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How Not To Advocate A Gold Standard

By Paul Nathan      Printer Friendly Version Bookmark and Share
Sep 7 2010 12:16PM

www.kitco.com

Today,there is a growing interest in gold in general and the gold standard in particular as a replacement for the fiat standard that has failed so miserably over the last century.

Yet any attempt at returning to the gold standard is being undermined by statements containing a host of errors, inconsistencies, and contradictions about gold—statements made by those very individuals who are attempting to focus attention on gold and the virtues of a gold standard. A bad argument advocating a return to the gold standard can be more harmful to the case for gold than no argument at all.

One source of such arguments is that many gold advocates look at gold through the eyes of an investor rather than the eyes of an economist. Consequently, short term, superficial and sometimes misleading interest in gold is being encouraged at the expense of long term education and consistent economic theory. This approach must ultimately be counterproductive and self defeating.

The market is being saturated with literature containing misconceptions and inexact or incorrect terminology. This has led to anti gold positions (i.e., positions inconsistent with capitalism and a free market), most of which can be traced to poorly defined concepts, discussions drawn out of context, and misidentified cause/effect relationships. The following arguments, terms, and positions regarding gold, its present role in international monetary matters and its proposed role in future international monetary reform, have presented a recurring, yet self defeating "defense" of gold and the gold standard.

The "Intrinsic Worth" Argument

It has been said that gold has "intrinsic worth." This argument represents a theory of economics inconsistent with the free market and consequently with the gold standard.

The intrinsic theory of value holds that worth or value is contained within an object. It holds that economic goods possess value inherently, innately, despite the market, despite supply and demand, i.e., in spite of men’s values, choices, and actions.

Free market economists reject this argument. They hold that no man can jump outside the market and declare what a particular commodity is "worth"; that all commodities are subject to the laws of supply and demand; that in economics there is no such thing as "intrinsic worth", only market worth.

"Worth" means "value" and value presupposes a valuer. As men’s values differ and change, market values change. As supply and demand conditions change, the exchange ratios of commodities relative to one another change.

Gold is not exempt from these economic laws, and yet gold is often treated as if it were. By using such unscientific terms as "intrinsic worth," the gold advocate can only hurt his own case — and he has. The inability of many gold advocates to objectively answer the question, "why gold?" has led to the misunderstanding of gold and to such popular terms as "gold, the mystic metal."

Gold would not be called "mystic" if it were understood. And understanding begins with defining one’s terms. It is only through invalid concepts such as "intrinsic worth" that absurd terms such as "mystic metal" can gain popularity.

The "Store of Value" Argument

The argument that gold is a "store of value" is often used as a substitute for the "intrinsic worth" argument. Unless precisely qualified, the term can lead to the same errors, fallacies, and fallacious theories of the "intrinsic worth" argument. Thus, it may lead to a misunderstanding of the nature of money and of a proper theory of value.

"Store of value" is a term often used by those who argue that gold will always represent a constant value, i.e., that gold is a "fixed yardstick" representing constant purchasing power. Implicit in this argument, once again, is the idea that gold is intrinsically valuable — immune from the laws of the market. Not so. The possibilities of gold strikes, gold shortages, fiat money inflation, depression and deflation, fluctuation of industrial demand, the relative market value of other commodities, and the differing knowledge, values, and expectations of men — all these factors have the potential of increasing or decreasing the value of gold for individuals.

Does this mean that under a gold standard the "price index" and the value of money will fluctuate? It certainly does. It's purchasing power in relation to all other commodities will rise and fall over time. But this is precisely the beauty of the free market and the case for freedom —that prices are allowed to fluctuate freely, thereby corresponding to the constantly changing and diverse values of free individuals. The advocates of a free market are not Utopians — they are realists who recognize that there are no guarantees of economic security in this world; they are willing to accept the consequences of their actions — and to accept the verdict of a free market.

The advocates of a free market are not willing to trade their freedom for security. The "store of value" argument offers men just such a trade. While a gold standard does offer men more stability of value than any other free monetary system, it does not offer men a constant value. There is no harm in stating that gold is a store of value so long as one knows and states exactly what is meant by the term — i.e., that gold has stability of value and represents perhaps the best monetary method of saving. In a free society, one is certainly free to store that which one values, so long as it is understood that the value of one’s savings is not immune from the influence of the market.

