A Future for Gold
Republican Richard M. Nixon closed the gold window Aug. 15, 1971, breaking the last monetary link with the precious metal. During the next three decades, prices as measured by the CPI more than quadrupled, or, put another way, the value of the U.S. dollar has fallen to 24 cents.
Meanwhile, the dollar has lost more than two-thirds of its value versus the Swiss franc, Japanese yen and German deutschmark. Much of the damage was done in the first decade after Nixon's action. Gold surged from $35 to more than $800 per ounce as the consequences of the federal government's massive 1960s spending spree--domestic (Great Society) and foreign (Vietnam) collapsed the U.S. dollar in financial markets.
Americans, living through one of the greatest booms in our nation's history, should never forget gold's historic role as a straitjacket that keeps wasteful career politicians from destroying taxpayer wealth and human progress through inflation. They should also remember some of the current prosperity is probably illusory-- built on a credit boom fueled by massive federal spending increases.
Federal Reserve Chairman Alan Greenspan's repeated references to the gold standard, over a 35-year period, have led anti-inflationists to question whether gold could once again serve some formal role in the U.S. monetary system. "An almost hysterical antagonism toward the gold standard is one issue which unites statists of all persuasions," Mr. Greenspan wrote in an essay, "Gold and Economic Freedom" (The Objectivist, July 1966). "...In the absence of the gold standard, there is no way to protect savings from confiscation through inflation."
During his confirmation hearing as Fed chairman in July 1987, Mr. Greenspan wrote U.S. Senate Banking Committee Chair William Proxmire, "Under the conditions of the 19th Century, the gold standard probably worked more effectively then critics assert today, and if the key conditions could be replicated we might be well served by such a standard."
Mr. Greenspan has not backed away from his philosophical commitment to the gold standard during congressional testimony in the ensuing 14-year period, even if he fails to defend its practical merits now.
Can the gold standard be restored? There are considerable political obstacles to overcome; others involve technical issues of finance that were addressed by Greenspan in a Wall Street Journal essay (Sept. 1, 1981). Given the Fed Chair's remarks, and the approaching 30th anniversary of Nixon's grievous mistake, it is time to consider a new political agenda for gold that addresses the prospect of inflation.
Two schools of economic thought in the 20th Century shunned a role for gold. These were the Keynesians, whose founder, the British economist John Maynard Keynes, termed gold "a barbrous relic;" and the Chicago school monetarists led by Nobel laureate Dr. Milton Friedman.
But intellectual support for a golden role emerges from two schools of economic thought: the venerable 125-year-old Austrian school of Carl Menger, Eugen Böhm-Bawerk, Nobel laureate Friedrich Hayek, Ludwig Von Mises, and Murray Rothbard; and the modern supply-siders, who trace their roots to Say's Law, and whose major advocates have been Dr. Arthur Laffer, former U.S. Rep. Jack Kemp, R-N.Y., author Jude Wanninski (The Way The World Works) and The Journal's editorial page.
The supply-siders began to argue in the late 1970s for a gold price rule to stabilize prices. Under a price rule, commodity prices, including gold, would be stabilized by the Fed within a target range. If commodity prices declined below the range the Fed would ease monetary policy to bring them within the target. If prices increased above the range the Fed would en to bring them into the target. Supply-siders contend gold is the most important commodity, a sort of North Star for monetary authorities to follow. There is some evidence the Fed, under Paul Volcker, used an informal price rule in the early 1980s. Former FOMC members such as Manuel Johnson have also publicly disclosed they followed commodity prices in setting monetary policy.
After Republican Ronald Reagan was elected president in 1980 the supply-siders aggressively promoted a formal gold price rule. The Fed would have the power to stabilize the dollar, a fiat currency, by fixing the gold price. Dr. Laffer and colleague Charles Kadlec wrote:
"The purpose of a gold standard is not to turn every dollar bill into a warehouse receipt for an equivalent amount of gold, but to provide the central bank with an operating rule that will facilitate the maintenance of a stable price level." (Wall Street Journal, Oct. 13, 1981). Gold could be one of many commodities in a basket index, or even be excluded; one reason the price rule proposal was not welcomed by Austrians. Nor was it adopted by many Republican politicians in the 1980s; the idea quietly disappeared from public view. But the gold price rule could reemerge as a policy idea or platform plank within the Republican Party if inflation returns or the U.S. dollar falls.
The political obstacles to gold are clear: the classic gold standard, or any variant such as a price rule, are anathema to career politicians because it restricts their ability to spend taxdollars and engage in wasteful spending. There are no references to gold in the 2000 Democratic and Republican platforms. This is not surprising given the relative disinflation--falling inflation rates--of the last two decades. Only the Libertarians formally promote the idea, noting a gold standard would give the American people veto power over Fed monetary policy by giving them the means to demand the precious metal as redemption for dollars declining in value. By contrast, the current fiat money system gives central banks and politicians that power.
