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Jun 17, 2008
Below is an extract from a commentary originally posted at www.speculative-investor.com on 15th Jun, 2008.
A lot of the world’s problems stem from the abilities of the government and the banking system (the central bank and the private banks) to inflate the supply of money. This is because the inflation: a) distorts price signals, leading to the misdirection of valuable resources and slower economic growth, b) supports the expansion of government power and thus leads to a less-free society, c) benefits leveraged speculators and the asset-rich at the expense of conservative savers and the asset-poor, leading to greater wealth disparities than would otherwise exist and to resentment amongst those who are on fixed incomes or at the bottom half of the economic ladder, and d) supports the militaristic objectives of governments. The problem of inflation would not occur, however, if gold were the general medium of exchange because governments and banks cannot create gold. This prompts the following questions:
1. How can we get from where we are now to the point where gold is money?
2. Will gold return to its historical role as the general medium of exchange within the foreseeable future?
The first question is easy to answer. Most serious advocates of returning gold to its position as the official currency of the realm concoct detailed plans as to how a gold-based monetary system should be structured and implemented, but if gold truly is the best money then such plans are neither required nor desirable. All that would have to happen is the abolition of the central bank and legal tender laws, thus leaving the market free to choose the general medium of exchange. If gold is, as we believe, ideally suited to perform the monetary role, then market forces would inevitably cause it to recapture this role if such forces were allowed to operate.
Gresham’s Law states that bad money chases out good money, but Gresham’s Law only applies when legal tender laws force people to accept the bad money at face value. In the absence of legal tender laws the good money will chase out the bad because people will refuse to accept the bad money in exchange for their valuable goods, services and assets.
In other words, if gold is the best form of money then returning gold to its monetary role will not require any additional laws or institutions. It will, instead, simply require the removal of some existing laws and institutions. In particular, there should be nothing in a country’s constitution that specifies what the general medium of exchange should be, and the government should certainly NOT be granted the power to coin or print money or to otherwise exert influence over the supply of money. For example, the writers of the US Constitution committed a grave error when they stipulated what the money should be (gold and silver coin) and granted Congress the monopolistic right to coin new money, because in doing so they unwittingly opened the door to the monetary mischief that has since occurred. If the US Constitution had said anything at all about money it should have said something along the lines of: «The government shall stay completely out of the money business.»
The bottom line is that there should not be any «official» money. Based on thousands of years of history we can be very confident that if left to its own devices the market will choose gold, or the combination of gold and silver, as money, but the main point is that the market must be left to its own devices.
By the way, we don’t mean to imply that the transition from the current government-managed monetary system to a new system based solely on market forces would be simple, smooth and painless. Mountains of debt and derivatives have been amassed on the premise that there will always be plenty of monetary inflation, so it might be necessary to phase the central bank out over a number of years rather than eliminate it in one fell swoop.
The second question is impossible to answer. Governments and banks will never willingly give up the right to create new money, so the only way that gold could ever again become the general medium of exchange is following the total collapse of the current system. In other words, it is very unlikely that the control of money could ever be wrested from the government and returned to the free market in the absence of a total monetary breakdown. And even then, there is no guarantee that a gold-based system would rise from the ashes of our current system.
Apart from the government/bank alliance’s desire to maintain control of the money supply, ignorance is the biggest obstacle facing the return of gold to its traditional monetary role. The vast majority of people, including some intelligent and thoughtful people, believe the dual fallacies that the supply of money must grow at a certain rate to support economic growth and that in times of stress the government can help the economy by increasing its borrowing/spending (financed by increasing the money supply). Also, very few people understand the link between the rising prices that they complain about and the increase in the supply of money, a lack of understanding that the representatives of governments and central banks take every opportunity to nurture.
For example, the statements emanating from this weekend’s meeting of G8 finance ministers were worded as if rising commodity prices were the CAUSE of the problem rather than a SYMPTOM of what was happening to money (as far as we can tell, the increase in the supply of money was not even mentioned). For another example, at this same meeting US Treasury Secretary Henry Paulson should have ‘brought the house down’ when, according to this article, he «urged countries to let markets work, not rely on subsidies». This really was a funny thing for him to say given that the subsidies and tariffs put in place to protect the US ethanol and sugar-growing industries are probably the second most important cause of rising grain prices. The image of a pot pointing at a kettle and yelling «You’re black!» springs to mind, and yet most people take such statements at face value.
For some strange reason, despite the continual flood of lies spewing forth from the halls of government and the mountain of evidence that economic well-being and freedom from government meddling are positively correlated, there is a general distrust of the free market.