gold ~ reality check?

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    Gary North's REALITY CHECK

    Issue 201 December 26, 2002


    The recent move up in the price of gold has
    strengthened the hand of the camp of gold bugs. But this
    is a tiny camp. Among professional economists, support of
    a gold coin standard is limited mainly to members of the
    Austrian School, which has been a tiny minority in the
    profession. There are a few supply-side economists who
    call for a government-run monetary system comprised mostly
    of credit money, which in turn is created by a government-
    licensed monopoly, the commercial banking system. Behind
    this monopoly stands another government-licensed monopoly,
    the central bank. The number of academic economists who
    believe that there should be laws against fractional
    reserve banking -- that banks should not be allowed to loan
    out money long term that has been deposited short term --
    is probably under fifty, and may be under a dozen.

    What economists think is a marginal issue. The
    crucial issue to the operation of any monetary system is
    what participants in the market decide to use as money.
    Here, the issue today is clear: the public does not use
    gold coins as money. Gold coins in the United States were
    removed from circulation by executive order in 1933. In
    Europe, the banks' suspension of redeemability in gold
    coins took place within weeks of the outbreak of World War
    I in the summer of 1914. England restored redeemability in
    1925, but a public run on the Bank of England's gold forced
    the Bank to suspend payment in 1931.

    With the universal suspension of gold coin
    redeemability by citizens by 1933, the public was forced to
    accept the theft of their deposits. They were taught by
    every media outlet including the universities that gold was
    a barbarous relic, in the words of self-taught economist,
    the mathematician ( B.A. degree ) , John Maynard Keynes. The
    world's bankers applauded. So did the world's political
    leaders. Without the threat of a run on the banks' gold,
    politicians and bankers could create money at will. They
    could print up all the money they wanted because the public
    could not demand gold coins in exchange for their bank
    deposits and their paper money. The golden handcuffs were
    thrown away, and they remain discarded.

    Austrian School economists are in favor of a gold coin
    standard because they are in favor of market-created money.
    They are convinced that gold and silver coins will function
    as money whenever laws establishing bank monopolies are
    abolished, when contract law is enforced by the civil
    government, and when no agency is allowed to issue receipts
    for precious metals ( or anything else ) that are not backed
    100% by the assets necessary to redeem them. Austrian
    School economists present the case for gold in terms of
    real-world decisions by acting individuals on an unhampered
    free market. They deny that gold has intrinsic value,
    i.e., value independent of the decisions of acting
    individuals. They insist that gold has had historic value
    because of its industrial uses, its applications in jewelry
    and art, and demand for gold as money -- mainly the last


    The case for a gold coin standard is the case for
    individual economic sovereignty. It is a case for a
    monetary standard that arises without government
    interference for or against gold as money. This is the
    case for voluntary contracts.

    The modern economy is not a voluntaristic system. The
    laws reflect the political power of special-interest voting
    blocs. Commercial banks are among the most powerful of
    these special interests. The modern monetary system is
    therefore a rigged system. It always has been, but from
    the end of the Napoleonic wars in 1815 until the outbreak
    of World War I in 1914, the international monetary system
    was the least rigged system since the days of the gold coin
    standard in the Byzantine Empire, which enjoyed eight
    centuries of stable money.

    The public in the West today is completely unfamiliar
    with gold as money. Everyone uses paper money or bank
    credit money: checks and credit cards. Contracts are
    written in terms of bank credit money. Everyone's economic
    plans are based on men's faith in the long-term sovereignty
    of governments over money, which means bank credit money.
    The mark of this faith is the capital markets' responses to
    decisions of the Federal Reserve System, which is seen as
    an appendage of Alan Greenspan. He has the power to move
    markets up or down merely by controlling the degree of
    clarity in his public pronouncements.

    If we are going to defend intellectually the
    legitimacy of free market economics and free market
    institutions, then we must adopt the principle of consumer
    sovereignty. The primary justification of the free market
    is that it extends the greatest authority to the individual
    over his own affairs. It makes individuals responsible for
    the allocation whatever they own. It is a system based on
    the judicial and moral principle of individual legal

    So, the intellectual defenders of the pure gold coin
    standard are caught in a bind. They believe that
    government manipulation of the monetary system is
    inefficient. This interference with consumer sovereignty
    over money through contract law must produce a
    misallocation of money, meaning capital. The present
    system will produce booms and busts in the capital markets
    and the consumer markets. They stand on the sidelines and
    yell "stop" every time the central bank interferes with
    interest rates by increasing or decreasing the supply of
    "high-powered money" -- mainly its holdings of government
    debt certificates.

