Mises Daily Articles
The Case for the Barbarous Relic
[This talk was given in New York, New York, March 21, 2006.]
When Mr. Bush went to war, he put little thought into financing it, which signifies fiscal irresponsibility. Under the framers' design, he is supposed to go to Congress to ask for the money, all the money, and if Congress doesn't have it, the war can't go on unless taxes are raised or private investors are willing to front the money by buying debt.
But that was then and this is now. Now it seems that the war budget is merely an abstraction. Whether it is $5 billion, $50 billion, or $500 billion, is an interesting piece of information but it is not decisive information. It will not make the difference between whether we pursue war or peace as a nation.
When Mr. Bush created a new prescription drug benefit, there was no national debate on the cost. People who have met with him on the matter report that he dismisses any talk of such things. In fact, there is no national debate of any substance on any part of the budget. The numbers are too large, and the financing seems to be a matter of magic. Therefore all talk of deficits and debt amount to little more than political rhetoric.
Let us ask why. How is it that the federal government seems so uniquely immune from the limits imposed by economic scarcity? The American people from time to time wonder: where the heck does all this money come from, and why does there seem to be no limit to it?
The answer is found in the powers that belong to that marble palace on Constitution Avenue called the Federal Reserve. Here is an institution that possesses the legal power to create as many dollars as it pleases, any time it pleases, and for any reason it pleases. I stipulate that it is the "legal" power because we all know what would happen if you or I tried this at home.
This power to create money is what makes it possible to run debts that soar to the stratosphere. It is what makes it possible for US government debt to trade without a default premium. It is what gives the president the chutzpah to go to war without seeking full financing or even much in the way of permission from Congress. It is the money machine, and with it you can run the world — at least until you run the economy into the ground.
And there are indeed consequences. Credit expansion and money creation distort interest rate signals and set off business fluctuations, recessions, and depression, not to mention sector-specific booms. This power also depreciates the value of currency, which is why the dollar that was worth a dollar when the Fed was created is now worth less than 5 cents in real terms.
But of all the consequences of central banking and fiat money, war is the worst because it exacts the biggest price from citizens and foreigners and everyone else caught in the crossfire. That is why sound money — by which I mean the gold standard — is a key to peace and freedom.
Two hundred years ago, when the United States was a modest commercial republic, the president could take a walk down Pennsylvania Avenue — by himself — and talk to anyone who approached him. If he wasn't on a walk outdoors, he was most likely at home, and you could speak to him by knocking on the door of the White House and presenting yourself.
The Hamiltonians and their agenda of mercantilism, paper money, and presidential exaltation had been humiliated in the election of 1800. Jeffersonianism had prevailed against them. And though Jefferson made some missteps during his presidency — not even Jefferson could be fully trusted with power — the policy bias was clear: frugality, free trade, hard money, and decentralized government.
Today? The president moves about like Caesar Augustus, with a vast court of civil and military aides, doctors, secretaries, valets, hairdressers, makeup artists, bodyguards, drivers, baggage handlers, cooks, food tasters, praetorian guards, snipers, bulletproof limos, a portable hospital, and an armored rostrum. And that's when he travels in the United States.
When Bush visited Ottawa, members of parliament were refused entry into their own legislature by the massed power of the Secret Service, in violation of Canadian law. When Bush visited London, 5,000 additional police were assigned to protect him. Parks and streets and neighborhoods were closed. Riflemen thronged the roofs. The queen was horrified by the trashed condition of the grounds and great rooms of Buckingham Palace, but that meant nothing as versus the alleged security of the emperor.
He counts far more than any other human being on earth. So, of course, every event is staged to the extreme. The president is spoken to by no regular person. There are as many walls that separate us from him as between the supposed government of Iraq and its people, or the old Soviet Politburo and the Russian people.
These people live and breathe fear.
The paranoia of the Bush circle has infected the whole regime. The entire government — elected officials, appointed staff, permanent bureaucracy — has shifted in the last decade from pretending to be the people's servants to admitting that they regard the people as a threat. Thus do we see the stream of legislation permitting ever more power to spy, confiscate, and jail without trial.
