13. Gold Standards: True and False

CHAPTER 13

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Gold Standards: True and False¹

The Basic Characteristics of a Genuine Gold Standard

Expressions of sympathy for gold as a potentially useful device for restraining the more flagrant excesses of the political control of money hardly constitute an endorsement of the overall traditional case for the gold standard. For implicit in the case for gold is a vision of an ideal monetary system in which government is totally and permanently debarred from manipulating the supply of money. Under the ideal hard-money regime, the composition, quantity, and value of the commodity used as money is determined exclusively by market forces. In fact, strictly speaking, the advocate of hard money does not favor a gold standard per se, but endorses whatever commodity is chosen by the market as the general medium of exchange. The hard-money program tends to be couched in terms of the gold standard because gold represents the money that emerged in the past from a natural selection process of the free market that spanned centuries.

With this caveat, I now turn to the characteristics of a “real” or “genuine” gold standard as this is construed within the context of the traditional, or hard-money, case for gold. The defining characteristic of such a monetary system has been incisively identified by Milton Friedman. In his words, “A real, honest-to-God gold standard … would be one in which gold was literally money, and money literally gold, under which transactions would literally be made in terms either of the yellow metal itself, or of pieces of paper that were 100 per cent warehouse certificates for gold.”²

Thus, under a genuine gold standard, the monetary unit is, in fact as well as in law, a unit of weight of gold. This is the case whether the monetary unit bears the name of a standard unit of weight, such as a “gram” or “ounce,” or whether it bears a special name, like “dollar” or “franc,” that designates specifically a standard weight of the commodity used as money.

While it is true that certain types of government intervention in the monetary system are consistent with the basic criterion of a genuine gold standard, it is equally true that no particular government policy is essential to the operation of this monetary standard. Indeed, as Friedman notes, “If a domestic money consists of a commodity, a pure gold standard or cowrie bead standard, the principles of monetary policy are very simple. There aren’t any. The commodity money takes care of itself.”³

Under the quintessential hard-money regime, therefore, the money-supply process is totally privatized. The mining, minting, certification, and warehousing of the commodity money are undertaken by private firms competing for profits in an entirely unrestricted and unregulated market. The money supply consists of gold in various shapes and weight denominations and claims to gold, in the form of paper notes or checkable demand deposits, that are accepted in monetary transactions as a substitute for the physical commodity money. These money substitutes are literally warehouse receipts that are redeemable for gold on demand at the issuing institutions, which hold a specifically earmarked reserve of gold exactly equal in amount to their demand liabilities. Barring fraud or counterfeiting, the total supply of money in the economy is therefore always equal to the total weight of gold held in the money balances of the nonbank public and in the reserves of the banks.

The total supply of money and the total demand of the public for money balances determine the value or purchasing power of money in terms of other goods and services on the market. Thus, for example, if the demand for money increases while the supply of money remains unchanged, the purchasing power of money rises. That is to say, the alternative quantities of goods and services for which a given unit of money, such as an ounce of gold, can be exchanged increase; or, obversely, the money prices of goods and services undergo a general fall. A rise in the purchasing power of money also results from a decrease in the supply of money in the face of an unchanged demand for money. On the other hand, a decline in the demand for money or an augmentation of its supply, other things remaining equal, brings about a decrease in the purchasing power of the monetary unit manifested in a general rise of money prices in the economy.

Like the purchasing power of money, the quantity of money itself is governed purely by the market conditions affecting the overall demand for and supply of gold. These include the total demand for gold for monetary and nonmonetary uses and the monetary costs involved in producing gold. A change in either factor brings about a change in the quantity of money in the economy.

To see how this occurs, let us begin from a position of equilibrium, in which the supply of and demand for money, and hence its purchasing power, are constant. In this situation, gold-mining firms maximize monetary profits by producing a quantity of gold per year just equal to the annual amount allocated to nonmonetary uses plus the amount used up or destroyed in monetary employment during the course of the year. In this equilibrium situation the net return to a unit of gold, say an ounce, employed in industrial production processes tends to be equal to an equivalent weight of monetary gold.

