All Commentary
Friday, October 1, 1965

Back to Gold?

Mr. Hazlitt is the well-known economic and financial analyst, columnist, lecturer, and au­thor of numerous books, including What You Should Know About Inflation (Princeton, N. J.: D. Van Nostrand, 1960; second edition, 1965).

In February of this year Presi­dent de Gaulle of France startled the financial world by calling for a return to an international gold standard. American and British monetary managers replied that he was asking for the restoration of a world lost forever. But some eminent economists strongly en­dorsed his proposal. They argued that only a return to national cur­rencies directly convertible into gold could bring an end to the chronic monetary inflation of the last twenty years in nearly every country in the world.

What is the gold standard? How did it come about? When and why was it abandoned? And why is there now in many quarters a strong demand for its restoration?

We can best understand the an­swers to these questions by a glance into history. In primitive societies exchange was conducted by barter. But as labor and pro­duction became more divided and specialized, a man found it hard to find someone who happened to have just what he wanted and hap­pened to want just what he had. So people tried to exchange their goods first for some article that nearly everybody wanted so that they could exchange this article in turn for the exact things they happened to want.

This common commodity became a medium of exchangemoney.

All sorts of things have been used in human history as such a common medium of exchange—cattle, tobacco, precious stones, the precious metals, particularly silver and gold. Finally gold be­came dominant, the “standard” money.

Gold had tremendous advan­tages. It could be fashioned into beautiful ornaments and jewelry. Because it was both beautiful and scarce, gold combined very high value with comparatively little weight and bulk ; it could there­fore be easily held and stored. Gold “kept” indefinitely ; it did not spoil or rust; it was not only durable but practically indestruc­tible. Gold could be hammered or stamped into almost any shape or precisely divided into any desired size or unit of weight. There were chemical and other tests that could establish whether it was genuine. And as it could be stamped into coins of a precise weight, the val­ues of all other goods could be exactly expressed in units of gold. It therefore became not only the medium of exchange but the “standard of value.” Records show that gold was being used as a form of money as long ago as 3,000 B.C. Gold coins were struck as early as 800 or 700 B.C.

One of gold’s very advantages, however, also presented a problem. Its high value compared with its weight and bulk increased the risks of its being stolen. In the sixteenth and even into the nine­teenth centuries (as one will find from the plays of Ben Jonson and Moliere and the novels of George Eliot and Balzac) some people kept almost their entire fortunes in gold in their own houses. But most people came more and more into the habit of leaving their gold for safekeeping in the vaults of goldsmiths. The goldsmiths gave them a receipt for it.

The Origin of Banks

Then came a development that probably no one had originally foreseen. The people who had left their gold in a goldsmith’s vault found, when they wanted to make a purchase or pay a debt, that they did not have to go to the vaults themselves for their gold. They could simply issue an order to the goldsmith to pay over the gold to the person from whom they had purchased something. This second man might find in turn that he did not want the actual gold; he was content to leave it for safekeeping at the goldsmith’s, and in turn is­sue orders to the goldsmith to pay specified amounts of gold to still a third person. And so on.

This was the origin of banks, and of both bank notes and checks.

If the receipts were made out by the goldsmith or banker himself, for round sums payable to bearer, they were bank notes. If they were orders to pay made out by the legal owners of the gold themselves, for varying specified amounts to be paid to particular persons, they were checks. In either case, though the ownership of the gold con­stantly changed and the bank notes circulated, the gold itself almost never left the vault !

When the goldsmiths and banks made the discovery that their customers rarely demanded the actual gold, they came to feel that it was safe to issue more notes promising to pay gold than the actual amount of gold they had on hand. They counted on the high unlikelihood that everybody would demand his gold at once.

This practice seemed safe and even prudent for another reason. An honest bank did not simply is­sue more notes, more IOU’s, than the amount of actual gold it had in its vaults. It would make loans to borrowers secured by salable assets of the borrowers. The bank notes issued in excess of the gold held by the bank were also secured by these assets. An honest bank’s assets therefore continued to re­main at least equal to its liabil­ities.

