The Free Market Reader

 

2 FIAT MONEY AND THE GOLD STANDARD

Confidence and Money

Llewellyn H. Rockwell, Jr.

In Ohio and Maryland, state-run savings and loan insurance schemes failed when depositors asked for their money. The crises came to an end, at least on the surface, with coverage from the Federal Savings and Loan Insurance Corporation.

The FSLIC was seen as a cure, not because of its assets—they cover less than .8% of deposits—but because of the Federal Reserve’s implicit promise to print enough dollars to cover any FSLIC (or Federal Deposit Insurance Corporation) crisis. To stop just the Continental Illinois bank run, the Fed created $3.5 billion to avoid draining the FDIC, which has assets covering less than .8% of deposits.

The S&L industry is shakier than ever before, thanks in part to real-estate and junk-bond speculation. The city of Washington, D.C., for example, has seven federally insured S&Ls. Only two meet the FSLIC’s minimal requirement of a net worth equal to 3% of liabilities—and this is calculated using very liberal accounting standards. When you apply slightly stricter ones, two of the seven have a negative net worth.

This is true despite FSLIC gimmicks—such as “net-worth certificates”—designed to paper over S&L problems. Subtract these, and rate old mortgages at the market rather than the face value, and virtually the entire industry would be technically bankrupt.

“Technically” is the key word, however, because so long as the Fed stands ready to make cheap loans through the discount window—a subsidy S&Js now share with banks—and to bail out the FSLIC, the industry will be kept afloat. (The value of the dollar will be another matter, however.)

In Ohio and Maryland, loss of confidence was blamed for the runs on the S&Ls. That is, depositors—after reading about fraud involving one state-insured institution—worried that their money might be at risk in all of them, and sought to withdraw it.

It’s hard to imagine a similar problem in any other business. The computer industry, for example, couldn’t go out of existence overnight because of fraud at one company causing a “loss of confidence.” Of course, IBM doesn’t pledge to have customers’ property available on demand, while at the same time loaning it to others.

The dollar itself, thanks to the Fed, also depends on confidence, and as with the S&Ls, this can be lost overnight when the monetary and fiscal chickens come home to roost.

Justifiable confidence in the dollar, the S&Ls, and the banks will only come with a gold standard, and with savings and lending institutions built upon it: ones that would not—in the absence of federal subsidies—go belly up upon being asked to keep their word.

Bank Runs and Water Shortages

Murray N. Rothbard

It was a scene familiar to any nostalgia buff: all-night lines waiting for the banks (first in Ohio, then in Maryland) to open; pompous but mendacious assurances by the bankers that all is well and that the people should go home; a stubborn insistence by depositors to get their money out; and the consequent closing of the banks by government, while at the same time the banks were permitted to stay in existence and collect the debts due them by their borrowers.

In other words, instead of government protecting private property and enforcing voluntary contracts, it deliberately violated the property of the depositors by barring them from retrieving their own money from the banks.

All this was, of course, a replay of the early 1930s: the last era of massive runs on the banks. On the surface the weakness was the fact that the failed banks were insured by private or state deposit insurance agencies, whereas the banks that easily withstood the storm were insured by the federal government (FDIC for commercial banks; FSLIC for savings and loan banks).

But why? What is the magic elixir possessed by the federal government that neither private firms nor states can muster? The defenders of the private insurance agencies noted that they were technically in better financial shape than FSLIC or FDIC, since they had greater reserves per deposit dollar insured. How is it that private firms, so far superior to government in all other operations, should be so defective in this one area? Is there something unique about money that requires federal control?

The answer to this puzzle lies in the anguished statements of the savings and loan banks in Ohio and in Maryland, after the first of their number went under because of spectacularly unsound loans. “What a pity,” they in effect complained, “that the failure of this one unsound bank should drag the sound banks down with them!”

But in what sense is a bank “sound” when one whisper of doom, one faltering of public confidence, should quickly bring the bank down? In what other industry does a mere rumor or frisson of doubt swiftly bring down a mighty and seemingly solid firm? What is there about banking that public confidence should play such a decisive and overwhelmingly important role?

The answer lies in the nature of our banking system, in the fact that both commercial banks and thrift banks (mutual savings and savings-and-loan) have been systematically engaging in fractional-reserve banking: that is, they have far less cash on hand than there are demand claims to cash outstanding. For commercial banks, the reserve fraction is now about 10%; for the thrifts it is far less.

This means that the depositor who thinks he has $10,000 in a bank is misled; in a proportionate sense, there is only, say, $1,000 or less there. And yet, both the checking depositor and the savings depositor thinks that he can withdraw his money at any time on demand. Obviously, such a system, which is considered fraud when practiced by other businesses, rests on a confidence trick: that is, it can only work so long as the bulk of depositors do not catch on to the scam and try to get their money out. The confidence is essential, and also misguided. That is why once the public catches on, and bank runs begin, they are irresistible and cannot be stopped.

We now see why private enterprise works so badly in the deposit insurance business. For private enterprise only works in a business that is legitimate and useful, where needs are being fulfilled. It is impossible to “insure” a firm, even less so an industry, that is inherently insolvent. Fractional reserve banks, being inherently insolvent, are uninsurable.

What, then, is the magic potion of the federal government? Why does everyone trust the FDIC and FSLIC even though their reserve ratios are lower than private agencies, and though they too have only a very small fraction of total insured deposits in cash to stem any bank run? The answer is really quite simple: because everyone realizes, and realizes correctly, that only the federal government—and not the states or private firms—can print legal tender dollars. Everyone knows that, in case of a bank run, the U.S. Treasury would simply order the Fed to print enough cash to bail out any depositors who want it. The Fed has the unlimited power to print dollars, and it is this unlimited power to inflate that stands behind the current fractional-reserve banking system.

Yes, the FDIC and FSLIC “work,” but only because the unlimited monopoly power to print money can “work” to bail out any firm or person on earth. For it was precisely bank runs, as severe as they were that, before 1933, kept the banking system under check, and prevented any substantial amount of inflation.

But now bank runs—at least for the overwhelming majority of banks under federal deposits insurance—are over, and we have been paying and will continue to pay the horrendous price of saving the banks: chronic and unlimited inflation.

Putting an end to inflation requires not only the abolition of the Fed but also the abolition of the FDIC and FSLIC. At long last, banks would be treated like any firm in any other industry. In short, if they can’t meet their contractual obligations they will be required to go under and liquidate. It would be instructive to see how many banks would survive if the massive governmental props were finally taken away.

Water Not Running

Most people agree that government is generally less efficient than private enterprise, but it is little realized that the difference goes far beyond efficiency. For one thing, there is a crucial difference in attitude toward the consumer. Private business firms are constantly courting the consumer, always eager to increase the sales of their products. So insistent is that courtship that business advertising is often criticized by liberal aesthetes and intellectuals as strident and unmannerly. But government, unlike private enterprise, is not in the business of seeking profits or trying to avoid losses. Far from eager to court the consumer, government officials invariably regard consumers as an annoying intrusion and as “wasteful” users of “their” (government’s) scarce resources. Governments are invariably at war with their consumers.

This contempt and hostility toward consumers reaches its apogee in socialist states, where government’s power is at its maximum. But a similar attitude appears in areas of government activity in all countries. Until a few decades ago, for example, water supplies to consumers in the United States were furnished by private companies. These were almost all socialized, so that government has come to monopolize water services.

In New York City, which shifted to a monopoly of government water several decades ago, there was never, in previous decades, any wailing about a “water shortage.” But, recently, in a climate that is not conspicuously dry, a water shortage has reappeared every few years. This July water levels in the reservoirs supplying New York City were down to an unprecedented 55% of capacity, in contrast to the normal 94%. But surely, nature is not solely to blame, since neighboring New Jersey’s water levels are still at a respectable 80%. It seems that the New York water bureaucrats must have carefully sought out nearby spots that particularly suffer from chronic drought. It also turns out that the New York pipelines were constructed too narrowly to increase water flow from wetter regions.

More important is New York’s typical bureaucratic response to this, as well as to other periodic water crises. Water, as usual with government, is priced in an economically irrational manner. Apartment buildings, for example, pay a fixed water fee per apartment to the government. Since tenants pay nothing for water, they have no incentive to use it economically; and since landlords pay a fixed fee, regardless of use, they too couldn’t care less.

Whereas private firms try to price their goods or services to achieve the highest profit—i.e. to supply consumer needs most fully and at least cost—government has no incentive to price for highest profit or to keep down costs. Quite the contrary. Government’s incentive is to subsidize favored pressure groups or voting blocs; for government is pressured by its basic situation to price politically rather than economically.

