gold standard a fair hearing, but both ultimately reject the idea as unworkable. This rejection is based on some faulty underlying assumptions as well as some muddled thinking. In an attempt to clarify the some of these issues, I have transcribed the interview and interjected some of my own comments from my vantage point here in the peanut gallery. I wasn’t invited to the interview, but that won’t stop me from participating in it on behalf of gold bugs everywhere!

You can view the video by clicking here.

It begins with the host, Janet Al-Saad: We’re joined today by Simon Constable, staff reporter here for the Street.com to discuss the candidacy of Ron Paul, US Representative for the State of Texas for the Presidency in 2008. Ron Paul has proposed a novel idea, that is returning to the gold standard and replacing the Fed altogether…So, this sounds like a little bit of a wacky idea. Tell us what would actually be involved in returning to the gold standard.

Simon Constable: On the face of it, it appears a little bit wacky, but there is some good historical precedent for this. What it would involve in general is that the money that we use on a day-to-day basis would be backed by gold and would be exchangeable into gold. That’s how the money system operated in the 19th century, which was the heyday of the gold standard, and also how it operated after the Second World War under the so-called Bretton Woods Agreement.

What Ron Paul is really interested in trying to do is contain inflation. One of the things he says at the moment is that the Fed, because of pressures from politicians, the Fed has a tendency to print too much money, and that causes inflation. And he doesn't like that, he thinks that's kind of a tax on the people, and he wants to get away from that…with no discretionary monetary policy – that sort of thing.

Nystrom’s Comment: Great job, Simon! The Fed does indeed print too much money, and that is a tax on people that silently eats away at their savings. However, that part you slipped in at the end – practically mumbled it – about ‘no discretionary monetary policy’ – is just not true. There is considerable flexibility built into the gold standard. For a fuller discussion, see Gold or the Fed.

Janet Al-Saad: Some critics say that for all the inflation containing benefits of returning to the gold standard, you create new problems, such as creating a rather inflexible system that might not be compatible with the current world economic system that is popular today. And also there's a difficulty of setting the gold price at any particular moment.

Nystrom’s Comment: The interviewer actually used these words: "it might not be compatible with the current economic system that is popular today." We’re talking about getting rid of the current system, so it would definitely be incompatible. Gold backed currency is also called an “honest money” system, because each paper bill represents an actual claim on gold, as opposed to the current system wherein each paper unit merely represents...a piece of paper. “The current economic system that is popular today” is an inflationary one that enriches those who are in control of the printing presses, at the expense of common people. We want to get rid of this system. So yes, you are correct. The two would be incompatible.

As far as “setting the gold price” goes: No one has to "set" the price of anything in a free market. Prices adjust automatically based on supply and demand. This is not the Soviet Union after all. Or is it? Under the current system, the small cabal of men that sits on the Federal Reserve Board has an incredible amount of power. These men were never elected, yet their decisions on interest rate policy determine what your mortgage payment will be, your car payment, and whether you’ll have a job or not. This is called central planning, and in 1989 the world learned once and for all that centrally planned economies don’t work.

Simon Constable: I talked with a number of economic historians about what had happened in the past and whether the 19th century was a great time to live because of the gold standard. And they said that inflation was contained, but that there were other problems. One of the problems was that when you had a financial panic, it tended to run out of control because there was no central bank. It would feed on itself. There was no Fed that would say, “Oh, lets just lend everyone a little more money, or just print some more money and that will contain the panic so that it does not become an epidemic. You can't really do that with a gold standard, and that's really a worry. The other thing is that...

Nystrom’s Comment: Whoa, Simon - hang on there just a sec! Let's examine that statement. We certainly had a central bank back during the panic of 1929, but it didn't "help contain the panic." Instead, the Fed's policies led directly to the Great Depression - the most prolonged financial and industrial slump in American history. Sure, there were booms and busts in the 19th century, but none were as bad as the Big One that started in ’29. Current Fed Chairman Ben Bernanke even admitted recently that it was the Fed that caused the Great Depression. But then he said with a wink, "we're sorry. We won't do it again."

That’s right Ben, next time it will certainly be much worse. Let's take a look at 2001, the last time we had something approaching a financial panic in the US. At that time, the Fed did “step up to the plate” to “open the monetary spigots” in order to stand as the “lender of last resort,” lowering interest rates in its own panic, and in effect “printing more money and loaning it out.”

A financial panic was not so much averted as it was postponed. Instead of a panic and a crash, we had the opposite: The housing bubble. The Fed’s torrent of artificially cheap money gave people an incentive to borrow, spend and speculate rather than save and invest. Thanks to the Fed's cheap money policy lowered real interest rates to levels below that of inflation. This might sound like confusing jargon to some, but this is what it means:

If your savings account is paying 1.5% interest, but inflation is running at 3% per year or higher, then it makes no sense at all to save. (The government says inflation is around 3%, but if you live in America, eat, drive and / or pay for a place to live, you know that inflation is actually much higher.) As a result, money saved is worth less in the future – not more. Therefore it is better to spend now, before the money is eaten away by the hidden tax of inflation. Or better yet, if you can borrow money on an adjustable rate ARM at 4% to buy a house while prices are increasing at 20% per year (like in 2003), that is even better.