There was one catch. The bank’s liabilities, which were in gold, were all payable on demand, with­out prior notice. But its assets, consisting mainly of its loans to customers, were most of them pay­able only on some date in the fu­ture. The bank might be “solvent” (in the sense that the value of its assets equaled the value of its liabilities) but it would be at least partly “illiquid.” If all its depos­itors demanded their gold at once, it could not possibly pay them all.

Yet such a situation might not develop in a lifetime. So in nearly every country the banks went on expanding their credit until the amount of bank-note and demand-deposit liabilities (that is, the amount of “money”) was several times the amount of gold held in the banks’ vaults.

The Fractional Reserve

In the United States today there are $11 of Federal Reserve notes and demand-deposit liabilities—i.e., $11 of money—for every $1 of gold.

Up until 1929, this situation—a gold standard with only a “frac­tional” gold reserve—was ac­cepted as sound by the great body of monetary economists, and even as the best system attainable. There were two things about it, however, that were commonly overlooked. First, if there was, say, four, five, or ten times as much note and deposit “money” in circulation as the amount of gold against which this money had been issued, it meant that prices were far higher as a result of this more abundant money, per­haps four, five, or ten times high­er, than if there had been no more money than the amount of gold. And business was built upon, and had become dependent upon, this amount of money and this level of wages and prices.

Now if, in this situation, some big bank or company failed, or the prices of stocks tumbled, or some other event precipitated a collapse of confidence, prices of commodities might begin to fall ; more failures would be touched off ; banks would refuse to renew loans ; they would start calling old loans ; goods would be dumped on the market. As the amount of loans was contracted, the amount of bank notes and deposits against them would also shrink. In short, the supply of money itself would begin to fall. This would touch off a still further decline of prices and buying and a further decline of confidence.

That is the story of every major depression. It is the story of the Great Depression from 1929 to 1933.

From Boom to Slump

What happened in 1929 and after, some economists argue, is that the gold standard “collapsed.” They say we should never go back to it or depend upon it again. But other economists argue that it was not the gold standard that “col­lapsed” but unsound political and economic policies that destroyed it. Excessive expansion of credit, they say, is bound to lead in the end to a violent contraction of credit. A boom stimulated by easy credit and cheap money must be followed by a crisis and a slump.

In 1944, however, at a confer­ence in Bretton Woods, New Ham-shire, the official representatives of 44 nations decided—mainly under the influence of John Maynard Keynes of Great Britain and Har­ry Dexter White of the United States—to set up a new interna­tional currency system in which the central banks of the leading countries would cooperate with each other and coordinate their currency systems through an In­ternational Monetary Fund. They would all deposit “quotas” in the Fund, only one-quarter of which need be in gold, and the rest in their own currencies. They would all be entitled to draw on this Fund quickly for credits and other currencies.

The United States alone explic­itly undertook to keep its cur­rency convertible at all times into gold. This privilege of converting their dollars was not given to its own citizens, who were forbidden to hold gold (except in the form of jewelry or teeth fillings) ; the privilege was given only to for­eign central banks and official in­ternational institutions. Our gov­ernment pledged itself to convert these foreign holdings of dollars into gold on demand at the fixed rate of $35 an ounce. Two-way convertibility at this rate meant that a dollar was the equivalent of one-thirty-fifth of an ounce of gold.

The other currencies were not tied to gold in this direct way. They were simply tied to the dol­lar by the commitment of the var­ious countries not to let their cur­rencies fluctuate (in terms of the dollar) by more than 1 per cent either way from their adopted par values. The other countries could hold and count dollars as part of their reserves on the same basis as if dollars were gold.

