Copyright 1991 - Reginald H. Howe
THE GOLDEN SEXTANT
A recent book entitled Good Money touts "SRI" - socially responsible investing - , or how to do good (socially) while doing well (financially).(1) But whatever the legal currency -
dollars, marks, yen, francs or pounds - in which practitioners of SRI make their investments, they cannot make bad money good. SRI cannot repeal Gresham's law. Properly understood, good money is good, not because of the motives of its owners, but because of its own intrinsic character. Truly good money will produce far more social benefits than any amount of bad money spent with good intentions.
The shortcomings of the international monetary system - some would say "chaos" - that has developed since President Nixon closed the gold window twenty years ago are obvious: persistent structural inflation, much higher interest rates, and lower rates of economic growth than under prior gold-based monetary regimes.(2) A private Swiss bank in Zurich now awards an annual prize for "the best paper describing how the international monetary system could be improved." It seeks "extraordinary proposals in the field of monetary science and policy." But why keep trying try to fix a second-rate system when a proven system works better? The improvement that the international monetary system needs is not a novel and untested repair, but a modernized version of what worked so well in the past: the gold standard.
Contrary to the predictions of many if not most economists, the closure of the gold window in 1971 did not mark the beginning of gold's demise as money. True, gold is no longer convertible into national currencies at fixed prices. But just as currencies may be exchanged for each other at market prices, they may also be exchanged for gold. More importantly, gold is still loaned and borrowed as money by major banks and businesses. Gold has its own interest rate, determined entirely by the markets. Daily, in spot and forward markets around the world, gold is arbitraged against the major currencies based on relative interest rates.
The notion that gold does not earn interest is a mere canard. Loans made and repayable in gold, together with interest payable in gold, are a standard feature of international finance at the highest levels. In the gold mining industry gold loans are a common method of financing new mines. Senior gold mining companies can ordinarily obtain gold loans at annual interest rates of around 2 percent.
But gold loans are not confined to the gold mining industry. On December 4, 1990, the Financial Times (London) reported: "The inter-dealer gold-loan rate (sometimes described in the jargon as gold libor - short for London interbank offered rate) has climbed to its highest-ever level." The prior day's record rate: 3.25 percent on an annual basis for a one month gold loan. The accompanying chart showed that this rate had been at 0.5 percent during the first half of 1990. However, much of the gold loaned in this market comes from central banks, some of whom experienced embarrassing defaults when Drexel Burnham Lambert financial services group, a frequent gold borrower, collapsed. As a result, a number of central banks curtailed their gold lending activities, at least temporarily, causing gold libor to rise.
A startling aspect of the Financial Times article was the prediction by some dealers that gold libor might rise to 7 or 8 percent in 1991. For this prediction to come true, either interest rates around the world would have had to rise dramatically to double-digit levels, or gold itself would have had to go into backwardation - something that has never happened
and is generally believed impossible. Why this prediction would have necessarily involved these consequences explains how gold remains an intrinsic part of the international monetary system, and why the implementation of a modernized gold standard would not be difficult given the political will to do so.
ARBITRAGE, CONTANGO and BACKWARDATION
Arbitrage is the process by which small discrepancies in different markets for the same item are harmonized by those with the necessary information and market access. It takes place
between different spot markets, and between spot markets and forward or futures markets.
Backwardation occurs when the price of a commodity or currency for future or forward delivery is less than its price for spot or current delivery. It contrasts with the more normal situation - known as contango - when the future price is greater than the spot price. In commodities, fears about the availability of short term supplies can often lead to backwardation. For example, after Iraq's invasion of Kuwait, prices for spot and nearby oil futures contracts rose to near $40 per barrel, while prices 2 or 3 years out remained at not much over $20.
In the currency and gold markets, situations of contango and backwardation are primarily driven by arbitrage and relative interest rates.
Foreign currency prices may be stated two ways: the local currency equivalent of one unit of foreign currency (e.g., DM1.00 equals US$0.6000, which is the dollar price of one mark); or the number of units of foreign currency that one unit of local currency will purchase (e.g., US$1.00 equals DM1.6667, which is the price in marks of one dollar). Gold prices, like commodity prices, are ordinarily stated in the first manner: as the price in currency of one unit of the commodity (e.g., US$350 per troy ounce of gold).
