All Commentary
Saturday, September 1, 1973

No Shortage of Gold

Dr. Sennholz heads the Department of Economics at Grove City College and is a noted writer and lecturer on monetary and economic affairs.

Many economists seem to agree on the virtues of the gold standard. It limits the power of governments or banks to create excessive amounts of paper currency and bank deposits, that is, to cause inflation. And it affords an international standard with stable patterns of exchange rates that encourage international trade and investments. But the same economists usually reject it without much hesitation because of its assumed disadvantages.

The gold standard, they say, does not allow sufficient flexibility in the supply of money. The quantity of newly mined gold is not closely related to the growing needs of the world economy. If it had not been for the use of paper money, a serious shortage of money would have developed and economic progress would have been impeded. The gold standard, they say, also makes it difficult for a single country to isolate its economy from depression or inflation in the rest of the world. It does not permit exchange rate changes and resists government controls over international trade and payments.

It is true, the gold standard makes it difficult to isolate one country from another. After all, the common currency that is gold would invite exchanges of goods and services and thus thwart an isolationist policy. For this reason, completely regimented economies cannot possibly tolerate the gold standard that springs from economic freedom and inherently resists regimentation. It is true, the gold standard also exposes all countries that adhere to it to imported inflations and depressions.

But as the chances of any gold inflation—and depression that would follow such an inflation — are extremely small, the danger of contagion is equally small. It is smaller by far than with the floating fiat standard that suffers frequent disruptions and uncertainties, or with the dollar-exchange standard that actually has inundated the world with inflation and credit expansion.

It must also be admitted that the gold standard is inconsistent with government controls over international trade and payment. But we should like to question the objection that the newly mined gold is not closely related to the growing needs of business and that a serious shortage of money would have developed without the issue of paper money. In fact, this popular objection to the gold standard is rooted in several ancient errors that live on in spite of the refutations by economists.

Gold in History

There is no shortage of gold today and there has been no such shortage in the past. Indeed, it is inconceivable that the needs of business will ever require more gold than is presently available. Gold has been an item of wealth and a medium of exchange in all of the great civilizations. Throughout history men have toiled for this enduring metal and used it in economic exchanges. It has been estimated that most of the gold won from the earth during the last 10,000 years, perhaps from the beginning of man, can still be accounted for in man’s vaults today, and in ornaments, jewelry, and other artifacts throughout the world. No other possession of man has been so jealously guarded as gold. And yet, we are to believe that today we are suffering from a serious shortage of gold and therefore must be content with fiat money.

Economic policies are the product of economic ideas. This is true also in the sphere of monetary policies and the organization of the monetary system. The advocates of government paper and foes of gold are motivated by the age-old notion that the monetary system in scope and elasticity has to be tailored to the monetary needs of business. They believe that these needs exceed the available supply of gold, which deprives it of any monetary usefulness and thus makes it a relic of the distant past.

The Monetary Needs of Business

With most contemporary economists, the notion of the monetary requirements of business implies the need for an institution, organization, or authority that will determine and provide the requirements. It ultimately implies that the government must either establish such an institution or provide the required money itself. These writers, in fact, accept without further thought government control over the people’s money. Today, all but a few economists readily accept the apparent axiom that it is the function of the government to issue money and regulate its value. Like the great classical economists, they blindly trust in the monetary integrity and trustworthiness of government and the body politic. But while we can understand the faith of Hume, Thornton, and Ricardo, we are at a loss to explain the confidence of our contemporaries. We understand Ricardo when he proclaimed that “In a free society, with an enlightened legislature, the power of issuing paper money, under the requisite checks of convertibility at the will of the holder, might be safely lodged in the hands of commissioners…”1 The English economists had reason to be proud of their political and economic achievements and confident in the world’s future in liberty. However, it is more difficult to understand any such naive confidence today. After half a century of monetary depreciation and economic instability, still to accept the dogma that it is the proper function of government to issue money and regulate its value, reflects a high degree of insensibility to our monetary plight.

A Persistent Fallacy

And yet, the world of contemporary American economics blindly accepts the dogma. It is true, we may witness heated debates between the Monetarists and Keynesians about the proper rate of currency expansion by government, or the proper monetary/fiscal mix of Federal policy. But when their squabbles occasionally subside they all agree on “the disadvantages” of the gold standard and the desirability of fiat currency. They vehemently deny the only alternative: monetary freedom and a genuine free market.

