This article originally appeared in a newsletter:
The Objectivist
published in 1966 and was reprinted in
Ayn Rand's
Capitalism: The Unknown Ideal
An almost hysterical antagonism toward the gold standard is
one issue which unites statists of all persuasions. They
seem to sense - perhaps more clearly and subtly than many
consistent defenders of laissez-faire - that gold and
economic freedom are inseparable, that the gold standard is
an instrument of laissez-faire and that each implies and
requires the other.
In order to understand the source of their antagonism, it is
necessary first to understand the specific role of gold in a
free society.
Money is the common denominator of all economic
transactions. It is that commodity which serves as a medium
of exchange, is universally acceptable to all participants
in an exchange economy as payment for their goods or
services, and can, therefore, be used as a standard of
market value and as a store of value, i.e., as a means of
saving.
The existence of such a commodity is a precondition of a
division of labor economy. If men did not have some
commodity of objective value which was generally acceptable
as money, they would have to resort to primitive barter or
be forced to live on self-sufficient farms and forgo the
inestimable advantages of specialization. If men had no
means to store value, i.e., to save, neither long-range
planning nor exchange would be possible.
What medium of exchange will be acceptable to all
participants in an economy is not determined arbitrarily.
First, the medium of exchange should be durable. In a
primitive society of meager wealth, wheat might be
sufficiently durable to serve as a medium, since all
exchanges would occur only during and immediately after the
harvest, leaving no value-surplus to store. But where
store-of-value considerations are important, as they are in
richer, more civilized societies, the medium of exchange
must be a durable commodity, usually a metal. A metal is
generally chosen because it is homogeneous and divisible:
every unit is the same as every other and it can be blended
or formed in any quantity. Precious jewels, for example, are
neither homogeneous nor divisible. More important, the
commodity chosen as a medium must be a luxury. Human desires
for luxuries are unlimited and, therefore, luxury goods are
always in demand and will always be acceptable. Wheat is a
luxury in underfed civilizations, but not in a prosperous
society. Cigarettes ordinarily would not serve as money, but
they did in post-World War II Europe where they were
considered a luxury. The term "luxury good" implies scarcity
and high unit value. Having a high unit value, such a good
is easily portable; for instance, an ounce of gold is worth
a half-ton of pig iron.
In the early stages of a developing money economy, several
media of exchange might be used, since a wide variety of
commodities would fulfill the foregoing conditions. However,
one of the commodities will gradually displace all others,
by being more widely acceptable. Preferences on what to hold
as a store of value, will shift to the most widely
acceptable commodity, which, in turn, will make it still
more acceptable. The shift is progressive until that
commodity becomes the sole medium of exchange. The use of a
single medium is highly advantageous for the same reasons
that a money economy is superior to a barter economy: it
makes exchanges possible on an incalculably wider scale.
Whether the single medium is gold, silver, seashells,
cattle, or tobacco is optional, depending on the context and
development of a given economy. In fact, all have been
employed, at various times, as media of exchange. Even in
the present century, two major commodities, gold and silver,
have been used as international media of exchange, with gold
becoming the predominant one. Gold, having both artistic and
functional uses and being relatively scarce, has significant
advantages over all other media of exchange. Since the
beginning of World War I, it has been virtually the sole
international standard of exchange. If all goods and
services were to be paid for in gold, large payments would
be difficult to execute and this would tend to limit the
extent of a society's divisions of labor and specialization.
Thus a logical extension of the creation of a medium of
exchange is the development of a banking system and credit
instruments (bank notes and deposits) which act as a
substitute for, but are convertible into, gold.
A free banking system based on gold is able to extend credit
and thus to create bank notes (currency) and deposits,
according to the production requirements of the economy.
