Gary North is a member of the Economists’ National Committee on Monetary Policy.
Americans are peculiar people. Consider, for example, their marvelous ability to memorize vast quantities of data concerning sports events, as well as their skill in recognizing the most subtle legal points in the operation of complex athletic contests. The Saturday Evening Post used to have a regular feature, "So You Think You Know Baseball?" in which the most intricate and perplexing situations that had appeared in certain games were presented and the reader was challenged to referee the game and make a decision. Yet, when confronted with some question concerning the devaluation of the pound, these same people are dumbfounded. They cannot seem to grasp the simplest laws of trade; the various functions of money completely elude their powers of comprehension. It is not a matter of stupidity, exactly, but they just do not want to learn; it is better to leave such matters to "the experts." They fail to realize that their daily lives are far more intimately connected to the operations of the economy than they are to the outcome of a sports event. They can shout "Kill the umpire!" with no sense of shame, while they would never whisper and scarcely dare think to "Question the economic advisors."
Interestingly enough, the rules governing the operation of an economy are rather analogous to those governing a game. A game, like an economic system, must have stated rules; teams must be willing to abide by these rules; the rules must bear some relation to the reality of the game and the ability of the men to play it. Perhaps most important to the smooth functioning of a game, and an economy, is the presence of a respected, mutually acceptable referee. A sound international economy must have all of these things; so, for that matter, should a domestic economy. If a man wants to understand the "rules of the game" in international monetary affairs, he might do well to keep in mind that they should resemble the rules of a sport. The analogy is not perfect, of course; if it were, it would not be an analogy. But it can serve as a handy guideline by which we can examine the various reports that are coming out of Washington, London, and Paris.
The Rules for Basketball
Basketball can serve as our analogous sport. It is the only sport of American origin that can be dated precisely. Dr. James Naismith invented it for use in the YMCA program in 1891. It has become, in terms of paid attendance, America’s most popular sport. While most of us are not intimately familiar with the game, at least we know something about it. This is more than most people can say about their own economy.
Like basketball, the international monetary system has gone through a series of changes since 1891. Prior to 1922, the United States and most of Western Europe were on a full international (and domestic) gold coin standard. Paper currencies were freely convertible into a stated quantity and fineness of gold or silver. Gold was the medium of payment internationally. Because of this free convertibility rule, central banks and governments were partially restrained in the creation of paper currency and debt; if the value of the paper began to fall, due to an increase in the supply, domestic populations and foreigners rushed to convert the paper into specie metals.
In 1922, however, a decisive change came. Many nations, notably Germany, had been experiencing rampant inflation since the beginning of World War I. They had been printing vastly more paper IOU’s for gold than they had gold in reserve. This practice had thrown the previously smooth operation of the international gold standard into confusion. All countries wanted to maintain their gold reserves against the demands of both domestic and foreign populations, yet they also wanted to enjoy the so-called benefits of domestic inflation. Thus, their domestic inflationary policies had come into conflict with the operation of the international trading community.’ As the value of the paper bills fell, many of the nations began to experience gold drains. Gold maintained its purchasing power, and even rose; paper currencies, in most cases, could hardly claim as much.
Genoa Conference of 1922
The result was the Genoa Conference of 1922. At that conference, the representatives of various nations attempted to find a substitute for the full gold standard. They decided that instead of the requirement that a nation keep its gold reserves proportional to its outstanding IOU’s against gold, a new rule would be imposed: a central bank or a national treasury could now keep, instead of gold, interest-bearing bonds and securities of nations that would maintain a monetary system freely convertible into gold. Free convertibility was to be maintained among nations and their financial representatives, though not necessarily between a nation and its domestic population.
It was at this point that the full gold coin standard was abandoned; in its place came the "gold exchange standard," which has developed into something fundamentally different from the gold standard which had existed before. Jacques Rueff has analyzed the great defects of this system.-2 The worst aspect is that an inverted pyramid of paper money and debt has been created; it rests on a tiny fraction of gold reserves. The United States and England have, until quite recently, been able to create vast quantities of unbacked money without feeling the effects of a gold run. Other nations have been willing to hold our bonds instead of demanding gold and thereby putting pressure on our policies of domestic inflation. They, in turn, have expanded their own domestic currencies on the assumption that our bonds are "as good as gold," and therefore equal to gold.