Since government services are almost never priced so as to clear the market, i.e. equate supply and demand, it tends to price far below the market, and therefore bring about an artificial “shortage.” Since the shortage is manifest in people not being able to find the product, government’s natural despotic bent leads it invariably to treat the shortage by turning to coercive restraints and rationing.

Morally, government can then have its cake and eat it too: have the fun of pushing people around, while wrapping itself in the cloak of solidarity and universal “sacrifice” in the face of the great new emergency. In short, when the supply of water drops, governments almost never respond the way a business firm would: raise the price in order to clear the market. Instead, the price stays low, and restraints are then placed on watering one’s lawn, washing one’s car, and even taking showers. In this way, everyone is exhorted to sacrifice, except that priorities of sacrifice are worked out and imposed by the government, which happily decides how much lawn watering, or showering, may be permitted on what days in the face of the great crisis.

Several years ago, California water officials were loudly complaining about a water shortage and imposing local rationing, when suddenly an embarrassing event occurred: torrential rains all over the drought areas of the state. After lamely insisting that no one should be misled by the seeming end of the drought, the authorities finally had to end that line of attack, and then the title of the Emergency Office of Water Shortage was hastily changed to the Office of Flood Control.

In New York, this summer, Mayor Edward Koch has already levied strict controls on water use, including a ban on washing cars, and imposition of a minimum of 78 degrees for air conditioners in commercial buildings, plus the turning off of the conditioners for two hours during each working day (virtually all of these air conditioners are water-cooled). 78 degrees is tantamount to no air-conditioning at all, and will wreak great hardship on office workers, as well as patrons of movies and restaurants.

Air-conditioning has always been a favorite target for puritanical government officials; during the trumped-up “energy shortage” of the late 1970s, President Carter’s executive order putting a floor of 78 degrees on every commercial air conditioner was enthusiastically enforced, even though the “energy saving” was negligible. As long as misery can be imposed on the consumer, why worry about the rationale? (What is now a time-honored custom in New York of reluctance to serve water to restaurant patrons originated in a long-forgotten water “shortage” of decades ago.)

There is no need for any of these totalitarian controls. If the government wants to conserve water and lessen its use, all it need do is raise the price. It doesn’t have to order an end to this or that use, set priorities, or decide who should be allowed to drink more than three glasses a day. All it has to do is clear the market, and let people conserve each in his own way and at his own pace.

In the longer run, what the government should do is privatize the water supply, and let water be supplied, like oil or Pepsi-Cola, by private firms trying to make a profit and to satisfy and court consumers, and not to gain power by making them suffer.

The World Currency Crisis

Murray N. Rothbard

I: Keynesians and Fixed
Exchange Rates, 1944-73

The world is in permanent monetary crisis, but once in a while, the crisis flares up acutely, and we noisily shift gears from one flawed monetary system to another. We go back and forth from fixed paper rates to fluctuating rates, to some inchoate and aborted blend of the two. Each new system, each basic change, is hailed extravagantly by economists, bankers, the financial press, politicians, and central banks, as the final and permanent solution to our persistent monetary woes.

Then, after some years, the inevitable breakdown occurs, and the Establishment trots out another bauble, another wondrous monetary nostrum for us to admire. Right now, we are on the edge of another shift.

To stop this shell game, we must first understand it. First, we must realize that there are three coherent systems of international money, of which only one is sound and non-inflationary. The sound money is the genuine gold standard; “genuine” in the sense that each currency is defined as a certain unit of weight of gold, and is redeemable at that weight.

Exchange rates between currencies were “fixed” in the sense that each was defined as a given weight of gold; for example, since the dollar was defined as one-twentieth of a gold ounce and the pound sterling as .24 of a gold ounce, the exchange rate between the two was naturally fixed at their proportionate gold weight, i.e., £1 = $4.87.

The other two systems are the Keynesian ideal, where all currencies are fixed in terms of an international paper unit, fluctuating independent fiat-paper moneys. Keynes wanted to call his new world paper unit the bancor while U.S. Treasury official (and secret Communist) Harry Dexter White wanted to name it the unita. Bancor or unita, these new paper tickets would ideally be issued by a World Reserve Bank and would form the reserves of the various central banks. Then, the World Reserve Bank could inflate the bancor at will, and the bancor would provide reserves upon which the Fed, the Bank of England, etc. could pyramid a multiple expansion of their respective national fiat currencies.

The whole world would then be able to inflate together, and therefore not suffer the inconvenience of inflationary countries losing either gold or income to sound-money countries. All the countries could inflate in a centrally-coordinated fashion, and we could suffer manipulation and inflation by a world government-banking elite without check or hindrance. At the end of the road would be a horrendous world-wide hyper-inflation, with no way of escaping into sounder or less inflated currencies.

Fortunately, national rivalries have prevented the Keynesians from achieving their goal, and so they had to settle for “second best,” the Bretton Woods system that the U.S. and Britain foisted on the world in 1944, and which lasted until its collapse in 1971. Instead of the bancor, the dollar served as the international reserve upon which other currencies could pyramid their money and credit. The dollar, in turn, was tied to gold in a mockery of a genuine gold standard, at the prewar par of $35 per ounce. In the first place, dollars were not redeemable in gold coins, as they had been before, but only in large and heavy gold bars, which were worth many thousands of dollars. And secondly, only foreign governments and central banks could redeem their dollars in gold even on this limited basis.

For two decades, the system seemed to work well, as the U.S. issued more and more dollars, and they were then used by foreign central banks as a base for their own inflation. In short, for years the U.S. was able to “export inflation” to foreign countries without suffering the ravages itself. Eventually, however, the ever-more inflated dollar became depreciated on the gold market, and the lure of high priced gold they could obtain from the U.S. at the bargain $35 per ounce led European central banks to cash in dollars for gold. The house of cards collapsed when President Nixon, in an ignominious declaration of bankruptcy, slammed shut the gold window and went off the last remnants of the gold standard in August 1971.

With Bretton Woods gone, the Western powers now tried a system that was not only unstable but also incoherent: fixing exchange rates without gold or even any international paper money with which to make payments. The Western powers signed the ill-fated Smithsonian Agreement on December 18, 1971, which was hailed by President Nixon as “the greatest monetary agreement in the history of the world.” But if currencies are purely fiat, with no international money, they become goods in themselves, and fixed exchange rates are then bound to violate the market rates set by supply and demand.

At that time the inflated dollar was heavily overvalued in regard to Western European and Japanese currencies. At the overvalued dollar rate, there were repeated scrambles to buy European and Japanese moneys at bargain rates, and to get rid of dollars. Repeated “shortages” of the harder moneys resulted from this maximum price control of their exchange rates. Finally, panic selling of the dollar broke the Smithsonian system apart in March 1973. With the collapse of Bretton Woods and the far more rapid disintegration of the “greatest monetary agreement” in world history, both the phony gold standard and the fixed paper exchange rate systems were widely and correctly seen to be inherent failures. The world now embarked, almost by accident on a new era: a world of fluctuating fiat paper moneys. Friedmanite monetarism was to have its day in the sun.

II: Monetarists and Fluctuating
Fiat Monies, 1973-?

The Friedmanite monetarists had now come into their own, replacing the Keynesians as the favorites of the financial press and of the international monetary establishment. Governments and central banks began to hail the soundness and permanence of fluctuating exchange rates as fervently as they had once trumpeted the eternal virtues of Bretton Woods. The monetarists proclaimed the ideal international monetary system to be freely fluctuating exchange rates between different moneys, with no government intervention to try to stabilize or even moderate the fluctuations. In that way, exchange rates would reflect, from day to day, the fluctuations of supply and demand, just as prices do on the free market.

Of course, the world had suffered mightily from fluctuating fiat money in the not too distant past: the 1930s, when every country had gone off gold (a phony gold standard preserved for foreign central banks by the United States). The problem is that each nation-state kept fixing its exchange rates, and the result was currency blocs, aggressive devaluations attempting to expand exports and restrict imports, and economic warfare culminating in World War II. So the monetarists were insistent that the fluctuations must be absolutely free of all government intervention.

But, in the first place, the Friedmanite plan is politically so naive as to be almost impossible to put into practice. For what the monetarists do, in effect, is to make each currency fiat paper issued by the national government. They give total power over money to that government and its central bank, and then they issue stern admonitions to the wielders of absolute power: “Remember, use your power wisely, don’t under any circumstances interfere with exchange rates.” But inevitably, governments will find many reasons to interfere: to force exchange rates up or down, or stabilize them, and there is nothing to stop them from exercising their natural instincts to control and intervene.