Individual owners of gold are induced, by payments of
interest, to deposit their gold in a bank (against which
they can draw checks). But since it is rarely the case that
all depositors want to withdraw all their gold at the same
time, the banker need keep only a fraction of his total
deposits in gold as reserves. This enables the banker to
loan out more than the amount of his gold deposits (which
means that he holds claims to gold rather than gold as
security of his deposits). But the amount of loans which he
can afford to make is not arbitrary: he has to gauge it in
relation to his reserves and to the status of his
investments.
When banks loan money to finance productive and profitable
endeavors, the loans are paid off rapidly and bank credit
continues to be generally available. But when the business
ventures financed by bank credit are less profitable and
slow to pay off, bankers soon find that their loans
outstanding are excessive relative to their gold reserves,
and they begin to curtail new lending, usually by charging
higher interest rates. This tends to restrict the financing
of new ventures and requires the existing borrowers to
improve their profitability before they can obtain credit
for further expansion. Thus, under the gold standard, a free
banking system stands as the protector of an economy's
stability and balanced growth. When gold is accepted as the
medium of exchange by most or all nations, an unhampered
free international gold standard serves to foster a
world-wide division of labor and the broadest international
trade. Even though the units of exchange (the dollar, the
pound, the franc, etc.) differ from country to country, when
all are defined in terms of gold the economies of the
different countries act as one-so long as there are no
restraints on trade or on the movement of capital. Credit,
interest rates, and prices tend to follow similar patterns
in all countries. For example, if banks in one country
extend credit too liberally, interest rates in that country
will tend to fall, inducing depositors to shift their gold
to higher-interest paying banks in other countries. This
will immediately cause a shortage of bank reserves in the
"easy money" country, inducing tighter credit standards and
a return to competitively higher interest rates again.
A fully free banking system and fully consistent gold
standard have not as yet been achieved. But prior to World
War I, the banking system in the United States (and in most
of the world) was based on gold and even though governments
intervened occasionally, banking was more free than
controlled. Periodically, as a result of overly rapid credit
expansion, banks became loaned up to the limit of their gold
reserves, interest rates rose sharply, new credit was cut
off, and the economy went into a sharp, but short-lived
recession. (Compared with the depressions of 1920 and 1932,
the pre-World War I business declines were mild indeed.) It
was limited gold reserves that stopped the unbalanced
expansions of business activity, before they could develop
into the post-World Was I type of disaster. The readjustment
periods were short and the economies quickly reestablished a
sound basis to resume expansion.
But the process of cure was misdiagnosed as the disease: if
shortage of bank reserves was causing a business
decline-argued economic interventionists-why not find a way
of supplying increased reserves to the banks so they never
need be short! If banks can continue to loan money
indefinitely-it was claimed-there need never be any slumps
in business. And so the Federal Reserve System was organized
in 1913. It consisted of twelve regional Federal Reserve
banks nominally owned by private bankers, but in fact
government sponsored, controlled, and supported. Credit
extended by these banks is in practice (though not legally)
backed by the taxing power of the federal government.
Technically, we remained on the gold standard; individuals
were still free to own gold, and gold continued to be used
as bank reserves. But now, in addition to gold, credit
extended by the Federal Reserve banks ("paper reserves")
could serve as legal tender to pay depositors.
When business in the United States underwent a mild
contraction in 1927, the Federal Reserve created more paper
reserves in the hope of forestalling any possible bank
reserve shortage. More disastrous, however, was the Federal
Reserve's attempt to assist Great Britain who had been
losing gold to us because the Bank of England refused to
allow interest rates to rise when market forces dictated (it
was politically unpalatable). The reasoning of the
authorities involved was as follows: if the Federal Reserve
pumped excessive paper reserves into American banks,
interest rates in the United States would fall to a level
comparable with those in Great Britain; this would act to
stop Britain's gold loss and avoid the political
embarrassment of having to raise interest rates. The "Fed"
succeeded; it stopped the gold loss, but it nearly destroyed
the economies of the world, in the process. The excess
credit which the Fed pumped into the economy spilled over
into the stock market-triggering a fantastic speculative
boom. Belatedly, Federal Reserve officials attempted to sop
up the excess reserves and finally succeeded in braking the
boom. But it was too late: by 1929 the speculative
imbalances had become so overwhelming that the attempt
precipitated a sharp retrenching and a consequent
demoralizing of business confidence. As a result, the
American economy collapsed. Great Britain fared even worse,
and rather than absorb the full consequences of her previous
folly, she abandoned the gold standard completely in 1931,
tearing asunder what remained of the fabric of confidence
and inducing a world-wide series of bank failures. The world
economies plunged into the Great Depression of the 1930's.
