Gold and Economic Freedom

by Alan Greenspan
[written in 1966]

(this is an excerpt from the paper written)

,...

"In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value. If there were, the government would have to make its holding illegal, as was done in the case of gold. If everyone decided, for example, to convert all his bank deposits to silver or copper or any other good, and thereafter declined to accept checks as payment for goods, bank deposits would lose their purchasing power and government-created bank credit would be worthless as a claim on goods. The financial policy of the welfare state requires that there be no way for the owners of wealth to protect themselves.

This is the shabby secret of the welfare statists’ tirades against gold. Deficit spending is simply a scheme for the confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights. If one grasps this, one has no difficulty in understanding the statists’ antagonism toward the gold standard."

~ Alan Greenspan

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(this is the entire paper for your reference)

Gold and Economic Freedom

by Alan Greenspan
[written in 1966]

This article originally appeared in a newsletter: The Objectivist published in 1966 and was reprinted in Ayn Rand’s Capitalism: The Unknown Ideal.

An almost hysterical antagonism toward the gold standard is one issue which unites statists of all persuasions. They seem to sense - perhaps more clearly and subtly than many consistent defenders of laissez-faire - that gold and economic freedom are inseparable, that the gold standard is an instrument of laissez-faire and that each implies and requires the other.

In order to understand the source of their antagonism, it is necessary first to understand the specific role of gold in a free society.

Money is the common denominator of all economic transactions. It is that commodity which serves as a medium of exchange, is universally acceptable to all participants in an exchange economy as payment for their goods or services, and can, therefore, be used as a standard of market value and as a store of value, i.e., as a means of saving.

The existence of such a commodity is a precondition of a division of labor economy. If men did not have some commodity of objective value which was generally acceptable as money, they would have to resort to primitive barter or be forced to live on self-sufficient farms and forgo the inestimable advantages of specialization. If men had no means to store value, i.e., to save, neither long-range planning nor exchange would be possible.

What medium of exchange will be acceptable to all participants in an economy is not determined arbitrarily. First, the medium of exchange should be durable. In a primitive society of meager wealth, wheat might be sufficiently durable to serve as a medium, since all exchanges would occur only during and immediately after the harvest, leaving no value-surplus to store. But where store-of-value considerations are important, as they are in richer, more civilized societies, the medium of exchange must be a durable commodity, usually a metal. A metal is generally chosen because it is homogeneous and divisible: every unit is the same as every other and it can be blended or formed in any quantity. Precious jewels, for example, are neither homogeneous nor divisible. More important, the commodity chosen as a medium must be a luxury. Human desires for luxuries are unlimited and, therefore, luxury goods are always in demand and will always be acceptable. Wheat is a luxury in underfed civilizations, but not in a prosperous society. Cigarettes ordinarily would not serve as money, but they did in post-World War II Europe where they were considered a luxury. The term “luxury good” implies scarcity and high unit value. Having a high unit value, such a good is easily portable; for instance, an ounce of gold is worth a half-ton of pig iron.

In the early stages of a developing money economy, several media of exchange might be used, since a wide variety of commodities would fulfill the foregoing conditions. However, one of the commodities will gradually displace all others, by being more widely acceptable. Preferences on what to hold as a store of value, will shift to the most widely acceptable commodity, which, in turn, will make it still more acceptable. The shift is progressive until that commodity becomes the sole medium of exchange. The use of a single medium is highly advantageous for the same reasons that a money economy is superior to a barter economy: it makes exchanges possible on an incalculably wider scale.

Whether the single medium is gold, silver, seashells, cattle, or tobacco is optional, depending on the context and development of a given economy. In fact, all have been employed, at various times, as media of exchange. Even in the present century, two major commodities, gold and silver, have been used as international media of exchange, with gold becoming the predominant one. Gold, having both artistic and functional uses and being relatively scarce, has significant advantages over all other media of exchange. Since the beginning of World War I, it has been virtually the sole international standard of exchange. If all goods and services were to be paid for in gold, large payments would be difficult to execute and this would tend to limit the extent of a society’s divisions of labor and specialization. Thus a logical extension of the creation of a medium of exchange is the development of a banking system and credit instruments (bank notes and deposits) which act as a substitute for, but are convertible into, gold.