And so what we have had since 1973 is an incoherent blend of “fixed” and fluctuating, unhampered and hampered, foreign currency markets. Even Beryl W. Sprinkel, a dedicated monetarist who served as Undersecretary of Treasury for Monetary Policy in the first Reagan Administration, was forced to backtrack on his early achievement of persuading the Administration to decontrol exchange rates. Even he was compelled to intervene in “emergency” situations, and now the second Reagan Administration is moving insistently in the direction of refixing exchange rates.

The problem with freely fluctuating rates is not only political. One virtue of fixed rates, especially under gold but even to some extent under paper, is that they keep a check on national inflation by central banks. The virtue of fluctuating rates—that they prevent sudden monetary crises due to arbitrarily valued currencies—is a mixed blessing, because at least those crises provided a much-needed restraint on domestic inflation. Freely fluctuating rates mean that the only damper on domestic inflation is that the currency might depreciate. Yet countries often want their money to depreciate, as we have seen in the recent agitation to soften the dollar and thereby subsidize exports and restrict imports—a back-door protectionism. The current refixers have one sound point: that worldwide inflation only became rampant in the mid and late 1970s, after the last fixed-rate discipline was removed.

The refixers are on the march. During November 1985, a major, well-publicized international monetary conference took place in Washington, organized by Representative Jack Kemp and Senator Bill Bradley, and including representatives from the Fed, foreign central banks, and Wall Street banks, this liberal-conservative spectrum agreed on the basic objective: refixing exchange rates. But refixing is no solution; it will only bring back the arbitrary valuations, and the breakdowns of Bretton Woods and the Smithsonian. Probably what we will get eventually is a world-wide application of the current “snake,” in which Western European currencies are tied together so that they can fluctuate but only within a fixed zone. This pointless and inchoate blend of fixed and fluctuating currencies can only bring us the problems of both systems.

When will we realize that only a genuine gold standard can bring us the virtues of both systems and a great deal more: free markets, absence of inflation, and exchange rates that are fixed not arbitrarily by government but as units of weights of a precious market commodity, gold?

Understanding the Austrian Theory of the Business Cycle

Mark Skousen

One of the highlights of my professional career occurred recently when I had the opportunity to talk with Professor F. A. Hayek at his vacation home in the Austrian Alps. It was an unforgettable experience. Since the death of Ludwig von Mises in 1973, Professor Hayek has been the acknowledged dean of the “Austrian” school of economics, which teaches individualism, laissez-faire economics, and the gold standard. He is now 86 years old, but sharp and alert, and still working hard on a number of projects.

Professor Hayek is the oldest living member of the Austrian school, which began in Vienna with Carl Menger in the 1870s, and continued with Eugen von Böhm-Bawerk, Ludwig von Mises, and Murray N. Rothbard, among others. In 1974, Professor Hayek won the Nobel Prize in Economics for his work on the Mises-Hayek theory of the business cycle.

Of all the many contributions of the “Austrians,” their theory of the business cycle is one of the most valuable. Economists and Wall Street analysts have known for decades that the markets are highly volatile. There is a business cycle in national output, interest rates, and inflation, creating bull and bear markets in stocks, bonds, gold, and so on. And Austrian theory is the only satisfactory explanation of this business cycle.

The first thing to understand is that the principle source of economic disruption and the business cycle is irresponsible government policy. The business cycle, inflation, and high nominal interest rates are not caused by the free market, but by government’s monetary and fiscal policies.

Without government intervention, the free-market economy would reflect:

1) Stable interest rates, probably in the 2%-3% range, as in the 1950s.

2) No inflation. In fact, historically, average prices have tended to decline slightly with a free market and gold standard.

3) Low unemployment. No minimum wage laws and forced collective bargaining, which keep wages artificially high during a recession.

4) High savings rate. Contrary to standard Keynesian doctrine, high personal savings rates are good for economic growth.

5) Economic growth without recessions or depressions.

But as long as government is ubiquitous, and controls the supply of money, it will appear that “capitalism” is inherently unstable, as the Marxists say. Only the wise student of history and economic science knows that government policy, not the free market, is responsible for economic instability.

The key to understanding the economic cycle is what the Austrians call the “structure of production.” Unlike the Keynesians and Monetarists, the Austrians look at the economy not as a whole, but as a collection of individual parts—not “macroeconomics,” but “microeconomics.”

The easiest way to understand the “structure of production” is to see how the economy exists at a single moment, as if a snapshot were taken. If the whole economy were suddenly frozen, what would you see? You would see some products and services completed, such as cars coming off the assembly line ready to sell to consumers. Other products would be half finished, and still others would be just starting production.

In other words, there is an order to the production of goods and services in an economy. The “higher” order or stages of production are “capital goods,” which include tools, machinery, raw materials, trucks, and other goods necessary to produce final consumer goods, which include automobiles, food, clothing, and so on.

This distinction is very important in understanding the inflationary boom-bust cycle. As the Austrians point out, the central bank (the Federal Reserve) expands the money supply in a way that affects certain industries more than others. Historically, because the Fed expands the money supply primarily through the credit markets, the capital-goods investor has been more affected than the consumer-goods market.

There are essentially four states to the business cycle:

First, the inflationary boom. The Fed expands the money supply by purchasing Treasury securities from banks. Profits in capital-intensive industries tend to rise, and because the stock market is highly capital-intensive, the stock market goes through a bull market. However, at the later stages of the inflationary boom, consumer prices start catching up, the stock market loses its luster, and the bull market ends. Also, at the end of the inflationary cycle, gold and silver and other inflation hedges move up sharply.

Second, the credit crunch. Once consumer prices start rising sharply, and interest rates start edging up, the Fed usually puts on the brakes and causes a credit crunch. Interest rates rise rapidly as capital industries scramble for funds to escape bankruptcy.

Third, recession. Production of capital goods falls more sharply than consumer goods. Gross National Product declines, and stocks continue to fall. Interest rates start dropping as demand for credit declines. Prices for commodities and capital goods tend to fall more sharply than consumer goods, which sometimes continue to rise (“inflationary recession”).

Fourth, economic recovery. The recession in capital goods ends as the economy returns to stability. The Austrians are the only school with satisfactory answers to two questions facing economics today: 1) how it is possible to have low inflation in the face of double-digit increases in the money supply, and 2) inflationary recession.

The “low-inflation” environment continues, despite 10% annual increases in the money supply, because of the previous “malinvestments” in the capital goods industries. When companies are on their backs, it requires a greater increase in credit than the previous cycle to achieve a return to previous levels of economic prosperity. After the economy has gone through a major recession and the inflationary psychology has been broken, the government must expand the money supply at a higher rate than the previous cycle in order to achieve the same level of economic activity and price inflation. Note, however, that under President Reagan, the money supply has grown at the same rate as under President Carter, but not more—therefore, we would expect, under Austrian theory, the inflation rate to fall below the double-digit rates of the 1970s. Indeed it has.

I believe the money supply must expand at a 15% to 20% annual rate in order to rekindle double-digit price inflation this time around. So far it hasn’t happened, although lately M1 has been growing at a 14% rate. At some point, of course, price inflation will catch up, but it’s too early to tell when this will happen.

During the inflationary stage of the business cycle, production and prices for capital goods and raw commodities tend to rise much more than for final consumer goods. Only at the later stages of the inflationary boom do consumer goods (as measured by the Consumer Price Index) begin to rise.

Look, for example, at the production of automobiles. During an inflationary boom, the price of iron, steel, aluminum, and other producer goods used in building cars may increase substantially, perhaps doubling in value. But the price of an automobile in the showroom may increase only 5% to 10%.

During a recession, just the opposite occurs. Prices for producers’ goods and raw commodities drop sharply, compared to consumer goods. In the case of cars, steel may fall sharply in price. Meanwhile, the price of finished cars may fall only slightly, or, as has occurred recently, continue to rise.

Thus, consumer goods always tend to rise in a recession relative to capital goods. If you look at the statistics of any recession, you’ll note that the raw commodities price index and the wholesale price index fell by a greater amount than consumer prices. Consumer prices also tended to fall, but not by the same amount. In other words, consumer prices rose in relation to wholesale and commodity prices.

The relationship still holds even today during a recession, except that now in absolute terms, consumer prices are rising instead of falling. This is because the magnitude of monetary inflation is much greater than in past cycles. So, relative to capital goods, all recessions are “inflationary recessions.” It’s just that such a relationship didn’t become obvious until the Consumer Price Index continued to rise in the 1973-1975 recession and the 1980-1981 recession.