International Monetary Fund Promotes Inflation

The system has not worked well. There is no evidence that it has “shortened the duration and les­sened the degree of disequilibrium in the international balances of payments of members,” which was one of its six principal declared purposes. It has not maintained a stable value and purchasing power of the currencies of individual members. This vital need was not even a declared purpose.

In fact, under it inflation and depreciation of currencies have been rampant. Of the 48 or so national members of the Fund in 1949, practically all except the United States devalued their cur­rencies (i.e., reduced their value) that year following devaluation of the British pound from $4.03 to $2.80. Of the 102 present mem­bers of the Fund, the great ma­jority have either formally de­valued since they joined, or al­lowed their currencies to fall in value since then as compared with the dollar.

The dollar itself, since 1945, has lost 43 per cent of its pur­chasing power. In the last ten years alone the German mark has lost 19 per cent of its purchasing power, the British pound 26 per cent, the Italian lira 27 per cent, the French franc 36 per cent, and leading South American curren­cies from 92 to 95 per cent.

In addition, the two “key” cur­rencies, the currencies that can be used as reserves by other coun­tries—the British pound sterling and the U. S. dollar—have been plagued by special problems. In the last twelve months the pound has had to be repeatedly rescued by huge loans, totaling more than $4 billion, from the Fund and from a group of other countries.

Balance of Payments

The United States has been harassed since the end of 1957 by a serious and apparently chronic “deficit in the balance of pay­ments.” This is the name given to the excess in the amount of dol­lars going abroad (for foreign aid, for investments, for tourist expenditures, for imports, and for other payments) over the amount of dollars coming in (in payment for our exports to foreign coun­tries, etc.). This deficit in the balance of payments has been run­ning since the end of 1957 at a rate of more than $3 billion a year. In the seven-year period to the end of 1964, the total deficit in our balance of payments came to $24.6 billion.

This had led, among other things, to a fall in the amount of gold holdings of the United States from $22.9 billion at the end of 1957 to $13.9 billion now—a loss of $9 billion gold to foreign countries.

Other changes have taken place. As a result of the chronic deficit in the balance of payments, for­eigners have short-term claims on the United States of $27.8 billion. And $19 billion of these are held by foreign central banks and in­ternational organizations that have a legal right to demand gold for them. This is $5 billion more gold than we hold altogether. Evenof the $13.9 billion gold that we do hold, the Treasury is still le­gally obliged to keep some $8.8 billion against outstanding Fed­eral Reserve notes.

This is why officials and econo­mists not only in the United States but all over the Western world are now discussing a world mon­etary reform. Most of them are putting forward proposals to in­crease “reserves” and to increase “liquidity.” They argue that there isn’t enough “liquidity”—that is, that there isn’t enough money and credit, or soon won’t be—to con­duct the constantly growing vol­ume of world trade. Most of them tell us that the gold standard is outmoded. In any case, they say, there isn’t enough gold in the world to serve as the basis for national currencies and interna­tional settlements.

The Minority View

But the advocates of a return to a full gold standard, who though now in a minority include some of the world’s most distin­guished economists, are not im­pressed by these arguments for still further monetary expansion. They say these are merely argu­ments for still further inflation. And they contend that this further monetary expansion or inflation, apart from its positive dangers, would be a futile means even of achieving the ends that the expan­sionists themselves have in mind.

Suppose, say the gold-standard advocates, we were to double the amount of money now in the world. We could not, in the long run, conduct any greater volume of business and trade than we could before. For the result of in­creasing the amount of money would be merely to increase cor­respondingly the wages and prices at which business and trade were conducted. In other words, the result of doubling the supply of money, other things remaining unchanged, would be roughly to cut in half the purchasing power of the currency unit. The process would be as ridiculous as it would be futile. This is the sad lesson that inflating countries soon or late learn to their sorrow.