Gold "Price" Predictions

One way pro gold advocates have been trying to attract attention to gold is by arousing investor interest through predictions of a higher gold "price." General estimates of prices are not by themselves harmful. But specific price predictions are indirectly harmful to the case for gold.

The "price" of gold is determined by the values of those participating in the gold market. No man on earth, no group of mathematicians (no matter how many charts and graphs they employ), no computer on earth, is capable of knowing the values of all consumers and suppliers within the market. Therefore, to try to precisely predict something as specific as a price is impossible. The fact is, individual values are constantly changing, just as the factors of supply, demand, and cost are changing. individual's cannot have precise, prior knowledge of prices, and by pretending to can only confuse and undercut the entire concept and basis of free market economic theory.

There is no place for crystal balls in science — and that includes the science of economics. Those attempting to attract attention to gold by making precise price predictions are contradicting and obscuring the meaning of the free market and therefore undercutting the case for a gold standard.

The "Legal Tender" Argument

Many advocates of gold argue that if gold were made legal tender, not only would individuals be allowed to own and use gold as money, but this would necessarily lead to a gold standard. What is forgotten is that this country’s legal tender laws are precisely what prevent citizens from using gold as money today. Legal tender laws established the legal precedent of coercive government monopoly over the issuance and use of Federal Reserve Notes.

The free market economist does not contend that gold must be money. He contends only that money must be market originated. The case for the gold standard is part of the broader case for commodity money. Consistent advocates of the gold standard hold that gold possesses those qualities and characteristics most conducive to the function of a medium of exchange, but they do not say that gold will forever be suitable as money. Neither do they hold that gold must be accepted as money whether people want to accept it or not. They do not ask for the police powers of state to enforce their idea of what money should be. Thus, they oppose legal tender laws.

Further, legal tender laws are not necessary. All that is necessary is that individual's possess the right of contract. For example, if a man contracts to pay one hundred ounces of gold to another man who agrees to accept this sum in payment, the courts need only recognize what has been chosen as money, and assure that the obligation be discharged.

There is nothing wrong with defining the dollar as a specific amount of gold and declaring it as the nations medium of exchange.  But it is quite another thing to prevent competing monies as is the case today.

Legal tender laws are not what is needed to return to a gold standard. On the contrary, they are one of the major factors today preventing the world from returning to gold.

The "Official Price of Gold" Fetish

Many advocates of gold argue that an "official price" of gold is both necessary and desirable. This position accepts the premise of opponents of the gold standard: that legal tender laws should be established allowing governments to legally fix and regulate the value of money. The free market position rejects this premise. It holds that the medium of exchange should be market originated and market regulated — not government originated and government regulated. This means that the value of money should be determined on the free market — not dictated by government decree.

At this point, the "official price" advocate usually says, "But if the price of gold isn’t fixed, then no one will know what money is worth." And in the sense of having precise, prior knowledge of gold’s exchange value, this is true — just as it is true for all other commodity exchange values.

It is interesting to note that those who argue both that gold should be fixed in value and that gold is a constant store of value, hold a contradictory position in which one claim offsets the other. If gold is already a constant store of value, why should its "price" be fixed? And if it is necessary and desirable to fix the "price" of gold, then how can it be argued that gold has an intrinsically constant value? One need not fix that which is constant, and that which one does fix cannot be defined as constant. Such inconsistency pervades pro-gold literature today. In fact, what is being advocated is that gold should be a "fixed yardstick" — a constant "store of value" — by government directive, rather than a stable store of value by market "directive." Government determination to fix the purchasing power of the monetary unit ignores, contradicts and denies the law of the market.

Under a gold standard in which all nations deal in weights of gold, exchange rates would necessarily be fixed by relative weight — not by law. No formal international monetary system would be necessary and no nation would be forced into, or prevented from, using other monies such as silver, paper, and so forth. A gold standard does not require exchange rates fixed by law. It assumes only that exchange rates will be fixed as a result of adherence to the definition of money. This means that if a monetary unit is defined as one ounce of gold, it will necessarily exchange for other monetary units defined in gold at a precise ratio — unless the monetary unit is debased and misrepresented.

"pegging" gold to a given number of dollars would only amount to a fiction in today’s climate, just as it would be a fiction to fix the price of any commodity. The free market must be allowed to determine the value of gold and all money substitutes, just as it determines the value of any and all commodities — by supply, consumer demand, and the cost of production. Just as there is no validity to the case for price controls, there is no validity to the case for exchange controls.

