7th Lecture: The Gold Standard: Its Importance and Restoration

The question which I want to treat tonight presents an excellent opportunity to illustrate one of the points made in the epistemological lectures—to explain the difference between economic ideas and judgments of values. As an individual I have a very definite idea of the political problem involved. The important point is that everybody who wants to arrive at such a judgment of value should know why he is doing this and he should understand the consequences of his action.

The question is how to return to the gold standard. And at what parity the return of the United States to a gold standard should be effected. We assume that we should return to a gold standard. A fiat money system cannot go on forever and must one day come to an end. The gold standard under present conditions is the only standard which makes the determination of the purchasing power of money independent of the changing ideas of political parties, governments, and pressure groups. The question is how should this return be effected—by accepting a gold price of $35 an ounce? Or by determining the price of the ounce of gold according to the market conditions at the time of the transition?

First of all, we must know why such problems are important. They are important because changes in the purchasing power of the monetary unit must necessarily bring about social consequences with respect to the income and wealth of various members of society. If the changes brought about by a shift in the money relation, that is by an increase or decrease in the quantity of money in relation to goods and services, would affect the various commodities and services to the same extent and at the same time, then the only consequences would be its repercussions on the content of old contracts concerning deferred payments, loans, and so on.

Let us deal with the social consequences due to the unevenness and lack of synchronization in the change of purchasing power brought about by inflation or deflation. Should these changes occur everywhere at the same time and to the same extent, people would discover one morning that the purchasing power of the monetary unit had changed overnight. But otherwise there would be no difference; the prices of the services they had been selling would also have changed by the same amount and in the same direction.

In inflation, the additional quantity of money enters the economic system through the wealth or income of definite individuals. If the government prints the money, the government is the first to get the new money. Additional demands and offers raise the prices for the products the government wants to acquire. The persons selling the commodities and services the government wants sell at higher prices. Then munitions workers, munitions entrepreneurs, and the soldiers all receive more than they did yesterday. These persons, in whose cash holdings this additional money appears, are in the position of being able to offer more money for their purchases. They have more money and larger incomes. Consequently they can spend more and they offer higher prices for the commodities they purchase. But these people don’t buy everything. Perhaps they buy beverages but not books.

There is now a second group favored by the increase in the amount of money, let us say the beverage producers who are getting more for the services and commodities they sell. The members of this second group are now in a favorable position because the services and commodities that they wish to purchase have not yet been affected. But other individuals—teachers and ministers, for instance—are still paid the former rate; in spite of the fact that the additional money has not affected the services they are selling, they must pay more for commodities that others have bid up in price.

In such an inflationary period there are losers and winners. The winners are the munitions workers, those selling products which go up in price at an earlier date than the commodities they are buying. As long as this continues there are problems every day. The winners are satisfied and keep silent; they don’t write letters to the editor to say that this is a wonderful thing. The entertainers, beverage salesmen, and others do good business at the time—they are the winners—they don’t talk, but they enjoy prosperity and spend. The losers are the other way round. Those at a disadvantage feel it. The housewife whose husband is still earning the same salary and has a number of children to feed is at a disadvantage. Until the inflation ends and for a long time afterwards there are losers and winners because such maladjustments exist. One hears in public only the voices of the losers.

In deflation, the same thing happens, but the other way round. There is a decrease in the amount of money. Those whose selling prices drop first of all are the losers; the winners are those whose selling prices drop at the end.

These price changes are the most spectacular effects of inflationary and deflationary changes in the amount of money.

Another characteristic of inflation is that all deferred payments are changed in their importance. If on the eve of the inflation you had borrowed $100 which could at that time buy ten A’s and if after six months as the result of the inflation, $100 can buy only five A’s, what you pay back to the creditor is worth less than before. You could, therefore, borrow money, buy ten units of A, wait six months and sell five units of A for $100 to pay back your loan; your net inflation profit would be five units of A worth $100; you, as the debtor, profit. The man who saved, the creditor, is hurt by the inflation. In order to deal with today’s problems, these things must be kept in mind.