If you want to learn more about this aspect of Austrian economics, I recommend the following books, all available from the Institute: What Has Government Done to Our Money?, by Murray N. Rothbard ($5), America’s Great Depression also by Rothbard ($20), An Introduction to Austrian Economics by Thomas C. Taylor ($6), and The Austrian Theory of the Trade Cycle by Ludwig von Mises and others ($5); shipping charge: $2.75 with each order.

All show that the only way that we can escape from the business cycle is through the establishment of sound money (i.e., a gold standard and no central bank) and the free market. If we are ever able to do so, the Austrian school of economics will deserve the credit.

Money Inflation and Price Inflation

Murray N. Rothbard

In the last few months, the Reagan administration seems to have achieved the culmination of its “economic miracle” of the last several years: while the money supply has skyrocketed upward in double digits, the consumer price index has remained virtually flat. Money cheap and abundant, stock and bond markets booming, and yet prices remaining stable: what could be better than that? Has the president, by inducing Americans to feel good and stand tall, really managed to repeal economic law? Has soft soap been able to erase the need for “root-canal” economics?

In the first place, we have heard that song before. During every boom period, statesmen, economists, and financial writers manage to find reasons for proclaiming that now, this time, we are living in a new age where old-fashioned economic law has been nullified and cast into the dust bin of history. The 1920s is a particularly instructive decade, because then we had expanding money and credit, and a stock and bond market boom, while prices remained constant. As a result, all the experts as well as the politicians announced that we were living in a brand “new era,” in which new tools available to government had eliminated inflations and depressions.

What were these marvelous new tools? As Bernard M. Baruch explained in an optimistic interview in the spring of 1929, they were (a) expanded cooperation between government and business; and (b) the Federal Reserve Act, “which gave us coordinated control of our financial resources and . . . a unified banking system.” And, as a result, the country was brimming with “self-confidence.” But, also as a result of these tools, there came 1929 and the Great Depression. Unfortunately both of these mechanisms are with us today in aggravated form. And great self confidence, which persisted in the market and among the public into 1931, didn’t help one whit when the fundamental realities took over.

But the problem is not simply history. There are very goods reasons why monetary inflation cannot bring endless prosperity. In the first place, even if there were no price inflation, monetary inflation is a bad proposition. For monetary inflation is counterfeiting, plain and simple. As in counterfeiting, the creation of new money simply diverts resources from producers, who have gotten their money honestly, to the early recipients of the new money—to the counterfeiters, and to those on whom they spend their money.

Counterfeiting is a method of taxation and redistribution—from producers to counterfeiters and to those early in the chain when counterfeiters spend their money and the money gets respent. Even if prices do not increase, this does not alleviate the coercive shift in income and wealth that takes place. As a matter of fact, some economists have interpreted price inflation as a desperate method by which the public, suffering from monetary inflation, tries to recoup its command of economic resources by raising prices at least as fast, if not faster, than the government prints new money.

Secondly, if new money is created via bank loans to business, as much of it is, the money inevitably distorts the pattern of productive investments. The fundamental insight of the “Austrian,” or Misesian, theory of the business cycle is that monetary inflation via loans to business causes overinvestment in capital goods, especially in such areas as construction, long-term investments, machine tools, and industrial commodities. On the other hand, there is a relative underinvestment in consumer goods industries. And since stock prices and real estate prices are titles to capital goods, there tends as well to be an excessive boom. It is not necessary for consumer prices to go up, and therefore to register as price inflation. And this is precisely what happened in the 1920s, fooling economists and financiers unfamiliar with Austrian analysis, and lulling them into the belief that no great crash or recession would be possible. The rest is history. So, the fact that prices have remained stable recently does not mean that we will not reap the whirlwind of recession and crash.

But why didn’t prices rise in the 1920s? Because the enormous increase in productivity and the supply of goods offset the increase of money. This offset did not, however, prevent a crash from developing, even though it did avert price inflation. Our good fortune, unfortunately, is not due to increased productivity. Productivity growth has been minimal since the 1970s, and real income and the standard of living have barely increased since that time.

The offsets to price inflation in the 1980s have been very different. At first, during the Reagan administration, a severe depression developed in 1981 and continued into 1983, of course dragging down the price inflation rate. Recovery was slow at first, and in the last few years, three special factors have held down price inflation. An enormous balance of trade deficit of $150 billion was eagerly enhanced by foreign investors in American dollars, which kept the dollar unprecedentedly high, and therefore import prices low, despite the huge deficit.

Secondly, and unusually, a flood of cash dollars stayed overseas, in hyperinflating countries of Asia and Latin America, to serve as underground money in place of the increasingly worthless domestic currency. And thirdly, the well-known collapse of the OPEC cartel at last brought down oil and petroleum product prices to free-market levels. But all of these offsets are obviously one-shot, and are rapidly coming to an end. In fact, the dollar has already declined in value, compared to foreign currencies, by about 30% since last September.

We are left with the fourth offset to price inflation, the increased willingness by the public to hold money rather than spend it, as the public has become convinced that the Reagan administration has discovered the secrets to an economic miracle in which prices will never rise again. But the public has not been deeply convinced of this, because real interest rates (interest rates in money minus the inflation rate) are at the highest level in its history. And interest rates are strongly affected by people’s expectations of future price inflation; the higher the expectation, the higher the interest rate.

We may therefore expect a resumption of price inflation before long, and, as the public begins to wake up to the humbug nature of the “economic miracle,” we may expect that inflation to accelerate.

First Step Back to Gold

Murray N. Rothbard

September 1986 is an historic month in the history of United States monetary policy. For it is the first month in over fifty years—thanks to the heroic leadership of Ron Paul during his four terms in Congress—that the United States Treasury has minted a genuine gold coin.

Gold coins were the standard money in the United States until Franklin Roosevelt repudiated the gold standard and confiscated the gold coins Americans possessed in 1933. Not only were these gold coins confiscated, under cover of the depression emergency, but possession not only of gold coins but of all gold (with the exception of designated amounts grudgingly allowed to collectors, dentists, jewelers, and industrial users) was prohibited.

During the 1970s, Congress made possession of gold by Americans legal, and now the Treasury itself acknowledges at least some monetary use by minting its own gold coins. We have come a long way, in only a decade, from total outlawry to Treasury minting.

It is true that the political motives for the new coin were not all of the purest. Some of it was a way of trying to attract the gold coin business from the South African krugerrands, which somehow have acquired a taint of apartheid by their mere production in South Africa. But the important thing is that gold is at least partially back in monetary use, and also that the public will have a chance to see, look at, and invest in gold coins.

One of the ways by which government was able to weaken the gold standard, even before 1933, was to discourage its broad circulation as coins, and to convince the public that all the gold should be safely tucked away in the banks, in the form of bullion, rather than in general use as money in the form of coins. Since Americans were not using coins directly as money by 1933, it was relatively easy for the government to confiscate their coins without raising very much of an opposition.

The new American Eagle coin is a very convenient one for possible widespread use in the future. It usefully weighs exactly one troy ounce, and the front of the coin bears the familiar Saint-Gaudens design for the goddess Liberty that had been used on American gold coins from 1907 until 1933.

But while the minting of the new American Eagle coin is an excellent first step on the road back to sound money, much more needs to be done. It is important not to rest on our laurels.

For one thing, even though gold coins are now legal, the U.S. government has never relinquished its possession of the confiscated coins, nor given it back to its rightful owners, the possessors of U.S. dollars. So it is vitally important to denationalize the U.S. gold stock by returning it to private hands.

Secondly, there is what can only be considered a grisly joke perpetrated on us by the U.S. Treasury. The one-ounce gold coin is designated, like the pre-1933 coins, as “legal tender,” but only at $50. In other words, if you owe someone $500, you can legally pay your creditor in ten one-ounce coins. But of course you would only do so if you were an idiot, since on the market gold is now worth approximately $420 an ounce. At the designated rate, who would choose to pay their creditors in $4,200 of gold to discharge a $500 debt?

The phony, artificially low gold price, is of course so designed by the U.S. Treasury so as to make sure that no one would use these gold coins as money, that is, to make payments and discharge debt. Suppose, for example, that the government designated the one-ounce coin at a bit higher than the market price, say at $500. Then, everyone would rush to exchange their dollars for gold coins, and gold would swiftly replace dollars in circulation.

All this is a pleasant fantasy, of course, but even this superior system would not solve the major problem: what to do about the Federal Reserve and the banking system.