An Unstable Structure
With the devaluation of the pound and the pressures on the dollar, the pyramid appears to be toppling. This is why international monetary experts are frantically searching for some alternative means of payment besides gold. The structure of international trade is being threatened by a collapse of the means of payment; the gold exchange standard is in serious trouble. The "exported inflation" of the United States and Britain is being called to a halt, but in doing this, foreign central banks and treasuries are risking the destruction of the present monetary system.
In other words, the Genoa Conference changed the operational "rules of the game." It created a system which only delays the ultimate judgment of gold against inflationary policies. The delay, in Britain’s case, finally caught up in 1967; the United States is next on the list. For this reason, it is important to examine the assumption lying behind the Genoa Conference’s decision. The same assumption lies behind many of today’s anti-gold arguments. Before World War I, there had been relatively little change in the price structures of the various gold standard nations. England’s wholesale prices had remained relatively stable for a century. In the United States, there had actually been a fall in the price level between 1870 and 1900. This is only natural; since the supply of gold and paper currency in this country had remained relatively constant, and since industrial productivity had doubled, a fall in the price level was inevitable. Thus, the gold standard had encouraged men to accept as normal a somewhat stable or even declining price level. But the war and postwar inflations brought higher domestic, and therefore international, prices.
"Not Enough Gold"
Now, if these new prices — inflationary prices — were accepted as somehow sacrosanct, valid, and beyond criticism economically (as so many government officials wanted the public to believe), then the argument of the inflationists had to be accepted: "There is not enough gold to facilitate international exchange." This is absolutely true today, even as it was true then, given the level of the inflationary prices.
The argument went unchallenged, just as it is going unchallenged today. Anyone who called for a return to gold was at the same time calling for a return to the prewar, gold-based price level. This, in turn, called attention to the fact that governments had worked a sleight-of-hand operation: they had levied invisible taxes through currency debasement. Men and women were paying higher prices for goods, and some of them were forced to restrict their consumption of these goods and services. Here was the secret of war finance and the expansion of government operations.
It implied that the government officials had not been altogether honest with the public in regard to the actual costs of the war.
Naturally, governments did not want to make such an admission, any more than they want to make it today. So the new, inflated price levels were accepted as the standards of evaluation, and the various nations ratified the "gold exchange" standard. There was just not enough gold to go around. Gold had failed to reproduce itself as rapidly as the governments had printed unbacked paper currencies, and thus gold had failed to keep up with the rising price levels. Gold was to blame, not governmental policies of inflation. The gold standard had to be modified, clearly.
At that point, the true gold standard was abandoned; whatever failures of the modern "gold exchange" standard one wishes to acknowledge, they are not the failures of the international monetary system prior to 1922. If the "gold standard" has failed, as so many contemporary economists are saying today, it is not the full gold standard. It is the failure of the standard created by the governments themselves in 1922.
Changing the Game
Now, what has all this to do with basketball? Simply this: men can agree to changes in the rules of a game, but in doing so, they modify the game itself. Fifty years ago, before the advent of rules prohibiting a player from fouling the other in the act of shooting, or those abolishing the "center jump ball" after every score, the game was a much slower, much lower scoring affair. A score of 20 to 17 was common in 1920. Today a college team like UCLA can average almost a hundred points a game; even high schools, playing shorter games, have averaged in the "hundred plus" range. My grandfather, who played the game before 1920, refuses to watch the events on television. He insists that "it just isn’t the same game." It is not "real basketball." In a certain sense, he is correct; the game really is not the same any more.
The analogy, of course, is not air-tight. Other factors have changed the game, such as more skillful players, better training programs, the coming of the jump shot, and the development of good big players. Still, even here we can find a lesson. The coaches sought after Lew Alcindor with an intensity never before seen. It is exactly analogous to the frantic search for gold made by governments and central banks in the 1920′s (and today); everyone wants to augment his reserves of gold. But not all central banks can be equally successful in their quest, any more than all the coaches could achieve their dream of having Alcindor on their team; therefore, many are dissatisfied with the result.
It was the good fortune of UCLA that Alcindor selected that school to attend; similarly, it was the good fortune of this country that its policies of domestic inflation were not immediately challenged by the operation of the gold exchange standard. It was "good" in the short run, and "good" from the point of view of the government; until 1958, gold flowed into this country. The "gold exchange" standard made this possible, especially when coupled to the fact that European nations were inflating their monetary systems even faster than we were.