Before the war of Great Britain against Napoleon from the beginning of the nineteenth century to 1815, there had existed in England the classical gold standard—there were gold coins, and there were banknotes of the Bank of England in use as money substitutes. The Bank of England notes were redeemable in gold on demand; the paper was a gold substitute. Because people could get gold without delay, Englishmen took the notes without any hesitancy. This gave the government the idea of borrowing from the Bank of England and the British government found that was the easiest way to get money. As a consequence of their borrowing the quantity of domestic money increased and prices rose. With the rise of prices in Great Britain and not in foreign countries, merchants found it advantageous to import. In order to pay for these imports it was necessary to export gold. So more people asked for redemption of the banknotes. The managers of the Bank of England became alarmed and feared bankruptcy. The government suggested a very easy remedy; they passed a law relieving the Bank of England of the obligation of redeeming their banknotes; they suspended the payment of specie. The law made meaningless the statement on the banknotes that they could be redeemed.

The government borrowed more and more. A higher price for gold resulted. Gold coins were handled at an additional premium. The official rate before the Napoleonic Wars was one ounce of gold to £3 17s 10 1/2d. In 1814, shortly before the end of the war, the actual price in terms of the Bank of England notes was £5 4s. The gold price had risen almost 50 percent in terms of British pounds; in other words, the value of the British pound had declined.

After the war of Great Britain against France ended, Great Britain decided to return to the gold standard. The only method considered was to deflate and return to the pre-war parity—£3 17s 10 1/2d per ounce of gold. So they reduced the amount of money; they contracted. To deflate the government must borrow from the public—not from the banks. And it must not spend the money which comes in; it must destroy it. This is difficult as you can imagine. You will rarely find Ministers of Finance who are ready to do this. But at that time it occurred—because they believed it was the only “honest” and “just” way.

Now, let us see how “just” and “fair” such a method is. If a man had contracted a loan before 1797, and had not yet paid it back, it would have been correct to say he should pay the pre-war value. But don’t forget that many people had borrowed money during the period of the suspension of specie payment on the part of the Bank of England. Many British farmers especially, who wanted to improve their property to assist England to survive the war when imports were not easy, had mortgaged their farms and received the devalued or “light” pounds. And now came a law which required them to pay back “heavy” pounds. Is this “fair”? Is this “just”?

For these farmers there was still another complication. When peace returned, imports increased and they had to compete against more imports than before the war. While their debts and their payments of interest and principal increased, the price of their products dropped. These two factors contributed to a tremendous agricultural crisis in Great Britain in the 1820s. Among the important consequences of this crisis was an intensification of the Corn Laws, which were later abolished in the 1840s.

The government was also a borrower and had borrowed “light” pounds. Yet according to the new law the government—which was the taxpayers—had to pay back “heavy” pounds. Thus a privilege was granted those persons who had bought government bonds with “light” pounds and who were repaid in “heavy” pounds.

There also resulted all the consequences of price changes. There were winners and losers. This brought about a very great powerful drive for inflation in Great Britain, led by the so-called group of “Birmingham Little Shilling Men.” After some years, when all the changes had been effected, the crisis disappeared. Part of the nation had been enriched at the expense of others who were impoverished. Finally Great Britain enjoyed stable money again.

During the first World War, the British government again embarked on an inflation. The pound was devalued against its gold equivalent. Then after the war the government wanted to return to the gold standard. But again they didn’t realize that to return to the gold standard at the pre-war parity of the pound would bring a sequence of events similar to that which occurred after the Napoleonic Wars. It was inexcusable that the great British Empire did not know how to go about it. They didn’t understand the theory, nor did they know the history. They had had the experience but didn’t recognize it. The situation was once aptly described by a Swedish man [Count Oxenstierna] who said, “Dost thou not know, my son, with how little wisdom the world is ruled.”

In 1922, Lord Keynes had already written a book in which he pointed out that domestic stability is more important than the stability of foreign exchange rates. I remember when I had a talk several years before this occurred with a British banker, not a socialist agitator, who told me, “Never again will the British people have to pay a higher rate of interest to the usurers of the world market for gold in order to keep a British currency at parity.” These were the ideas that prevailed, you know. And it was the same in this country.

When Britain returned to the gold standard after World War I, the Chancellor of the Exchequer at the time [1925], Mr. Winston Churchill, returned to the pre-war parity of the pound. He didn’t know that conditions were different in Great Britain than in other countries. London was the banking center of the world before the first World War, and for this reason foreign nations kept considerable amounts of deposits with the British banks. When war comes, these foreign deposits are called “hot money,” because depositors fear inflation and devaluation of the pound. They are anxious to withdraw their money but will wait if they believe that Great Britain will return to the pre-war parity.