To solve that problem, it would not be enough merely to find a way to get the gold out of the hands of the Treasury. For that gold is technically owned by the Federal Reserve Banks, although kept in trust for the Fed by the Treasury at Fort Knox and other depositories. Furthermore, the Federal Reserve has the absolute monopoly on the printing of dollars, and that monopoly would remain even if people began to trade in dollars for Treasury gold coins.

It is indeed important to denationalize gold—to get it out of Fort Knox and into the hands of the people. But it is just as, if not more, important to denationalize the dollar—that is, to tie the name “dollar” firmly and irretrievably to a fixed weight of gold. Every piece of gold at Fort Knox would be tied to the dollar, and then, and only then, the Federal Reserve System could be swiftly abolished, and the gold poured back into the hands of the public at the fixed dollar weights. To accomplish this task, those who wish to return the gold of the nation and the dollar from the government to the people will have to agree on the fixed weight.

It is best to pick the initial definition of the gold dollar at the most convenient rate. Certainly $50 an ounce of gold is not it. There are good arguments for the current market price, for higher than the current price, and for a price sufficiently high (or a dollar weight sufficiently low) so as to enable the Fed, upon liquidation, to pay off not only its own debts but also all bank demand deposits one-for-one in gold (which would require a gold price of approximately $1,600 per ounce). But within those parameters, it almost doesn’t matter what price is chosen, so long as these reforms are effected as soon as possible, and the country returns to sound money.

Sound Money: Gold or Denationalized?

Llewellyn H. Rockwell, Jr.

Hard-money advocates in American politics, from Thomas Jefferson to Ron Paul, have always favored a specie standard: that is, the dollar defined as a weight of precious metal.

In Austrian economics, the tradition has been the same. Carl Menger and Eugen von Böhm-Bawerk advocated a gold standard as politicians and as professors. (They were both cabinet ministers as well as scholars.) Ludwig von Mises, the greatest exponent of the Austrian school, was the first fully to apply Austrian theory to money. He too advocated a gold standard as well as the abolition of central banking and the establishment of 100%-reserve, non-inflationary free banking.

Building on Menger, Mises showed—in his famous regression theorem—that money must originate on the market as a useful commodity. The most liquid (i.e., the most readily acceptable) commodity becomes money. From the dawn of civilization, this has been gold, with silver playing a useful subsidiary role.

But, like many other truths, this idea is unpopular in mainstream economics, where fiat-paper money, central banking, commercial bank privilege, and inflation are considered scientific. In response to this, there is growing popularity for a monetary theory that threatens neither the academic nor the banking establishment.

That theory (and the resulting policy prescriptions) has four parts: 1) Forget gold. Keynes called it a “barbarous relic,” and so it is; 2) Ignore the Federal Reserve. It can be circumvented, and besides, it may even be a “market institution” (huh?); 3) Criticize legal-tender laws as the central problem; 4) Encourage banks to issue their own unbacked paper money, which would then outcompete the Fed’s dollars.

Point one is answered by theory and history, as shown by Mises. Point two: the Federal Reserve was created and is sustained by the government’s police power. It is perhaps the most anti-market institution in America, as well as the Politburo of our monetary enemy. Its predecessor was called the “Monster” by Andrew Jackson, and that is still a good name for this unconstitutional giant of state control and banking privilege.

Point three is irrelevant and a policy dead-end. Legal-tender laws, which require us to accept Federal Reserve Notes, are unconstitutional restraints on our freedom and should be repealed. But as Murray N. Rothbard has shown, this is not enough to allow private, non-dollar competitors to succeed. Mises’s regression theorem proves that people, having used the dollar for two centuries, will not switch to Chase Manhattan “Rockies” (or whatever the banks’ currencies would be called). Even at the height of the great German or Chinese inflations, with monetary depreciation in thousands of percent, people still clung to marks and yen.

These currencies, like the dollar, the pound, and the franc, originated on the market as useful commodities, and were then nationalized by government. Only monies that originate on the market as useful commodities can win acceptance. That’s why #4 is, as Professor Rothbard points out, an entrepreneurial scheme masquerading as theory, although he is happy to allow the market to decide its fate.

Only the denationalization of the dollar, not money generically, will end the tyranny of inflation and the business cycle, and of the transfers of wealth from the working and middle classes to the government-connected rich that go with them.

That means fixing the dollar permanently as a weight of gold: probably about 1/2,000 of an ounce, which would back the entire money supply with the gold held by the U.S. government, and the U.S. gold held by the International Monetary Fund. This gold would then be disgorged to the American people in return for their notes and deposits. Just as important, the central bank would be abolished, and banks required to adhere to the same standards of non-fraudulent behavior as other businesses. They would get no government license to inflate.

This is a very long-run cause, of course, and it is criticized as unrealistic by the would-be mainstreamers. But it is their strategy that is actually impractical.

Great change must originate in the world of ideas. But we will never bring about a monetary revolution without mobilizing the people. And great popular movements cannot be built on repealing legal tender. Gold and anti-central banking, as our own history shows, are mobilizing issues. They also have the not-inconsiderable virtue of being true.

When we do establish sound money, and gold coins circulate, Morgan Guaranty will be free to print up its irredeemable “Trilats.” Just don’t ask me to accept them.

Alan Greenspan: A Minority Report on the New Fed Chairman

Murray N. Rothbard

The press is resounding with acclaim for the accession to Power of Alan Greenspan as chairman of the Fed; economists from right, left, and center weigh in with hosannas for Alan’s greatness, acumen, and unparalleled insights into the “numbers.” The only reservation seems to be that Alan might not enjoy the enormous power and reverence accorded to his predecessor, for he does not have the height of a basketball player, is not bald, and does not smoke imposing cigars.

The astute observer might feel that anyone accorded such unanimous applause from the Establishment couldn’t be all good, and in this case he would be right on the mark. I knew Alan thirty years ago, and have followed his career with interest ever since.

I found particularly remarkable the recent statements in the press that Greenspan’s economic consulting firm of Townsend-Greenspan might go under, because it turns out that what the firm really sells is not its econometric forecasting models, or its famous numbers, but Greenspan himself, and his gift for saying absolutely nothing at great length and in rococo syntax with no clearcut position of any kind.

As to his eminence as a forecaster, he ruefully admitted that a pension-fund managing firm he founded a few years ago just folded for lack of ability to apply the forecasting where it counted: when investment funds were on the line.

Greenspan’s real qualification is that he can be trusted never to rock the Establishment’s boat. He has long positioned himself in the very middle of the economic spectrum. He is, like most other long-time Republican economists, a conservative Keynesian, which in these days is almost indistinguishable from the liberal Keynesians in the Democratic camp. In fact, his views are virtually the same as Paul Volcker, also a conservative Keynesian. Which means that he wants moderate deficits and tax increases, and will loudly worry about inflation as he pours on increases in the money supply.

There is one thing, however, that makes Greenspan unique, and that sets him off from his Establishment buddies. And that is that he is a follower of Ayn Rand, and therefore “philosophically” believes in laissez-faire and even the gold standard. But as the New York Times and other important media hastened to assure us, Alan only believes in laissez-faire “on the high philosophical level.” In practice, in the policies he advocates, he is a centrist like everyone else because he is a “pragmatist.”

As an alleged “laissez-faire pragmatist,” at no time in his prominent twenty-year career in politics has he ever advocated anything that even remotely smacks of laissez-faire, or even any approach toward it. For Greenspan, laissez-faire is not a lodestar, a standard, and a guide by which to set one’s course; instead, it is simply a curiosity kept in the closet, totally divorced from his concrete policy conclusions.

Thus, Greenspan is only in favor of the gold standard if all conditions are right: if the budget is balanced, trade is free, inflation is licked, everyone has the right philosophy, etc. In the same way, he might say he only favors free trade if all conditions are right: if the budget is balanced, unions are weak, we have a gold standard, the right philosophy, etc. In short, never are one’s “high philosophical principles” applied to one’s actions. It becomes almost piquant for the Establishment to have this man in its camp.

Over the years, Greenspan has, for example, supported President Ford’s imbecilic Whip Inflation Now buttons when he was Chairman of the Council of Economic Advisers. Much worse is the fact that this “high philosophic” adherent of laissez-faire saved the racketeering Social Security program in 1982, just when the general public began to realize that the program was bankrupt and there was a good chance of finally slaughtering this great sacred cow of American politics. Greenspan stepped in as head of a “bipartisan” (i.e. conservative and liberal centrists) Social Security Commission, and “saved” the system from bankruptcy by slapping on higher Social Security taxes.

