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The Power of Gold

November 29, 2001

The perennial debate over gold is as old as civilization. What makes money valuable? Why do we happily accept some pieces of paper and refuse others? 

It is because one does or does not have some degree of confidence in the government that issues a currency. So today, for example, almost all players in the National Hockey League, Canadians as well as Americans and Europeans, expect to be paid in U.S. dollars. The American dollar recently has been a much stronger currency than the Canadian dollar. Canada, which has a much bigger welfare-state structure than the United States, also has an inflation rate much higher than its southern neighbor does. Therefore, its currency is depreciating at a faster rate. 

Inflation is and always has been caused by governments that print too much money (i.e., Weimar Germany, France in the early stages of the French Revolution, and the United States' Revolutionary War government, the Continental Congress, which issued so much currency that its money was said to be "not worth a continental"). The result of this monetary mayhem is that people save less and buy more today. That's because tomorrow, they think, money will be worth less than today.  

But inflation, great economists such as F.A. Hayek and Ludwig von Mises have warned us, is a kind of drug that, in its beginning phases, appears to be harmless. "It is the true opium of the people," Mises wrote in his superb treatise, The Theory of Money and Credit (p. 485). Inflation's damage is often overlooked by most people because it is usually gradual. (A good way of measuring the long-term effects of inflation is to price something one hasn't bought for several years.) But once inflation hits high rates, it becomes an addiction. And it is very difficult to break an addiction which, at the outset, seemed to be bestowing prosperity on a nation. 

Gold is said to be the antidote to inflationary money. Governments in history that used the gold standard--no government today does--were forced to reduce their gold stock when they ran deficits. Under the gold standard, reckless spending is stopped because governments don't want to lose more and more of their gold. Gold, its advocates have said through the centuries, is designed to protect an individual against the damage caused by the disease called that is inflation created by central banks.

Through the years, millions of men and women, facing the loss of their property because of the tendency of governments to use inflation to rob Peter in order to pay Paul, kept some of their assets in gold. Gold was respectable. It was recognized as a hard money almost everywhere. It backed almost all the major currencies in the West until the 1930s, when many democratic governments discovered the wonders of inflation and its comrade-in-arms, fiat money. That's money backed by nothing but the promise of a government.

But old habits take a long time to die, and millions of people, to this day, have continued to hold gold as a hedge against potentially unscrupulous governments and uncertain times. (By the way, as I write these words, gold is one of the few categories of mutual funds having a good year.) Governments often promise too much, fight wars that last much longer than expected, or just simply miscalculate and find themselves without money to pay off political debts. 

Backed into a corner, governments--unlike the individual--usually will not tighten their belts. They're run by pols who want to be re-elected. They'll run the printing presses. Inflation will discourage savings and appears to enrich people. But it is an illusion, a kind of monetary legerdemain. People have more paper money. However, it buys less than when they had less paper money, but their buying power was greater. Gold, which the author of this controversial book takes every chance to malign, in perilous times generally will go up in value. It represents a vote of no confidence in the monetary authorities. The individual, faced with war or some other terrible circumstance, can take his or her gold to another nation and begin again. 

Now we come to Peter L. Bernstein, the brilliant author of many fascinating books, including Against the Gods and Capital Ideas.  

Bernstein believes that those favoring gold are as misguided as those who believe in astrology or witchcraft or, dropping down a few steps, those who believe in the promises of politicos in the midst of a hot campaign. The gold bugs, he insisted, "all were fools for gold, chasing an illusion. None ended up where they hoped" (p. 372). One of Bernstein's heroes in this book is the most widely celebrated economist of the twentieth century, John Maynard Keynes. Bernstein praises him for helping to take Britain off the gold standard. After the Brits, FDR moved the United States away a bit from the gold standard, and Keynes wrote of the president's action, "Roosevelt [was] magnificently right" (p. 322).

FDR in 1933 took gold out of the hands of Americans. It became a crime for them to hold gold (an act that Bernstein doesn't spend much time exploring) and for them to make payments in gold. The dollar, which was whatever the political authorities defined it as, was made legal tender. The U.S. Supreme Court later backed this remarkable act of theft. "With the stroke of a pen," wrote economist Hans Sennholz in "Money and Freedom," the "Court permitted every debtor to defraud his creditors, and granted government the privilege of robbing its creditors under the pretext of paying them--all in the name of the Constitution" (p. 29).

FDR rigged the price of gold, opting for inflation to help the American economy recover from the depths of the Great Depression. Bernstein said FDR had cured the nation's economic ills as measured by Wall Street. 

"By early 1937," Bernstein writes, "the Dow Jones Industrial Average stood at 200, a mighty surge from its nadir at 40 touched during the darkest days of 1932. Happy Days were here again" (p. 323).

Were they? Had FDR's inflation worked magic and established prosperity?