Never has Franz Oppenheimer's view of the state been more clearly on display: it is there to dominate, exploit, and protect itself against any challenges to its power. It clings to power like Gollum holding the ring. And that power is deployed, not for the ostensible purpose of protecting people but for protecting the state and its interests. When Oppenheimer theorized in 1908 that this was the true nature of the state, he was shouted down and pilloried for denying the doctrine of government as a social compact. Today his claims read like a description of the day's political news.
Most Americans are aware that something has gone very wrong but they are at a loss to sort out the causes, especially the ones that are most invisible. This is where the excellent book by William Bonner and Addison Wiggin, titled Empire of Debt (Wiley: 2006) performs an extraordinary service. In addition to being accomplished financial analysts, Bonner and Wiggin are talented historical writers. And they put this talent to work in the cause of examining empire's political and economic effects.
The authors not only provide a frightening picture of the mess that the US government has made at home and abroad; they also understand the crucial role that the monetary regime has played in this debacle. They show how the legal right to counterfeit — that's what the Fed grants the government — has changed the structure of the government and led to the loss of liberty and the rise of an imperial power unlike any known by history.
In the commercial republic of Jefferson, money was gold and silver. Government had no power to print currency. It was not even allowed to tax directly. What money it had came from tariff revenue, and pressure from exporters and importers kept it low. Even if Jefferson had wanted to be a tyrant, there was no means to do so. If the wall of separation between money and the state were not as high as it might have been, there was still a barrier that put a curb on power mongering.
Today, however, all the money government could ever want is easily available via a monetary policy that depends critically on the capacity of the Fed to create money out of thin air. The Fed's printing presses back every debt note issued by the Fed, and the new currency is sopped up by foreign central banks and private holdings around the world, particularly among Asian nations. The dollar is, for now, the world reserve currency, which permits the United States to sustain a world empire without paying the price — again, for now.
The critical turning point was one I remember well. Richard Nixon enacted, by imperial decree, a purely fiat dollar, repudiating solemn promises to redeem in gold. After that, with the printing presses running 24/7, the pax dollarum could be "financed." To understand the connection requires that we understand two fields of study that are usually kept separate: foreign-policy analytics and monetary economics. It is in understanding the relationship that our authors excel.
Alan Greenspan had pretended to be against it all, but given the chance for power, he happily repudiated his restrictionist gold standard views. He eagerly supplied the credit for the expensive wars, the expensive bread, and the expensive circuses that have wrecked empires from Rome to London. His successor promises more of the same.
While the loss of gold money was a turning point, the imperial urge has much deeper roots. It all began, say the authors, when the balmy Teddy Roosevelt began riding rough over small, poor nations. They might have gone back further in time. Robert E. Lee, writing Lord Acton, feared that the federal victory over the South would mean despotism at home and empire abroad. It wasn't too many years later when the religious maniac McKinley launched an attack on Spain, seizing colonies in grand fashion, and murdering any natives who objected.
Or we might even look back further. The hard core might even see the US government's imperial career beginning with its conquest and colonization of northern Mexico. Maybe its roots are in the Colonial Era with New England's religio-culture drive to improve and perfect the world through pastoral coercion and belligerence.
Regardless, the modern history is undeniably disgraceful. In the midst of my favorite chapter, "Woodrow Crosses the Rubicon," they pause to repudiate the great killer presidents, and to praise instead men like Warren G. Harding. He ended (for a time) US rule over Haiti, and pardoned the antiwar socialist Eugene Debs, who had been jailed and his health destroyed by Wilson for criticizing conscription. Further, they note that there is no Harding Law, no Harding Building in DC, no war he started, and no government program he launched.
Wilson, in contrast, established the Federal Reserve, the income-tax police, and the direct election of senators. The latter wiped out an original buttress to states' rights, and led to more and more centralization, as senators saw themselves as representatives of DC to their states, rather than of the state legislatures to the central government. Frank Chodorov called it "The Revolution of 1913."
The Federal Reserve's monetary manipulations to finance World War I, and then the boom of the 1920s, led to the Great Depression and then the Roosevelt revolution towards massive statism. Contrary to left-wing fantasies, it has not only not been repealed; it has marched forward unrelentingly.