Alan is a long-time member of the famed Trilateral Commission, the Rockefeller-dominated pinnacle of the financial-political power elite in this country. And as he assumes his post as head of the Fed, he leaves his honored place on the board of directors of J. P. Morgan & Co. and Morgan Guaranty Trust. Yes, the Establishment has good reason to sleep soundly with Greenspan at our monetary helm. And as icing on the cake, they know that Greenspan’s “philosophical” Randianism will undoubtedly fool many free market advocates into thinking that a champion of their cause now perches high in the seats of power.

Fiat Paper Money: Tyranny’s Credit Card

J. Tucker Alford

In the 20th century, the American dollar has a grim history. It has only about 9% of its 1913 value, because Federal Reserve inflation has caused consumer prices to increase more than eleven-fold.

During the same time, the power of the central bank has increased enormously, as has the presence of the federal government in the economy. Compared to the previous 113 years, the difference is startling. Then, prices generally fell, and prosperity was always on the rise.

The crucial difference between then and now is the quality of the dollar. Today’s dollar is created out of thin air by the U.S. government, and there is virtually no restraint on the Federal Reserve’s power. But when there is no Fed and money is a real commodity like gold, as during the 19th century, money is more likely to maintain its quality and purchasing power.

Money has not always been in the claws of the government. In fact, as Carl Menger theorized, money very likely came about through the process of the market. Ludwig von Mises went even further and proved that the free market was the only place money could develop. Government coercion never has and never will be able to impose a new institution of money on the economy.

Even so, money has been the victim of brutal attacks by the government. In the Middle Ages, monarchs found that raising taxes was a risky way to raise revenue. It often provoked violent revolution, and kings didn’t relish the risk of meeting the executioner’s ax. Instead, they found a discreet and underhanded way to extract wealth from the public: debasement of coinage. The king would call in coins for reissue, melt them down, and redistribute them with slightly less gold content, but with the same face value. The “excess” gold would pay off the kings debts, and while the value of the circulating coins would drop, the public outcry was limited.

Paper money first came into use to save the cost of physically transporting bullion. People felt uncomfortable carrying around large quantities of gold. They placed their gold with a goldsmith, and he issued a paper receipt for the deposit, guaranteeing the bearer payment of the gold on demand. The depositor could then use his receipt for the purchase of goods and services. Goldsmiths, soon called banks, began redeeming one another’s gold receipts, and paper receipts became accepted as substitutes for money.

The goldsmiths, however, quickly recognized an opportunity to make more profits. They began printing up phony gold receipts and spending them for their own use. They could even lend them out and charge interest, knowing all depositors wouldn’t call for redemption at once. This counterfeiting is today hailed as the basis of our banking system: fractional reserve banking.

Always hanging over the head of the banker-goldsmith, however, was the threat that too many of his depositors would redeem their notes for gold on the same day. His bank, like all modern banks, was inherently broke, but its bankruptcy became apparent only in the event of a bank run. If he couldn’t meet his depositors’ demands, he would likely be hanged.

Governments, of course, found paper money to their liking. In the New World, paper money was first used in Massachusetts in 1690. After several failed pillaging expeditions into Canada, the colonial government issued irredeemable paper to pay the troops. Back then, no one would accept a simple piece of paper in exchange for real goods, so the government had to promise to redeem in specie at a certain date in the future. It also promised that there would be only one such issue. But the government’s promise was as thin as its paper, and many more such issues followed when the government found itself short on money.

The people of colonial America learned to distrust paper money. During the Revolutionary War, Congress issued paper notes called Continentals, which were not backed in gold. They were issued in great quantities, and thus depreciated until they were worth next to nothing. People knew the true cause of the depreciation of the Continental. It wasn’t aliens, speculators, slackers, hoarders, or jobbers. It was the government defrauding the people with its printing presses. That’s why they wrote gold and silver into the Constitution.

Today, however, the banking and central banking system is so complex that few know why the dollar continues to lose value. The Fed doesn’t help much with its confusing array of money stock and liquid asset definitions (Ms). Much better is Professor Murray N. Rothbard’s True Money Supply (TMS). It combines selected components of the different Ms according to Austrian theory, and provides a more accurate accounting of the total outstanding medium of exchange at any given time.

The first step in the establishment of a 100% gold standard money must be to define the U.S. dollar as a weight of gold, with 100% redeemability insured. The dollar was once 1/20 an ounce of gold. It was then devalued to 1/35 an ounce of gold. What would it be now if the dollar were again tied to gold? To approximate the answer we only need to know the government’s gold stock, the current money supply, and some simple mathematics.

Using the Federal Reserve’s M1 as money (cash, checking accounts, and travelers checks), the dollar would be defined as 1/2837 of an ounce gold. This would value the government’s gold stock at $749.3 billion and enable all of Ml to be back by gold at 100%.

Using Rothbard’s broader definition of money, TMS, the most recent figures show the dollar would be defined as 1/7340 an ounce of gold. (Just think what the Fed has done: the pre-1934 dollar was 1/20 ounce!) This would allow the government’s gold to cover all of TMS. The Federal Reserve’s assets could then be sold, and the whole ugly system dismantled.

Though there are few dedicated individuals who remain champions of hard, honest money, the mainstream lambastes the gold standard advocates as archaic, reactionary, anachronistic, loony, and Neanderthal.

The record speaks for itself. Even under an imperfect gold standard, from the end of the American Civil War to World War I, the world experienced unprecedented prosperity and improvement in living standards. Since the “Progressives” destroyed the dollar in 1913, there has been worldwide inflation, the impoverishment of the developing world, the decline of Western prosperity, and a rise of totalitarianism, both right and left. It is anti-gold statists who are pointing us toward the despotism and barbarism of a new Neanderthal era.

Hard money is free money, and it goes hand in hand with liberty and democracy. Fiat paper money is tyranny’s credit card. One can only hope that circumstances need not get worse before they get better. Perhaps someday our nine-cent paper ticket will give way to a genuine, honest gold dollar.

Back to Fixed Exchange Rates: Another “New Economic Order”

Murray N. Rothbard

Hold on to your hats: the world has now embarked on yet another “new economic order”—which means another disaster in the making. Ever since the abandonment of the “classical” gold coin standard in World War I [by the United States in 1933], world authorities have been searching for a way to replace the peaceful world rule of gold by the coordinated, coercive rule of the world’s governments.

They have searched for a way to replace the sound money of gold by an internationally coordinated inflation which would provide cheap money, abundant increases in the money supply, increasing government expenditures, and prices that do not rise too wildly or too far out of control, and with no embarrassing monetary crises or excessive declines in any one country’s currency. In short, governments have tried to square the circle, or, to have their pleasant inflationary cake without “eating” it by suffering decidedly unpleasant consequences.

The first new economic order of the 20th century was the New Era dominated by Great Britain, in which the world’s countries were induced to ground their currencies on a phony gold standard, actually based on the British pound sterling, which was in turn loosely based on the dollar and gold. When this recipe for internationally coordinated inflation collapsed and helped create the Great Depression of the 1930s, a new and very similar international order was constructed at Bretton Woods in 1944. In this case, another phony gold standard was created, this time with all currencies based on the U.S. dollar, in turn supposedly redeemable, not in gold coin to the public, but in gold bullion to foreign central banks and governments at $35 an ounce.

In the late 1920s, governments of the various nations could inflate their currencies by pyramiding on top of an inflating pound; similarly in the Bretton Woods system, the U.S. exported its own inflation by encouraging other countries to inflate on top of their expanding accumulation of dollar reserves. As world currencies, and especially the dollar, kept inflating, it became evident that gold was undervalued and dollars overvalued at the old $35 par, so that Western European countries, reluctant to continue inflationary policies, began to demand gold for their accumulated dollars [in short, Gresham’s Law, that money overvalued by the government will drive undervalued money out of circulation, came into effect]. Since the U.S. was not able to redeem its gold obligations, President Nixon went off the Bretton Woods standard, which had come to its inevitable demise in 1971.

Since that date, or rather since 1933, the world has had a fluctuating fiat standard, that is, exchange rates of currencies have fluctuated in accordance with supply and demand on the market. There are grave problems with fluctuating exchange rates, largely because of the abandonment of one world money [i.e. gold] and the shift to international barter. Because there is no world money, every nation is free to inflate its own currency at will—and hence to suffer a decline in its exchange rates. And because there is no longer a world money, fluctuating uncertain exchange rates create a double uncertainty on top of the usual price system—creating, in effect, multi-price systems in the world. The inflation and volatility under the fluctuating exchange rate regime has caused politicians and economists to try to resurrect a system of fixed exchange rates—but this time, without even the element of the gold standard that marked the Bretton Woods era. But without a world gold money, this means that nations are fixing exchange rates arbitrarily, without reference to supply and demand, and on the alleged superior wisdom of economists and politicians as to what exchange rates should be.

