Chairman of the Federal Reserve
Mar 25, 2012
Re: Open Letter to Discuss Your Misunderstandings About Gold
You have publicly gone on record with some off-the-wall assertions about the gold standard. What made you think you could get away with it? Your best strategy would have been to ignore gold. Although I concede that with the endgame of the regime of irredeemable paper money near, you might not be able to pretend that people aren't talking and thinking about gold. You can't win, Ben. In this letter I will address your claims and explain your errors so that the whole world can see them, even if you cannot.
Before I get into your specious claims, I want to point out two of important facts. First, the gold standard exists when people are free to choose what they wish to use for money. Gold has won this market competition over thousands of years, but the key is that when people are not forced to use government-issued scrip they choose gold. And that's the shabby little secret of your irredeemable paper money, Ben. You have legal tender laws to force creditors to accept it, whether they would or not. Will you please let people be free?
Second, central planning does not work. The Politburo in the since-collapsed Soviet Union did not know how many shoes to make of what sizes. And you don't know what rate of interest to set. Central planning has always led to the collapse of the specialization of labor and the economy with it, to the degree that it is attempted. The Federal Reserve, the central bank of the USA, is the central planner for money, credit, interest, and discount. Given the importance of money to every single aspect of the economy, it is no exaggeration to say that there is no such thing as a free market built on top of a centrally planned monetary system.
In your speech at George Washington University, you made the following claims:
- The gold standard hasn't really worked since the end of WWI.
- To have a gold standard, you have to go dig up gold in South Africa and put it in a basement in New York. It's nonsensical.
- The gold standard links the currencies of every country, causing policy in one country to transmit to another. So for example, if the U.K. fixes the number of pounds to an ounce of gold, and the U.S. fixes the number of dollars to an ounce of gold, then the pound and the U.S. dollar inadvertently become linked.
- It creates deflation, as William Jennings Bryan noted. The meaning of the "cross of gold" speech: Because farmers had debts fixed in gold, loss of pricing power in commodities killed them.
- The gold standard tends to cause interest rates to rise during downturns and interest rates to fall during good times, the exact opposite of what monetary policy should be doing.
- The economy was far more volatile under the gold standard.
- The only way the gold standard works is if people are convinced that the central bank ONLY cares about maintaining the gold standard. The moment there's a hint of another priority (like falling unemployment) it all falls apart.
- Gold standards leave central banks open to speculative runs, since they usually don't hold all the gold.
- The gold standard is based on the "desire to maintain the value of the dollar"--implying a "desire to have very low price stability."
- The gold standard is based on an aversion to allowing the central bank to respond with monetary policy to booms and busts, and a desire not to give the central bank that power.
- There's simply not "enough" gold
- The commitment to the gold standard is that no matter how bad the economy gets, we're going to stick to the gold standard.
- The gold standard was one of the main reasons the Great Depression was so bad and so long.
Please forgive me if my takedown runs a little bit long. I've found that it is much easier to commit a logical fallacy in a sound bite than it is to explain the full context. I will take your assertions in order.
1. The gold standard hasn't really worked since the end of WWI.
This is true. Just prior to Christmas in 1913 (which is before the beginning of the war, by the way) the Federal Reserve Act was passed into law. Ever since, the Fed has taken for itself and been granted more and more power to try to centrally plan money and credit. You and your predecessors have been in power for a century, but this fact is in no way an argument against the gold standard.
2. To have a gold standard, you have to go dig up gold in South Africa and put it in a basement in New York. It's nonsensical.
The fact is that for thousands of years, people have been digging gold up and putting it in basements. To call the behavior of so many people over so many years "nonsense" is arrogant. A free country has room for arrogant men, but no place for arrogant men to back their whims with a gun. From 1933 until 1975, one could be imprisoned for the "crime" of possessing gold. To this day, it is not legal for a creditor to demand payment in gold. If you are so confident that you are right and all good men should be happy that you print dollars at your discretion, can we agree on an experiment? Let's repeal the laws that force creditors to accept paper, and the laws that nullify gold clauses in contracts, and the taxes on the "gains" in gold, and the laws that force taxpayers to use dollars as their unit of account for bookkeeping purposes, and see what people choose when the gun is not compelling them. I will wager one ounce of good gold against a frayed old dollar bill that people will choose gold if you let them. Should I book my flight to Washington to pinky-shake on our bet?
