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 The Truth about Gold and Economic Freedom.

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Number of posts : 440
Registration date : 2007-07-01

PostSubject: The Truth about Gold and Economic Freedom.   Wed Oct 03, 2007 11:20 pm

"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." You'll be shocked to
learn who actually authored these words, as well as their implication
into the future...

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

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 War 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

Gold and Economic Freedom -- by Alan Greenspan - [written in 1966]

(This article originally appeared in a newsletter: The Objectivist
published in 1966 and was reprinted in Ayn Rand's Capitalism: The
Unknown Ideal)
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