This article is published by permission from a paper before a meeting of the Committee for Monetary Research and Education, March 22, 1975.
Recent economic developments reflect and portend the painful convulsions of our fiat money system. The federal government is projecting a budget deficit of $34.7 billion for fiscal 1975 and a deficit of $51.9 billion for fiscal 1976. The U.S. Congress can be expected to boost federal spending even further which, together with the growing deficits of such “off-budget” agencies as the Postal Service and the Environmental Protection Agency, may raise the total federal deficit to more than $100 billion. State and local government deficits are making additional demands for economic resources. To finance such deficits out of the savings of the American people is well-nigh impossible. Therefore, the federal government may be expected to rely increasingly upon its monetary arm, the Federal Reserve System. Only hyper-inflation can finance super deficits.
A budgetary deficit is not just a temporary shortage of money that is readily covered by a loan. It is not primarily a monetary phenomenon that is efficiently handled by monetary authorities and bankers. Instead, a federal deficit means consumption of economic resources — real goods and services — beyond those taken directly from taxpayers. It consumes the real wealth and substance of savers who didectly or indirectly buy the new Treasury obligations. The coming $100 billion deficit, in fact, greatly exceeds the annual savings of the American people, which were estimated to be $74.4 billion in 1973 and $76.7 billion in 1974. (Federal Reserve Bulletin, February, 1975, p. 57).
Whenever our savings are consumed by government, they obviously can no longer be used by individuals who would build or buy homes, household appliances, or make some other improvements. More facilities of production are used to serve government demand, fewer are left to cater to private demand. As the U.S. Treasury enters the capital market to sell its bills, notes and bonds, it absorbs and consumes the very substance of economic productivity. Its capital demand is felt as a chronic lack of capital for industry and commerce, for public utilities, for development of more energy, modernization and renovation and new production facilities. It is felt as a universal “shortage of funds” which, in reality, is a shortage of real savings and economic resources. Plagued by such shortages and enmeshed in serious economic difficulties and crises, the federal government then calls on the Federal Reserve System to alleviate the shortages through credit expansion and money creation. Tons of new paper money are thus to take the place of real goods that are consumed by our political organizations.
The inevitable rise in prices of goods, commonly called inflation, then serves to withdraw the resources from certain individuals and redirects them to the spender with the newly created purchasing power, the federal government. Inflation acts as a federal tax on all holders of money and claims to money. It silently and efficiently transfers real income and wealth from millions of individuals to the inflating government. Nor do most of the victims understand the nature of this taxing process. After all, rising prices can be blamed on merchants and industrialists, thus exculpating the government that is withdrawing and consuming the economic resources. The very administration that is conducting such policies may even blame businessmen for the inflation and proceed to impose price and wage controls on its victims.
A Tool of Politics
In the coming years of galloping inflation the American people may come to understand the true nature of the fiat system that makes government the creator and guardian of money. They may learn what the defenders of gold as money knew all along, that fiat money is political money — an effective tool for the financial aspirations of political parties and administrations. Fiat money serves as an important implement, not only for such policies as “full employment” and “economic growth,” but also for massive redistribution of economic wealth from creditors to debtors. Fiat money is the political device ideally suited to achieve the transfer of income and wealth on a gigantic scale.
Inflation that gradually erodes the capital substance of the middle class can be effective in the fog of political confusion and economic ignorance. In a few years of double-digit inflation, the savings bonds, pension funds, life insurance policies and even corporate stock holdings which constitute the very substance of the middle class, are consumed by government or transferred into the possession of debtors. Massive deficits financed by double-digit inflation thus sustain the redistributive society that heretofore depended mainly on confiscatory taxation of its richer members.
The proceeds of inflation as a tax on monetary assets accrue not only to the government that is actively inflating the currency but also to all other debtors, including corporations and individuals. When the dollar depreciates, all creditors lose while all debtors gain, whether they are political organizations or corporations. Economic property is redistributed universally from a large class of victims, commonly the middle class, to the political institutions and a new class of nouveaux riches, which is enjoying the fall-out effects of inflation. We need not emphasize here that such policies create new sources of economic conflict and social strife.
Yearning for Stability
The yearning of the people of America for “stable money” is a natural reaction to the painful experience of unprecedented instability. The task of philosophers, jurists, historians, and economists is to explain the alternative to the fiat system, to teach the virtues and advantages of natural money which is also honest money. If people who work and trade are free to choose between political fiat and gold or silver, they naturally turn to the precious metals. They choose the gold standard as a monetary system in which gold is proper money and all paper moneys are merely substitutes that are payable in gold. This makes the U.S. dollar a piece of gold of a certain weight and fineness.
But it is a popular mistake that is shared by many historians and economists alike that the gold standard affords monetary stability and that gold coins are endowed with unchanging purchasing power. In a changing world of human action, no money can be neutral or stable. Even a 100 percent hard-money gold standard, in which the currency of each country would consist exclusively of gold, cannot afford stability of purchasing power to its gold coins. Just as the price of an economic good is ultimately determined by the subjective valuation of buyers and sellers, so is the purchasing power of money. Individual valuation of money is subject to the same considerations of demand and supply as that of all other goods and services. People expend labor or forgo the enjoyment of other economic goods in order to acquire money. At times they bid for money, at other times they offer money, and all this bidding and offering ultimately determines the purchasing power of money in the same way as it determines the mutual exchange ratios of other goods.
