The Free Market’s Unlikely Champion

In the dark hours of a collapse is when the free market tends to undergo its most radical depredations. Politicians never seem to grasp the complexities of what’s going on, but understand that SOMETHING needs to be done. Like FDR, they just start changing things and hope for the best. Later, a whole generation of economists would praise FDR for his decisive actions. “It’s not that his actions were particularly good,” they might say, “but something needed to be done.” A crisis can not go unanswered. To believe otherwise is sacrilege in macroeconomics. If one believes that an economy can be managed by comparing aggregate supply to aggregate demand, then one has not only the right, but the responsibility to correct the situation.

“With great power, comes great responsibility” were the fictionalized words of Spiderman’s Uncle Ben to Peter Parker, the main character. Peter resisted being called to the role of hero, but in the end, who else had the power to save the world. And this must be how politicians and macroeconomists must feel. They have been given the almost superhuman power to restore confidence in Capitalism by correcting some of the messier elements of the free market system.

And then there’s France. France has always been the butt of America’s jokes; the nation labeled by Homer Simpson as the land of “cheese eating surrender monkeys.” Americans fancy themselves as rugged individualists living by their wits in the dog eat dog world of free market capitalism.  We seem to feel that France is the sissy brother of our western allies: people speaking a strange language in a system so collectivist in their Socialism that it borders on Communist. Like most of America’s fantasies, we seem a bit off base; our system is far more collectivist (and socialist) than we would like to admit and our attitudes regarding France seem unduly harsh. Truthfully, I feel that those two nations have much more in common that either would like to admit. 

Lest we forget, it was France that enabled us to win our independence to begin with. While Americans seem to approach having an empire as a novel idea with grand appeal, France has already gone through their empire phase, complete with an attempt to take over the world through force. And when it comes to fiscal discipline, France seems to have a better understanding of when the game is up than we do. Experience is the best teacher and France has been burned before in the game of holding foreign currencies in the name of global stability. As Murray Rothbard recounted in A History of Money and Banking in the United States: The Colonial Era to World War II France was made a dutiful martyr early in the game of modern finance.

After the aftermath of the first world war, Britain made an attempt to return to the gold standard at their pre-war par. Normally this would have been a very contractionary move, as Britain had vastly inflated their money supply to fight the first world war and therefore there was a far greater ration of paper pounds to central bank gold to back it. One would expect that they would merely have taken the more conventional move of returning to the gold standard at a new par that reflected the vastly inflated quantity of paper notes in circulation. If Britain desired, for whatever reason, to return to valuing the pound at the old par, then one would then have expected for Britain to start contracting their money supply over the years as the United States did in retiring the greenback after the Civil War. But the master planners in Britain, now doubt influenced by the most prominent British economist of the time, John Maynard Keynes. Instead they desired to actually inflate their money supply while simultaneously revert to redeeming their pound in gold. While this scheme might seem absurd to the likes of ordinary mortals like you and I, the British economists felt they could do it.

Part of the plan was that they would not redeem the pound for gold with ordinary citizens, so it was not a true gold standard but rather what became to be called a gold exchange standard. Since the other nations of the world were also in shambles from the first world war (with the notable exception of the United States) Britain felt that no one else would be in a position to present large quantities of paper pounds for redemption as long as the Britain could get the United States to play along. The Federal Reserve, under the leadership of Benjamin Strong, supported this move by the British, for it required the Federal Reserve to expand its money supply even more than the British were doing. Both countries economies underwent a huge inflationary boom in “the roaring twenties”. We all know how that story ended.

What is often lost on those of us not familiar with Rothbard’s excellent history, is that the central bank of France began acquiring large quantities of British pounds as its industries revived and it ran a trade surplus with its British neighbor. The French became nervous as they watched the British and the United States continue their inflationary campaign. They understood that Britain might have a problem redeeming all of the pounds the French possessed should they be ever be presented. But the British central banker, Lord Montagu Norman, convinced the French that Great Britain would stand by their pledge to redeem their pound in gold, even if they had to start raising interest rates and end their inflationary campaign to do it.

