23. The Return to Sound Money

CHAPTER 23 THE RETURN TO SOUND MONEY

Summary

The disintegration of the worldwide classical gold standard has gone hand-in-hand with the march toward all-round central planning. The return to sound money involves a renunciation of inflation. This is only possible if the public recognizes the futility of interventionist government.

The return to sound money still means a return to the gold standard. Only under this system will the determination of the monetary unit’s purchasing power remain outside the sphere of government control. The only way to truly safeguard a nation’s money is to remove all avenues for inflation. This includes not only the government’s resorting to the printing press to finance its deficits, but also commercial banks’ ability to issue deposits not fully backed up by money proper.

For a relatively small country (“Ruritania”) the government of which has been using inflation to finance its deficits, the government must first (temporarily) prohibit the further issuance of fiduciary media denominated in “rurs.” Once the rur’s exchange rate (as well as the price of gold quoted in rurs) has clearly peaked, the government of Ruritania locks in the current market price of either a U.S. dollar or gold (quoted in rurs). An agency will be dedicated with the sole task of maintaining the rur’s redemption rate to either the dollar or gold at this rate, forever. Ruritania will be back on the gold exchange standard.

The United States government must return to the classical gold standard. An agency will be established that will buy or sell gold against dollars upon demand, at this rate. In order to provide more resistance to future inflation, the government should suppress small-denomination paper notes, which would force Americans to once again carry full-weight gold coins in their cash balances.

Only an abandonment of the interventionist mindset, coupled with a return to the classical gold standard, can safeguard the currency.

Chapter Outline

1. Monetary Policy and the Present Trend Toward All-Round Planning

The disintegration of the worldwide classical gold standard has gone hand-in-hand with the march toward all-round central planning. The trends are related. Inflation allows government officials to seize control of more resources than the public would otherwise approve. Rising prices pushes people into higher tax brackets and allows the government to tax “excess profits” from businesses. The social unrest caused by inflation can be blamed upon capitalism, giving the government yet another pretext to expand its power.

The return to sound money involves a renunciation of inflation. This is only possible if the public recognizes the futility of interventionist government.

2. The Integral Gold Standard

The only way to truly safeguard a nation’s money is to remove all avenues for inflation. This includes not only the government’s resorting to the printing press to finance its deficits, but also commercial banks’ ability to issue deposits not fully backed up by money proper. In other words, governments must spend only what they tax or borrow, and banks must be prohibited from issuing new fiduciary media.

3. Currency Reform in Ruritania

For a relatively small country the government of which has been using inflation to finance its deficits, the crucial thing is to quickly assure world investors that the currency is stabilized. There is a two-step process involved. First, the government of Ruritania must (temporarily) prohibit the further issuance of fiduciary media denominated in “rurs,” the currency of the country. This will cause the exchange rate of the rur to stop falling against other, major currencies as well as gold.

Once the rur’s exchange rate (as well as the price of gold quoted in rurs) has clearly peaked, and begun a definite downward trend, it is time for step two. In this stage, the government of Ruritania locks in the current market price of either a U.S. dollar or gold (quoted in rurs). An agency will be dedicated with the sole task of maintaining the rur’s redemption rate to either the dollar or gold at this rate, forever. If people turn in dollars or gold (depending on the choice of the link), the agency is allowed to issue new rurs, which are backed up 100 percent by the new deposit. At this point, the rur will be back on either a dollar- or gold-exchange standard, and no new fiduciary media can be issued.

4. The United States’ Return to a Sound Currency

The United States government must return to the classical gold standard, which offered a stronger check on inflation than the gold-exchange standard. It must first prohibit the issuance of new dollars, whether in the form of Treasury notes or bank balances not backed up 100 percent by cash deposits. After the dollar-price of gold stabilizes, the U.S. government will announce the current market price as the new, permanent exchange rate between the U.S. dollar and gold. (The new price might very well be higher than the official rate of $35 per ounce, established in the Bretton Woods agreement near the end of World War II, and lasting until Richard Nixon abolished the last remnants of the gold standard in 1971.)

An agency will be established that will buy or sell gold against dollars upon demand, at this rate. In order to provide more resistance to future inflation, the government should suppress small-denomination paper notes, which would force Americans to once again carry full-weight gold coins in their cash balances.