With this comes a belligerent and blind nationalism that has affected the whole culture in one degree or another. In an empire, the people must become "hollow dummies," said Orwell. They must believe they are superior to others, and have a right to tell others what to do. Americans seem to go beyond even this. They believe that other countries actually want to be invaded and occupied and shaped into mini-America by the United States.
American business is still heroically capitalistic, entrepreneurs brilliant and brave at creatively serving the needs of the people, though hog-tied by the vastest government in planetary history. On top of that, every aspect of the economy is distorted by the expansionary policies of the Federal Reserve, resulting — in just one instance — in a huge housing bubble.
Thanks to the incentives created by the welfare state and the Fed, Americans tend to consume more than they earn. Stocks today trade for about 20 times earnings, whereas the norm is 12–15. Houses usually increase at the rate of inflation, not 10 times as fast. A global power monopoly is also abnormal. At some point, all the myths cherished by the imperial people, say our authors, must go to "humbug heaven."
Something else that will revert to the norm: wages. There is no inherent reason that a plumber with a US flag pin should earn more than one with a crescent moon. In India, real incomes have doubled in the last 10 years. In the United States they have been stagnant or worse. The inequitable draining of the world's resources into America, made possible by the military empire and its financial structure since Bretton Woods, is also coming to an end.
From the Romans to the Fourth Crusade, and their Venetian and French aggressors, to Genghis Khan to the Spaniards and Napoleon and the Brits, Bonner and Wiggin teach us the lessons of empire, with learning and irony. "A great empire," they note, "is to the world of geopolitics what a great bubble is to the world of economics. It's attractive at the outset but a catastrophe eventually."
President Bush came to office under the idea that he would run a frugal government. But what has been the result? The real growth rate of total government outlays is 5% per year, as compared with Clinton's 1.5%. Whereas past presidents felt the need to make a choice between domestic and foreign policy spending, Bush has caused the government to gorge on both.
He has combined the military spending increases of the Reagan era with the domestic spending increases of the Ford/Carter era. His discretionary domestic outlays are running up 8% per year and military spending is running up 12% per year. Domestic spending is running at twice the level of Clinton. I wish we could say he was another Lyndon Johnson but Johnson's domestic spending runs about 20% of Bush's.
As a result, the federal budget is in ghastly shape. Spending is running $2.6 trillion per year. If today you slashed the budget in half, you would be back to the small-government days of the beginning of Clinton's first term. If you cut it in half again, you would be taken back to Reagan's first term, a time when people date the beginning of budgets cuts that never happened.
The same is true for government debt. The debt ceiling now exceeds $8.2 trillion. But these figures mean nothing to any normal person. We might as well say that it is $458 bazillion, for it is impossible for anyone to grasp the meaning of those numbers. They are far too large, and not only for us. They are too large for anyone in the federal government to comprehend much less control.
And this raises a very important point about the reform that everyone seems to agree we so desperately need. We hear about the need for new laws, a new Contract with America, a new class of politicians, or a constitutional amendment. Folks, we've been through this many times. These are diversions. What we face is a massive institutional problem. It is not surprising that we are ruled by a government that wants to spend ever more money to buy votes and rule an ever-larger roost. The mystery that needs explaining is how they come to get away with it.
Let's say you have a wayward son for whom you continually co-sign on his bank loans. He borrows and borrows, spends and spends, more and more every month and year. You call, you write, you warn, you threaten, you lecture, you scold, you sternly disapprove. But the one thing you do not do is stop co-signing notes. What do you suppose the wayward son's reaction will be?
If he is truly wayward — and all of history suggests that the state is worse than any wayward son — he will keep it up until you are driven to financial ruin. So long as you are willing to underwrite his habits, you are enabling irresponsibility.
The same is true with the federal government. The reason spending is out of control is that there is no institutional break to interrupt the pattern. Spending and debt continue to rise with no apparent consequence for anyone. The politicians make promises, the pundits scold, the voters sit back in discomforted bemusement, and the game continues without limit: ever more programs, benefits, and wars.