So the French played along and held onto their British pounds. As the situation became increasingly untenable, the French began demanding that the British halt their inflationary ways and instead start contracting their money supply. The British were forced to either abandon their pledge to the world to redeem their pounds or they had to stop inflating. Instead of face the pain that might come with higher interest rates, they chose the abandon their gold standard.  France’s central bank had to take a huge loss on the paper pounds it held in it’s vaults.

Fast forward a few decades, and now the players are slightly different, but the story remains the same. Now it is the United States that is maintaining a gold exchange standard, and France is, once again, acquiring a large number of paper dollars. It received similar pledges from the United States that it would stand by its pledge to redeem the dollars in gold, but France once against watched as first LBJ and later Nixon expanded the money supply to increase government entitlements and fight a war in Southeast Asia. As they saying goes, “Fool me once, shame on you, fool me twice, shame on me.” Or, as President Bush shortened it, “You can’t get fooled again.” And so the French didn’t.

Having been burned by their previous experience with England no doubt colored the French decision to continue presenting their dollars to the United States for redemption. And again the leaders of the currency promising to redeem the dollar in gold, were so resistant to the idea of reigning in their spending, that they chose instead to simply make them irredeemable. Yet again, France and the other nations of the world took a loss on their dollar holdings, and today the loss has now spread over to the include debt instruments backed by the dollar as well. 

So now the French are lecturing the world on the benefits of fiscal discipline: Both French President Nicolar Sarkozy as well as Europe’s central banker Jean-Clause Trichet have recently announced a conference in mid-November that will be attended by all of the major western powers including the United States. The topic of this conference is to be a return to the Bretton Woods accord- the accord which Nixon abandoned by ceasing redemption of dollars for gold. 

It’s not hard to figure out the true motive here. Sarkozy and Trichet want to displace the US Dollar from the reserve currency of the world and instead put the Euro in its place. And why not? God has not ordained the US Dollar legal tender for all debts, the US government has; the history of the dollars reign as reserve currency of the world is one ripe with abuse as America has inflated its money supply and forced the other nations of the world to eat the cost. The nations of the world might be ready for a new currency, and Sarkozy and Trichet are certainly ready to make it the Euro. Odds are, this conference may produce little more than lip service, but there is also a chance that Europe may announce a coup by declaring a standard of redeem ability for the Euro in gold. If so, then I would image a stampede of the nations of the world out of the US Dollar and into this newly found hard money. I can only imagine what would happen to the value of the dollar.

European Leaders Speak of Return to Bretton Woods

There is a saying on Wall Street that “markets make opinions.” That means that when markets are trending higher, there is talk about how innovation and technology have made us prosperous as a people; when markets are falling, we talk of how we have lost our competitive edge. It’s similar to Vegas gamblers. When they are winning, they have a system. When they are losing, they are unlucky. 

When the inflationary boom is raging, politics love to talk about how the people deserve this newfound prosperity they are experiencing. When the deflationary contraction comes, we talk of lost virtue. The market becomes a drought in everyone’s mind and the politicians become the priests of the Rain God come to tell us we must repent. So I can’t say I’m particularly surprised to see that British Prime Minister Gordon Brown and European Central Bank President Claude Trichet have recently been calling for a return to the first Bretton Woods agreement. As those of you know who have read my book, Bretton Woods was the agreement reached after World War II whereby the United States would redeem gold at $35 an ounce and the rest of the world would use the US Dollar as their reserve currency. 

Ah, the excesses of paper money. I guess when the wheels come off the wagon, it’s suddenly cool for Trichet to say that, what the world really needs is “”discipline: macroeconomic discipline, monetary discipline, market discipline.” That’s akin to a drunk saying in the midst of his hangover that he really needs to stop drinking. Yes, the world does need monetary discipline, but it does not possess the world power to impose it on itself and the central bankers of the world are happy to oblige it along it’s merry way. Although it is possible that there is more here than just giving a nod to virtue in the aftermath of the credit orgy; it is possible that this may be the early murmuring of an actual move away from the US Dollar and towards a new financial order. As I mentioned in this blog on October 13th, a move away from the Dollar is inevitable at some point, and it’s possible that the European leaders would like to stop the death of 1000 cuts that is propping up the dollar. Perhaps they’d like to be rid of the current system sooner rather than later. 