Political obstacles do not mean all economists, even those at the Fed, dismiss gold on an intellectual level. In addition to Greenspan's remarks, some Fed research has noted the powerful economic advantages of gold. In the May 1981 Federal Reserve Bank of St. Louis Bulletin, Michael Bordo noted the price level and real economic activity were more stable under the classic gold standard. Bond yields were dramatically lower, in the two to three percent range, due to reduced inflationary expectations. Finally, recessions under the gold standard, while common, were harsh but much shorter than in our time.
Adopting the gold standard would be the final step in a long process; politically, the obstacles are so great it could only be re-established given a monetary crisis, rampant, persistent inflation. In the interim, however, it is possible for supply-siders and Austrians, entrepreneurs and workers, hard money legislators and informed citizens to advance a political agenda for gold including:
- Congressional action requiring the Fed to acknowledge gold's important role, as a price signal; to monitor its price in financial markets; and require its chair to discuss the metal before Congress.
- Federal and state legislation authorizing the sale of gold-backed treasuries and state bonds.
- Congressional action reauthorizing the U.S. Gold Commission, which examined the gold issue early in the first Reagan administration. The Gold Commission was the last federal panel to formally study a return to the gold standard. The panel's majority opposed the idea, the minority forcefully dissented in a long report, "The Case For Gold."
A political agenda for gold would lay the groundwork for the political response that will occur if an inflation crisis emerges in the future.
The Fed and a Gold Price Signal
The Fed conducts monetary policy through changes in the discount rate, i.e., the short-term interest rate it charges member banks; and open market operations such as the purchase or sale of treasuries or currency. (But the market sets long-term rates, one reason the 10-Year treasury note and 30-Year treasury bond are bellweathers closely watched by financial markets). To tighten monetary policy, the Fed raises the discount rate and sells treasuries. To ease, it lowers the discount rate and purchases treasuries. Its officials attempt to estimate what is occurring in the economy by reviewing monetary aggregates (ex. M3) and dozens of market prices. The system is far from perfect: the Fed has made many mistakes that it later admitted such as its policy in the early 1930s and mid-to-late 1970s.
Gold advocates frequently note that market signals such as prices provide more accurate information to Fed policymakers than the econometric models so beloved by academics. These are based on past data, and are unable, as the Austrians note, to predict rapidly changing price changes in the real world of financial markets. A rising gold price is a signal of inflationary expectations while a falling price, over a long period, signals disinflation or deflation.
Congress passed HCR 133 in March 1975 requiring the Fed to "maintain long-run growth of the monetary and credit aggregates commensurate with the economy's long-run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates." This legislation is known as "Humphrey-Hawkins," after its sponsors. Since then, the Fed chair has testified semi-annually before Congress and openly discussed his use of aggregates and prices in setting policy.
According to ex-FOMC members, questions about the stability of some aggregates led the Fed to utilize other market signals. These include the U.S. dollar's foreign exchange value. Briefly, an increase in the U.S. dollar's foreign exchange value versus other currencies could serve as a market signal for the Fed to ease to prevent the currency from rising too much.
Conversely, a decline in the dollar's for-ex value could serve as a signal for the Fed to tighten to prevent its further fall. They also include interest rates. In 1995, the German Bundesbank and Bank of Japan lowered their short-term discount rates in an effort to prevent the deutschmark and yen from rising too high versus the dollar. Despite the rate cuts the dollar continued to fall for a time. A Fed easing given these events would have been likely to cause the dollar to fall further; a ening might have stopped the decline.
The Fed also follows commodity prices, among them gold, informally. Formal recognition would legitimize gold in any policy debate and be an important victory for hard-money advocates. In political terms, career politicians and the Keynesians and monetarists who advise them could no longer dismiss gold so readily. But the most important reason is that Mr. Greenspan will eventually leave the Fed, most likely replaced by a Keynesian or monetarist dismissive of gold's importance.
Gold Bonds And The Federal Budget Deficit
One of the most frequently overlooked advantages of the gold standard were interest rates substantially lower then those faced by Americans in the 20th Century's latter half. Declining interest rates and falling bond yields have long been synonymous with the gold standard. In his definitive work, History Of Interest Rates, 2000 B.C. To The Present, Sydney Homer wrote that long bond yields declined almost steadily in the last two decades of the 19th Century. The price stability that existed under the gold standard contributed to low real interest rates of about two percent and bond yields half of what they have been in our time. This fact has serious implications for federal spending, the annual budget deficit and U.S. national debt.