Meanwhile, our taxes are not being raised to the point that the payers are squawking inordinately. No one talks openly of raising taxes anymore. Indeed, the Republicans talk of locking in tax cuts and of granting ever more.
Consider that the financial problems of the individual state somehow rarely afflict the US government. The US government carries debt that would be unthinkable at the state level, to say nothing of corporations, families, or individuals. These latter institutions get into financial trouble from time to time; what they do not do, and cannot do, is run a debt of four and three-quarters trillion dollars.
Corporations can run high amounts of debt, as can state governments, but those debts must be marketed on the free market, and they carry a default premium. Corporations that are irresponsible face punishment in the markets. States that go too much in the red are threatened with bankruptcy.
Not so with US government debt. Interest rates are set by markets but they closely track the rates that the Fed charges to its member banks. The risk of holding federal debt, as everyone knows, is nearly zero, which is perhaps the only reason that anyone holds it at all.
The answer to this puzzle is to be found in one institution that only rarely makes an appearance in our public debate. I'm speaking of our system of money and banking. Since the end of the gold standard of the Bretton Woods age — the last institutional check on out-of-control government that existed — we have lived under a fiat money regime. Thanks to the monopoly control exercised by the Federal Reserve and granted by the US government, the government has been given a blank check to spend as it wants. The Fed is now the guarantor that the bills will be paid.
Actually, no one in the modern age has explained this point with more exuberant satisfaction than Ben Bernanke, the new chairman of the Federal Reserve:
The U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.
Even from his own remarks, we can clearly see that he is wrong that the power to create money comes without cost. Since 1970, the value of the dollar in terms of goods and services has dropped dramatically to 19 cents. More dollars in circulation means each of those dollars buys less.
In our times, it is commonly accepted that inflation is not a problem. But consider just how lucky we are to be living in the age of globalization and economic reform. More markets opening abroad — China, India, Malaysia, Indonesia, Russia, Eastern Europe, and, to a lesser extent, Latin America — has meant a price boon for the American consumer, with thousands of products dropping in price due to lower production costs and increased competition. International trade has been a lifesaver.
Imagine if we subtract these tradable goods and services out of the question. We are left with health, education, and housing — the three sectors that have seen the highest increase in price in the last 10 years. They are increasing at two, three, and four times the annual rate of the consumer price index.
And inflation is only part of the cost. In any fiat money system, the money is not dropped from a helicopter but enters in through the banking system and the mechanism of the interest rate. Artificially low interest rates mean a greater expansion of money creation. These low rates mislead investors that there is enough savings available to support the investment. Sector-wide and economy-wide bubbles appear that eventually deflate and foil the plans of investors and consumers. Thus do we have the business cycle as a result.
The greatest mystery in the history of economic theory, and still the most unresolved controversy in the economics profession, is the nature and source of the business cycle. Why do recessions occur and why do booms occur? Why do they tend to follow each other with some degree of regularity?
Solving the mystery of the business cycle is a different task than confronted Adam Smith and the classical economists. They sought to answer the question of how economies grow. They concluded that free exchange and capital accumulation are the sources. But the mystery of the business deals with a far more complex problem of why growth seems to occur intermittently. This is a question that only began to absorb economists in the middle of the last century.
Part of the reason is that business cycles simply didn't exist in the prior centuries. We get a clue to the ultimate resolution of this problem by noting that central banks didn't exist before business cycles began to be noticed. But it took economists a very long time before they put two and two together to understand that it is the activities of the central bank itself that brings about the trade cycle.
In Karl Marx's view, the business cycle was an inherent part of the capitalist economic system and a signal of its fundamental instability. He foresaw cycles worsening, with each recession worse than the last, and ultimately leading to the breakdown of capitalism itself. For decades socialists echoed his forecast, and attempted to reinterpret every cycle as a millennial sign that the capitalist system was being trampled by forces of history.