Bernstein's account of American economic history is incomplete at best and disingenuous at worst. By the fall of 1937 and into 1938, the inflationary measures, which initially seemed to succeed, were failing. The drug was wearing off. The nation went back into a brutal depression, one in which FDR's chief political adviser, James Farley, warned that the economy was in as bad a shape as when FDR took office from Herbert Hoover in 1933. 

FDR's renunciation of gold and his embrace of inflation, Bernstein to the contrary, did not restore the nation's economy. Even Doris Kearns Goodwin, very much a pro-FDR historian, recently wrote, "The America over which Roosevelt presided in 1940 was in its eleventh year of depression" ("No Ordinary Time," p. 42). Another historian writes, "The resulting downturn began in August 1937 and continued through the winter and spring of 1938. It was nothing short of catastrophic" (FDR's Fireside Chats, Russell D. Buhite, ed., p. 111).

It is a fairy tale that FDR's New Deal, through his injection of inflation and his hostility to gold, brought "Happy Days" to the United States and restored a strong economy. It was World War II that accomplished the latter, which is grisly way to bring prosperity to a nation. (Robert Nisbet would write that FDR, "was by no means the first ruler in history to find his attention turning to the dogs of war in the wake of domestic failures." See Roosevelt and Stalin: The Failed Courtship, p. 93.) 

War has many costs--in many ways, as we see civil liberties possibly under siege today--in more ways than one. In most cases, war means disaster for an economy. Unfortunately, it is also a godsend for many ruling elites who the wave the bloody flag. War is usually the health of the George Washington Plunkitt.

Some 35 years after FDR's monetary mischief, President Richard Nixon's monetary and fiscal policies were failing because he insisted on keeping most of the expensive policies of the Great Society--in some cases, such as Social Security and affirmative action, he actually expanded them--while at the same time continuing to fight the Vietnam War. 

Nixon finally took a step that stole billions of dollars from people around the world who were holding dollars based on their previously guaranteed convertibility to gold. Nixon said the U.S. dollar, which had been the international reserve currency, could no longer be redeemed for gold. With another stroke of a president's pen, dollars were suddenly officially worth much less.

The U.S. was officially off the gold standard. Several things followed. Nixon, supposedly a Republican conservative who favored free markets, announced that he was now "a Keynesian" in economics. Foreigners who held dollars--especially Arab oil officials who had billions of dollars in petro-dollars--became angry and looked for ways to get back at the U.S. (They raised oil prices.) 

Nixon's measures, which ironically were designed to battle inflation and bring down high interest rates, caused one of the most difficult inflationary episodes in American economic history. Annual inflation was rising at a rate of 12 percent by the end of the 1970s. The prime rate went slightly north of 20 percent, a rate that once would have been called usury. But, by the end of the decade, it had been several years since Nixon had been removed from office, and his disastrous economic policies were by then an afterthought in the wake of Watergate. 

Bernstein, in this disappointing book, passes few judgments on the terrible results of Nixonomics. We know he admires FDR, but what about Nixon? Wasn't Nixon the apotheosis of what Bernstein's argues for in this book? The man who helped to destroy the gold standard. Bernstein turns the story of gold upside down. At the end of the book, he's warning that, "The most striking feature of this long history is that gold led most of the protagonists of the drama into the ditch." 

So one is left to conclude that Bernstein favors fiat money. Now and forever, and let's pay tribute to our lords and masters--the central bankers of this world. And, by implication, Bernstein must believe that those running monetary policies around the globe should only be limited by their common sense, which, in the case of central banks and the political leaders who appoint them, can mean anything and everything. But central bank policies are usually bad. They usually result in a boom-or-bust business cycle as predicted by the great Austrian economists.

"Irredeemable paper money," wrote the economist Irving Fisher, "has almost invariably proved a curse to the country using it." A bank is as dangerous as a standing army, many American opponents of central banks have held. It is as difficult to get rid of a central bank as it is to rid a nation of a military-industrial complex.

One concludes that Bernstein is a Keynesian who believes government can manage inflation. That is tantamount to saying that a little cholera isn't a bad thing because, after all, it can be managed so it will never get out of hand. Today, the debate over gold as money, for the time being, is no longer a big issue as it was back in the miserable 1970s or in the early 1980s, when the nation sloughed through a recession and double-digit rates of inflation, the results of stagflation--something Keynesian economists, armed with the Phillips Curve, had previously said was not possible.

But, given the history of governments and their insistence on monopolizing money creation and management, it is inevitable that the gold debate will flare up again. Governments can, and have, outlawed the ownership of gold. They cannot outlaw the effects of fiat money. They can't wish away unpleasant economic outcomes such as a plunging stock market and stagflation. The unpleasant side effects of inflationary rates will happen again. The debate over gold will be reopened, much, I trust, to the disgust of Peter L. Bernstein.


Gregory Bresiger is a writer and editor in New York. His work has appeared in Traders Magazine, The New York Post and The Journal of Libertarian Studies.  See his Mises.org Articles Archive, and send him MAIL.

Note: The views expressed on Mises.org are not necessarily those of the Mises Institute.

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