Wouldn’t it be a coup for the Euro if it became redeemable in gold? That would assure it that it would become the next reserve currency in the world. Such a move would spell the end of the US empire, because we could no longer print the money needed to run it and traditionally the Europeans have wanted the US to be strong as a protection from Russia. But they may see the writing on the wall and figure that the US Dollar is going to collapse anyway and that Russia is not nearly as strong as it once was. Perhaps they are considering a move towards become great powers on their own merits once against rather than merely a protectorate of the United States. 

It certainly would be, as the Chinese curse says, “interesting times” indeed.

The Endgame Begins

Despite the fact that I’m an avid gamer, my Chess game is pretty horrible. There was a one point in my life where I thought I might devote some time to it, but that never came to be. I do know through my limited reading on the subject that serious students of the game divide Chess into three parts: opening, midgame, and endgame. Because the game has so much history, and because the number of opening moves are very limited, much of the opening tends to follow historical convention of various “opens.” But the open only goes for the first handful of moves. Before too long, the game has broken from the predictable opening to the midgame where the players have now gone from “following the script” to making moves as best they see fit on their own accord. The midgame is where the players are forced to begin making entirely their own decisions, but the situation is also so dependent on the opening that an experienced player can look at a game in progress and reliably predict what opens both players used.

Then after most of the pieces have been taken, the endgame begins. In terms of moves, the endgame can be the longest part of the game. If played out to its conclusion, it can take quite a few moves to advance a pawn to the other end of the board, regain a queen, and checkmate the opposing king. But often good players will simply concede when they see that that is where the game is going. There are no specific markers that delineate opening from midgame from endgame. It’s more a subjective judegement that people can make when reading over the games moves, but there is, to my knowledge, no textbook definition upon which one can say “Ah, with this move, the endgame has begun.” And yet, it is something that experienced players can recognize immediately. In that way, Chess is a bit like global markets.

When compared to a game of chess, the current financial order can be said to have started back in 1944 when John Maynard Keynes led the Western Allies to agree upon a new financial system near Bretton Woods New Hampshire. As discussed in my book, the Bretton Woods agreement set about a new monetary order by which all of the currencies of the world would maintain pegs to the US Dollar which in turn would be fully redeemable in gold. In this way, all of the world’s currencies were indirectly redeemable in gold. More importantly to the United States, the US Dollar became “as good as gold” to the powers of the world. This is how the “game” of our current financial system opened, and the opening moves were indeed predictable. 

The US Dollar became the strongest currency in the world. It was readily taken everywhere and all nations worked to develop a positive trade balance with the United States so that they could begin saving this new version of paper gold in the vaults of their central banks. The currencies of the world did not vary much against each other as each was pegged to a given amount of dollars. All appeared stable and predictable. But as the game advanced, the situation developed to where their became a strain on the gold reserves of the United States. The United States had enjoyed the ability to, in essence, print paper that others took as gold upon demand. No nation can be expected to not abuse such a monumental privilege. Particularly not when there was a Cold War going on. The 1960s say a huge inflationary expansion of the US Dollar as both LBJ and Nixon expanded social spending while financing an expensive war in Southeast Asia. Various nations of the world, particularly France, began presenting their dollars to the US Treasury and asking for gold. Either the United States would have to stop all of this spending or it would have to cease redeeming in gold. In 1971, Nixon chose the later and the midgame began. 

As mentioned, in the midgame, the players have more ownership in their own decisions rather than following a pre-planned set of moves. Now the currencies of the world were free to “float” against each other. The conversion ratios between one nation and another fluctuated daily. Currency traders and not central bankers increasingly began to determine what a given currency was worth in terms of all other currencies. The US Dollar was now going to have to compete on the world marketplace, but because of how revered it had been at the start of the system, to many of the world’s central banks had too large a stake in it to allow it to collapse; remember, the opening has a huge influence on the development of the midgame. There were some scary times at the end of the 1970s where it seemed like the US Dollar was going to collapse, but ultimately it was simply too pervasive a currency and the economic and military power of the United States too strong to allow its currency to be treated like that of a banana republic- even if there was an amazing similarity between the policies of the two. 