5. The Controversy Concerning the Choice of the New Gold Parity

Within the ranks of those advocating a return of the U.S. to the gold standard, there is controversy over the appropriate exchange rate. The restorers want to go back on gold at the rate of $35 per ounce, which was established in the 1934 Gold Reserve Act (and was the gold price used in the Bretton Woods system). The stabilizers want to free the market to hold and use gold, then set the dollar to the new price of gold that will be established in the market, even if it happens to be more than $35 per ounce.

The arguments of the restorers are inconsistent. There is nothing “honest” about going back to $35 per ounce. A much stronger case could be made that the pre-1933 price of $20.67 per ounce of gold was the true parity, which Roosevelt then dishonored as one of his first acts in office. Furthermore, the people who were harmed by the prior inflation would not necessarily be the same ones to benefit from a current bout of deflation. For example, it is true that a bond originally issued in (say) 1928, promising to pay $1,000 per year for fifty years, would have had its “real” market value sabotaged when FDR devalued the dollar. Yet if the original purchaser of the bond sold it in (say) 1950, then the new owner has already taken into account the new inflationary regime. The full capital loss has already been absorbed by the original owner. At this point, to raise the purchasing power of the dollar by restoring gold to its former parity, would be to present a gift to the new owner of the bond.

The other major flaw with the restorers’ viewpoint is that inflation is harmful not merely because it affects deferred payments. Money is not neutral, and an intentional deflation will have undesirable consequences that will occur in addition to—rather than undoing—the earlier consequences of the inflation.

Concluding Remarks

The public and most intellectuals lament the consequences of inflation, yet they support those policies (government deficit spending and low interest rates) that require inflation. Only an abandonment of the interventionist mindset, coupled with a return to the classical gold standard, can safeguard the currency.

Technical Notes

• On pages 439–40, Mises laments that even many supporters of sound money do not recognize the danger in bank credit expansion when undertaken to support business (as opposed to financing government deficits). Yet the circulation credit theory of the trade cycle (developed in part III, chapter v) shows the weakness in this thinking. That is why Mises here advocates a complete prohibition on the issuance of new fiduciary media, since he believes it is the only sure way to avoid future crises that will inevitably discredit capitalism. (Note that Mises’s suggested reforms would not transform the banking system into a 100-percent-reserve arrangement, because the previously issued fiduciary media would still exist.)

• Although they are similar, Mises’s proposals (in sections 3 and 4) for currency reform in the generic small country “Ruritania” versus the United States are different. Mises wants to quickly stop the rapidly depreciating currency of Ruritania, the government of which has been monetizing its deficits. Mises is content to stop the downward spiral by restoring Ruritania to either a dollar- or a gold-exchange standard. (Recall that the dollar itself was still tied to gold at the official rate of $35 per ounce when Mises wrote these proposals.) For the United States, Mises wants to stop the further issuance of fiduciary media—in order to arrest the boom-bust cycle—and to restore the classical gold standard. This latter objective explains Mises’s proposal for abolishing paper notes in denominations of $5, $10, and perhaps $20, so that the public would carry full-weight gold coins (stamped with $5, $10, etc.) for these transactions.

New Terminology

Restorers: Those who want a country to return to a gold standard at a historic parity, a move that would require deflation.

Stabilizers: Those who want a country to return to a gold standard by locking in the current market price of gold.

Monetizing government deficits: Covering the difference between government expenditures versus tax receipts and loans from private lenders, by resort to the printing press.

Study Questions

1. Explain: “While advocating high prices and wage rates as a panacea and praising the Administration for having raised ‘national income’ ... to an unprecedented height, they blamed private enterprise for charging outrageous prices and profiteering.” (p. 437)

*2. Mises writes (pp. 437–38) that allegedly progressive governments will not abandon their “most formidable weapon, inflation.” Yet isn’t this a version of the critique of the gold standard (pp. 420–21) that said modern governments were no longer willing to follow the rules of the gold-standard game?

3. In what consists the “eminence of the gold standard”? (p. 438)

4. Why does Mises (humorously) pick the name “John Badman” for the Ruritanian in one of his thought experiments? (p. 446)

5. What is the “incurable defect” of the gold-exchange standard (as opposed to the classical gold standard)? (p. 451)

Study Guide to the Theory of Money and Credit