Gold is in contango against the dollar (or any other currency) when the future price of gold expressed in that currency is greater than the current price. Put another way, gold is in contango against a currency when one ounce of gold will purchase more of that currency in the forward markets than at spot. And a currency is in backwardation against gold when one unit of the currency will purchase less gold for future than spot delivery.
Similarly, the dollar is in contango against the mark when the future price of marks expressed in marks is greater than the current price. The future or forward price of a foreign currency expressed in terms of itself is the number of units of that currency that one unit of local currency will buy.
When one currency is in contango against another, the other is necessarily in backwardation against the first. Thus, when the dollar is in contango against the Deutschmark, the mark is in backwardation against the dollar, meaning that the price of marks expressed in dollars is less for future delivery than for current transactions.
HOW CURRENCIES and GOLD ARE ARBITRAGED
In dollar denominated forward and futures markets for gold, arbitrage results in a contango that is ordinarily slightly below the U. S. treasury bill rate. In the currency markets, arbitrage puts currencies with lower interest rates in contango against those with higher rates, and currencies with higher rates in backwardation against those with lower rates. All currencies are in backwardation against gold since it carries a lower interest rate structure than any currency.
These relationships are readily apparent in Table A below. All figures are market quotations for January 20, 1989, as reported in The Wall Street Journal or the Financial Times (London). Interest rate ranges for each currency are treasury bill rates for the dollar and Euro-currency rates for the mark, yen and pound for one to six months, which are the maturities matching the forward contracts. Gold prices are the closing prices on the Comex in New York. The interest rate for gold is gold libor, which for purposes of this table and Table B is assumed to be 2.0 to 2.5 percent.(3)
US$ Mark Yen Pound Gold
8.2%-8.8% 5.5%-5.9% 4.3%-4.7% 12.8%-13.1% 2.0%-2.5%
$/DM DM/$ $/Y Y/$ $/£ £/$ $/Oz Oz/$
spot .5444 1.8370 .007831 127.70 1.7755 .5632 408.50 .002448
forward: 30-day .5460 1.8314 .007867 127.11 1.7697 .5651 409.30 .002443
90-day .5491 1.8211 .007925 126.18 1.7599 .5682 414.40 .002413
180-day .5540 1.8052 .008019 124.70 1.7481 .5720 425.00 .002353
Table A depicts a time period during which German and Japanese interest rates were lower than rates in the United States. Accordingly, the dollar is shown in backwardation versus the mark and the yen, meaning that $1 would purchase progressively fewer marks and yen as the delivery dates lengthened into the future. Today, with U. S. interest rates lower than rates in Germany and Japan, the dollar is in contango against them, meaning that $1 will purchase progressively more marks and yen for future delivery than at their spot prices.
However, a dollar still will not purchase more gold for future than for spot delivery. These relationships are shown in Table B, constructed in the same manner as Table A, but using market quotations for September 9, 1991.
US$ Mark Yen Pound Gold
4.9%-5.5% 9.0%-9.4% 6.6%-7.1% 10.0%-10.4% 2.0%-2.5%
$/DM DM/$ $/Y Y/$ $/£ £/$ $/Oz Oz/$
spot .5903 1.6940 .007429 134.60 1.7335 .5769 351.10 .002848
forward: 30-day .5886 1.6990 .007422 134.74 1.7269 .5791 352.10 .002840
90-day .5850 1.7093 .007409 134.98 1.7149 .5831 355.20 .002815
180-day .5800 1.7241 .007402 135.10 1.6993 .5885 361.20 .002769
In Table B, the difference in price between spot (September) gold and 90-day forward (December) gold is $4.10, which is 1.17 percent above the spot rate and represents an approximate annual contango of 4.7 percent versus a 90-day treasury bill rate of 5.4 percent. The same calculations applied to Table A give an annual contango of about 5.8 percent versus a 90-day treasury bill rate of 8.5 percent. The same calculations at the other maturities yield similar comparisons (in both tables the 180-day gold contract is actually seven months out).