But eventually the midgame ends. After most of the pieces have been taken, the players try to surmise who has the advantage and plan accordingly. In our little game, the pieces have been falling all in a row lately. Whether its the housing market, the stock market, or commodities, one pieces after another has been taken off of the board as a safe place to put your money. Lately even the banking system itself, the equivalent of the king in our allegory, has been in danger of getting captured. The endgame is starting. The players of the world are looking at the board and have realized that the financial order of the last six decades is about to collapse. They are starting to plan accordingly. On October 10th, Italian Prime Minister Silvio Berlusconi announced that the world leaders were considering closing the financial markets of the world so that they would have time to “rewrite the rules of international finance.” He would later say that he was just speculating about a rumor, but one does have to wonder whether he was forced to recant by the other world leaders who had wanted more secrecy maintained around their meeting. 

Whether the meeting was real, or whether it isn’t it does beg the question of when one is going to happen. I say when, because I just don’t see how the powers of the world are going to sit by and watch this deflationary collapse unfold without a fight. Confidence has become shaken in the banks of the world, and part of the reason for this is because the banks of the world have far more liabilities than they have assets when the market actions of the past year have been taken into account. A new plan whereby a large block of nations pledged a significant portion of assets to back their banking system would restore confidence in that banks structure and that nation might thereby gain an advantage in prestige over the other nations of the world. A new economic order to replace the now defunct Bretton Woods agreement must be in the works somewhere; if nothing else, it would be needed as a contingency against further collapse of confidence. 

This all spells the end of the dollar. Like a chess game, the players of the world know that its just a matter of time (a matter of moves) before the once almighty dollar is reduced to far less than the paper its printed on. We are about to once again discover the words of Ludwig von Mises who wrote that “”Government is the only institution that can take a valuable commodity like paper, and make it worthless by applying ink.”

Why Gold?

Nat posted this question:

Really, as an investment right now, any commodity is a good buy. I would say gold, guns and bullets are pretty valuable. So your second question is really the one i am asking about. Why should we peg the dollar to gold and not some other natural resource? Gold has no true value. Its pretty, is used in some manufacturing, has a history, but other than that, useless.

I would again recommend that anyone who has this question read Murray Rothbard’s essay Case for the 100% Gold Dollar. It succinctly answers this very question. So as to not just rehash what Rothbard argues, I’d like to make this a hypothetical exercise. 

Pretend for a moment that the government had no power to issue money or to declare legal tender. A lot of people have a hard time with this because they feel that money inherently comes from the government, but they are wrong. As I say in my book, money is a self-organizing principle of a community. So at the beginning we would see various communities using different commodities as money. Perhaps the East Coast would settle on using gold as their money, but let’s say Nevada preferred Silver, except for this one town in Nevada which has decided to use cigarettes. 

So we had those three commodities being used as money in three different places. That may seem crazy, but it’s not in any way different that the situation we have today with different countries standardizing on different fiat monies with no backing whatsoever. When I go to Canada in a couple of weeks I an going to exchange some of my American Dollars for some Canadian Dollars; returning to our hypothetical example, if you were visiting the East Coast, you would exchange your silver currency for gold. In this way, the free market would determine both the exchange rates of all of the commodities used as money. In addition, each person in a given community would be allowed to chose what form they wanted to store their wealth in. 

So you can think of this hypothetical exercise as a grand social experiment regarding money. As the communities began to trade more and more with each other, there would be a tendency to standardize on one particular money so that trade could be normalized across more communities. Whatever this grand money would have to be would have to meet certain criteria:

1. People would need to value it. 
2. It would need to be scare. (So oxygen is out until the air is so polluted we can’t breathe it anymore).
3. It would need to be easily transported.
4. It would need to be rendered into standardized units.  
5. It would need to be a store of value across time. So it would need to not be easily perishable. 

Ok, let’s come back from the hypothetical experiment for now. In this thought experiment we learned that money is a self-organizing principle and that as communities traded with each other there would be a tendency towards adopting the same money as your trading partners.

Now here’s the kicker. This experiment has been run already- more than once. Precious metals always seem to become the desired money upon which communities settle. I can’t tell you why it is that humans value precious metals, but we do. So the reason I’m saying we should return to gold now is because it the money that societies have always gravitated towards for at least the last 4000 years or so.