3. The gold standard links the currencies of every country, causing policy in one country to transmit to another. So for example, if the U.K. fixes the number of pounds to an ounce of gold, and the U.S. fixes the number of dollars to an ounce of gold, then the pound and the U.S. dollar inadvertently become linked.
Actually, Ben, you are describing the gold exchange standard that prevailed from the insane treaty at Bretton Woods until it collapsed in 1971 with Nixon's default. The choice is not between price fixing vs. excluding gold altogether. The choice is between the freedom for people to choose gold vs. your smart and efficient central planning.
4. It creates deflation, as William Jennings Bryan noted. The meaning of the "cross of gold" speech: Because farmers had debts fixed in gold, loss of pricing power in commodities killed them.
By the way, Ben, the Coinage Act of 1792 fixed the price of silver in terms of gold at (15:1). Like every instance of laws that attempt to interfere with the markets, this provision was an unmitigated disaster. Whichever metal is officially valued at less than its market value will be pulled out of circulation and sent elsewhere for its market price. Whichever metal is overvalued will be imported from every corner of the earth and come flooding into the country.
In 1873, the government was ready to open the US Mint again. But when they wrote the list of which coins the Mint was authorized to coin, they somehow "forgot" to include the one ounce silver coin. Silver was demonetized. I am sure it had nothing to do with lust for power by the good men who ran the government, nor with any lobbying that might have occurred around that time. This was dubbed the "Crime of '73".
Demonetizing silver destroyed enormous amounts of capital, Ben. Just imagine that a farmer, to use your example, has been working hard and saving all his life. And then the government, in callous and cavalier fashion, passes a law that destroys the value of his savings. But this is the power you crave, isn't it? This is the power of central planning, to sit in an office in Washington, taking into account your whims, pet theories, and the desires of lobbyists and casually dispose of the income and wealth of the people without their consent.
5. The gold standard tends to cause interest rates to rise during downturns and interest rates to fall during good times, the exact opposite of what monetary policy should be doing.
You have pushed interest rates down to zero on the short end. This has achieved nothing good, and yet you are unwilling to consider that, just maybe, your pet theory is wrong? Good thing your pet theory is enforced on the rest of us at gunpoint, eh Ben?
We should pause for a moment to reflect on the nature of downturns. The original promise of the central bank was that it would prevent downturns! As recently as the "Great Moderation" which abruptly ended in 2001, this myth was widely believed. But we see that downturns are not prevented by the central bank. Instead, much larger downturns (such as the one which began in 2008) are caused by the central bank.
Let us look at the nature of these downturns. For a while, the bank encourages credit expansion by various means. The bond speculators (which did not exist under the gold standard) jump onto the bandwagon and the result is that interest rates have fallen for more than 30 years in a row.
During this long period, as you can imagine, much counterfeit credit is created. By counterfeit credit, I mean where either the saver is unwilling to lend or even unknowing (such as anyone who deposits in a bank nowadays) or when the borrower lacks either the means or intent to repay (such as the government, or many bond issuers and banks). Sooner or later, the game is up. The borrower can no longer keep current on the interest payments. Not even by "rolling" the debt. As an aside, Ben, this is another dirty secret of the irredeemable currency: there is no way for any debt, ever, to be repaid; it only moves from one debtor to another and ultimately ends up at the Fed or the Treasury.
So what you blithely call a "downturn" is the painful process of writing off bad loans. Capital has been destroyed, and everyone who made bad loans must write it off. You are correct that interest rates should rise as a result! Capital is far more scarce than people believed during the boom.
6. The economy was far more volatile under the gold standard.
I don't think even you believe this, so I will not comment further except to note that the 1929 crash occurred under the tender ministrations and brilliant central planning of the Fed.
7. The only way the gold standard works is if people are convinced that the central bank ONLY cares about maintaining the gold standard. The moment there's a hint of another priority (like falling unemployment) it all falls apart.