Suppose the contango on Comex gold falls below the treasury bill rate by significantly more than the ordinarily minimal costs of storage, insurance and transaction charges. Owners of gold can then simultaneously sell at spot, invest the proceeds in treasury bills, and buy an equal amount of gold for future delivery at a price equal to spot plus the contango. When the futures contracts mature, they cash in the treasury bills and take delivery on their futures contracts, paying for the gold with the proceeds from the treasury bills and pocketing a relatively riskless profit equal to the treasury bill rate less the contango. At no time were they exposed to changes in the dollar price of gold.
On the other hand, suppose the contango on Comex gold rises significantly above the treasury bill rate. Now someone able to borrow at favorable rates can buy gold at spot, paying with the borrowed funds, and simultaneously write (sell) futures contracts for the same quantity of gold at spot plus the contango.(4) Again, the result is a relatively riskless profit, this time equal to the contango less the interest expense. And again, at no time was the arbitrageur exposed to changes in the dollar price of gold.
Now suppose that gold libor rose to 8 percent, treasury bills stayed at 5.0 to 5.5, and gold remained in contango against the dollar. Arbitrageurs would borrow dollars, buy gold, loan the gold at the higher rate, and cover their long gold position in the forward market, where they could still sell gold at a price higher than spot. They would make a relatively riskless profit equal to the interest rate differential plus the contango. They would continue to make this riskless profit until they drove gold libor below the treasury bill rate or gold into backwardation against the dollar sufficiently to restore market equilibrium, i.e, eliminate the opportunity for riskless profit.
By a similar process, the major currencies are arbitraged against each other in the spot and forward currency markets every day. It is a never-ending market process, responding to and at the same time affecting both the cross rates among the currencies and the interest rates applicable to each.
The forward and futures markets for currencies differ from those for commodities in two principal respects: the total existing supply is overwhelmingly large relative to current additions to supply; and the cost of carry is almost entirely interest expense. In these two respects, gold is like currencies, not commodities. All the gold ever mined totals little more than a hundred thousand metric tons, of which over 80 percent is still held in essentially monetary form as bars, coins and high karat jewelry, and almost one-third is still held in reserves by official monetary institutions. Annual new supply from all sources is only some 2000-2500 tons, or an annual addition to total supply of 2 to 2.5 percent. Viewing gold as a commodity, any temporary shortages will quickly be met from existing stocks. Viewing it as money, the long term rate of growth of total supply is lower than that of any national
currency, which largely explains why gold always carries a lower interest rate structure.
For these reasons, gold has never gone into backwardation in any currency. Far from demonetizing gold, twenty years of experience with floating exchange rates and increasingly free currency markets has only underscored gold's intrinsic character as the world's most reliable money. Modern gold loans are market proof that the low interest rates historically associated with gold-based monetary regimes were the product of gold convertibility, that is, of
money "as good as gold."
GOLD LOANS for EVERYONE
Gold loans today are not for everyone. If the gold price rises sharply during the period of the loan, the borrower may have difficulty repaying the gold. Accordingly, under current conditions, gold loans are ordinarily made only to certain types of borrowers: gold mining companies; businesses, such as jewelry manufacturers, that hold gold in inventory; and major financial institutions that, in addition to top credit ratings, have the ability to hedge at reasonable cost against adverse changes in the gold price during the life of the loan. Most individuals and small businesses do not qualify for gold loans, just as they do not qualify for foreign currency loans.
If money or currency better than gold is invented, the markets will confirm the achievement by giving the new medium a lower interest rate than gold and a contango against it. In the meantime, however, why not heed what the markets are saying? Why not give everyone ready access to the best money available by making national currencies once again as good as gold?
The end of the Cold War has unmasked for the drivel they were many dogmas about the efficacy of command economies. That nearly all these dogmas found considerable support in the economics departments of major colleges and universities throughout the free world ought, at the very least, raise doubts about many of the past academic objections to the gold standard.
The essence of these objections revolves around a supposed loss of national monetary sovereignty, meaning a reduction in the ability of the central bank to manipulate domestic interest rates, prevent recessions, and promote the growth of the national economy. The basic problem with this objection is that central banks do not possess the powers that the objection assumes, or at least do not possess them to the extent assumed. What is more, whatever their powers in this regard, they are eroding as all national economies become part of an increasingly
integrated and interdependent world economy with largely deregulated financial markets.