Now I’m not saying that gold will be the money of the human race for the next 4000 years.  Perhaps in the future we will develop a Star Trek fabricator that, in addition to piping hot Earl Gray tea, will render as much gold as you could possibly ask for. The commodity of choice in the Star Trek Universe might be Dilithium crystals or antimatter, because that’s what makes society go. But that world won’t evolve over night, and if and when it does evolve, gold will be tradable as a commodity for these dilithium crystals right up until we technology got to the point where we had complete control over all matter. 

In the meantime, if you are still not convinced that gold should serve as our money, and Article I, Section 10 of the US Constitution which reads that “No state shall… emit bills of credit; make anything but gold and silver coin a tender in payment of debts” still hasn’t convinced you, then know that I as a free market person respect your right to call for any form of money you wish. We can it is conceivable that we could always start the experiment over and allow all communities to start trading in their own money, but I’d be prepared to put a heavy wager on precious metals coming out on top. 

In terms of the world we live in today, you are correct in saying that any natural resource can conceivably be used as a money to back a currency, but bankers are still partial to things they can put in their vault. Even in today’s world, where every effort has been made to demonetize gold, every central banker in the world will still show and accept it to be shown on a balance sheet as asset. That’s saying something. So if gold is still used as a money amongst central bankers today, despite all of the efforts to the world’s governments to deny it’s use as money, then that’s really saying something.

The one final thing I want to point to is that virtually all commodities in the world are lower today than they were a year ago, except gold. It is the commodity that people have fled to as they have lost faith in the system. So much so that many bullion dealers haven’t been able to keep gold coins in stock. What do you think the odds are that people are going to suddenly stop valuing it?

So, my question to you is, “Why not gold?”

Answering Taylor’s Questions

My good friend Taylor asks three questions:

1. My point here was that while I agree there is much historical precedent for the value of gold there is no promise it will continue to be valued. In that regard gold is no more valuable than paper money. People have historically wanted gold, so it has value. People currently want cash, so it is valuable. The value is arbitrary; it is valued because people want it. The major difference seems to me to be that people have wanted gold longer than they have wanted dollars. The ” intrinsic value” is still a man-made convention, why does it matter what medium it applies to?

2. It is one thing for my dollars to become worthless from hyper-inflation a-la-Germany in the 20’s, it is quite another for my elected officials to vote to make my dollars worthless over night. Yes, I understand you point that they have been voting my dollar to be of less value for decades, but the marginal inflation we have experienced so far I can stomach, and plan for. Overnight worthlessness of everybody’s savings could cause riots.

3. This brings up another question I have had regarding the gold standard. How does it accommodate its inherent lack of elasticity? I. E., if a Spanish Galleon carrying billions in gold is sunk and unrecoverable there are sever consequences to the market and to commodity values. If one of the US Fed Banks is incinerated, and billions of paper dollars are lost the Fed can quite easily reprint those losses and the impact would seem to be minimal. Similarly, gold is a much more scarce commodity compared to paper. What happens when we have mined it all?

The question of whether and why gold is valuable seems to come up a lot. I’m not sure why; outside of land, I can think of nothing that humans have consistently held to be as valuable as gold and silver have proven to be. Humans have valued many things through each age of human development such as dyes during the Roman times, spices during the Middle Ages, and oil today, but precious metals have been held to be valuable during each and every age.

If we wanted to use a commodity based form of money, we could chose between many forms of wealth currently valued in today’s society. We could use oil reserves (for instance) as a basis for a currency. Oil is a scarce commodity whose value does not depend on the health of the government that is issuing the money and is available in standard units of accounting, but precious metals also have all of these quantities. In addition, precious metals have the further advantage in that they have: a much longer history of being held as valuable; a more dense form of wealth; easier to store; and far more resistant to destruction.

Now I do often hear the argument that humans could just decide that they don’t want gold anymore and it would lose it’s intrinsic value. I don’t really see how that’s possible given how many thousands of years we have favored the stuff, and, even in that highly unlikely scenario, it would still have a value as money so long as the nations of the world agreed to value it as such. Which is just my way of saying that it’s silly for us to worry that gold may one day lose all value given that right now our entire economy is based on something that inherently has no value at all!