The cycle theories of Marx were far from the only reason his ideas came to be accepted by intellectuals. The Great Depression seemed to confirm Marx's view of business cycle and gave a boost to the socialist cause. Beginning in the early 1930s, a huge debate ensued between market advocates like Henry Hazlitt, author of Economics in One Lesson, and socialist intellectuals writing in the pages of leftist weeklies like The Nation. The socialists pointed to the declining share of the return on capital enjoyed by the workers and the rising profits of the exploiter class. They said that the Great Depression ensued when workers no longer had the means to purchase products of their own making. The only answer, then, is to redistribute property from the capitalists to the workers, and insure that society, as embodied by the state, and not private owners of capital, would control the means of production.
Here again, over time, the socialists learned that it was not necessary to bring about a revolution to achieve this end. Congress, the executive branch, and state legislatures were all that was necessary to prevent owners of capital from controlling the uses of their own property.
For a time, it appeared that the socialist interpretation of the Great Depression was winning out. And even to this day, the interpretation is underscored in John Kenneth Galbraith's interesting but wrongheaded book on the Great Depression, and in countless PBS documentaries. The fallacy with all of these accounts is that they deal with the downturn, as if it is the only issue worth examining, but not with a larger perspective of the cycle in general. Only by broadening our horizons to understand the boom phase of the cycle as well can we arrive at reasonable conclusions and solid recommendations for minimizing the role of cycles.
In 1936, John Maynard Keynes came out with his General Theory, which came to dominate macroeconomic thinking for decades following. Though his original work is rarely read by professional economists, and virtually never discussed in the classroom setting, the assumptions behind his theory still dominate much of economic thinking.
In Keynes's theory, like Marx's, the business cycle is an inherent part of the market economy. But he argued it was not necessary to overthrow property and markets in order to control them. The government, working hand in glove with Keynesian economists of course, could pursue policies that would keep business cycles at bay. The problem, said Keynes, was fundamentally twofold.
First, the price system doesn't work very well or reflect real economic needs. Prices and wages often do not adjust in ways that coordinate the economy. But by manipulating prices, mainly through inflation, the system could be fixed up. Second, the investment sector is fundamentally irrational. Animal spirits periodically sweep through markets, causing businesses to underinvest in things that are needed and overinvest in things that are not.
There are two ways out of this problem. We can live with the resulting business cycles, but that creates its own problems since the price system is so deeply flawed. Or we can manipulate the demand-side of the economy to force it into coordination with the supply side. As a result of this Keynesian-style analysis, the government now had an intellectual justification for the huge New Deal machinery that had been established to manage the economy. After the war, this Keynesian machinery became a permanent part of government policy.
Economists deluded themselves into thinking they could smooth out business cycles by managing countercyclical fiscal and monetary policies. The result, of course, was far different. In the postwar period, business cycles became progressively worse, with every attempt to manage them seeming to create its own problems, among them inflation, hyperinflation, enormous government debts, and rising deficits. I think we should also include, as a cost of Keynesian policy, the loss of freedom that Americans experience. No longer did we have a government that largely stayed out of economic policy. Rather, we had a government that regarded itself as all-knowing and regarded the market economy as essentially stupid.
Is the business cycle truly a natural part of the free market? Ludwig von Mises explored this question in his 1912 book called A Theory of Money and Credit. He first explored the possibility that discoordinations in gold flows between countries, caused by bad monetary policies, might be the source of booms and busts. And while he concluded that this is the root of international business cycles, he said this doesn't explain how a business cycle could be created in a single country. In exploring this issue, he went much further in his analysis that any previous thinker.
His resulting theory is called the Austrian Theory of the Business Cycle. The Austrian theory notes that it is crucial to understand the boom times in order to understand the bust. To generate an economic boom, the central bank artificially lowers interest rates, creating the illusion of increased savings. Faced with new credit availability, the business sector borrows to expand production and begin long-term investment projects. The boom continues so long as interest rates remain artificially held down. Businesses continue to invest in projects for which there is no real, underlying economic demand or rationale. This type of investment is what Mises called malinvestment.
Note that during this period, the increased money and credit don't necessarily result in higher prices. The monetary inflation is bringing about a fundamental structural change in the economy, but it is not creating any ill effects. Production is expanding, unemployment and interest rates are low, the stock market is booming, and everyone appears to be getting richer. We can recognize this in the United States and Britain in the 1920s, Asia in the 1980s and early 1990s, and quite possibly the United States again today.