If people want security of purchasing power, they need not and should not look for government guaranteed "security"; they can easily obtain security through the free market by including in all contracts that purchases, repayments, and the like be made in money adjusted to compensate for any changes in the value of money. Futures markets can be, and have been, established in any commodity, money, or money substitute that individual's show a desire to participate in. Yet rarely have people sought a guaranteed protection against loss.

Those who argue for an "official price" of gold can only hurt the case for a free market and therefore a gold standard. Price controls contradict a free market and therefore should be avoided. This includes control of all prices, including the "price" of money. Price controls have always been counterproductive and self-defeating. Worse, they establish the principle of government provided "security" at the expense of individual freedom. To argue that an "official price" of gold is necessary and desirable is to argue that the free market is not.

The Devaluation Syndrome

The argument that there must be and/or should be a major devaluation of the dollar is an offshoot of the "official price" argument. It accepts all the premises of that argument and therefore makes the same mistakes. But there are further implications of this argument that must be examined.

First, devaluation means a return to a monetary system of fixed exchange rates at a time when inflation makes it impossible to fix the value of anything, let alone the value of money. Bretton Woods is an eloquent example of what happens, given fixed exchange rates together with inflationary policies. It is not good enough to say, "Well, we shouldn’t have inflation. Fixed exchange rates would work if government stopped printing money and adhered to the value of the monetary unit." The fact is that we do have inflation and may continue to have inflation -- or even deflation -- for many years to come. The devaluation argument drops the matter out of context and reverses cause and effect by demanding a system of stable money and prices at a time when there is no reason to assume that this kind of stability is possible to the world.

Second, the devaluation argument delegates to the International Monetary Fund (IMF) the power to establish an international monetary system by law. Implicit in the devaluation argument is acceptance of the unfounded assumption over the decades offered by the IMF, that this time the devaluation and exchange rate realignment will be final. Many advocates of a gold standard unwittingly accept this assumption and thus believe that the way to achieve a gold standard is through fixed exchange rates and a major devaluation which would reestablish a convertible gold dollar. This, they believe, is the way to eliminate inflation.

But in fact just the opposite is true. It is not a gold standard that will lead to the elimination of inflation; it is the elimination of inflation that will lead to a gold standard. To attempt to maintain an international gold standard through the IMF is impossible, given today’s political context —we would only end up "going off gold" again with gold getting the blame for the resulting crisis. Allow individual's to use gold as money and an international gold standard will naturally evolve — when and only when government monetary policy becomes non-inflationary. Until then, gold and exchange rates of national monies should be left free to seek their own levels.

Fixed exchange rates will never (and should never) result from a formal international organization such as the IMF. The stability of exchange rates will be the result, not of government price fixing, but of non-inflationary adherence to the value of money — i.e., the elimination of legal sanctions that permit any government agency or bank to fraudulently increase the money supply.

Under a gold standard in which all nations deal in weights of gold, exchange rates would necessarily be fixed by relative weight — not by law. No formal international monetary system would be necessary and no nation would be forced into, or prevented from, using other monies such as silver, paper, and so forth. A gold standard does not require exchange rates fixed by law. It assumes only that exchange rates will be fixed as a result of adherence to the definition of money. This means that if a monetary unit is defined as one ounce of gold, it will necessarily exchange for other monetary units at a precise ratio — unless the monetary unit is debased and misrepresented.

Thus there is no need for a formal, i.e., legal, international monetary system. All that is needed is the free market. The way back to a gold standard is not backward toward the Bretton Woods system, but forward toward a non-inflationary system of freely self-adjusting exchange rates in terms of currencies and gold.

Third, the argument for devaluation is inconsistent with and contradicts another main argument propagated today by gold advocates: that the world is headed for runaway inflation and/or depression and deflation. If it can be reasonably assumed that prices may skyrocket or plunge, as most gold advocates contend, what sense does it make to advocate raising the "price" of gold and fixing exchange rates?

If it is anticipated that prices will fluctuate dramatically, exchange rates need to be as flexible as possible to adjust quickly to individual's changing economic evaluations, to price cost factors, and to supply and demand conditions. It makes no sense at all to advocate fixing the "price" of gold, exchange rates (or anything else) when expectations are that prices will rise or fall dramatically. Such price controls are doomed to failure and can only result in dangerous economic and monetary distortions that will ultimately lead to the restriction of trade and to a lower standard of living for individuals.