The money supply needs no regulation; it can be left to the free market in which individuals determine the demand for and supply of money. A person wants to keep a certain store of purchasing power, a margin of wealth in the form of money. It does not matter to him whether this wealth is represented by a few large units of money or by numerous smaller units with the same total purchasing power. And he is not interested in an increase in the number of units if such an increase constitutes no addition to his wealth. This is not to deny that people frequently complain about their “lack of money” or their “need for more money.” What they mean, of course, is additional wealth, not merely more monetary units with smaller purchasing power. But this popular mode of expression probably has contributed to the spread of erroneous notions according to which monetary expansion is identical with additional wealth. Our present policies of inflation seem to draw public support from this primitive confusion.

More than 200 years ago John Law was victim of this confusion when he stated that “a larger quantity (of money) employs more people than a smaller one. And a limited quantity can employ only a proportionate number.” It also made Benjamin Franklin denounce the “want of money in a country” as “discouraging laboring and handicraft from coming to settle in it.” And it made Alexander Hamilton advocate currency expansion for the development of the “vast tracts of waste land.” But only additional real capital in the shape of plants and equipment can employ additional people at unchanged wage rates, or develop new tracts of land. It is true, even without additional capital, a market economy readily adjusts to additions in the labor supply until every worker who seeks employment is fully employed. But in this process of adjustment wage rates must decline on account of the declining marginal productivity of labor. Monetary expansion tends to hide this wage reduction as it tends to support nominal wages, or even may raise them, while real wages decline.

The “full-employment” economists, such as Lord Keynes and his followers, recommend monetary expansion because of this very wage reduction. They correctly realize that institutional maladjustments may prevent a necessary readjustment and thus cause chronic unemployment. The labor unions may enforce wage rates that are higher than the market rates, which inevitably leads to unemployment. Or political expedience may call for the enactment of minimum wage legislation that causes mass unemployment. Under such conditions the full-employment economists recommend monetary expansion as a face-saving device for both the labor government and labor unions. But while it alleviates the unemployment, it causes a new set of ominous effects. It originates the economic boom that will be followed by an other recession. It benefits the debtors at the expense of the creditors. And while it depreciates the currency, it causes maladjustment and capital consumption and destroys individual thrift and self-reliance.

Consequences of Depreciation

In fact, the effects of currency depreciation, no matter how expedient such a policy may be, are worse than the restrictive effects of labor legislation and union policies. Furthermore, monetary expansion as a face-saving device sooner or later must come to an end. If not soon abandoned by a courageous administration, it will destroy the currency. If it is abandoned in time, the maladjustments and restrictive effects of labor legislation and union policies will then be fully visible.

No matter how ominous and ultimately disastrous this array of consequences of currency expansion may be, it is immensely popular with short-sighted and poorly-informed people. After all, currency expansion at first generates an economic boom; it benefits the large class of debtors; it causes a sensation of ease and affluence; it is a face-saving device for popular but harmful labor policies; and last but not least, it affords government and its army of politicians and bureaucrats more revenue and power than they would enjoy without inflation. But all these effects that may explain the popularity of currency expansion do not prove the necessity of expanding the stock of money for any objective reason. In fact, an increase in the money supply confers no social benefits whatsoever. It merely redistributes income and wealth, disrupts and misguides economic production and, as such, constitutes a powerful weapon of conflict within society.

In a free market economy, it is utterly irrelevant what the total stock of money should be. Any given quantity renders the full services and yields the maximum utility of a medium of exchange. No additional utility can be derived from additions to the quantity of money. When the stock is relatively large, the purchasing power of the individual units of money will be relatively small. And when the stock is small, the purchasing power of the individual units will be relatively large. No wealth can be created and no economic growth can be achieved by changing the quantity of the medium of exchange. It is so obvious, and yet so obscured by the specious reasoning of special interest spokesmen, that the printing of another ton of paper money does not create new wealth. It merely wastes valuable paper resources and generates the redistributive effects mentioned above.

Money is only a medium of exchange. To add additional media merely tends to reduce their exchange value, their purchasing power. Only the production of additional consumer goods and capital goods enhances the wealth and income of society. For this reason, some economists consider the mining of gold a sheer waste of capital and labor. Man is burrowing the ground in search of gold, they say, merely to hide it again in a vault underground. And since gold is a very expensive medium of exchange, why should it not be replaced with a cheaper medium, such as paper money?

If gold were to serve merely as medium of exchange, new mining would indeed be superfluous. But it is also a commodity that is used in countless different ways. Its mining, therefore, does enrich society in the form of ornaments, dental uses, industrial products, and the like. Gold mining is as useful as any other mining that serves to satisfy human wants.