An improvement in the technology of mining gold or the discovery of new, more accessible sources of gold destroys this initial equilibrium by lowering the costs and thereby increasing the profitability of gold production, resulting in an increased annual output of gold. With an unchanged demand for money, the larger supply of the commodity money exerts an upward pressure on prices that reduces the purchasing power of money, as each gold ounce now purchases fewer goods and services on the market.

The general rise of prices in the economy includes the prices of goods in whose production gold enters as an input, such as jewelry, dental filling, and various electronic products. The result is that a unit of gold employed in industrial processes now yields a net return in terms of monetary gold that is greater than its own weight, and this encourages entrepreneurs to allocate additional quantities of the metal to the production of various consumer and capital goods. The resulting increase in the supplies of these gold products eventually drives their prices down and eliminates the discrepancy between the value of gold in monetary and nonmonetary uses. The absorption of part of the new gold in nonmonetary uses thus serves to temper the effect of the increased output of gold on the money supply. Nonetheless, in the new equilibrium, the supply of monetary gold will have risen, producing a general increase in prices or a reduction in the purchasing power of money.

In the opposite case, in which the costs of producing the monetary metal increase, due for instance to a depletion of the most accessible old ore deposits, the result is a reduction in the annual rate of production of gold. In the long run, this reduction entails a contraction of the industrial uses of gold as well as a decline in the money supply and, hence, a general fall in prices or rise in the purchasing power of money.

While changes in the monetary costs of producing gold, therefore, do have an effect on the money supply, this effect tends to be minimal. The reason is that gold is an extremely scarce as well as a highly durable commodity, and its annual production tends to be a tiny proportion of the existing stock. As a result, even relatively large reductions or increases in the costs of producing gold will not cause great short-term fluctuations in the supply of money.

The quantity of money also responds to forces operating on the demand side. For instance, an increase in the demand for money, other things constant, effects a general lowering of prices in the economy, including the prices of the resources employed in mining gold. Consequently, the production of gold is rendered more profitable relative to the production of other goods and services. Entrepreneurs respond by increasing the rate of production from currently operational mines, by reopening old mines whose continued operation had become unprofitable, and by initiating the exploitation of known but previously submarginal deposits of gold. They also increase investment in the search for new sources of gold and in the development of new and less costly methods of extraction. Furthermore, the higher monetary value of gold gives individuals an incentive to shift additional amounts of existing gold from industrial and consumption uses to monetary employments. Thus, an increase in the market demand for money, which is initially satisfied by an increase in the purchasing power of the monetary unit, calls forth a gradual expansion of the supply of money that tends, in the long run, to offset the initial decline in prices and to restore the purchasing power of money.

Conversely, a fall in the demand for money causes a general rise in prices and, in the process, drives up the costs associated with mining gold. As higher costs reduce the profit margins of gold-mining firms, the production of the metal tends to fall off. Also, the general price rise in the economy spreads to all industrial inputs, including gold, and this stimulates a shift of some units of gold out of money balances and into industrial employments. The operation of these forces eventually results in a contraction of the supply of money that tends to reverse the initial rise of prices and reestablish the original purchasing power of the monetary unit.

The foregoing analysis of the factors governing the quantity and purchasing power of money under a pure commodity standard permits us to lay to rest two persistent and related objections to the gold standard.

The first criticism is that the supply of gold and, therefore, of money is determined “arbitrarily,” since it depends on such fortuitous factors as discoveries of new mines and technological improvements in the methods of extraction. This is surely a curious, if not vacuous, use of the term “arbitrary” since the supplies of oil, copper, wheat, and, for that matter, of all goods produced on the market are influenced by changes in the availability of the natural resources required in their production as well as by advances in technology. Moreover, in the specific case of gold, purely fortuitous discoveries of new gold deposits and of improved methods of extraction have long ceased to have a significant effect on the annual output of gold. The regularization of gold production has resulted from the operation of the market itself. In a pathbreaking but unduly neglected article on “Causes of Changes in Gold Supply,” Frank W. Paish observed:

[T]he power of economic forces to accelerate or delay the exhaustion of existing deposits, and to promote or discourage the discovery of new ones, is now so great that changes in the output of gold are now much less “accidental” and much more “induced” than they were half a century ago. Today, indeed, there is no reason to assume that the output of gold is less sensitive to changes in costs than is the output of other commodities.⁴

The second charge frequently brought against the gold standard is that it cannot provide for the monetary needs of a growing economy. Increases in the supply of money, it is alleged, are necessary to finance the purchases of the increasing quantities of goods and services resulting from economic growth. The gold standard cannot be depended on to produce the required additions to the money supply at the right times or in the right proportions. The consequence of such monetary deficiency is a stunting of economic growth or possibly even a precipitous depression.