The British didn’t know what they were doing in 1925 in returning to the gold standard. Even the most stupid man in England should have known that the British labor unions were adamant in their demands for higher wages and that wages had been raised to such a point that there was permanent unemployment, with millions of persons out of work. Yet, in the face of such a situation, the British government increased the value of the pound. They made the “light” pound the “heavy” pound, thus increasing the real wages of workers without any change in the number of jobs. The result was that British production costs, which were already high under the existing wage rates, too high for the world market, were enhanced even more.

Great Britain made a bad mistake by returning to the pre-war parity of the pound in 1925. This added to the income of persons who had bought bonds or otherwise lent money in “light” pounds. The government had to collect more taxes to repay those bonds in “heavy” pounds. A catastrophe resulted. The United Kingdom cannot feed and clothe its population out of domestic resources; it must import food and raw materials and pay for these with manufactured goods, most of them produced from imported raw materials. They found themselves in a situation where they were unable to export enough to preserve their standard of living. Labor unions would not consider a reduction in wages.

To avoid hurting the interests of those who lent “heavy” pounds, it would not have been necessary to return to the pre-war parity. It could have been arranged that a loan contracted in 1910 would be paid back in a higher number of pounds than when contracted. Although this might have helped, it wouldn’t necessarily have been “just” or “fair,” because the bond might have changed hands several times.

Because of the problems that developed, the government capitulated in 1931, by devaluing the pound four times more than it had been devalued before 1925. This meant that Great Britain, still a great creditor nation, made a gift of hundreds of pounds to foreign debtors who, after 1931, could pay their debts to Britain in “light” pounds. What kind of statesmen were these? Winston Churchill, as Chancellor of the Exchequer, was badly advised.

Now in the United States, we have the question of how to return to the gold standard. In my opinion, there can be no question as to the necessity for doing that. But the question is at what parity we should return. Should it be determined through stabilization, by abolition of the laws against holding gold, and stopping the increase in the quantity of money? Within a short time after some haggling, there would be more or less a price for gold which would not affect the purchasing power. One could then return to the gold standard. Leaving aside the problem of old debts, this wouldn’t change anything—this wouldn’t destroy the whole economic system.

But there are among the minority favoring a return to the gold standard very eminent men who favor resumption of specie payment at the rate of $35 an ounce. They say this is the only “honest” solution. I don’t know why these gentlemen are precisely in favor of $35. One must stabilize at the present-day gold value of the money without deflation. To return to the gold standard at $35 per ounce of gold would cause a deflation, because today [1951] $35 is no longer considered the equivalent of an ounce of gold. The price of gold is much higher, as can be seen from the quotation of the American dollar in Switzerland and other neutral countries. If the American government redeems the dollar at $35 there would be a tremendous withdrawal of gold from this country, which would make the whole thing unpopular.

If one wants to deflate after considering all of the tremendous disadvantages of deflation, if one wants to go back to an old value which has only a theoretical value, why go back to the New Deal value, which was never anything but a specter in the law books and never had any real significance to Americans? Why not go back to the original old United States dollar—$20.67? Why just the New Deal dollar? They say it is a statutory dollar. Of course, $35 is the rate for foreigners, not for Americans—it is a criminal offense for Americans to own gold—at which governmental international dealings are made. [The prohibition against owning gold in this country has since been repealed. In January 1975, U.S. citizens regained the freedom to buy and own gold.] Many gold producers have been forced to sell gold. But US$35 is not the real market parity for gold. I don’t see why anyone should want to take on the disaster of a deflationary movement. Deflation is so very unpopular. Its unpopularity is exaggerated, but it couldn’t work because people are so opposed to it.

I see only one way to return to the gold standard—abolish laws against holding gold, re-establish the gold market and see what rate establishes itself. This would cause the least possible disruption. The greater part of gold is outside of this country. The U.S. government could keep quiet for a time, and not enter the gold market. There would be a drop in the price of gold on the black market. Nobody can know in advance how much the free gold price would be—but I would guess somewhere between $38 and $40. Then we could have a gold standard.

As a citizen I have my opinion. I don’t say it is wrong or dishonest to advocate a return to gold at $35 per ounce, but I say you are living in an illusory world if you believe it is possible to present the American people with a deflationary program such as returning to the $35 rate would mean. $35 is nothing but the rate of Mr. Morgenthau [Secretary of the Treasury under FDR’s New Deal]. Why take the New Deal dollar? If I know these advocates, they are not very enthusiastic New Dealers. The $35 an ounce gold ratio started in 1934, but eighteen years have elapsed since then.