Politicians are pressured by conflicting import and export interests, and economists have made the grave error of mistaking a long-run tendency (of exchange rates on a fluctuating market to rest at the proportion of purchasing-powers of the various currencies) for a criterion by which economists can correct the market. This attempt to place economists above the market overlooks the fact that the market properly sets exchange rates on the basis, not only of purchasing power proportions, but also expectations of the future, differences in interest rates, differences in tax policy, fears of future inflation of confiscation, etc. Once again, the market proves wiser than economists.

This new coordinated attempt to fix exchange rates began two years ago in a hysterical reaction against the high dollar. The Group of Seven nations [the U.S., Britain, France, Italy, West Germany, Japan, and Canada] helped drive down the value of the dollar, and then, in their wisdom, in February 1987, decided that the dollar was now somehow at a perfect rate, and coordinated their efforts to keep the dollar from falling further.

In reality, the dollar was high until early 1986 because foreigners had been unusually willing to invest in dollars—government bonds as well as others assets. While this happy situation continued, they were willing to finance Americans in buying cheap imports. After early 1987, this unusual willingness disappeared, and the dollar began to fall in order to equilibrate the U.S. balance of payments. Artificially propping up the dollar in 1987 has led the other countries of the Group of Seven to purchase billions of dollars with their own currencies—a short-sighted effort which cannot last forever, especially because West Germany and Japan have fortunately not been willing to inflate their own currencies and lower their interest rates further, to divert capital from themselves toward the U.S.

Instead of realizing that this coordination game is headed toward inevitable crisis and collapse, Secretary of Treasury James Baker, the creator of the new system, proposes to press ahead to a more formal New Order. In his September speech to the IMF and World Bank, Secretary Baker proposed a formal, coordinated regime of fixed exchange rates, in which—as a sop to public sentiment for gold—gold is to have an extremely shadowy, almost absurd, role. In the course of fine tuning the world economy, the central banks and treasuries of the world, in addition to looking at various “indicators” on their control panels—price levels, interest rates, GNP, unemployment rates, etc.—will also be consulting a new commodity price index of their own making which, by secret formula, would also include gold.

Such a ludicrous substitute for genuine gold money will certainly fool no one, and is an almost laughable example of the love of central bankers and treasury officials for secrecy and mystification for its own sake, so as to bewilder and bamboozle the public. I do not often agree with J. K. Galbraith, but he is certainly on the mark when he calls this new secret index a “marvelous exercise in fantasy and obfuscation.”

Politically, the secret index embodies a new ruling alliance within the Reagan Administration between such conservative Keynesians as Secretary Baker and such supply-siders as Professor Robert Mundell and Congressman Jack Kemp (who have both hailed the scheme as a glorious step in the right direction). The supply-siders have long desired the restoration of a Bretton Woods-type system that would allow coordinated world cheap money and inflation, coupled with a phony gold standard as camouflage, so as to build unjustified confidence in the new scheme among the pro-gold public.

The conservative Keynesians have long desired a new Bretton Woods, based eventually on a new world paper unit issued by a World Central Bank. Hence the new alliance. The alliance was made politically possible by the disappearance from the Reagan Administration of the Friedmanite monetarists, such as former Undersecretary of Treasury for Monetary Policy Beryl W. Sprinkel and Jerry Jordan, spokesmen for fluctuating exchange rates. With monetarism discredited by the repeated failures of their monetary predictions over the last several years, the route was cleared for a new international fixed rates system.

Unfortunately, the only thing worse than fluctuating exchange rates is fixed exchange rates based on fiat money and international coordination. Before rates were allowed to fluctuate, and after the end of Bretton Woods, the U.S. government tried such an order, in the international Smithsonian Agreement of December 1971. President Nixon hailed this agreement as “the greatest monetary agreement in the history of the world.” This exercise in international coordination lasted no more than a year and a half, foundering on monetary crises brought about by Gresham’s Law and overvaluation of the dollar.

How long will it take this new, New Order, along with its puerile secret index, to collapse as well?

Monetary Crises

Llewellyn H. Rockwell, Jr.

Since the 1690s, America has undergone more than 20 monetary crises. Some have led to genuine reform, others to increased government power.

The fitful fiat-money inflation of the colonial governments had its culmination in the much worse inflation engineered by the continental Congress. “Why should we consent to load our constituents with taxes,” said one Member, “when we can send to the printer for a whole wagonload of money, and pay for it with but one quire’s worth?”

The Americans managed to win the Revolution, despite the Congress, but the inflationary burden fell heaviest on the patriots. The Tories, Pelatia Webster reports, refused to have anything to do with the new money, and would accept only gold and silver. But many of those fighting for American freedom and independence accepted the Continental paper currency. As a result, they were wiped out when the Continental fell, because of the printing press, to one tenth of one percent of its original value. Webster, probably America’s first economist, said the whole experience was summed up for him by the sight of a drunken sailor dressed in a suit made entirely of Continental money.

But the debacle of government fiat money led, not to authoritarianism as is usually the case, but to restrictions on state power and the establishment of the classical gold standard. The American gold standard was never perfect. The government and its attendant banking interests were still able to manipulate it, which led to recurrent crises, but the damage was always limited. Until the establishment of the Federal Reserve System in 1913.

The Fed’s bank credit inflation of the 1920s led directly, in the Austrian business cycle, to the Great Depression, which gave Franklin D. Roosevelt the excuse to violate the Constitution and end the domestic gold standard. The international gold standard was killed by Richard Nixon on August 15, 1971, when he also imposed price and wage controls.

We’ve seen prices go up more than 350% since that day, with the inevitable busts. Since the depression of 1981-82, the Fed has increased the money supply by more than 100%. We saw the effects, as in the 1920s, in stock market and other booms. Since the crash of October, the media keep nervously asking if we’re facing a recession. The answer is, of course, yes. That was made inevitable by the inflation of 82-87. The question is what we do with it.

The government, as in previous crises, will try to use the coming troubles as an excuse for more of the poison that caused the troubles to begin with. But the climate of ideas really has changed.

Americans are much more suspicious of politicians and their nostrums than they were in the 1930s. There are signs that today, as in the 19th century, money can again become a political issue.

Thanks to Ron Paul and others, tens of millions of Americans own gold today, and know that its value is independent of government. Many know about, and approve of, the idea of a gold standard. In the academic world, thanks to Murray N. Rothbard and others, the intellectual case for the gold standard is being made with a logical brilliance unseen since the glory days of hard money, and it is buttressed as well with Ludwig von Mises’s Austrian business cycle theory, which shows the hidden damage wrought by inflation.

For those of us who believe an individual liberty and sound money, these are days of opportunity. There is chance for real reform. If we grasp it.

The Real Secrets of the Temple

Llewellyn H. Rockwell, Jr.

The Federal Reserve—the U.S. government’s central bank—was schemed at a secret meeting in 1910 at J. P. Morgan’s hunting club on Jekyll Island, Georgia.

The participants—who claimed, as they boarded a private railroad car in New York City, to be going on a hunting trip—were, in addition to Morgan himself: Senator Nelson W. Aldrich (R-RI), John D. Rockefeller’s son-in-law; A. Piatt Andrew, Assistant Secretary of the Treasury in the Taft administration; Henry P. Davison, the “political partner” (i.e., lobbyist) for J. P. Morgan’s banking house; Paul Warburg of Kuhn Loeb & Co., a German political partner brought to the U.S. specifically to help establish a central bank; and Frank A. Vanderlip of New York’s National City Bank (today’s Citibank).

Three years later the U.S. had a central bank, after a propaganda campaign using the Big Lie. Americans were told that major bankers—whom they heartily distrusted—were opposed to the Fed. In fact, the Fed was set up to cartelize the banking industry, doing for it what the ICC had done for big railroads and the FTC for other big businesses. Before 1913, market forces prevented any one bank or group of banks from expanding the money supply too egrediously. The Fed changed all that by enabling big banks to inflate together while protecting them from competition.

In its origins and its operations, the Federal Reserve is the most secretive of American political institutions. After his briefings before the first presidential debate with Ronald Reagan in 1984, Walter Mondale exclaimed to his campaign manager: “For the first time I understand the Federal Reserve!”

Like Mondale, a U.S. senator for many years and then vice president, we are told almost nothing about what the Fed does and why. All we hear—from political leaders, bankers, pundits, and kept economists—is that it ensures prosperity and prevents depressions, that its officials know exactly what they’re doing, and that no one in his right mind could possibly question its existence.