The Law of Costs Applies to Money

Actually, the great expense of gold mining and processing assures the limitation of its quantity and therefore its value. Both gold and paper money are subject to the “law of costs,” which explains why gold has remained so valuable over the millennia and why the value of paper money always falls to the level of costs of the paper. This law, which is so well-established in economic literature, states that in the long run the market price of freely reproducible goods tends to equal the costs of production. For if the market price should rise considerably above cost, production of the goods becomes profitable, which invites additional production. When more goods are produced and offered on the market, their price begins to fall in accordance with the law of demand and supply. Conversely, if the market price should fall below cost and inflict losses on manufacturers, production is restricted or abandoned. Thus, the supply in the market is decreased, which tends to raise the price again in conformity with the law of supply and demand. Of course, the law of costs does not conflict with the basic principle of value and price. Their determination originates in the consumers’ subjective valuations of finished products.

The law of costs obviously is applicable to gold. When its exchange value rises, mining becomes more profitable, which will encourage the search for gold and invite mining of ore that heretofore was unprofitable because of low gold content or other high mining costs. When additional quantities of gold are offered on the market, its exchange value or purchasing power tends to decline in accordance with the law of supply and demand. Conversely, when its exchange value falls, the opposite effects tend to ensue, thus discouraging further mining.

A Delayed Reaction

That paper money is subject to the law of costs is vehemently denied by all who favor such money. After all, they retort, the profit motive does not apply to its production and management. Its exchange value may be kept far above its cost of manufacture through wise restraint and management by monetary authorities.

It must be admitted that the law of costs works slowly on money, more slowly indeed than on other goods. It may take several decades before the paper money exchange value falls to the level of manufacturing costs. After all, the fall is rather considerable, from the value of gold — for which the paper money first substitutes — to that of the printing paper. Few other commodities ever experience such a large discrepancy between market value and manufacturing costs when the law of costs begins to work. But this original discrepancy does not refute the applicability of the law; it merely offers an explanation for the length of time needed for the price-cost adjustment.

It must also be admitted that a certain measure of restraint prevents an immediate fall of the paper money value to the level of manufacturing costs. Popular opposition prevents the monetary authorities from multiplying the quantity of paper issue too rapidly, which would depreciate its value at intolerable rates and lead to an early disintegration of the exchange economy. In a democratic society these monetary authorities and their political employers would soon be removed from office and be replaced by others promising more restraint.

But no matter who manages the fiat money, the law of costs is working quietly and continuously. After all, the manufacturers do profit from a gradual expansion of the money supply. The profit motive is as applicable to money as it is to all other goods. The only difference between the manufacturer of fiat money and that of other goods is the monopolistic position of the former and the normally competitive limitations of the latter. Who would contend that the incomes and fortunes of central bankers and the jobs of many thousands of their employees do not provide a powerful motive for currency expansion? To stabilize the stock of money is to deny them position and power and thus income and wealth.

Political Motivation

The profit motive for fiat money expansion is even stronger with the administration in power and thousands of politicians seeking the votes of their electorates. Election to high political office usually assures great personal fortune, prestige, and power, and successful politicians quickly rise from rags to riches. But in order to be elected in a redistributive conflict society, commonly called the welfare society, the candidate for political office is tempted to promise his electorate any conceivable benefit. It is true, he may at first propose to tax the rich members of his society whose few votes may be ignored. But when their incomes and fortunes no longer yield the additional revenue needed for costly handouts, called social benefits, the welfare politician resorts to deficit spending. That is to say, he calls for currency expansion that facilitates the government expenditures that hopefully win the vote and support of his electorate and thus assure his election. When seen in this light, the profit motive is surely applicable to the manufacture of paper money.

Or, the politicians in power conduct full-employment policies through easy money and credit expansion. In search of the popular boom that would assure their re-election, they spend and inflate and thus set into operation the law of costs. Who would believe that such policies are not motivated by the personal gains that accrue to the politicians in power?

But this profit motive must be sharply distinguished from that in the competitive exchange economy. When encompassed by competition, the motive is a powerful driving force for the best possible service to the ultimate bosses, the consumers. It raises output and income and leads to capital formation and high standards of living. But in the case of the monopolistic manufacture of paper money by government authorities, the profit motive finds expression in currency expansion, which is inflation. In the end, when the law of costs has completely prevailed and the exchange value of money equals the cost of paper manufacture, not only the fiat money is destroyed but also the individual-enterprise private-property order. For inflation not only bears bitter economic fruits but also has evil social, political, and moral consequences.

  • Hans F. Sennholz (1922-2007) was Ludwig von Mises' first PhD student in the United States. He taught economics at Grove City College, 1956–1992, having been hired as department chair upon arrival. After he retired, he became president of the Foundation for Economic Education, 1992–1997.