A free banking system based on gold is able to extend credit and thus to create bank notes (currency) and deposits, according to the production requirements of the economy. Individual owners of gold are induced, by payments of interest, to deposit their gold in a bank (against which they can draw checks). But since it is rarely the case that all depositors want to withdraw all their gold at the same time, the banker need keep only a fraction of his total deposits in gold as reserves. This enables the banker to loan out more than the amount of his gold deposits (which means that he holds claims to gold rather than gold as security of his deposits). But the amount of loans which he can afford to make is not arbitrary: he has to gauge it in relation to his reserves and to the status of his investments.

When banks loan money to finance productive and profitable endeavors, the loans are paid off rapidly and bank credit continues to be generally available. But when the business ventures financed by bank credit are less profitable and slow to pay off, bankers soon find that their loans outstanding are excessive relative to their gold reserves, and they begin to curtail new lending, usually by charging higher interest rates. This tends to restrict the financing of new ventures and requires the existing borrowers to improve their profitability before they can obtain credit for further expansion. Thus, under the gold standard, a free banking system stands as the protector of an economy’s stability and balanced growth. When gold is accepted as the medium of exchange by most or all nations, an unhampered free international gold standard serves to foster a world-wide division of labor and the broadest international trade. Even though the units of exchange (the dollar, the pound, the franc, etc.) differ from country to country, when all are defined in terms of gold the economies of the different countries act as one-so long as there are no restraints on trade or on the movement of capital. Credit, interest rates, and prices tend to follow similar patterns in all countries. For example, if banks in one country extend credit too liberally, interest rates in that country will tend to fall, inducing depositors to shift their gold to higher-interest paying banks in other countries. This will immediately cause a shortage of bank reserves in the “easy money” country, inducing tighter credit standards and a return to competitively higher interest rates again.

A fully free banking system and fully consistent gold standard have not as yet been achieved. But prior to World War I, the banking system in the United States (and in most of the world) was based on gold and even though governments intervened occasionally, banking was more free than controlled. Periodically, as a result of overly rapid credit expansion, banks became loaned up to the limit of their gold reserves, interest rates rose sharply, new credit was cut off, and the economy went into a sharp, but short-lived recession. (Compared with the depressions of 1920 and 1932, the pre-World War I business declines were mild indeed.) It was limited gold reserves that stopped the unbalanced expansions of business activity, before they could develop into the post-World Was I type of disaster. The readjustment periods were short and the economies quickly reestablished a sound basis to resume expansion.

But the process of cure was misdiagnosed as the disease: if shortage of bank reserves was causing a business decline-argued economic interventionists-why not find a way of supplying increased reserves to the banks so they never need be short! If banks can continue to loan money indefinitely-it was claimed-there need never be any slumps in business. And so the Federal Reserve System was organized in 1913. It consisted of twelve regional Federal Reserve banks nominally owned by private bankers, but in fact government sponsored, controlled, and supported. Credit extended by these banks is in practice (though not legally) backed by the taxing power of the federal government. Technically, we remained on the gold standard; individuals were still free to own gold, and gold continued to be used as bank reserves. But now, in addition to gold, credit extended by the Federal Reserve banks (”paper reserves”) could serve as legal tender to pay depositors.

When business in the United States underwent a mild contraction in 1927, the Federal Reserve created more paper reserves in the hope of forestalling any possible bank reserve shortage. More disastrous, however, was the Federal Reserve’s attempt to assist Great Britain who had been losing gold to us because the Bank of England refused to allow interest rates to rise when market forces dictated (it was politically unpalatable). The reasoning of the authorities involved was as follows: if the Federal Reserve pumped excessive paper reserves into American banks, interest rates in the United States would fall to a level comparable with those in Great Britain; this would act to stop Britain’s gold loss and avoid the political embarrassment of having to raise interest rates. The “Fed” succeeded; it stopped the gold loss, but it nearly destroyed the economies of the world, in the process. The excess credit which the Fed pumped into the economy spilled over into the stock market-triggering a fantastic speculative boom. Belatedly, Federal Reserve officials attempted to sop up the excess reserves and finally succeeded in braking the boom. But it was too late: by 1929 the speculative imbalances had become so overwhelming that the attempt precipitated a sharp retrenching and a consequent demoralizing of business confidence. As a result, the American economy collapsed. Great Britain fared even worse, and rather than absorb the full consequences of her previous folly, she abandoned the gold standard completely in 1931, tearing asunder what remained of the fabric of confidence and inducing a world-wide series of bank failures. The world economies plunged into the Great Depression of the 1930’s.

