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Gold And Economic Freedom
by Alan Greenspan (1967)
 During
the 1950s, Alan Greenspan was a member of the intellectual inner circle of
self-designated "objectivist" and libertarian Ayn Rand. The following article
was penned by Mr. Greenspan for the first issue of what was to become Rand's
widely-circulated Objectivist Newsletter.
When Gerald Ford appointed Mr. Greenspan to
the Council of Economic Advisors, Greenspan invited Rand to his swearing-in
ceremony. He even attended her funeral in 1982.
In 1967, Rand published her non-fiction book 'Capitalism, The Unknown Ideal' in
which she included Gold and Economic Freedom, the essay by Alan Greenspan which
appears below. Drawing heavily from Murray Rothbard's much longer 'The Mystery
of Banking,' Greenspan argues persuasively in favor of a gold standard and
against the concept of a central bank.
Quoting from below, the greatest legal counterfeiter in the history of the world
states, "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.'
Can this possibly be the same 'Easy Al' -- recently the world's most powerful
central banker and Chairman of the world's greatest Central Bank?
Who got to him?
GOLD
AND ECONOMIC FREEDOM
by Alan Greenspan
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.
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