But this boom is not self-sustaining. When businesses bring products to market at the end of the production process, they are met with consumers who have neither the savings nor the income to purchase them. Once prices eventually do begin to creep up, the discoordinations between the investment and spending sector begin to be revealed. The central bank raises rates to prevent conspicuous declines in the purchasing power of money, and the boom begins to reverse itself. This process can occur over six months or 15 years. There is no set formula. The timing is largely unpredictable as well, especially in a global economy.
But these business cycles do terrible damage to the economy. They bankrupt businesses that were only trying to follow the market's signaling devices, and they could not have known with certainty that the Fed was manipulating the signals. They throw people out of work, not because their managers or the owners of businesses were engaged in inefficient production, but because they were dealt a bad hand by the money managers at the top of the central bank.
The central bank has long felt the pressures of politics to keep interest rates unnaturally low. These come from both the president and the Congress. The president, of course, is concerned about keeping rates low before elections. Quite often, he is willing to tolerate a recession after election to his first term. But no president will tolerate a recession leading up to the election itself. The Fed chairman, who frequently proclaims his independence on politics, is in fact utterly dependent on favors from the White House. In order to maintain the Fed's much ballyhooed independence, it must do what the president wants.
The central bank also faces pressures from its member banks, who profit from lower rates.
Congress also has an impact. If we ever see the Fed chairman threatened with investigations into the Fed's secrecy, or badgered in front of committees, it is nearly always done in times when interest rates are high. Special interest groups — from large manufacturers to farmers — lobby their Congressman to intervene. There are very few politicians who call the Fed to complain when it is keeping the lid on interest rates.
Of course, the media plays a role in the interest-rate conspiracy as well. They are always ready to tell the public about the sad plight of borrowers who are being squeezed by high interest rates. Telling the story of a structure of production that has fallen into misalignment because of artificially low rates just doesn't make good copy. The media fans the flames — especially during recessions, when every business failure is considered to be a national tragedy, instead of part of the natural cleansing process of the market economy.
The media also add to the general sense that the boom phase of the cycle is the good phase and the bust is the bad phase. In fact, looked at from an economic perspective, the boom phase is the one that should worry us. It is during these times when borrowers are being misled and economic misalignments are taking place. The bust represents a period of honesty and decency, when at last reality is catching up to the lies that low interest rates have been telling.
The common misperception that economic booms should go on forever is what gives impetus for governments to intervene. But any intervention designed to soften the blow of a recession can only end up in prolonging the agony, just as it did during the Great Depression and as such efforts are doing today in Asia.
What should government do during a recession? The short answer is nothing. It should take care to ensure there are no obstacles to the downward adjustment of wages and that the market is free to generate entrepreneurial opportunities, but otherwise it should stay out of the way.
Compare the actions of Warren G. Harding with those of Herbert Hoover. In 1921, the United States experienced a major economic downturn, which was a direct result of the inflationized economy of wartime. Unemployment reached 11.7%, even as high as 15%, and output crashed. This was after unemployment fell to 1.4% in 1919. Economists generally rank the severity of this depression more extensive than even the one that would follow a decade later.
There was no shortage of advice given to the Harding administration. Henry Ford and Thomas Edison wanted to create fiat money on a huge scale. The secretary of commerce, Herbert Hoover, wanted a massive public works program. In this, he worked with two prominent governors, Calvin Coolidge and Al Smith. Labor leaders were demanding make-work programs.
In the end, however, before these plans could be implemented, the economy began to rebound. By 1922, unemployment was back down to reasonable levels, output was expanding, and the economy was rebounding across the board. This was laissez faire at work. The politicians could not act fast enough, and thank goodness. The depression was over in a year.
Compare this to the actions of the Hoover administration. Despite his reputation as a do-nothing president, he did far too much. He attempted to keep wages propped up and stop business failures. He embarked on a massive public works spending program and erected high tariff barriers. He might have been living out a fantasy first developed when he was secretary of commerce, but the economy was a victim. We did not enter recovery as we should have and could have, and instead we got a national socialist as a president for three straight terms.
