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Gold or the Fed?

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Tags The FedGold Standard

02/01/1997Jeffrey M. Herbener

The Free Market 15, no. 2 (February 1997)

 

If members of the congressional classes of 1994 and 1996 are serious about curbing government, they should rally around Ron Paul, the newly elected congressman from Texas's 14th district. For Ron, a longtime friend of the Mises Institute, is the outstanding political opponent of the main engine of statism in American life: the Federal Reserve.

In his prior terms in the House, Ron was an indefatigable advocate of the free-market monetary system--the pure gold standard--and the bane of Fed officials. In those days, the power of his case rested on how the gold standard could eliminate business cycles and inflation, important points that still apply.

But today, a renewed effort to abolish the Fed and establish gold as money has a new source of strength. A recent partial audit of the Fed showed the central bank as a corrupt and wasteful bureaucratic empire, with cost overruns large enough to dethrone the head of any other agency. And if this isn't enough to invite attention, the Fed has again reelected an incumbent president, which should alarm any Republican worth his campaign contribution.

Yet the biggest obstacle to a gold standard, as always, is intellectual. What these Congressmen need is a good monetary education. Four objections invariably crop up when the subject of gold is raised. Here they are, with some short answers.

 

1. The gold standard is too costly. This claim overlooks the efficiency of the market itself. Entrepreneurs produce the right amount of each good because they must pay market prices to successfully bid for factors of production.

If they could avoid these market-imposed production costs, it would be profitable for them to vastly over-produce. Fiat money can be produced at a low cost, which is one reason the government can produce so much, and cause so much inflation.

Moreover, to re-monetize gold would require no expense of mining and refining. Vast hoards of gold sit idly in government vaults. There would be only the one-time cost of minting bullion into coins, followed by a declaration by the Treasury that it will redeem Federal Reserve notes in gold coin at a fixed rate.

The Fed could then be liquidated and the profits used to cover the Treasury's minting costs. Government could then revoke legal tender laws that prohibit private mints and banks from producing the gold coins and fully-redeemable paper money demanded by the public.

 

2. The gold standard is too inflexible. Even if the money stock were fixed, it is enough to buy any amount of goods. If there are a lot of goods, prices will be low; if goods are few, prices will be high. With the money stock fixed, economic growth results in a consistently falling price for goods and a rising value of savings.

If prices fall, production does not become less profitable. Entrepreneurial demand adjusts factor prices to the prices of consumer goods, and profit margins are left intact. If falling prices did indeed lower profits, rising prices would consistently increase profits. In fact, inflation has long coincided with lower, long-run rates of economic growth and profitability.

Moreover, the money stock under a pure gold standard is not fixed. A rise in the demand for money increases its market value, which makes it profitable to produce more gold coins. Entrepreneurs increase the stock of money by production, which mitigates the rise in its market value and bids up factor prices.

In a period of economic growth, money demand increases and brings forth neither too much nor too little additional money, but precisely the amount warranted. The Fed, in contrast, has no market test to guide its policies. It is left to vacillate between over-issue and under-issue, with consequent price inflations and recessions.

 

3. A gold standard is too unstable. In fact, under a gold standard, the variability of changes in money's purchasing power are strictly limited by the market costs of changing the stock of money. At its extreme, a gold standard results in falling prices at a rate that corresponds to the rate that economic production expands. Prices rise only in proportion to the reduced costs of gold production.

In contrast, the variability of price inflation under fiat money is unlimited. The Fed can double the money stock overnight or cut it in half. Just the prospect invites the Fed chairman to exercise unwarranted market power. Traders on Wall Street hang on to his every utterance.

A gold standard, in contrast, produces a relatively constant purchasing power of money. This is not the same as a constant "price level," which is a chimera. It cannot be defined or measured, as the debate about the accuracy of the CPI reveals. No matter how prescient, the Fed cannot attain a monetary-policy goal it cannot define.

 

4. A gold standard has failed in the past. The U.S. has never been on a pure gold standard. The closer we've come to one, the better off we've been. As we've moved further and further from one, the worse off our economy has been, and the more the government has grown.

The problems of the gold standard resulted from a system that was not pure enough. It was compromised in one respect or another: paper-money inflation, banking regulation, legally protected fractional reserves, bimetallism, the presence of a central bank, etc. By learning from the past, we can eliminate each of these problems and allow a free-market system to flourish in money as it does in other sectors.

The Republican revolutionaries should take up their anti-government cause again, and this time--led by Ron Paul--attack the fundamental source of today's economic problems. It's not public opinion, an imperfect Constitution, nor the lack of this or that regulation. It's big governments best friend, the Federal Reserve itself.

 

Jeffrey Herbener teaches economics at Grove City College

Cite This Article

Herbener, Jeffrey. "Gold or the Fed?" The Free Market 15, no. 2 (February 1997).

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