In other words, the Fed caused the housing bubble. Today government, businesses and individuals are all in more debt than they were in 2001, and 70% of Americans think the economy is getting worse. It makes me wonder what Ben will do for an encore. Encourage people to borrow yet more money?

Simon Constable continues: …The other thing is that when wages adjust in the current economy - when we have a little bit of inflation, and if wages get too high, inflation eats away at it. But under the gold standard you didn’t have that and wages needed to move down. And for most people living, the idea of wages having to move down from one year to the next is not something most people would like.

Nystrom’s comment: Under the current economic system, of course people don’t like it when their wages go down, because prices keep going up! However, as we’ve already discussed, a gold standard is a completely different paradigm. If wages do go down under the gold standard, people won’t mind because the price of goods will likely be going down even faster!

As an example, look at computers today vs. ten years ago. They are better, faster and more powerful – yet they are also cheaper, both in real dollars and in inflation adjusted dollars. This is deflation, which the Fed will tell you in no uncertain terms and under all conditions is bad. But I kind of like it – don’t you? Cheaper is better.

Under a gold standard, the price of most all goods would behave in a similar fashion – getting cheaper and cheaper over time. Producers would be in competition to lower prices rather than to raise them. So if workers' salaries went down, but things got cheaper faster, I doubt people would mind. As it is now, things get more expensive year after year but salaries go down anyway!

Janet Al-Saad: Ron Paul is a little bit of a long shot candidate who seems to have a few other idiosyncratic ideas. Namely, (smirks) he would also abolish the IRS. What is Ron Paul’s likelihood of election in 2008, and should investors continue to keep an eye on him?

Nystrom’s comment: You said it with a smirk! The part about how he would abolish the IRS – you smirked! This gives viewers the subtle clue that this is another “wacky” idea not to be taken seriously.

Far from it. If you truly examine Ron Paul’s ideas (“I’m not talking about fiddling with the code, I mean abolish the income tax and the IRS and replace them with nothing.”) they make a tremendous amount of sense. Both the IRS and the Federal Reserve were created in 1913, and there is a sinister relationship between the two that most citizens remain unaware of (I will elaborate on this in future editions – please sign up to be notified).

But just remember that our country did just fine without the Fed and without the income tax for 137 years. A dollar in George Washington's time was worth about the same as a dollar in 1913. After the creation of the Fed, that same dollar is today worth only about 5 cents. This is according the Fed’s own inflation calculator. The dollar's value has systematically been destroyed by the hidden tax of inflation.

Simon Constable: I think investors should continue to keep an eye on him because he’s raising issues which are important today. Inflation is a big issue and people are looking at it and this draws attention to it. I think the likelihood of him winning – from what everyone is telling me – is pretty much zero. But he’s an interesting character, and he’s entertaining, too.

Nystrom’s comment: An interesting character indeed – a rarity in this modern world, he is both a true patriot and an independent thinker. And hell yes he’s entertaining! Ron Paul is the best entertainment value in town. Seeing someone tell the truth in this time of near universal deceit is a rare sight indeed.

By all means keep listening. I have a feeling his entertaining message will start grow on you. And America loves a long shot.

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Thanks to Brian Heyer for the video link, and Charles Zentay for the text link. For more information on the Federal Reserve, read G. Edward Griffin’s book “The Creature from Jeckyll Island.”

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Gold doesn't matter

Gold vs. fiat currency doesn't matter if fractional reserve banking and debt-based currency are allowed to continue. We had a gold standard with the Fed for 60 years and it still led to monetary inflation. Either fractional reserve banking must end or at the very least the required reserve ratios must be lowered to something like 2:1 to curb monetary inflation and overall debt.

Commodity backed currency is fine, and it doesn't even have to be strictly gold. It could be a variety of commodities that are much less scarce than gold.

All I'm saying is that keeping fractional reserve practices the same while switching to gold backed currency would do much less to curb inflation and debt than would limiting or abolishing fractional reserve banking.

the stranger's picture

Constable - wrong on gold

Simon Constable is consistently wrong on gold; and to quote Rob
Kirby “This is what happens when someone tries to commentate on things which they have little or no understanding.” - it amazes me he continues to comment on the subject. Thanks for taking the time to dissect the misinf- er, interview.

 

Michael Nystrom's picture

A Phone Call with the Federal Reserve

Grant sent this message:

This increased my understanding of the situation immeasurably.

A Phone Call with the Federal Reserve

The only way to make sense out of change is to plunge into it, move with it, and join the dance. - Alan Watts

Amazing Article

M. Raborn

 

This is an amazing article.  Thanks for the printed version for those of us who do not have high-speed DSL.  Also thanks for your commentary, which makes it even more understandable.  I will be looking forward to the "follow up" edition.  Thanks Michael for all the good stuff you do with this web site!

M. Raborn

The Fed admission is mindblowing

I'm speechless.