How to Return to Gold; H. Hazlitt

The bank takes for granted, with out explicitly saying so, that the only form of gold standard now being recommended is a full, 100 percent gold backing for out standing money and credit. This is Henry Hazlitt, noted economist, author, editor, r. viewer and columnist, is well known to readers of the New York Times, Newsweek, The Freeman, Barron's, Human Events and manyothers. For moreon inflation, see his recent book, The Inflation Crisis, and How to Resolve If. not the system that prevailed in the nineteenth century, or at any time since. What the world then had and now calls the uclassical" gold standard-was a fractional gold re serve system-that is, one in which each nation's gold stock represented only a fraction of its outstanding money and credit. My own preference happens to be for a full gold standard. But as most advocates of a return to the gold standard have in mind the previous fractional reserve system, that should be discussed first. The basic objection to it is that until the re serve falls to the legal minimum fraction permitted, there is continu ous pressure from banks to continue expanding their loans. But when the minimum reserve is reached, politi cal pressure is likely to develop to reduce the required gold reserve 523 524 THE FREEMAN September still further to permit the volume of credit to be further increased. The historic tendency, therefore, is for the required gold reserve to be con stantly attenuated.

Dwindling Reserves When the United States officially ceased gold payments in 1971, for example, its outstanding quantity of money and credit (M-2, including both demand and time bank depos its) had expanded to $454.5 billion. Against this, the U.S. gold stock was only about $12.3 billion (291.60 mil lion fine troy ounces at $42.22 an ounce), or only 2.7 percent. In other words, there was only one dollar in gold to redeem every thirty-seven dollars of paper credit. The situation was even worse than this, because under the then existing ((gold-exchange" standard, the currencies of all other coun tries-more than 100 of them-in the International Monetary Fund were convertible merely into dol lars, while only the dollars were directly convertible into gold. This made our American gold reserve equal to only some small fraction of 1 percent of· the total outstanding money and credit which was sup posed to be directly or indirectly convertible into it.

When the Texas Commerce Bank's letter contends that a return to the gold standard would Utie changes in the money supply to changes in the quantity of gold in Ft. Knox," and on a dollar-for dollar basis, it is assuming, as I have al ready pointed out, that the return would be to a 100 percent gold re serve system. It falls into a number of other misconceptions. It assumes, for example, that to return to a gold standard the government would once more have to establish a fixed relationship between the dollar and an ounce of gold-a new official uprice" for gold-and it mentions $450 as a possibility. But under today's conditions, when every nation on earth has abandoned the gold standard, and nearly all of them have followed recklessly inflationary policies for the last ten or twenty years, it would be practically impossible for the monetary managers of anyone country to establish a fixed relation ship between its present currency unit and gold that they could count on not to prove either dangerously inflationary or dangerously de flationary .

When the United States, after its greenback adventure in the Civil War, decided in 1875 to return the dollar to the previous gold parity, beginning in 1879, and when Bri tain decided rn early 1925 to work its way back to the old parity of $4.86 for the pound, both countries experienced several years of severe deflation and unemployment.

1980 HOW TO RETURN TO GOLD 525 Today it would not only be dif ficult and dangerous, but unneces sary, for any country to try to tie the purchasing power of its existing paper money to any fixed ratio with a new gold-standard currency. All that would be necessary would be the minting of a new gold coin (and perhaps the issuance of gold certifi cates), stamped not in dollars, pounds, marks, or any other na tional unit, but simply with its weight-an ounce, a gram, ten grams, or whatever. (If coined in a metric unit of weight, such as a ten-gram piece, it would circulate as an international medium of ex change no matter by what leading country issued.) Countries issuing such coins should make neither them nor their previous irredeemable paper cur rencies compulsory legal tender. The market rate between their paper currencies and gold would be left free to fluctuate daily. Private citizens would be free to make con tracts with each other for repayment of new long-term debts in either pa per or gold, and such contracts should be enforceable. Private citi zens, corporations or banks should also be free to mint gold coins and issue gold-certificates against them, subject to suit for fraud, short weight or non-performance. Within such a legal framework, an alternative and dependable currency system would always be available for increased use whenever a paper currency began depreciating so fast that no body wanted to continue doing busi ness in it.

Two Possibilities Let me sum up. There are two possible kinds of gold standard, one requiring only a fractional gold re serve against outstanding currency and credit, the other requiring a 100 percent gold reserve against it. The first was the kind the Western world actually operated on from about the middle of the nineteenth century to 1914 (and to some extent in later periods until 1971). The problem with it is that either the required fraction of gold reserve keeps being reduced as the legal minimum re serve is approached, thus permitting a great deal of inflation even under the gold standard; or credit that has been expanding must be suddenly tightened to prevent the gold re serve from falling below the set legal limit. In the second case, which frequently occurred, individual countries, seeking to safeguard their gold reserves, suffered the familiar cycles of credit expansion and con traction, boom and depression.

A 100 percent gold reserve system prevents this consequence. But under it, prices do depend upon the existing gold supply; the volume of money and credit cannot be ex panded at will. There can be no inflation. And that is precisely why 526 THE FREEMAN 80 many people oppose the system. That is why the author of the Texas Commerce Bank letter opposes it. In his words, it Hcannot support the increased needs for liquidity arising from greater world trade .... The gold standard does not provide suffi cient flexibility to deal with today's complex domestic and international conditions." By ((flexibility" the bank means credit expansion. And credit expan sion, when left to the whim of gov ernment authorities, means infla tion. The great merit of the gold standard is precisely that it takes the decision regarding the quantity of money out of the hands of the politicians. The quantity of gold can only be determined by the physical amount that is discovered, extracted and refined, whereas the quantity of paper money can be determined by political caprice.

Misplaced Fears Opponents of the gold standard sometimes express the fear that new annual supplies of gold will finally prove insufficient to u carry on the growing volume of world trade." Such fears are misplaced. The exist ing amount of money is always suf ficient to carry on the existing volume of trade; it is merely the overall price average that is affected. There is, of course, a theoretic possibility that the annual increase in gold supplies might finally prove insufficient to keep commodity prices from falling dangerously and disruptively. Such a shrinkage in new gold production has never actu ally occurred. The opposite has. There have been ((gold inflations," like that following the gold rush to California in 1849 and later discov eries. But the worst that could hap pen, if new gold supplies started to dry up, would be a return to a frac tional instead of a 100 percent gold standard.

((The myriad problems of adopting the gold standard," reads the last sentence of the bank's letter, ((sug_ gest that its adoption is not the optimal way to control inflation." It is significant that the bank letter does not tell us what this optimal way would be. The experience over the last decades of 140 members of the International Monetary Fund proves that it could not be con tinuance of irredeemable currencies under government regulation. Return to the gold standard is not only the ((optimal" way to control inflation; it is the only way. (f) The Gold Room, .Vea' YrJrk City, 1869 SINCE 1933 when President F. D. Roosevelt prohibited private own ership of gold, United States money has been completely in government hands. Monetary instability has, consequently, been institu tionalized. Inflation has fol lowed wave of inflation. Just con sider some figures: From 1967 to 1978, the consumer price index dou bled. In 1979, the index rose by 14 per cent-a pace that would double the CPI again in only 5 years. Yet the first months of 1980 have shown the CPI increasing at an annual rate of around 20 per cent. These figures speak for themselves. Government has lost control of inflation. An ticipating two centuries ago that the Mr. Rader is Legislative Counsel in the office of Con gressman Philip Crane.