During its heyday, the classical gold standard was not generally regarded as impinging upon monetary sovereignty. Rather, in any circumstances short of major war, devaluation was simply unacceptable as a policy option in most nations. Interestingly, Mrs. Thatcher recently invoked the notion of monetary sovereignty in opposing British participation in a common European currency. The Germans have a well-known anathema to inflation. They are unlikely to participate unless given sufficient control over a common European currency to assure that it remains as inflation-resistant as the Deutschmark. The notion that the Bank of England might become a branch of the Bundesbank apparently was more than Mrs. Thatcher could stomach. But all Europeans, not just the British and the Germans, might find a common European currency easier to accept if it were based on gold, not paper. Gold is a neutral monetary sovereign with an impeccable record on inflation.
Another common objection used to be that a gold standard would benefit South Africa and the Soviet Union, both large gold producers. Since these nations are no longer the political pariahs that they were, this objection - never well-taken as a matter of economics - has lost much of its political appeal. What is more, the United States is now the second largest gold producer after South Africa, and a number of nations have become quite significant gold producers.
In 1989, Jude Wanniski and U. S. Federal Reserve Board Governor Wayne Angell urged the Soviet Union to adopt a convertible gold ruble.(5) Governor Angell emphasized the likely benefits of gold convertibility on the government's borrowing costs, suggesting: "As markets gain experience with Soviet gold-backed bonds, interest on the bonds could be expected to decline, perhaps approaching 2%, the going rate for U. S. gold-mining company bonds." If the United States could borrow at 2 percent, the savings in interest expense on the national debt would be sufficient to eliminate the federal budget deficit.
History provides many examples of nations that have restored gold convertibility to their currencies and thereby not just stopped inflation but also triggered periods of rapid economic growth. Alan Reynolds has suggested five case studies.(6) Two involve the United States: "The Hamilton Dollar of 1792" covers the period immediately following the adoption of the Constitution; and "Ending the Greenback Era" covers the return to the gold standard after the Civil War. Modern history, including many current examples, shows that reasonably sound money is a prerequisite for economic growth, and that the sounder the money, the higher the growth rate is likely to be.
In recognition of this fact, the central banks of all major industrial nations now pose as tough inflation fighters. But they do not fight inflation with the proven remedy that also promotes economic growth by lowering interest rates. They fight it with high interest rates, and worse yet, high real interest rates. Before assuming his present position as Chairman of the U. S. Federal Reserve Board, Alan Greenspan wrote: "In the absence of a gold standard, there is no way to protect savings from confiscation through inflation."(7) Today he is still committed to the goal of zero inflation. But the means he advocates are dramatically different.(8)
Why does Mr. Angell refuse to embrace gold convertibility as a way to lower U. S. interest rates and reduce the U. S. budget deficit? Why does Mr. Greenspan refuse to embrace it as a way to end U. S. inflation? Why do finance ministers and central bankers all over the world refuse to embrace a modernized gold standard? The answer is simple. A modernized gold standard would require the governments they represent to put their financial houses in order or face the prospect of national bankruptcy. No longer would the credit of national governments rest ultimately on their power to print money. No longer could votes be bought by loading ever more government debt on future generations. Instead, like all other borrowers, national governments would have to match expenditures to income. In the United States particularly, the administration and Congress would have to start making some of the hard choices that they have heretofore avoided. Political leaders would have to lead. The high real interest rates of the 1980's were necessary to prevent unlimited fiat money from rapidly degenerating into worthless paper, as it threatened to do during the 1970's. Most knowledgeable observers of the gold market assign competition from high real rates as the primary reason for gold's decline from an average annual price just over $600 in 1980 to just over $380 in 1989 and 1990.(9) But high real interest rates are not competition just for gold. They are competition for all investments. When short term government securities offer high real yields, they raise the threshold level of profitability that any investment or business must achieve in order to make economic sense. The threshold is raised across the risk spectrum, from conservative to speculative, and the risk/reward ratio is shifted in favor of government paper. Governments with unlimited power to print legal tender can keep borrowing under conditions of high real rates long after other borrowers are driven from the field. Indeed, by forcing out other borrowers, governments free more credit for themselves.
A credible gold standard gives everyone - rather than a select few - the benefits of gold's low and relatively stable interest rates. It enables everyone to be a gold producer because the national currency becomes simply a proxy for gold. All loans are effectively gold loans.