The Great Merit of Gold

The detractors of gold com­plain that it is difficult and costly to increase the supply of the metal, and that this depends upon the “accidents” of discovery of new mines or the invention of bet­ter processes of extraction. But the advocates of a gold standard argue that this is precisely gold’s great merit. The supply of gold is governed by nature; it is not, like the supply of paper money, sub­ject merely to the schemes of dem­agogues or the whims of poli­ticians. Nobody ever thinks he has quite enough money. Once the idea is accepted that money is some­thing whose supply is determined simply by the printing press, it becomes impossible for the poli­ticians in power to resist the con­stant demands for further infla­tion. Gold may not be a theo­retically perfect basis for money ; but it has the merit of making the money supply, and therefore the value of the monetary unit, in­dependent of governmental ma­nipulation and political pressure.

And this is a tremendous merit. When a country is not on a gold standard, when its citizens are not even permitted to own gold, when they are told that irredeem­able paper money is just as good, when they are compelled to accept payment in such paper of debts or pensions that are owed to them, when what they have put aside, for retirement or old-age, in sav­ings banks or insurance policies, consists of this irredeemable pa­per money, then they are left without protection as the issue of this paper money is increased and the purchasing power of each unit falls ; then they can be completely impoverished by the political de­cisions of the “monetary mana­gers.”

I have just said that the dollar itself, “the best currency in the world,” has lost 43 per cent of its purchasing power of twenty years ago. This means that a man who retired with $10,000 of savings in 1945 now finds that that capital will buy less than three-fifths as much as it did then.

But Americans, so far, have been the very lucky ones. The situ­ation is much worse in England, and still worse in France. In some South American countries practi­cally the whole value of people’s savings—92 to 95 cents in every dollar—has been wiped out in the last ten years.

Not a Managed Money

The tremendous merit of gold is, if we want to put it that way, a negative one : It is not a man­aged paper money that can ruin everyone who is legally forced to accept it or who puts his confi­dence in it. The technical criti­cisms of the gold standard become utterly trivial when compared with this single merit. The ex­perience of the last twenty years in practically every country proves that the monetary managers are the pawns of the politicians, and cannot be trusted.

Many people, including econ­omists who ought to know better, talk as if the world had already abandoned the gold standard. They are mistaken. The world’s currencies are still tied to gold, though in a loose, indirect, and precarious way. Other currencies are tied to the American dollar, and convertible into it, at definite “official” rates (unfortunately subject to sudden change) through the International Monetary Fund. And the dollar is still, though in an increasingly restricted way, convertible into gold at $35 an ounce.

Indeed, the American problem today, and the world problem to­day, is precisely how to maintain this limited convertibility of the dollar (and hence indirectly of other currencies) into a fixed quantity of gold. This is why the American loss of gold, and the growing claims against our gold supply, are being viewed with such concern.

The $35 Question

The crucial question that the world has now to answer is this: As the present system and present policies are rapidly becoming un­tenable, shall the world’s curren­cies abandon all links to gold, and leave the supply of each nation’s money to be determined by politi­cal management, or shall the world’s leading currencies return to a gold standard—that is, shall each leading currency be made once again fully convertible into gold on demand at a fixed rate?

Whatever may have been the shortcomings of the old gold standard, as it operated in the nine­teenth and the early twentieth cen­tury, it gave the world, in fact, an international money. When all lead­ing currencies were directly con­vertible into a fixed amount of gold on demand, they were of course at all times convertible into each other at the equivalent fixed cross rates. Businessmen in every country could have confidence in

the currencies of other countries. In final settlement, gold was the one universally acceptable curren­cy everywhere. It is still the one universally acceptable commodity to those who are still legally al­lowed to get it.

Instead of ignoring or deplor­ing or combating this fact, the world’s governments might start building on it once more.

  • Henry Hazlitt (1894-1993) was the great economic journalist of the 20th century. He is the author of Economics in One Lesson among 20 other books. See his complete bibliography. He was chief editorial writer for the New York Times, and wrote weekly for Newsweek. He served in an editorial capacity at The Freeman and was a board member of the Foundation for Economic Education.