Real Reasons Unstated
The losers, whether rival coaches or rival governments, are never happy. The coaches immediately imposed a rule against the famous "dunk shot," which had been perfected into a fine art by Alcindor. This was to equalize the game for the small man, we were told ("small man": anyone under six feet four inches). Of course, Alcindor was the only college player to use the shot regularly. What the coaches really wanted to do was to equalize their teams with UCLA’s squad. But this was left unsaid.
In the same way, the Genoa conferees did not admit that the real cause of the alteration of the rules was the fact that they wanted to pursue their own domestic inflationary policies more easily. The confiscation involved in all inflation had to go on, by definition, but the excuse given did not mention this side of the problem. No, the changes were made only to "modernize" international monetary arrangements.
What it really boils down to is that coaches want to win ball games, and without big men who are also skilled players their chances of doing so are dimmed. Similarly, countries that inflate their currencies lose gold to foreign nations (and domestic populations, if their rights of gold ownership are not declared "criminal" by officials of the state). The rules must be changed; gold and talented tall men are in too short a supply.
The difficulty arises, naturally, when the losers try to change the rules too much, and in doing so either isolate themselves from the game everyone else is playing, or else destroy the game itself. This is precisely what the Soviet Union attempted to do a few years ago. The Soviets have never beaten the United States in an Olympic basketball game (no nation has). Thus, they proposed sweeping changes: a twelve-foot basket, seven men on each team, and free substitution of players. Not surprisingly, the Soviet press reported that Soviet fans were far more pleased with this new game.
Had these changes been acceptable to the Olympic rules committee, it would have forced the United States to change its entire basketball structure at the amateur level (an unlikely event) or else suffer the consequences when its Olympic teams entered international competition without being familiar with the different rules. The rules committee ignored the recommendation, and today the Soviet teams play the game by the "old-fashioned" rules, whether or not the public behind the Iron Curtain "enjoyed the game far more" the other way.
A Different Situation
The average sports fan, when he hears of such "unsportsmanlike conduct," is likely to scoff at these tactics. Yet consider what the United States is trying to do in the world’s monetary affairs. Our nation is now suffering a gold drain as a direct result of our own domestic policies of inflation. Since we do not want to lose our gold reserves or stop the inflation, we are caught in a dilemma. We are now attempting to have the "rules of the game" shifted in our favor, in order that we might avoid the payment of our gold debts to foreign nations. We want a "paper gold" system, or a special drawing rights system, or any other kind of system which will permit us to forfeit all or a portion of our gold debts.
Since 1958, the "gold exchange" standard has been working to our disadvantage. We want it amended. The world at present holds twice as many potential claims to our gold as we have gold to pay (assuming that Congress abandons the already meager 25 per cent gold reserve requirement for the support, and restraint, of our domestic money supply). The 1922 rules, which seemed to be of such benefit to us for so long, now appear to be hurting our international position. Unfortunately for our officials at the Rio de Janeiro conference of the International Monetary Fund in September of 1967, any alteration that is in our plans will inevitably hurt our "opposition" — those nations and central banks to whom we have made lawful commitments to pay gold on demand. The Rio conference was therefore a failure, whether the news media admitted this or not.
Like the rule change aimed at Alcindor and the rule changes proposed by the Soviet Union, the ultimate motivation behind them was never mentioned in public. At the Rio meeting, no one spoke publicly about the possibility of a unilateral devaluation of the dollar; in private, according to Franz Pick, the delegates spoke of little else. The game goes on.
Gold Plays No Favorites
One thing is certain, however. There will always be referees. They are not loved men, and both teams may from time to time raise a cry against them. Nevertheless, they are vital. A game could not survive without them. Sometimes they may take the form of an informal agreement, such as in golf; anyone continually breaking the rules is ostracized by the other players. The players themselves act as the referees, and in a certain sense, this is what goes on in international finance and trade.