    The public understands none of this. Neither do most
    economists and politicians. All they know is that, once
    adopted, the central bank's control over money is like
    holding a tiger by the tail. The central bank can't let
    loose safely. Neither can the rest of us. This is why,
    three decades ago, economist F. A. Hayek wrote a book on
    monetary policy titled, A TIGER BY THE TAIL: THE KEYNESIAN
    LEGACY OF INFLATION. Two years later, he received the
    Nobel Prize in economics, but not for this book.

    The fact that the public doesn't understand monetary
    theory isn't the bedrock assumption of my theory that the
    public isn't interested in gold as money. The public has
    never understand monetary theory, even in the gold standard
    era. They knew this much: crooks can counterfeit money.
    They knew that it is difficult to counterfeit gold and
    silver coins. So, people voluntarily used gold coins in
    exchange. They demanded gold coins for large transactions,
    with silver coins for smaller transactions. What mattered
    most for monetary policy was the individual's legal
    authority to walk into a bank and exchange his banknotes or
    his deposit certificates issued by the bank and get gold
    coins. The banks could also do the same thing to the
    United States Treasury.

    Today, the public doesn't regard gold as money. If we
    are to make the case for gold as money, we must acknowledge
    the reality that gold is money today only for central
    banks. They tag their bars of gold stored mainly in the
    Federal Reserve Bank of New York. Employees in the vault
    move these bars back and forth into appropriate piles.
    This is how central banks clear their accounts with each
    other. Some central bankers still believe that gold is
    money, but only for central bankers. They regard gold as
    money for their closed, monopolistic little world. After
    all, they stole it fair and square from commercial banks,
    who stole it fair and square from their depositors. The
    victims did not complain much in 1914, 1931, and 1933.
    Possession is nine-tenths of the law, especially when
    governments not only go along with the existing
    arrangement, they created it.


    The mountain of debt piles up because creditors are
    convinced that the central banks will not inflate their
    currency units "too much," and debtors are convinced that
    central banks will not allow price deflation. They believe
    that the existing pile of debt will never be repaid. It
    cannot be repaid without shrinking the money supply,
    because the monetary system is based on the monetization of
    debt, especially government debt, by the central banks. If
    the government ever paid off their debts, forcing the
    central banks to sell their debt, the central banks would
    have to monetize something else as a replacement asset in
    the monetary base. If the banks don't monetize debt, then
    they must monetize equity: stocks, real estate, or ( if
    necessary to prevent monetary deflation ) desk chairs.

    The world's existing debt level is assumed to be a
    floor. It is assumed to be like a ratchet. It moves only
    in one direction: up. This means that monetary reform is
    never discussed by economists and reformers except in terms
    of preserving the existing debt floor. To speak of the
    repayment of debt in general is to speak of either monetary
    deflation, price deflation, bankruptcy, and depression ( the
    shrinking of the monetary base back to the level of gold
    coins ) or else the transfer of ownership to central banks
    ( the monetization of equity ) . We are riding the debt

    This morality of this system was described by David
    about 3,000 years ago: "The wicked borroweth and payeth not
    again" ( Psalms 36:21a ) . The results of this monetary
    policy were described by the prophet Isaiah 250 years
    later: "Thy silver has become dross, thy wine mixed with
    water" ( Isaiah 1:22 ) .

    There is only one a way back to ( 1 ) a full gold coin
    standard without ( 2 ) fractional reserve banking that would
    not be massively deflationary, thereby destroying men's
    confidence in the free market. That non-deflationary
    transition would involve the central banks' raising the
    price of gold while simultaneously selling off its debt.
    The currency-denominated value of the nation's monetary
    base would remain the same.

    Then, to get the gold into the hands of the public,
    the central banks would either have to auction off their
    gold in the form of coins ( not bullion ) or else simply mail
    the same number and quantity of gold coins to individual
    voters or taxpayers. I think the latter strategy would be
    the most politically acceptable. I just don't think there
    is any constituency for it. If one appeared, governments
    would fight it, and academic economists would back the

    The main problem with a central-bank hike in the price
    of gold is this: it would create massive windfall profits
    for gold investors. This is politically unacceptable. If
    you think getting a flat tax substituted for the graduated
    income tax is a hard sell politically, think of what a pro-
    gold coin standard political movement would face, and how
    few people would understand the issues.