Regarding Taylor’s second question, I must confess that I find it extremely unlikely that we could voluntarily go back to a gold standard. Today’s dollars are trading at a much higher level in terms of goods and services than they would based on the comparative fundamentals of our America’s assets compared to its liabilities. Were the US government, to enact a gold standard it would have to set the value of the dollar at a level where it could be faithfully backed by the assets at hand, in which case the dollar would have to be valued far lower.

Taylor is correct is saying that we risk revolt from the citizenry because they would perceive that the government had acted to reduce the value of their currency. This would actually be an misperception on their part, because a continued mismanagement of the currency will eventually make it worthless (hence the title of my book), but people don’t understand these things. In part that’s by design. Politicians obfuscate the real cause of inflation away from their own mismanagement of the currency and instead blame whoever is in reach- greedy merchants, speculators, and other nations attempts at currency manipulation. People seem to have gone along with these explanations, and the true is probably too painful for them to accept. 

This is why I have resigned myself to the eventual collapse of the American way of life. To attempt to adopt a more rational and sustainable economic policy is simply political suicide at this point. People can not willingly give themselves over to the hard discipline of a gold standard if they have any belief at all that they can continue to prosper under the gluttony of a fiat money system. I instead believe it my calling to simply educate those of us who are ready to listen and consider the simple truth of this situation so that the idea will have time to germinate in people’s minds. My hope is that, after the collapse of the American Empire, that we can return to the policies that made us a great people to start with.

Regarding Taylor’s last couple of questions, gold’s strength is in its inelasticity. If elasticity where the best path to prosperity, then Zimbabwe would be a world power by now. Inelasticity forces discipline on a society and a government. To pursue a policy of inflation with an inelastic currency means that eventually a correction must occur. The same is true in an inelastic currency really, but the correction can be delayed for a far longer time. The benefits of an inelastic currency is that there is a shorter period of time between monetary abuse and the painful correction that it more closely links cause and effect in the minds of the people. I consider this a good thing. 

Regarding Taylor’s last question, gold will still possess all of the appropriate qualities of money even if we were to take every last bit of it out of the ground. The money supply does not need to expand in accords with the populace. Indeed, as I point out in my book, one of the most prosperous times for us as a nation was after the Civil War. From 1870 to 1900 the population of the United States was expanding while the money supply was actually shrinking because of the retirement of “Greenbacks” (our first experiment with fiat money) from circulation. It was one of the only times in American history that the buying power of the common’s mans wages actually grew steadily and our GDP expanded at the most rapid pace in our history.

US Mint now out of gold coins

For those of you who have bought and read my book will have a hard time following some of my advice regarding acquiring gold coins. Apparently the US Mint has run out of them. It seems that during times of economic uncertainty, they have enough gold to meet demand. Well I suppose that’s the government for ya. Can you really imagine anyone in the private sector going, “Hey, demand for our product has been going through the roof in recent months. I guess we’ll need to pull it off the market!”

Well fear not dear reader. There is still gold out there to be had. You’ll just need to buy foreign coins such as the South African Krugerrand. It’s available at a lower cost over spot anyway, so it’s a good deal. Unfortunately, you don’t get all the tax benefits that the American gold coins carry (also talked about in my book), but it’ll do in a pinch. Besides, if the government collapses, a one ounce gold coin is a one ounce gold coin and no one’s going to worry about the tax ramifications.

The one thing I find curious though, is that physical demand for gold seems to be at an all time high, yet the actual per ounce price of gold had been well below it’s all time high set back in March. What gives?  Some of my more conspiratorial friends believe that the government and central bankers are playing a hand in depressing gold prices so that investors will not see them as attractive investments during times of economic uncertainty. Their logic then suggests that the prices has been depressed too far for the US Mint to actually make a profit on the coinage, and so they stopped producing the coins. It’s an interesting theory and it does explain a few things, but I’m not so sure that’s the real story. 

One thing is for sure though, gold coins are going to become increasingly scarce as this crisis wears on. Get yours now!