Historically, the means of enforcing the basic rules — the laws of supply and demand — have been connected with gold. Ultimately, gold is the referee of the international trading community. It has been for thousands of years. Gold plays no favorites; it is an impartial, though demanding, taskmaster. It simply operates according to the laws of supply and demand. Try as they will, governments and central bank officials cannot legislate away these laws (could you play basketball with a hoop smaller than the ball?). Professor B. M. Anderson (curiously enough, he taught at UCLA before he died) has put it this way:
Gold is an unimaginative taskmaster. It demands that men and governments and central banks be honest. It demands that they keep their demand liabilities safely within the limits of their quick assets. It demands that they create no debts without seeing clearly how these debts can be paid. If a country will do these things, gold will stay with it and will come to it from other countries which are not meeting the requirements. But when a country creates debt light-heartedly, when a central bank makes rates of discount low and buys government securities to feed its money market, and permits an expansion of credit that goes into slow and illiquid assets, then gold grows nervous. Mobile capital of all kinds grows nervous. Then comes a flight of capital out of the country. Foreigners withdraw their funds from it, and its own citizens send their liquid funds away for safety.3
At this point, gold is withdrawn from the country in question. It is in light of this that we can understand President Johnson’s decision, announced on the first day of 1968, to restrict capital from flowing out of the United States through the imposition of exchange control laws. This is the first time in the history of this country that such a thing has been attempted. Mandatory restrictions are now placed on American capital that might have been invested abroad, so that the money cannot be used by foreign nations to buy our gold, or more properly to claim their gold which we are holding in storage.
Ironically, it was in 1958, the very year in which the gold outflow began, that President Eisenhower began to encourage American capital to flow abroad; tax benefits accrued to such investments. Gold, the impartial referee, has brought the change in policy, not the difference in political party affiliations of the respective Presidents. It was gold, and the economic laws that ultimately determine the movement of gold, that brought the conditions which convinced the President to impose exchange controls for the first time in our history. Government-created inflationary policies now have brought forth government-imposed restrictions on free trade and investment. Controls beget controls. Laws, even the laws of that "barbarous" metal (to use Keynes’ words and the words of Federal Reserve Chairman Martin), cannot be violated with impunity. Citizens may learn to trust their government, but other governments are not so easily deceived. The gold continues to flow out.
All of this has been an analogy, perhaps a strained one. The cases are different. Basketball is only a game for our enjoyment; if its rules are changed for one reason or another, probably little will be lost. The fans may feel that they have been deprived of a treat when they can no longer witness Alcindor’s mighty dunk shot, but the rather self-centered decision of the opposing coaches will not do much harm.
Lives Are at Stake
The operation of the international trading community is something vastly more important. It is a matter of life and death to certain nations (India, for example), and an extremely grave problem confronts the world today: how can the United States continue to inflate its currency while continuing to meet its international gold debts? How can a dangerous, and perhaps impossible, alteration of the means of payment be made without destroying the delicate fabric of international trust?
Let no one misunderstand our situation; it is a crisis. The nations which continue to violate the laws of supply and demand in monetary affairs are risking disaster. If they continue to violate the "rules" of supply and demand — the most fundamental rules which no piece of legislation can remove — irrespective of the decisions made in Genoa in 1922, the fabric of the "game" will be destroyed. No one will play in such a "game." Men will cooperate voluntarily only when they can trust other men to fulfill their obligations and commitments; the same is true of nations.
In the final analysis, the changes made at Genoa only changed the surface rules of the international monetary mechanism. The old gold standard was scrapped, but not the laws of supply and demand, and not the law made explicit by Professor Mises, that inflations, when halted, result in depressions.4 By abandoning the old gold standard, and by inflating its domestic currencies, the Western world brought on the debacle of 1929-39. The result, at least in part, was the rise of the Hitler regime, the imposition of exchange controls by many of the nations, the disruption of world trade, and the collapse of productivity when the international division of labor was hampered. The referee — gold — was hindered in its task of relaying the facts of the market to the world; it was hampered in restoring monetary stability to the world. The result, finally, has been the financial crisis of 1968. The "game," as Jacques Rueff has warned us, is in danger of being destroyed:
Since 1945 we have again been setting up the mechanism that, unquestionably, triggered the disaster of 1929-1933. We are now watching the consequences, as they follow in their ineluctable course. It is up to us to decide whether we are going to let our civilization drift farther toward the inevitable catastrophe. For those with foresight, our most pressing duty at this juncture is to impress on Western thinking that monetary matters are serious, that they require deliberate consideration and should be dealt with systematically.5
1 have dealt with this conflict in my essay, "Domestic Inflation versus International Solvency," THE FREEMAN (February 1967).
2 Jacques Rueff, The Age of Inflation (Chicago: Regnery Gateway, 1964).
3 B. M. Anderson, Economics and the Public Welfare (Princeton: Van Nostrand, 1949), p. 421.
4 Ludwig von Mises, Human Action (New Haven: Yale University Press, 1949), ch. 20. Of course, Mises shows that if the inflation is not stopped, the result will be a form of mass inflation even more destructive than a depression.
5 Rueff, The Age of Inflation, p. xiii.