After World War II until 1973, our monetary regime was dictated by the Bretton Woods agreement, which provided a fixed rate of redemption between the dollar and gold. The Fed broke this link by accelerating monetary inflation in the 1960s to help finance expenditures for the Great Society and Vietnam War. From the beginning of 1960 to the end of 1964, the Fed increased the money base 3% per year, but from the beginning of 1965 to the end of 1970, the Fed more than doubled the rate of increase to 6.3%. The average annual rate of price inflation went from 1.3% in the earlier period to 4.2% in the latter one.
After increasing the monetary base 8.7% per year from 1971–1974, the Fed accelerated the rate to 10.4% from 1975 to 1981. But after the debacle of the first half of the 1970s, it was difficult to convince foreigners to hold more dollars as reserve. Accelerating monetary and credit inflation by the Fed led to severe domestic price inflation (average annual rates of 11.2%), soaring interest rates (peaking in 1981 at a 14% 3-month), collapsing capital values (from 1976 to 1982, the Dow lost 22% and stood at 774 in 1982), and higher unemployment (peaking at 9.7% in 1982, a rate not seen since 1941).
From 1982 through 1990, the dollar began to regain its status as the world's reserve currency. The Fed expanded the monetary base 11% per year in the 1980s, but the demand to hold dollars overseas helped soak up the monetary inflation and the American economy experienced economic growth with low levels of price inflation. The annual rate of price inflation was only 5.9%. But the improved performance of the economy in the 1980s was only a foretaste of the renaissance of dollar dominance in the world.
American supremacy in the wake of the collapse of communism allowed the Fed to fully exploit the international dollar-reserve system. The new system opened up a vast new vista for overseas dollar holdings. From Russia and Eastern Europe to China and East Asia, the governments of former communist countries began to soak up dollars to hold as official reserves as they became part of the American "global" system.
Moving forward to our present situation, a major contest is afoot concerning what currency will continue to dominate the world. Will it be the dollar, the Euro, the Yen, or something else? Much depends on the productive power of the originating country. But in no case is the gold standard considered an option. This is a tragedy.
The alternative to the gold standard has been a disaster for liberty here and abroad. The larger and more powerful government is, the more human freedom is curbed. Economic and civil liberties are constantly threatened and undermined by well financed power. This one factor is more decisive in the rise of despotism than any other. Frugal states that lack the power to fund themselves cannot gain control over populations. Taxes alone rarely pay for despotism; despotism from time immemorial is financed through monetary expansion.
I cannot hand you my perfect prescription for how we can end this mess without cost. But I do say this: radical monetary reform is the most important step we could take today on behalf of free enterprise, peace, and human liberty generally. We do not lack plans to restore sound money. Indeed, defining the dollar as a fixed weight of gold and eliminating the power of the Fed to print money is all that is necessary. What we lack is the political will to do so.
A gold standard would be the single best reform we could make to the cause of freedom. Its commercial benefits include stability, predictability, and honesty in finance. Its moral benefits include a financial system that does not reward living beyond one's means. From the point of view of government, a gold standard would tie the hands of the state. They could wish and long for wars, welfare, foreign aid, bailouts, subsidies, and graft, but unless they could raise the money by taxing, all their talk would be pointless.
Let me clear up a few myths about gold. It is not the case that under a gold standard we would all find ourselves in the position of that young man in Treasure Island, with aching backs and throbbing fingers. Banks would continue to exist and compete on a sound basis. All financial services would continue to exist just as they do now, from credit cards and bank cards to PayPal and stock portfolio, checking and all the rest. Indeed, we would see an explosion of financial innovation under the gold standard because so many of the uncertainties associated with inflationary finance would be a thing of the past.
Money would become truly international, or would tend in that direction as more countries decided to make their currencies good as gold. And if we managed the transition right, government would have no monopoly on the production of money. This would be something handled by the private sector, as supplies competed based on beauty and design and reliability. In an ideal world, all currencies would be different names for precious metals, all interchangeable with each other based on weight and fineness.