However plausible it may be, this line of reasoning is untenable because it ignores the mechanism of demand and supply operative in a free market for money. The market ensures that any quantity of money is capable of performing all the work required of a medium of exchange by adjusting its purchasing power to the underlying conditions of demand and supply. The increasing stocks of goods that sellers seek to exchange for money in a growing economy represent an overall increase in the demand for money. Thus, if the quantity of money remains unchanged while real output grows, then overall prices are bid down and the purchasing power of money increases. With each unit of money now capable of doing more work in exchange, the same quantity of money suffices to finance the increased volume of transactions.

But this is by no means the end of the process. The general decline in prices brought about by the increased demand for money directly stimulates growth in the money supply. On the one hand, it renders gold mining more profitable. On the other, it causes a fall in the value of gold in industrial uses. The result is a flow of additional gold into the money balances of the public from these two sources. This expansion of the money supply tends to mitigate the fall of prices in the economy. Under a genuine gold standard, then, the growth in real output tends to naturally call forth additions to the money supply.

Finally, let me turn my attention to an objection raised specifically against the 100 percent gold standard, usually by proponents of a gold-based private fractional reserve, or “free,” banking system. It is alleged by these critics that the 100 percent reserve requirement for banks represents an arbitrary interference with a truly free-market banking system, wherein considerations of profit and loss would dictate the fraction of its demand liabilities that a bank keeps on hand in gold.

The basic problem with this allegation is that it confuses two very different types of institutions. The first type, let us call it a “bank,” operates directly on the money supply. The second, which I shall call a “money market mutual fund” for lack of a better term, influences the money supply only indirectly through its impact on monetary demand. Both of these institutions could and probably would exist as the product of purely private contractual arrangements consistent with a free-market monetary regime. It is the identification of the precise nature of these contractual arrangements that is the key issue here.

In the case of a bank, the 100 percent reserve requirement is not arbitrarily imposed from outside the market, but is dictated by the very nature of the bank’s function as a money warehouse. Now, we may not wish to use the name “bank” to designate such an institution, but that is beside the point.

What is important is that if people generally perceived a need, for whatever reason, to store a portion of their money balances outside their own households or businesses, entrepreneurs would invest in the establishment of money warehouses on the free market. For a competitively determined price, such a firm would accept gold deposits and store them under conditions stipulated in the contractual agreement entered into with the depositors. This transaction is not a credit transaction. The depositors’ gold is not loaned to the money warehouse to dispose of as it sees fit (for a stipulated period of time) but rather is bailed to it for the specific purpose of safekeeping. Under the terms of a bailment, the bailor surrenders physical possession of his property to the bailee for a stipulated purpose. Should the bailee use or dispose of the property for any but the specific purposes stipulated in the bailment contract, he would be violating the contract and committing fraud against the bailor.

Thus, a money warehouse operating on the free market is contractually obligated to always maintain in its vaults the entire amount of its depositors’ gold. Loaning part of it out at interest to a third party obviously constitutes an infringement of its contractual agreements.

Now things do not change just because the warehouse receipts or money certificates issued by the firm to its depositors, which entitle them to take physical possession of their gold as per terms of the contract, come to be used as money substitutes in exchange. Should the money warehouse print up and loan out additional quantities of (pseudo-) receipts and then honor them by paying out its depositors’ gold, it would still be defrauding them even if it took due care to always maintain a reserve of gold more than adequate to meet all their calls for redemption. In the same way, a tailor would be defrauding a customer who left a tuxedo with him to be altered if he rented it out to a third party, even though the tailor took special precautions to insure the tuxedo’s availability when the owner showed up with his claim check.