The "Stop Printing Money" Argument

Inflation is the fraudulent increase in the supply of money and credit. It is both immoral and impractical to inflate. Eventually inflation might be outlawed, but not today — and not overnight. Both rational economic analysis and history verify the disastrous consequences possible given a dramatic increase or decrease in the nation’s money stock.

In today’s context, when the whole of the American banking system and economy is geared toward inflationary finance, it is to no one’s short term or long term interest to advocate that government should immediately stop printing money or that the inflationary arm of government — the Federal Reserve Board — should be abolished. For, taken literally, these well meaning intentions could result in a nightmare of economic turmoil.

Rather, it should be stressed that the supply of fiat money should be stabilized to correspond to increases in the gold supply, and that structural changes within the banking system should take place to facilitate elimination of the artificial and arbitrary nature of note issuance. This would go a long way toward establishing the proper direction necessary for a return to gold.

The case against inflation can never be stated too often and its importance to a sound monetary system can never be overemphasized. Clearly the battle against inflation must be won before the return to a gold standard can be secure. But neither can the importance and necessity of a gradual return to gold be overemphasized.

Inflation certainly is immoral and economically impractical — but so is any proposal that aims to unleash unnecessary hardship on citizens in the name of "morality" and "practicality." The road toward a gold standard will be long and hard, but the road should be made as smooth as possible by intelligent guidance. Thus, advocates of a return to the gold standard should make clear their intentions: they should advocate a reduction in the fraudulent increase of the money supply — which means a reduction to the point at which this increase is based on the production of a particular commodity — which means gradual departure from a government regulated money supply and gradual return to a market regulated money supply.

On Context, Cause and Effect

It is important that one recognize just how far the educational process of this country must go before a return to the gold standard is possible. The gold standard requires monetary stability which means that all those government domestic programs now popularly advocated, and financed through inflation, must be opposed by the majority of U.S. citizens. Further, a gold standard requires economic stability, which means all of the mal-investments, over-consumption and misallocation of resources that have resulted from years of artificial, government made "booms" and led to a multitude of economic distortions, must take their toll. This means that the anticipation of recessions, depressions, inflation or deflation must be behind Americans and reasonable expectations of economic stability and real growth clearly in sight. This kind of stability is a long way off — yet this is the kind of stability necessary before a gold standard can be established as a lasting monetary system. The gold standard could never last long without confidence in future monetary and economic stability. If those presently advocating investing in gold and the ownership of other investment hedges are doing so because they are convinced that the world is headed for great monetary and economic instability, they should be equally convinced that it still is far too soon to be advocating a full return to the gold standard.

Even more premature is the attempt to submit specific proposals of exactly how to return to the gold standard. This problem must be seen in context. Even assuming that people desire to return to gold, any specific plans for implementing a return to gold will depend greatly on such factors as international monetary arrangements and conditions, domestic monetary and economic conditions, and the legal, financial and structural conditions of the banking system, and the technology available at the time. These conditions change. Thus, a good proposal today may be sadly lacking a year from now. Until fundamental political changes occur in this country, it is unreasonable for anyone to assume he must address himself to the question of specifically how to return to a gold standard.

Rather, one should concern himself with eliminating those laws which are preventing individual's from using gold as money and attacking those policies which encourage reckless government spending and inflation. The problem of how to return to a gold standard will ultimately be solved, for the most part, through solving these more fundamental problems.

A full gold standard cannot return until economic stability returns; we cannot return to economic stability until we return to monetary stability. Monetary stability cannot be secured until the source, nature and immorality of inflation is exposed to and understood by Americans. But the evils of inflation cannot be understood until individuals grasp the meaning of money and the nature of property rights. And property rights will not be secured without a full understanding and defense of individual rights. Thus, nothing less than a return to laissez faire capitalism and a free market will insure a return to and defense of the gold standard. Therefore, a massive and extensive educational task on the virtues of capitalism confronts all those who desire to effectively fight for a gold standard.

Individual's will want to return to gold only when they rediscover what money is, and they will not rediscover what money is until they understand why what they have is not money.

Anyone wishing to be added to my weekly commentary and market update, just contact me at Paulnathan2000@aol.com.

Paul Nathan
September, 2010

 

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Paul Nathan has specialized in gold and gold stocks and has written extensively on monetary and economic matters since 1968.

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