Some people believe you cure inflation by causing deflation. This is a little like suggesting that to cure a man who has been run over by an automobile going from north to south, you should run the car back over him again from south to north.

I agree it will be difficult to return to the gold standard. But the first step is to re-establish the gold market. Eventually there will be a gold price. At first the government could say it wouldn’t sell more gold at this price than it had sold on the average, for instance, over the last ten years.

The United States went off the gold standard because it was believed that inflation was beneficial. We wanted to adjust the standard according to prices. We imitated Great Britain, which went off the old parity in 1931. There was the depression and unemployment in the United States, and consequently it was necessary to adjust wages downward. This was not done. The devaluations of 1931 in Great Britain, of 1934 in the United States, and of 1935 in the Latin Monetary Union took place because the governments and the people were too weak to resist the labor unions. The labor unions believed that the higher the wages are, the better it is for labor. But if wages are raised above the market rate the result is permanent unemployment. Don’t believe that I am in favor of low wage rates. However, low wage rates were the necessary, inevitable consequence of the fact that there were more and more trade barriers in the world and more and more capital consumption. Tariffs reduce production all over the world and wage rates must go down. Prices are adjusted according to the standard. Trade barriers shift. Production goes from those places in which a smaller input produces a greater output to places where it is the other way around.

Let us say this, for instance: If the Portuguese government raises the tariff for something that the British used to export to Portugal, and consequently there develops in Portugal an industry of this type for which conditions in Portugal are very unfavorable and where, therefore, the costs of production are higher, and the British are forced to restrict their exports and must develop other industries for which the conditions in Great Britain are very unfavorable, the result is a general drop in productivity all over the world. Along with this there is the necessity to consume less, which means, for the worker, lower wage rates. And you cannot change lower wage rates by picketing. Pickets don’t keep wages up.

Therefore, if you say it was for the first time that a country walked off the gold standard when there was no reason to do it in world history, I would say it was not precisely for the first time.

The quantity of gold reserves doesn’t matter. If there is not a special reason to reduce the reserves, you must effect this transition to a gold standard at a rate at which current transactions do not change the amount of gold. The main thing is to find the parity at which the market can maintain without the transfer of gold.

The black market is a market. There is nothing “black” about it. A black market price takes into consideration the risk. When the blackness is taken away from this market, then prices will probably drop. So will it be with gold.

I don’t believe the danger of a runaway inflation is imminent because there are enough powerful people who are opposed to it to prevent it.

I am in favor of gold coins so that the individual will be involved, so one will realize when the slightest inflation takes place. The fact that the individual citizen can see when the situation changes is one of the most important checks of the Constitution against inflation.

The world is on a gold standard, but the United States is on a paper standard. A return to the gold standard is possible economically, but not politically. The present government is built on such tremendous domestic expenditures that if the people are not actively opposed, the government will always inflate. The advantage of the gold standard is that the purchasing power depends on conditions which are not subject to governments, political parties, and changing codes, creeds, and desires.

There is nothing divine about the gold standard but there are some reasons for it. The gold standard is a human institution. It has come into use through the course of history. The gold standard prevents the government from increasing the amount of money through inflation.

It is impossible to keep a fiat money stable. A very able economist, who was sometimes rather fantastic, the late Irving Fisher [1867–1947], was convinced that you could measure the purchasing power of money. He talked about the housewife’s basket filled with $10 worth of purchases. He believed that the purpose of keeping the purchasing power stable was to make the monetary unit such that it always buys the same assortment of various commodities. This is wonderful if you pick out as the standard lady of the world, a certain lady at a certain time. But for only a short time, for each person’s purchases are different, and each person’s purchases vary from time to time during a lifetime. How much gasoline did grandmother buy? How about baby food when the children are in college?

Irving Fisher neglected the unevenness and dealt only with markets as a standard of deferred payments. He started his movement in the field of monetary stability at a time when the drop in purchasing power was not very great. He started it because he was in favor of the creditors, which is remarkable in itself because very few people are in favor of creditors. Generally people are in favor of a steady slow downward movement of the purchasing power which favors debtors.

Sound money is that money the changes in purchasing power of which are very slow so that they do not affect business seriously.

Gladstone said, not even love had made so many people crazy as money.