In short, under a free-market monetary regime, banks are required to hold a 100 percent gold reserve for their notes and demand deposits, precisely because these are the contractual terms on which such money substitutes are issued. In this respect, free-market banks would have the same legal obligations as armored car companies do in today’s economy. Money is bailed to the latter for the performance of the specific tasks of transportation and temporary storage. I doubt if anyone would seriously suggest that the laws requiring these companies retain in their physical possession the full amount of money for which they have issued receipts constitutes an arbitrary intervention into the free market.

But there is a second type of nonbank institution that would very likely develop and flourish in an unrestricted market for monetary and financial services and that could have a significant, although indirect, effect on the supply of money. The prototype of this institution is the current money market mutual fund.

Unlike banks qua money warehouses, money market funds are not in the business of storing money. Their contractually specified function is to manage a short-term, fixed-income asset portfolio for their investors or shareholders. In effect, each shareholder has title not to a specific sum of money but to a pro rata share of the asset portfolio. Money market fund shares, therefore, are not ownership claims to money but to nonmonetary financial assets that are, for all intents and purposes, maturing daily. Checks written on money market funds are simply orders to the fund’s managers to liquidate a specified portion of the investor’s share of the portfolio and to pay a third party according to the terms of the contractual agreement between the fund’s managers and shareholders.

Under a free-market monetary system, money market funds would not be legally obliged to maintain 100 percent gold reserves or any reserves at all because of the specific contractual arrangements under which they exist and operate. It might be the case, however, that some funds, possibly to appeal to the more risk-averse members of the public, would offer investment portfolios containing a significant proportion of money or warehouse receipts for money. For example, a fund might feature a portfolio that is 20 percent invested in monetary gold. The managers of the fund would then be contractually obligated to always maintain 20 percent of the fund’s assets in the form of gold. Whether or not one wishes to refer to such an institution as a “fractional-reserve” bank is not the crucial issue. The important thing for the advocate of a genuine, 100 percent gold standard is that this financial arrangement is, in fact, purely the product of a private contractual agreement and therefore consistent with a free market in money.

If a money market fund’s assets are partially in the form of money, its shares represent ownership claims to money balances as well as to nonmonetary financial assets. The fund, in effect, is a hybrid institution operating partly as a money warehouse or bank. Its money assets should therefore be imputed on a pro rata basis to the money balances of its individual shareholders and the total counted in the aggregate money supply.

Not only are money market funds, of the pure or hybrid type, fully in accord with the principles of a genuine gold standard, but, in a denationalized monetary regime, it is not difficult to envision their shares becoming the predominant means of payment in the economy. This would bring about a precipitous fall in the demand for money, and hence for gold in monetary use, and the eventual reallocation of most of the monetary gold stock to nonmonetary employments. Taken to its extreme, this development would result in only a minute fraction of the existing gold stock remaining in monetary employment, solely as a means for clearing balances between money market funds, whose shares would be the only means of payment utilized by the general public.

While I would not expect this extreme scenario to play itself out, it illustrates how market forces might operate to reduce the much-lamented “resource cost” of a genuine gold standard. But in this case, as opposed to that of a government-monopolized paper fiat currency, the cost saving is genuine, because it is produced by the voluntary choices of market participants.

The Gold Price Rule: A Pseudo Gold Standard

In sharp contrast to the proponents of a genuine gold standard, who seek to put an end to government monetary policy by completely denationalizing the money-supply process, the advocates of a gold price rule seek to integrate gold into existing fiat money arrangements in such a way as to improve the conduct of government monetary policy.