8. Gold standards leave central banks open to speculative runs, since they usually don't hold all the gold.
No, Ben. I will address these points together: a gold standard is when there is no central bank. What you are substituting in your confusion is if the Fed were to somehow try to centrally plan gold. But you know that doesn't work, so I need not spend time arguing against it.
Speaking of unemployment, as you know, if the portion of the population who is deemed to be "in the workforce" hadn't been shrinking so much, the unemployment rate right now would be just below "staggering." And this is despite (or perhaps because of) your central planning activities.
9. The gold standard is based on the "desire to maintain the value of the dollar"--implying a "desire to have very low price stability."
The gold standard is about many things. Speaking of the value of the dollar, you are aware, I am sure, that it has lost about 98% of its value in the 100 years since your organization began centrally planning. Under gold, prices do not remain constant. That kind of stasis is neither possible nor desirable. Prices, and more importantly changes in prices, signal to consumers and entrepreneurs what is scarce and what is in demand. No, what remains stable is the rate of interest. And it is this rate that is manifestly unstable under the Fed's careful designs. As recently as 30 years ago, the rate on the 10-year US Treasury was almost 16%. Today it is 2.2%, having recently hit a low under 1.8% (and this rise of more than 22% in a short period of time is both staggering and revealing).
Changes in the rate of interest cause enormous destruction to industry. A rising rate destroys businesses one by one as each looks at financing new capital projects, or replacement for worn plant. But at each higher interest rate, fewer and fewer capital projects make any sense. So factories shut down, and ever more workers join the unemployment line. Does this strike a note, Ben?
Falling interest rates cause a more pernicious and subtle damage. Bond speculators make risk-free gains on their bonds. This money does not come out of thin air, however. Each bond issuer now has a higher present value of their liabilities. Good thing that FASB does not require them to mark liabilities to market when the bond price rises, or else there would be a serious problem! Actually, there is a serious problem even if we all close our eyes and pretend otherwise. Is that a fair characterization, Ben: that the purpose of the Fed is to help everyone play make-believe?
Under paper, neither prices nor interest rates have been stable. Have you taken a look at the chart for crude oil or most other commodities, Ben?
10. The gold standard is based on an aversion to allowing the central bank to respond with monetary policy to booms and busts, and a desire not to give the central bank that power.
Here you are correct, Ben. You should not have that power. No one should have that power. A brilliant author by the name of JRR Tolkien wrote a story about power. Have you ever read The Lord of the Rings or seen the version Peter Jackson made into film?
11. There's simply not "enough" gold
How much gold do you think there is, Ben? How much gold do you think a gold standard would need? You don't know either number, of course. This is just an old wives' tale. Do you also wear copper bracelets to ward off the common cold, or is that vampires (I forget)?
12. The commitment to the gold standard is that no matter how bad the economy gets, we're going to stick to the gold standard.
This is an interesting logical fallacy. You are lumping together commitment to gold with bad economy. This called "begging the question". You are presuming what you ought to be asking.
13. The gold standard was one of the main reasons the Great Depression was so bad and so long.
So you think that the disastrous adventure that combined both taxes and protectionism that led to a trade war and thence to collapsing trade had nothing to do with it? Or FDR's constant threats to change the rules of the game, thus rendering investments previously made worthless (there's that problem again)? What about the various other central planning interventions of both Hoover and the New Deal?
Or how about the falling interest rate structure that I mentioned above? When the government outlawed the ownership of gold, that herded people into the next-best choice: US Treasurys. This caused the interest rate to fall. Have you ever stopped to think what this does to savers, such as the small farmer for whom you weep crocodile tears?
Ben, I wrote a paper entitled "Gold Bonds: Averting Financial Armageddon" (http://keithweiner.posterous.com/gold-bonds-to-avert-financial-armageddon) because I am convinced that the regime of irredeemable paper money and hence the Fed is going to come to a sudden and catastrophic end. One way or the other, your power and the power of the Fed will be ended. I would prefer that it be ended without also ending western civilization, which is the course we're headed on right now. You remember that bit earlier about capital being rare and precious? Your policies are helping accelerate an unprecedented destruction of capital. When the capital is gone (if not sooner) the game will be up.
I would like to avoid plunging into a new Dark Age. Can we agree at least on this, Ben?