With a logic reminiscent of a generation earlier, statists argued that the gold standard was largely to blame for the credit debacle which led to the Great Depression. If the gold standard had not existed, they argued, Britain’s abandonment of gold payments in 1931 would not have caused the failure of banks all over the world. (The irony was that since 1913, we had been, not on a gold standard, but on what may be termed “a mixed gold standard”; yet it is gold that took the blame.) But the opposition to the gold standard in any form-from a growing number of welfare-state advocates-was prompted by a much subtler insight: the realization that the gold standard is incompatible with chronic deficit spending (the hallmark of the welfare state). Stripped of its academic jargon, the welfare state is nothing more than a mechanism by which governments confiscate the wealth of the productive members of a society to support a wide variety of welfare schemes. A substantial part of the confiscation is effected by taxation. But the welfare statists were quick to recognize that if they wished to retain political power, the amount of taxation had to be limited and they had to resort to programs of massive deficit spending, i.e., they had to borrow money, by issuing government bonds, to finance welfare expenditures on a large scale.

Under a gold standard, the amount of credit that an economy can support is determined by the economy’s tangible assets, since every credit instrument is ultimately a claim on some tangible asset. But government bonds are not backed by tangible wealth, only by the government’s promise to pay out of future tax revenues, and cannot easily be absorbed by the financial markets. A large volume of new government bonds can be sold to the public only at progressively higher interest rates. Thus, government deficit spending under a gold standard is severely limited. The abandonment of the gold standard made it possible for the welfare statists to use the banking system as a means to an unlimited expansion of credit. They have created paper reserves in the form of government bonds which-through a complex series of steps-the banks accept in place of tangible assets and treat as if they were an actual deposit, i.e., as the equivalent of what was formerly a deposit of gold. The holder of a government bond or of a bank deposit created by paper reserves believes that he has a valid claim on a real asset. But the fact is that there are now more claims outstanding than real assets. The law of supply and demand is not to be conned. As the supply of money (of claims) increases relative to the supply of tangible assets in the economy, prices must eventually rise. Thus the earnings saved by the productive members of the society lose value in terms of goods. When the economy’s books are finally balanced, one finds that this loss in value represents the goods purchased by the government for welfare or other purposes with the money proceeds of the government bonds financed by bank credit expansion.

In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value. If there were, the government would have to make its holding illegal, as was done in the case of gold. If everyone decided, for example, to convert all his bank deposits to silver or copper or any other good, and thereafter declined to accept checks as payment for goods, bank deposits would lose their purchasing power and government-created bank credit would be worthless as a claim on goods. The financial policy of the welfare state requires that there be no way for the owners of wealth to protect themselves.

This is the shabby secret of the welfare statists’ tirades against gold. Deficit spending is simply a scheme for the confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights. If one grasps this, one has no difficulty in understanding the statists’ antagonism toward the gold standard.

Economic Signs Point to Longer, Deeper Recession
By Neil Irwin, Washington Post Staff Writer
Tuesday, December 2, 2008; Page A01


Decline Began a Year Ago, Experts Declare; Wall Street Reacts With Huge Sell-Off

The U.S. economy entered a recession one year ago, a group of the nation's leading economists said yesterday, and new evidence that the downturn will be deep and prolonged sent the stock market plummeting.

The Dow Jones industrial average dropped 7.7 percent, or 680 points, on bleak economic reports, including one that showed that manufacturing activity in November was weaker than it had been since 1982. Investors plowed money into U.S. Treasury bonds, seen as safe havens in uncertain times.

Meanwhile, Federal Reserve Chairman Ben S. Bernanke indicated in a speech that he is inclined to keep cutting interest rates and using novel approaches to try to contain damage from the downturn. Treasury Secretary Henry M. Paulson Jr. said he is designing new programs to strengthen the financial system.

The pledges to take aggressive action come as the recession appears to be getting worse.

"Right now, we still seem to be in an accelerating downslope of this economic cycle," said Ethan Harris, head of U.S. economic research at Barclays Capital.

Economists with the nonprofit National Bureau of Economic Research announced yesterday that that cycle began in December 2007, long before the health of the financial system deteriorated this spring. The group's Business Cycle Dating Committee, made up of seven academic economists, determines when a recession begins and ends and is considered the arbiter of such things.

The committee defines a recession as "a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in production, employment, real income, and other indicators."