For example, economist Alan Reynolds, a staunch supporter of a monetary policy based on a gold price rule, argues: “The purpose of the gold standard is to improve the efficiency and predictability of monetary policy by providing a flexible signal and mechanism for balancing the supply of money with the demand for money at stable prices.”⁵ Elsewhere Reynolds writes: “The central issue, however, is whether monetary policy is to be judged by clumsy tools, like M1 or by results. When sensitive prices [such as the price of gold] are falling, money is too tight; when prices are rising, money is too loose.”⁶

Two other prominent supporters of a gold price rule, Arthur Laffer and Charles Kadlec state that “The purpose of a gold standard is not to turn every dollar bill into a warehouse receipt for an equivalent amount of gold, but to provide the central bank with an operating rule that will facilitate the maintenance of a stable price level.”⁷

What is of overriding significance in the foregoing passages is the explicit or implicit characterization of the gold standard as a mechanism deliberately designed to implement specified policy goals, such as a stable price level, that are aimed at by the government money managers. For it is the underlying conception of the nature and role of money that is implied in this portrayal of the gold standard that ultimately and irreparably divides the modern from the traditional advocates of a gold-based monetary regime. I shall make this point in greater depth after I spell out why the gold price rule is not a genuine gold standard.

Friedman has aptly characterized a pseudo gold standard as “a system in which, instead of gold being money and thereby determining the policy of the country, gold was a commodity whose price was fixed by governments.”⁸ While Friedman is referring here to the international monetary system between 1934 and 1971, his characterization applies to the various proposals for a monetary regime based on a gold price rule. In fact, proponents of the gold price rule have themselves pointed to the Bretton Woods system as the historical embodiment of the essence of their proposal.⁹

Basically, under a gold price rule, the Fed is charged with fixing the dollar price of gold. However, gold itself is not money but the “external standard” whose price the Fed is to fix in terms of the existing fiat dollar. Nor is it necessary that the Fed itself directly buy and sell dollars for gold to maintain the fixed gold price. The “intervention asset,” that is, the asset which the Fed trades on the market for gold, may just as well be U.S. government securities or foreign exchange or any commodity. All that is required of the Fed is that it sell some assets for dollars on the open market when the price of gold rises, thus deflating the supply of money and bringing the gold price back to its “target” level. If the price of gold begins to fall, the Fed is to purchase gold or other assets on the market, creating an inflation of the supply of dollars that drives the price of gold back up to its target level.

By using the gold price as a proxy for the general price level, the advocates of a price-rule regime thus hope to stabilize the purchasing power of the fiat dollar. While some of its supporters have made vague references to the desirability of getting gold coin into circulation,¹⁰ it is clear that the gold price rule is not meant to provide a genuine gold money.

In fact, gold itself need not play any role at all in the price-rule regime. As Arthur Laffer and Marc Miles point out, the external standard “could be a single commodity or a basket of commodities (a price index).”¹¹ Indeed, recently there have been calls for the Fed to institute a price rule targeting an index of spot commodity prices.¹²

Stripped of its gold-standard terminology, the price rule can be seen as a technique designed to guide the monetary authorities in managing the supply of fiat currency. It is thus very similar in nature, if not in technical detail, to the quantity rule advocated by the monetarists. This is clearly evident in Laffer and Miles’s admission that “in an unchanging world where all information is freely available, there of course would be a ‘quantity rule’ which would correspond to a given ‘price rule.’”¹³

What may be called “price-rule monetarism,” then, is vulnerable to criticism on precisely the same grounds as the more conventional quantity-rule monetarism. The most serious criticism of both varieties of monetarism is that they fail to come to grips with the root cause of inflation, namely, the government monopoly of the supply of money. The built-in inflationary bias of the political process virtually guarantees that both quantity and price rule targets will be ignored or revised when they become inconvenient to the government money managers.

We may appeal to history for evidence regarding the success of the gold price rule in stanching the flow of government fiat currency. We need look no further than the late, unlamented Bretton Woods system (1946–71). Under this “fixed-exchange-rate” system, the U.S. monetary authority followed a gold price rule, buying and selling gold at an officially fixed price of $35 per ounce. Foreign monetary authorities, on the other hand, pursued a dollar price rule, maintaining their respective national currencies convertible into dollars at a fixed price. According to Laffer and Miles, “as long as the rules of the system were being followed, the supplies of all currencies were constricted to a strict price relationship among one another and to gold.”¹⁴

Unfortunately, “the rules of the system” were subjected to numerous and repeated violations and evasions, including frequent outright readjustment of the price rules, i.e., exchange-rate devaluations, when they became inconvenient restraints on the inflationary policies pursued by particular national governments. Needless to say, the Bretton Woods system did not prevent the development of a worldwide inflation which brought the system to its knees in 1968 and led to its final collapse in 1971.