    There is no conceivable way to establish a full gold
    coin standard that doesn't involve either massive deflation
    or else a huge hike in the price of gold as the price of
    de-monetizing debt. A rise in the price of gold that did
    not also mandate the return to the public of all of the
    stolen gold would validate the central banks' ownership of
    most of the world's gold, which is the opposite of the
    traditional free market economist's case for gold:
    individual consumer sovereignty.

    My conclusions: ( 1 ) the level of debt will increase,
    ( 2 ) the central banks' monetization of debt will increase,
    and ( 3 ) monetary inflation will increase.

    If monetary inflation increases, gold will eventually
    rise in price. This is my case for gold as a commodity
    investment. Entrepreneurial ( "windfall" ) profits to gold
    owners will take place indirectly, through the price
    effects of monetary inflation, but not directly, i.e.,
    through a coordinated, international decision of the major
    central banks to de-monetize debt and re-monetize gold by
    ( 1 ) hiking its price and ( 2 ) substituting gold coins for
    debt as the monetary base, nation by nation.

    We really do have a tiger by the tail, just as Hayek
    wrote three decades ago. As investors, we must think
    through the implications of remaining behind the tiger. A
    few people may be able to escape safely, but most people
    cannot do so without facing the tiger face to face.
    Everyone can't sell currency-denominated assets at the top
    and buy gold or other inflation hedges at the bottom.

    I believe this process has already begun.


    It is conceivable that individuals will someday return
    to a full gold coin standard, but only in response to a
    breakdown in the monetary units of international trade.
    The cost of such a transition would be horrendous. Hardly
    anyone knows where to buy gold coins. There are not enough
    coin stores to handle demand for two or three billion
    adults to sell debt or equity ( to whom? ) and buy gold.

    There are technical ways to make the transition from
    credit money to gold money. It is possible to create
    digital bank accounts in gold, with 100% reserves. It
    could be computerized. Actually, this has already been
    done: click here .... But making the technology
    available is very different from persuading billions of
    individuals, most of whom do not have bank accounts, to
    make the transition a little at a time.

    For as long as the existing monetary system muddles
    through, most people will stick with it. I cannot imagine
    a smooth transition to a full gold coin standard, or even a
    100% reserve gold digital standard. This doesn't mean that
    it cannot be done. It means that I cannot imagine how, and
    that I have not seen any written case for how this smooth
    transition could be accomplished. It took World War I and
    the Great Depression to get voters to accept the legality
    of the theft of their gold by commercial banks and then by
    central banks. What will it take to reverse the theft and
    return gold to the general public as a way to jump-start a
    gold standard and a banking system without fractional

    If this transition comes, it is more likely to come in
    Asia, where the legacy of precious metals coins is
    stronger, and where the division of labor has not advanced
    to Western levels -- although it is advancing very fast.
    The problem is, Asian monetary systems are also credit-
    based, central bank-operated. They are all rigged
    currencies. As 2.5 billion people in India and China jog
    into middle-class living over the next two decades, the
    coin of the two realms will be mostly digital, credit-
    based, and therefore debt-based. Only if there are
    secondary markets among the masses that remain based on
    precious metals will the transition be easier.


    The recent upward move of gold's dollar-denominated
    price has to do with gold's status as a well-known
    inflation hedge and war hedge. We are experiencing nothing
    like "a return to gold." The public remains unfamiliar
    with gold coins, and this is not likely to change, short of
    an international economic catastrophe.

    We who are defenders of the free market must do what
    we can to educate people, especially ourselves, to
    understand the case for freedom and individual
    responsibility. This involves understanding the case for
    voluntary contracts. As part of this educational effort,
    we should make the case for honest money, which is the case
    against fractional reserve banking. But this task has
    barely begun, and the rise in debt is now becoming
    exponential. There will be a series of debt crises long
    before voters force the politicians to return to a full
    gold coin standard. That return would involve a return to
    freedom. For this, there is a small constituency, even
    among self-identified gold bugs.
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