Like virtually all of the official line, this is the reverse of the truth.

William Greider—one of America’s best political reporters—set out to examine all of this in Secrets of the Temple: How the Federal Reserve Runs the Country (Simon and Schuster, 1987). But the man who has exposed the charades of government in so many other areas does not do a similar job on the government’s great inflation machine.

To his credit, Greider has changed the way journalists think about the Fed. Even his old paper, the Washington Post, no longer automatically defers to the central bank, where once it ran its pronouncements as fact. Also to his credit, Greider has angered financiers and bankers by telling the truth: that the Fed is the most powerful policy-making institution in America and maybe the world. (Those who profit from what Andrew Jackson used to call the Monster prefer to continue operating in the dark.)

Greider criticizes the Fed, but for all the wrong reasons. For example, he claims it isn’t inflationary enough! And he calls for high, sustained inflation to create prosperity and justice. Inflation will resolve the eternal conflict between the rich and the poor, says Greider, in favor of the poor.

There is a seemingly eternal conflict, but it’s between those who use the government to get rich, and the rest of us who are thereby made poorer.

In his chapter on the founding of the Fed, Greider mentions the idea of the Fed as cartel, but he never brings it up again. His own position is that the Fed came about through popular demand, stimulated by political movements for higher farm prices and an end to bank panics. In fact, these groups provided only a political opportunity and an ideological excuse for the Morgan-Rockefeller forces—in cahoots with the politicians—to seize control of the dollar by establishing the Fed.

Greider claims that deflation, not inflation, benefits bankers, and says that the Fed seeks to promote “the virtual elimination of dollar inflation.” But the central bank was established only to circumvent the strictures of the gold standard. That is, it was founded to inflate.

The constituents of Fed Chairman Alan Greenspan are commercial bankers and the government, not depositors or citizens, and the Fed’s actions are primarily motivated by the interests of Washington and the big money-center banks.

Inflation benefits the Fed and its constituents as counterfeiting benefits a counterfeiter and his gang. The private counterfeiter, however, is a relatively minor criminal; the Fed does exactly what the counterfeiter does, but massively and on a world-wide scale. As in so many other areas, what is (rightly) condemned in the private sector is lauded in the public.

Greider calls inflation “a promising model for social equity.” “Many poor people” benefit since they don’t have to bear the rising costs of medical care and housing with “Medicaid and public housing.” Similarly, the “elderly” are “partially protected” from inflation because Social Security is “indexed to the inflation rate.”

The government, politicians, bureaucrats, banks, government contractors, and other interests profit, since they get the new money first, and can spend it before prices go up, thereby transferring wealth to themselves from the people who get it last.

Average taxpayers are harmed in at least five ways: first, since they receive new Fed money last, they can spend it only after prices have gone up; second, they pay a hidden tax of currency debasement on their dollar-denominated savings; third, they pay a direct tax for the salaries and perks of the bureaucrats, politicians, and welfare recipients whose incomes are indexed to inflation; fourth, they suffer the consequences of inflation-caused recessions and depressions; and five, they lose some of their liberty, since inflation strengthens the government at the expense of individual freedom.

The poor, despite Greider, are harmed especially. The inflation-fueled growth of government creates more hungry and homeless by decreasing general prosperity and opportunity. Then, only the smart, well-educated, and healthy can get ahead. Those most in need of a charitable helping hand are instead kicked in the teeth by Washington, D.C.

Inflation also increases the costs to the poor of becoming independent from the dole. However, like so many negatives for the people, this is a benefit for the government. By enlarging the dependent class, inflation justifies even more “poverty” programs actually designed to benefit bureaucrats, social workers, Medicaid doctors, D.C. consultants, public housing builders, etc.: the whole welfare industry.

Inflation, by illegitimately transferring wealth to the government-connected, also helps cement present social stratifications in place. The bigger government is, the fewer Horatio Algers there are. People who get to the top through force and fraud prefer it that way.

Inflation can help debtors (by stealing from savers)—one of its great advantages, according to Greider—but it mainly aids the greatest debtor of them all, big government, which is always and everywhere the enemy of the poor.

Then there is the business cycle, which even a little inflation will cause. In the free market, interest rates are determined by consumer preferences for savings over consumption. In the days of a real U.S. gold standard, this meant that corporations could issue 30-year bonds paying 3%.

The Austrian theory of the business cycle, developed by Ludwig von Mises, shows that when the Fed artificially lowers interest rates by injecting credit into the banking system, it gives businessmen the same signal as if people decided to save more of their incomes. In response, companies invest in processes to produce goods for later purchase by consumers with their larger savings.

But when businessmen seek to market these goods, they find the demand isn’t there. Consumers haven’t saved enough, and the investments were what Mises called “malinvestments”—those unjustified by real economic conditions. The result is a bust.

Any amount of new Fed money and credit will lead to these malinvestments, despite the claim of Greider (and of Milton Friedman) that recessions only occur when the Fed steps on the brakes. The monetarist notion of increasing the money supply every year by 3-5% “to keep up with GNP” is damaging for this very reason. Only zero inflation will do.

By the way, despite Friedman, there is nothing wrong with the Fed’s stopping the flow of money and credit to end the boom, as happened in 1929. The wrong was the inflation that took place during the 1920s, and the Hoover-Roosevelt policies that prevented a recovery for over a decade. The original culprit, of course, was the existence of an institution able to cause all this trouble.

Greider hates deflation, but it is the natural, healthy condition of the market. With the money supply relatively stable under a gold standard and the production of goods and services increasing, the dollar buys more. Prices gently fall (imagine the VCR situation extended to the whole market) and real wages increase. That’s what happened to our country in the 19th century, and it brought about the greatest economic growth in history.

Greider, good journalist that he is, does provide compelling accounts of the Fed’s Continental Illinois and Mexican debt bailouts, and new evidence that “Arthur Burns . . . deliberately manipulated monetary policy . . . to help re-elect his old friend Richard Nixon.” He quotes Fed Governors admitting that they consciously pursued a monetarist policy from 1979-1982 (something Friedman would like us to forget), shows how “Volcker stared down U.S. Senators and presidential advisers” during the recessions of the early 80s, and tells how the officers of Volcker’s old employer, Rockefeller’s Chase Manhattan Bank, persuaded him to loosen the money supply.

Greider criticizes the quantity theory of money as a “simple answer to bewildering complexities,” and cites money supply statistics from the 1970s and 1980s that use M-l as a base. But the “money supply” in these years can hardly be summarized by M-l because of financial deregulation (and the Fed’s propensity to keep changing its statistical bases to hide its activities). A much more accurate monetary statistic is the True Money Supply (TMS) constructed at the request of the Mises Institute by Murray Rothbard and Joseph Salerno on Austrian economic principles.

Greider does have one point, however: most economists do oversimplify the quantity theory of money. An increase in the money supply raises relative prices, but what mainstream economists call the “price level” is a fiction. As relative prices increase, different sectors of the economy are affected in different ways. Prices have risen, but far more important, the price structure has changed.

Greider rebukes Congressional Democrats for voting for the deregulation of interest rates in the Monetary Control Act of 1980. This aspect of the bill merely recognized something the market had already accomplished through money market funds. But he glosses over, or does not mention, other important provisions, which: centralized even more power in the Fed, removed all collateral from U.S. notes, enabled the Fed to reduce bank reserve requirements to zero, empowered the president to declare bank holidays, and allowed the Fed to monetize foreign debt (including nearly worthless Third World debt held by the money-center banks). Only Ron Paul, then a Congressman from Texas, understood what the bill really meant, and waged a courageous and single-handed fight against it.

The Secrets of the Temple serves an important purpose by shining a bright light on an institution for too long hidden in obfuscation and propaganda. But the real secrets of the temple are that: the Federal Reserve is an unconstitutional and illegitimate enterprise; it serves a narrow elite of bankers, government officials, and connected businessmen; it ensures prosperity for these insiders at the expense of the rest of us; it causes economic disasters; its officials are arrogant bumblers; and great statesmen and economists—from Andrew Jackson to Ron Paul, from Ludwig von Mises to Murray N. Rothbard—have wanted it or similar operations wiped from the face of the earth.

A central bank is incompatible with a free society. For the sake of our economy and our liberty, and of simple justice, we should abolish the Monster, and sow salt in the earth where it stood. In its place we need a real gold standard and non-fraudulent free banking, as Ludwig von Mises outlined, and as the Founding Fathers intended.