Money: Policy Tool or Social Institution?

From this brief overview of the gold price rule, it is evident that its proponents accept the currently prevailing view of money as a “tool” of government policy. According to this view, the monetary system is or ought to be deliberately and rationally constructed so as to promote as efficiently as possible the attainment of the various macropolicy goals sought by government planners. These policy goals are formulated and ranked in accordance with criteria that are developed independently of, and often in conflict with, the valuations and choices of market participants as these are expressed in the pattern of prices and quantities that spontaneously emerge in the free-market economy. From this standpoint, the degree to which a particular monetary policy is judged to be “optimal” depends on the extent to which it succeeds in altering the spontaneous microeconomic processes of the economy to yield macro-statistical outcomes that are consistent with the planners’ chosen policy goals.

Thus, those who defend the gold standard on the basis of its superiority or optimality as a technique of monetary policy differ little from the supporters of fiat money in their mode of argumentation. Both sides direct their arguments almost exclusively to the question of what means, that is, what monetary policy, is best suited to achieve certain identifiable and quantifiable macro-policy goals whose desirability—except for possible differences regarding weighting and statistical expression—is not subject to dispute.

The widely accepted goals that a successful monetary policy is supposed to achieve include: a stable value of the monetary unit or, more accurately, constancy of some selected price index, e.g., the CPI, the GNP deflator, or an index of spot commodity prices; the mitigation of cyclical fluctuations via the stabilization of various statistical aggregates and averages, such as the unemployment rate, the GNP index, the index of industrial production, and others; the maintenance of a high rate of secular growth in real output, once more as gauged by the behavior of selected statistical indicators; and stability of “real” interest rates.

Whether or not free-market processes should be modified in the service of such extra-market macro-policy goals by government manipulation of the supply of money—that is, whether or not government should conduct a monetary policy at all—is a question never addressed by those who regard money as a political tool deliberately and specifically fashioned for such a use.

In sum, the arguments of the policy-oriented advocates of gold are founded upon a presumption which they share in common with their anti-gold opponents and which hard-money advocates emphatically reject. This presumption is that money is a mechanism consciously designed and constructed to serve certain known purposes. These purposes are those of a small group of individuals acting in concert, namely government planners, and are therefore limited in number, subject to a unitary and consistent ranking and capable of being readily communicated to those undertaking the design of the monetary system. Following Hayek, the attitude toward monetary institutions to which this presumption gives rise may be designated “constructivism.”¹⁵

The constructivist approach to the nature and function of money is logically bound up with a particular view of the origin of money. According to this view, money originated in an extra-market social agreement or legal fiat as a useful convention consciously designed to overcome the perceived problems and inefficiencies of direct exchange.

It should be emphasized here that the basic point at issue between the monetary constructivists and those advocates of the gold standard who adopt a Mengerian perspective¹⁶ is not the normative one of whether money ought to be a tool of policy or an integral element of the market process but the existential one of whether money is one or the other. In affirming that money is in fact a market institution, hard-money advocates do not mean to deny that money can be subjected to political control, just as they would not wish to deny that market prices and interest rates can be controlled by the political authorities. Indeed, Menger himself pointed out that “legislative compulsion not infrequently encroaches upon this ‘organic’ developmental process [of money’s emergence] and thus accelerates or modifies the results.”¹⁷ But this is precisely the crux of the hard-money, or traditional, case for gold.

In the same way that price controls alter the “quality” of the affected prices, government monetary policy impinges on the “quality” of the institution of money. A price that is set by bureaucratic fiat ceases to provide market participants with relatively quick and accurate information regarding changes in present and future economic conditions, and also ceases to provide the incentives needed to induce actions in accordance with this information. Such a controlled price introduces an element of discoordination into the market economy. The most obvious manifestation of this discoordination is the failure of the plans of buyers and sellers to match, as reflected in surpluses or shortages of the good in question.