One result of price stability was the market's measure of predictability with respect to the dollar's value. The market's belief in long-term price stability encouraged people to enter into contracts with the expectation that commodity price changes would reflect real forces instead of changes in the currency unit's value. Investors and bondholders did not demand the inflation premium they do today because prices rose at a negligible, snail's rate. Interest rates and bond yields fell as a result.
If the federal government could finance its deficits at lower interest rates hundreds of billions in taxdollars could be saved. Since Nixon decoupled the dollar from gold in August 1971, the 30-year treasury bond's yield has ranged from six to more than 20 percent. Yields for 30-year treasuries are more than double yields under the gold standard even at the lowest of the fiat currency rates.
The cost to the American taxpayer of these higher interest rates is staggering. In 1995, the national debt stood at $4.8 trillion. Thus, the cost to taxpayers was $48 billion for every increase of 100 basis points (one full percentage point of interest; each basis point equals one-hundredth of a percent). If rates had fallen 300 basis points on treasuries in the mid-1990s the national debt would have virtually disappeared.
This math has not been lost on some members of Congress. In 1995, the following exchange occurred between U.S. Sen. Robert Bennett, R-Utah, and Chair Greenspan:
Sen. Bennett: We know how much pain we go through politically to try to cut $48 billion a year out of the budget, to try to get spending under control. Likewise, how much pain we go through if we try to pass a tax increase that produces $48 billion a year ... As I look at that, I become more convinced, therefore, that we must do whatever we can to see to it that interest rates are as low as possible for deficit reasons. And in trying to find some way to get them as low as possible without producing pernicious economic effects, I keep coming back to gold ... If we could somehow establish a tie between the dollar and gold, would it in fact bring down real interest rates and give us the potential of the kinds of savings on the deficit?
Chairman Greenspan: Senator, anything which would change the view of long-term inflation prospects in the United States, whether it be a gold standard, whether it be credible monetary and fiscal policy, or some combination, will effectively reduce both nominal and real interest rates. And if one looks in the past as to what types of interest rates occurred when expectations of long-term inflation were nonexistent, you get very low rates.
Politically, the Clinton administration should have a greater incentive then the Republican Congress to explore the use of gold bonds for deficit reduction and national debt retirement purposes. Time and again, President Clinton, members of his administration and Democratic members have stressed debt retirement as their priority.
Short-term gold treasuries could be issued with principal and interest payable in gold. The bond yield curve for the gold bonds would be calculated by arbitraging regular treasury rate yields for the same maturity with the forward delivery premium for gold on the futures market. Current prices suggest rates half of what they are today.
Conservatives and libertarians may object that proceeds from gold bond sales would be spent on federal programs that are not a legitimate function of government. This problem could be overcome by Congress specifying proceed would only be spent on national defense, justice administration and other duties specified in the U.S. Constitution.
Gold bonds need not be limited to the federal government. State, county and local governments could also issue them to achieve lower financing costs. One factor working against this occurring is the overall lack of knowledge among government officials regarding this potential innovation. Gold advocates should educate, and encourage.
A New Gold Commission
U.S. Rep. Ron Paul, R-Texas, has played a key role in several crucial victories for gold proponents occuring in the past quarter-century. In 1974, private ownership of gold was legalized, and the U.S. Treasury began circulating a gold coin in 1986 for the first time in more than a half century. In 1979, Rep. Paul amended the International Monetary Fund appropriation to require creation of a U.S. Gold Commission to study the feasability of a return to the gold standard.
Economic times were very different two decades ago: double-digit inflation was the norm and lawmakers were more willing to consider changes to the economic system. The fact that an official U.S. government body was considering gold as a solution for the first time since the 19th Century was a major achievement for Rep. Paul and his supporters. Although the panel's majority ultimately decided against the gold standard, millions of Americans were exposed to the idea for the first time.
A gold commission would become feasible again if oil prices rise and inflation returns. But it could also raise important issues--such as a price rule--if the opposite, i.e., deflation, occurs. Gold is more of a signal than an investment, and its fall from $800-plus in the early 1980s to $275 per ounce today is evidence, along with falling bond yields, of a long-term trend of disinflation. If disinflation evolves into deflation--bad deflation--monetary policy will once again emerge as a major issue along with, potentially, gold.
Promoting the Agenda
There will always be professional acadamics and corporate economists supporting a role for gold. But the best way to promote a political agenda for gold is by encouraging, and supporting the people's duly-elected representatives on Capitol Hill who fight to legitimize gold.
Only a handful of federal lawmakers, led by the brave Rep. Paul, pressed for the last Gold Commission; another small group is all that is necessary to affect change today. They should build coalitions, especially across the aisle, with other lawmakers who support transitory steps such as gold bonds or a price rule, if not the classic gold standard. To do otherwise is to concede the moral high ground to the funny money advocates and monetary cranks who have Congress' ear, and their fingers in the American public's pocketbook through inflation.