All plans to make money stable are contradictory to human nature and dangerous to individual freedom, as they would call on government to enforce the impossible. The yearning for “stable money,” therefore, is forever futile unless it means to want honest money that is free from the political processes of public treasuries and central banks. The best we can hope for is monetary freedom that embodies the freedom of contract and choice of money. In freedom, the American people once again could express their preference for gold and silver coins over depreciating political fiat.
A Crucial Choice
Our choice of a monetary system is of crucial importance. Do we want a system in which government creates and manages money through the political process? Or do we prefer to leave that choice to acting people who are exchanging goods and services on the market? If we rely on government we must be prepared to live with government fiat, which is ideally suited to serve political ends. Fiat money can be expanded or contracted at will, always accommodating the national policy of the moment. Above all, it can be inflated at will to supplement government revenue.
On the other hand, if buyers and sellers are free to make the selection they may choose a great variety of marketable goods as their media of exchange. In the past, in a selective process extending over several thousand years, they chose the precious metals, gold and silver, as their money. Are they no longer to be trusted with such freedom of choice?
Government need not establish the gold standard by any conscious or deliberate act. In fact, the gold standard needs neither rules nor regulations, no legislation or government control, merely the individual freedom to own gold. Of course, this freedom of gold ownership embodies the freedom not only to buy and sell gold for use in industrial production, but also to employ it in exchange.
The gold-coin standard means sound money. It is true, it cannot achieve the unattainable ideal of an absolutely stable currency. But it protects the monetary system from the influence of governments. The quantity of gold in existence is utterly independent of the wishes and manipulations of government officials and politicians, parties and pressure groups. There are no arbitrary “rules of the game,” which people must learn to observe. The gold standard is a social institution that is controlled by inexorable economic law.
The issuers of money substitutes keep their currencies at par with gold through unconditional redemption. The issuing bank can buy any amount of gold offered to it at the parity rate, and agrees to sell indiscriminately and on demand any amount of gold against its notes or deposits. It thereby renders no national service in the sense of “defending” or “protecting” its currency. It merely fulfills the contract it made when it issued the money substitutes.
Under the gold-coin standard, inflationary policies are not rendered impossible, but they are made difficult. Redemption requirements and the threat of drains of their gold reserves would restrain the issuers of money substitutes from inflationary expansion. For any such expansion would alarm the owners of substitutes and cause them to demand redemption in gold coin, which would spell ruin to the issuer. As the gold standard makes inflationary policies difficult, it avoids the wide fluctuations of economic activity, known as the business cycle. This binds the issuers of money substitutes within very narrow limits, and thus efficiently checks the sort of credit expansion that creates great instability and generates the economic boom and bust cycle.’
Professor William Graham Sumner, the great Yale economist of the pre-Federal Reserve era, described the instability of irredeemable paper currency as follows: “Scheme after scheme has been proposed and tried for realizing the gain which it was believed that cheap money could produce for the public; that is, for those who buy and use currency. This gain has been pursued as the alchemists pursued the philosopher’s stone, by trial and failure. Whether
there be any such gain or not, our attempts to win it have all failed, and they have cost us, in each generation, more than a purely specie currency would have cost, if each generation had had to buy it anew…. The revulsions to which the system was subject overwhelmed us in every decade. The notions on which the system was based are proved to have been delusion, disastrous to everybody concerned, including those who tried to profit by them.”2
A World Market
The international gold standard evolved without intergovernmental treaties and institutions. No one had to make the gold standard work as an international system. When the leading nations of the world had adopted gold as their currency, the world had an international money. It is true, the coins bore different names and had different weights. But this hardly mattered as long as they consisted of gold and could be exchanged freely. After all, an ounce of gold is an ounce of gold whether it consists of eagles or sovereigns.
The gold standard united the world as it overcame the problem of international payments. It facilitated international trade and finance, and thereby promoted a world-wide division of labor. Countries specialized in producing those internationally traded commodities which afforded them the greatest comparative advantage. But above all, the gold standard encouraged exportation of capital from the industrial countries to the backward areas. Without fear of devaluation losses or transfer restrictions, European capital eagerly sought profitable employment opportunities on all continents. It developed commerce and industry and thus improved working and living conditions all over the globe.
The history of the gold standard heralds the principles and achievements of free and honest money. The history of fiat money is little more than a register of monetary follies and inflations. Current affairs afford but another entry in this dismal register. We may hope for an early return of monetary freedom and sound money, but realization is hidden in the dark clouds of the future. Sound money is the most prominent concomitant of economic freedom and morality; fiat money is an inevitable symptom of their absence.
The duty of each of us is to understand and explain as best he can the principles of economic freedom and honest money. Our future depends on it.
1 Ludwig von Mises, Human Action, Yale University Press, 1949, p. 535 et seq.
2 William Graham Sumner, History of Banking in the U.S., New York: The Journal of Commerce and Commercial Bulletin, 1896, p. 472