Now, it may well be that the state of affairs that develops under the stimulus of the price control is, at least temporarily, consistent with government policy goals, as was the case in the United States during the “gasoline shortages” of the 1970s. Nevertheless, in terms of its social coordinating function, as opposed to its function as a policy tool, it is also quite clear that the controlled price is qualitatively inferior to its free-market counterpart. In other words, in attempting to deliberately transform a spontaneous market price into a tool for realizing their own extra-market objectives, government planners render that price much less fit to serve the diverse and multitudinous ends pursued by market participants.

Analogously, when the political authorities arrogate to themselves a legal monopoly of issuing money, the character of the money supply process undergoes a radical transformation. The government fiat-money managers are not in a position to receive the same information as free-market money suppliers pertaining to changes in the conditions affecting the demand for and production of the commodity money. Nor, as de facto monopolists, do they confront the incentives that would induce them to respond appropriately to such knowledge even if they could somehow miraculously obtain it. The upshot is that market participants receive an inferior-quality, and inexorably inflated, medium of exchange that tends to greatly impair the coordination, and hence achievement, of their individual purposes. This is the case even if, in contradiction to the lessons of theory and history, we assume that government money managers foreswear inflation and succeed in achieving their announced macro-statistical policy objectives, such as a stable price level and “full employment.” The reason is that money and monetary policy are not “neutral” to the constituent macroeconomic processes and quantities of the overall economy. Manipulating the supply of money to insure a particular aggregate statistical outcome, therefore, inevitably has an impact on these processes and quantities, diverting resources from those uses that are in accordance with consumers’ preferences.

Bibliography

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_____. 1968. “Real and Pseudo Gold Standards.” In Dollars and Deficits. Englewood Cliffs, N.J.: Prentice-Hall.

_____. 1970. Essays in Positive Economics. Chicago: University of Chicago Press.

_____. 1976. “Has Gold Lost Its Monetary Role?” In Milton Friedman in South Africa, M. Feldberg, K. Jowell, and S. Mulholland, eds. Johannesburg: University of Cape Town Graduate School of Business and The Sunday Times. (Friedman’s address was given at the University of Cape Town, 2 April 1976.)

_____. 1982. “Monetary Policy: Theory and Practice.” Journal of Money, Credit, and Banking 14 (February).

_____. 1962. “Should There Be an Independent Monetary Authority.” In In Search of a Monetary Constitution, L.B. Yeager, ed. Cambridge, Mass.: Harvard University Press.

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_____. 1978. “The Errors of Constructivism.” In idem, New Studies in Philosophy, Politics, Economics and the History of Ideas. Chicago: University of Chicago Press.

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_____. 1982. “Has the Fed Already Put Itself on a Price Rule?” Wall Street Journal (28 October): p. 30.

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Reynolds, Alan. 1981. Testimony before the United States Gold Policy Commission, Political and Economic Communications. Morristown, N.J.: Polyconomics, Inc.

_____. 1982. “The Monetary Debate: Stabilize Prices, Not Money.” Wall Street Journal (29 June): p. 26.

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_____. 1970. Man, Economy, and State: A Treatise on Economic Principles, 2 vols. Los Angeles: Nash Publishing.

_____. 1978. What Has Government Done to Our Money? Novato, Calif.: Libertarian Publishers.

Salerno, Joseph T. 1982. “The 100 Percent Gold Standard: A Proposal for Monetary Reform.” In Supply-Side Economics: A Critical Appraisal, Richard H. Fink, ed. Frederick, Md.: University Publications of America.

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From: “Gold Standards: True and False,” in The Search for Stable Money: Essays on Monetary Reform, eds. James A. Dorn and Anna J. Schwartz (Chicago: University of Chicago Press, 1987), pp. 241–55.

¹ Reprinted from Cato Journal 3 (Spring 1983): pp. 239–67, with revisions.

² M. Friedman, “Has Gold Lost Its Monetary Role?” in Milton Friedman in South Africa, ed. M. Feldberg, K. Jowell, and S. Mulholland (Johannesburg: University of Cape Town Graduate School of Business and The Sunday Times, 1976), p. 34. (Friedman’s address was given at the University of Cape Town, 2 April 1976.)