With a logic reminiscent of a generation earlier, statists
argued that the gold standard was largely to blame for the
credit debacle which led to the Great Depression. If the
gold standard had not existed, they argued, Britain's
abandonment of gold payments in 1931 would not have caused
the failure of banks all over the world. (The irony was that
since 1913, we had been, not on a gold standard, but on what
may be termed "a mixed gold standard"; yet it is gold that
took the blame.) But the opposition to the gold standard in
any form-from a growing number of welfare-state
advocates-was prompted by a much subtler insight: the
realization that the gold standard is incompatible with
chronic deficit spending (the hallmark of the welfare
state). Stripped of its academic jargon, the welfare state
is nothing more than a mechanism by which governments
confiscate the wealth of the productive members of a society
to support a wide variety of welfare schemes. A substantial
part of the confiscation is effected by taxation. But the
welfare statists were quick to recognize that if they wished
to retain political power, the amount of taxation had to be
limited and they had to resort to programs of massive
deficit spending, i.e., they had to borrow money, by issuing
government bonds, to finance welfare expenditures on a large
scale.
Under a gold standard, the amount of credit that an economy
can support is determined by the economy's tangible assets,
since every credit instrument is ultimately a claim on some
tangible asset. But government bonds are not backed by
tangible wealth, only by the government's promise to pay out
of future tax revenues, and cannot easily be absorbed by the
financial markets. A large volume of new government bonds
can be sold to the public only at progressively higher
interest rates. Thus, government deficit spending under a
gold standard is severely limited. The abandonment of the
gold standard made it possible for the welfare statists to
use the banking system as a means to an unlimited expansion
of credit. They have created paper reserves in the form of
government bonds which-through a complex series of steps-the
banks accept in place of tangible assets and treat as if
they were an actual deposit, i.e., as the equivalent of what
was formerly a deposit of gold. The holder of a government
bond or of a bank deposit created by paper reserves believes
that he has a valid claim on a real asset. But the fact is
that there are now more claims outstanding than real assets.
The law of supply and demand is not to be conned. As the
supply of money (of claims) increases relative to the supply
of tangible assets in the economy, prices must eventually
rise. Thus the earnings saved by the productive members of
the society lose value in terms of goods. When the economy's
books are finally balanced, one finds that this loss in
value represents the goods purchased by the government for
welfare or other purposes with the money proceeds of the
government bonds financed by bank credit expansion.
In the absence of the gold standard, there is no way to
protect savings from confiscation through inflation. There
is no safe store of value. If there were, the government
would have to make its holding illegal, as was done in the
case of gold. If everyone decided, for example, to convert
all his bank deposits to silver or copper or any other good,
and thereafter declined to accept checks as payment for
goods, bank deposits would lose their purchasing power and
government-created bank credit would be worthless as a claim
on goods. The financial policy of the welfare state requires
that there be no way for the owners of wealth to protect
themselves.
This is the shabby secret of the welfare statists' tirades
against gold. Deficit spending is simply a scheme for the
confiscation of wealth. Gold stands in the way of this
insidious process. It stands as a protector of property
rights. If one grasps this, one has no difficulty in
understanding the statists' antagonism toward the gold
standard.
###
Alan Greenspan
[written in 1966]
This article originally appeared in a newsletter called The
Objectivist published in 1966 and was reprinted in Ayn
Rand's Capitalism: The Unknown Ideal