If that sounds complicated or unreasonable, or even completely unviable, let us remember that all forms of freedom seem impossible in the midst of despotic control. Many intellectuals and officials in Russia and China couldn't imagine how society would work if people were permitted to live and work and move where they wanted. To them it sounded like chaos. Germans can't imagine how society would survive without strict laws on when retail shops can open and close. And people in Britain went into a panic recently on the suggestion that pubs be permitted to stay open longer than usual.
In our own country, we can't imagine the legalization of drugs, the elimination of the minimum wage, the abolition of Social Security, or not waging a war on someone every two years. These things just seem crazy to us because we have adapted to statism. So it is with money. We are used to the idea that government should run the monetary system. And that's why when we say we favor the gold standard, people think we are nuts. But today in China or Russia, anyone who favors a return of travel and moving restrictions is considered dangerous and deranged — which is precisely how I feel about anyone who says that government ought to be given full control of a nation's monetary institutions!
So I ask you to imagine how the world worked before the advent of central banking and before our permanent state of paper currency. Imagine if the money you made and saved were good as gold — a truly independent medium of exchange that was not subject to political manipulation, confiscation, or depreciation. The wizards at the Fed would not control our destinies; Congress's appetite for spending would be curbed; and the president would be a bit more cautious about embarking on wars that would cost political capital. It would be the world of Treasure Island, where the only criminals we would need to worry about owned boats, not fleets, and where the pirates sang about rum, not national anthems to the glory of the state.
How, then, to get from here to there? We need to re-spark a national debate. As with all such debates, they begin with scholarship and serious efforts at education. Toward this end, I would like to recommend three additional books to you as a follow-up to this short talk.
The first is What Has Government Done to Our Money?, a classic book by Murray Rothbard that explains what money is and how and why government destroyed it for its own purposes. He explores the theory and history of the gold standard and why it matters. The Mises Institute edition comes with another essay as a bonus: The Case for a 100% Gold Dollar, a piece that explains how we can get from our current situation to where we want to go.
The second is Rothbard's History of Money and Banking in the United States. Here we find that money was not always an obscure area of political life. It was once debated in all political speeches and in newspapers. We find here that in American history, the side of sound money was always held by the strongest believers in liberty, free trade, and peace. Reading this book and familiarizing yourself with American monetary history has the special benefit of making you realize that you aren't so crazy for thinking that this subject matters.
The third and final book is a monumental treatise by Jesús Huerta De Soto called Money, Bank Credit, and Economic Cycles. It might be the most important book on money to appear in human history. It is certainly the most advanced. It is the first book to integrate the microeconomic concern over the law that governs economic life with the macroeconomics of capital theory and business cycles. Its explorations of law in the ancient world and the emerging literature on the problem of fractional-reserve banking make it a hugely important contribution to our understanding. But prepare yourself: it is 900 pages!
You can find all three books on the Mises Institute website. If you really want to make a difference, consider gifts to your school, church, local library, local economics professors, or even state and federal politicians. We can't guarantee that this will make a difference but it keeps the issue alive and before the people who can make a difference. In the end, I don't believe that the answer rests with political action but education.
We have hardly faced our last economic crisis. And I can promise you that when the next one comes, the Fed will bear the lion's share of the blame. Of course they will deny it. But we don't need to let them get away with it. The sooner we can unseat the counterfeiters from their perches of power, the faster we can reclaim sound money and the freedom that protects and guards against the depredations of the powerful.
Alan Greenspan was correct when he wrote that the cause of the gold standard is bound up with the cause of freedom itself. Now that he has left the Fed, I hope that we can look forward to more essays from him making that same point. If they are not forthcoming, it will be up to those of us who still have the freedom to speak to make the point again and again that sound money is the best protection liberty ever had. It can be again.
It was John Maynard Keynes who called gold a barbarous relic. He also wrote in the introduction to the German edition of his book that the best system for implementing his policies required a total state on the scale that Germany was then creating. That alone should tell us something. It is not a barbarous relic. It is the monetary basis of the future of civilization and freedom.