³ M. Friedman, “Monetary Policy: Theory and Practice,” Journal of Money, Credit, and Banking 14 (February 1982): p. 99. For works detailing the nature and operation of a pure commodity money, see Murray N. Rothbard, “The Case for a 100 Per Cent Gold Dollar,” in In Search of a Monetary Constitution, ed. Leland B. Yeager (Cambridge, Mass.: Harvard University Press, 1962), pp. 94–136; idem, Man, Economy, and State: A Treatise on Economic Principles, 2 vols. (Los Angeles: Nash Publishing, 1970), vol. 2, pp. 66–764; idem, What Has Government Done to Our Money? (Novato, Calif.: Libertarian Publishers, 1978); Milton Friedman, “Real and Pseudo Gold Standards,” in Dollars and Deficits (Englewood Cliffs, N.J.: Prentice-Hall, 1968), pp. 247–65; idem, Essays in Positive Economics (Chicago: University of Chicago Press, 1970), pp. 206–10; idem, A Program for Monetary Stability (New York: Fordham University Press, 1959), pp. 4–9; idem “Should There Be an Independent Monetary Authority,” in In Search of a Monetary Constitution, pp. 220–24; Mark Skousen, The 100 Percent Gold Standard: Economics of a Pure Money Commodity (Lanham, Md.: University Press of America, 1980); and Joseph T. Salerno, “The 100 Percent Gold Standard: A Proposal for Monetary Reform,” in Supply-side Economics: A Critical Appraisal, ed. Richard H. Fink (Frederick, Md.: University Publications of America, 1982), pp. 458–74 [reprinted here as Chapter 12].

⁴ Frank W. Paish, The Post-War Financial Problem and Other Essays (London: Macmillan, 1950), p. 151.

⁵ Alan Reynolds, Testimony before the United States Gold Policy Commission, Political and Economic Communications (Morristown, N.J.: Polyconomics, Inc., 1981), p. 15.

⁶ Alan Reynolds, “The Monetary Debate: Stabilize Prices, Not Money,” Wall Street Journal (29 June 1982): p. 26.

⁷ Arthur B. Laffer and Charles W. Kadlec, “The Point of Linking the Dollar to Gold,” Wall Street Journal (13 October 1981): p. 32.

⁸ Friedman, “Has Gold Lost Its Monetary Role?” p. 36.

⁹ See, for example, Robert A. Mundell, “Gold Would Serve into the 21st Century,” Wall Street Journal (30 September 1981): p. 32.

¹⁰ Mundell, “Gold Would Serve,” p. 32; Arthur B. Laffer, Reinstatement of the Dollar: The Blueprint (Rolling Hills Estates, Calif.: A.B. Laffer Associates, 1980), p. 7.

¹¹ Arthur B. Laffer and Marc A. Miles, International Economics in an Integrated World (Oakland, N.J.: Scott, Foresman and Co., 1982), p. 399.

¹² See Reynolds, “The Monetary Debate,” p. 26; and Laffer and Kadlec, “Has the Fed Already Put Itself on a Price Rule?” Wall Street Journal (28 October 1982): p. 30.

¹³ Laffer and Miles, International Economics, p. 401.

¹⁴ Ibid., p. 260.

¹⁵ For illuminating critiques of the constructivist approach to social phenomena, see Hayek, “Kinds of Rationalism,” in idem, Studies in Philosophy, Politics and Economics (New York: Simon and Schuster, 1969), pp. 82–95; and idem, “The Errors of Constructivism,” in idem, New Studies in Philosophy, Politics, Economics and the History of Ideas (Chicago: University of Chicago Press, 1978), pp. 3–22.

¹⁶ Carl Menger demonstrated that money is an “organic” or “unintentionally created” social institution that is “the unintended result of innumerable efforts of economic subjects pursuing individual interests.” Menger, Problems of Economics and Sociology, ed. Louis Schneider, trans., Francis J. Nock (Urbana: University of Illinois Press, 1963), p. 158. For a detailed account of the Mengerian perspective on money, see Gerald P. O’Driscoll, Jr., “Money: Menger’s Evolutionary Theory,” History of Political Economy 18 (Winter 1986): pp. 601–16.

¹⁷ Menger, Problems of Economics, p. 157.