Assuming that the country is still in a recession -- the committee makes its announcements on a delayed basis, after examining definitive economic data -- the downturn will be the longest since at least the 1981-82 recession, which lasted 16 months. The current recession, at 12 months and counting, is already longer than the eight-month downturns the nation experienced in 1990-91 and 2001.

There is little doubt that the country is still in a recession, said economists not associated with the NBER. Economic data in recent months suggest that conditions are getting worse, not better.

Bernanke himself said yesterday that "economic activity appears to have downshifted further in the wake" of the deepening financial crisis in September and that "even if the functioning of financial markets continues to improve, economic conditions will probably remain weak for a time."

Most economists have considered it a foregone conclusion that a recession has been underway for months but have debated when it began. Employers started shrinking their payrolls at the end of last year, and many other measures of economic activity worsened then. But gross domestic product grew in the first six months of the year, and job losses have accelerated since August.

The business-cycle committee, chaired by Stanford University economist Robert Hall, relied heavily on employment data in making its call. Job growth turned negative in December, but for the first several months of the year, the economy was declining only modestly by most measures. It was only after problems in financial markets intensified in September that economic conditions deteriorated significantly.

"It's similar to back in 2001, when the economy was declining for a while, but it was not until the 9/11 attacks that there was a freefall in activity," said Mark Vitner, a senior economist at Wachovia. "That caused a slowdown to become a recession. That's why the committee waits so long to make a call, so it has as much data as possible to work with."

The formal designation of a recession was not the only source of economic gloom yesterday. The Institute for Supply Management's survey showed that manufacturing activity was weaker in November than it had been since 1982, when the nation experienced its worst downturn since World War II. Similar surveys yesterday showed that the manufacturing slump has extended to Europe and China. In a separate report, construction spending in the United States fell 1.2 percent in October, the Commerce Department said, worse than expected.

On Wall Street, demand for U.S. Treasury bonds was so high that investors were willing to accept extraordinarily low interest rates. The yield on a 10-year bond was 2.73 percent -- a record low -- meaning investors were willing to lend the U.S. government money at that rate for a decade.

Losses on equity markets spread to Asia. Japan's benchmark Nikkei average fell more than 5 percent in early trading today.

Top economic policymakers said they would use all possible measures to combat the slump. Bernanke, speaking to the Greater Austin Chamber of Commerce, said it would be "feasible" for the Fed to continue cutting the short-term interest rate it controls but noted that it could not go much lower. The federal funds rate stands at 1 percent, and analysts widely expect it to be cut at the Fed's policymaking meeting in two weeks.

Because the Fed cannot lower rates below zero, Bernanke indicated that he would continue trying to stimulate the economy through other means -- particularly by expanding the bank's intervention in private markets. He said the Fed, for example, could buy long-term Treasury securities or debt issued by the mortgage-finance companies Fannie Mae and Freddie Mac.

Last week, the Fed announced that it would deploy $500 billion to buy mortgage securities backed by the two companies and $100 billion of their debt. Those moves have already helped lower mortgage rates, thus stimulating the economy.

Bernanke also said that the Fed "can provide backstop liquidity not only to financial institutions, but directly to certain financial markets," referring to a recent program that was launched to support the commercial-paper market.

The Fed is already, in effect, lending money directly to companies that fund their operations with commercial paper, a form of short-term debt. Last week, it announced a similar action to effectively lend money for credit cards, auto loans and other consumer debt.

"He's confirming what they've already been doing," said Harris, the Barclays economist, "which is a dramatic expansion of their balance sheet, and creating direct lending programs that circumvent the banking system."

Although Bernanke left the door open to further expansions of direct Fed lending, he also signaled that the central bank would be aggressive in removing such programs to prevent inflation. "To avoid inflation in the long run and allow short-term interest rates ultimately to return to normal levels, the Fed's balance sheet will have to be brought back to a more sustainable level," he said.

Fed policymakers will ensure that this is done in a timely way, he said. "However," he added, "that is an issue for the future; for now, the goal of policy must be to support financial markets and the economy."

In Washington, Paulson indicated that there could be new programs before he leaves office in seven weeks.

"We are actively engaged in developing additional programs to strengthen our financial system so that lending flows into our economy," the Treasury secretary said in a speech to the Fortune 500 Forum. "When these programs are ready for implementation, we will discuss them with the Congress and the next administration.