A MODERNIZED GOLD STANDARD
A modernized gold standard would be much like the classical gold standard abandoned
in 1914 following the outbreak of World War I. The currencies of participating nations would be pegged to gold, and thereby to each other, at fixed rates. The governments of participating nations - through their central banks or treasury departments - would be committed to buying and selling gold at the official price. This commitment might be made generally to everyone, or only to major domestic financial institutions and the principal monetary authorities of other participating nations. It might also be limited to individual transactions above a set minimum size. The key is to make the promise of convertibility real, not to impose what might be a burdensome and unnecessary number of small transactions.
Unlike the Bretton Woods system of fixed exchange rates adopted after World War II, there would be no key currency. No single nation would have the power to wreck the system by unilaterally devaluing or going off gold. A participating nation that did so would either participate at a new parity rate, in the case of devaluation, or cease to participate.
Participating nations could chose for themselves between systems of central or free banking,(10)
and whether to have fractional reserve banking. Like the classical gold standard, a modernized gold standard requires prudent banking to work well, but it does not require any particular form of banking system. A modernized gold standard is not some sort of linkage between paper money and a basket of commodities, including gold. Theoretically, any currency could be defined as a particular combination of commodities, including gold. Then its commodity value - spot and future - could be determined each day based on market quotations. Index contracts could, and almost certainly would, be created and arbitraged against the contracts for its component commodities. But no commodity other than gold has an interest rate. What is more, all commodities except gold (and possibly silver) may go into backwardation, and many frequently do. Exactly how the markets would arbitrage such a monetary unit is difficult to predict, but there is no reason to think that it would receive a lower
interest rate than gold, or that gold would go into backwardation against it.
HOW TO SET the GOLD PRICE
If a modernized gold standard were adopted, what should the new "official" price of gold be? It is said by some in a position to know that this is the question to which President Reagan could never get a satisfactory answer. Instead, three sets of advisors gave him three different prices: significantly below current market; current market; and comfortably in excess of current market. The question is not as difficult as sometimes suggested.
As this article is being written, the current market price of gold is approximately $350 an ounce, which coincidentally is just about the official price of gold fifty years ago ($35/ounce) adjusted for increases in the U. S. consumer price index since 1940. But if the
U. S. and other major governments announced tomorrow that they were implementing a modernized gold standard forthwith at a new official price of $350 an ounce, they would probably unleash a quite severe deflation that would soon compel them to devalue.
On the other hand, if these same governments announced tomorrow that they intended to implement a modernized gold standard six months to one year from today at a price to be set in light of market developments during the intervening period, the gold and currency markets - through arbitrage - would give pretty good guidance as to what the new official price should be. The situation is not unlike what happens when a company is "put in play" as a possible takeover target. Today gold is not widely used as money and is nowhere legal tender in any practical sense. Most of the demand comes from the jewelry business. Investment demand for the past few years has been relatively light. On the supply side, the relatively high growth rate of the late 1980's due to new mine openings is reversing. High real interest rates continue to put downward pressure on the price. As this is being written, fears of forced gold sales by the former Soviet republics are adding to the downward pressure. And nobody is expecting the major governments of the world to return to a gold standard. This possibility is no more in today's gold price than the possibility of an unexpected buyout is in the price of most stocks.
When a takeover bid is announced, or a company is otherwise "put in play," arbitrageurs - the "arbs" in Wall Street parlance - bid up the price of the target company's shares based on their estimate of the company's value in a buyout and the chances it will happen. Essentially the same process would take place if the major governments indicated, or if the markets sensed, that a plan was afoot to return to the gold standard. Arbitrageurs in the gold and currency markets would then act on their best guess as to the chances that the plan would be implemented and, if it were, the most likely dollar gold price and currency cross rates.
If a modernized gold standard were adopted, what dollar gold price and currency cross rates should be used? Most people would probably agree that whatever dollar gold price and currency cross rates are used, they should not upset existing financial relationships any more than absolutely necessary. In other words, they should not result in significant deflation or inflation in any country. At the same time, they should give every prospect of being sustainable for the long term. How would the arbs try to divine this dollar gold price and these currency cross rates? What sorts of information would they consider?
The cost of mining gold is as good a starting point as any. Under a gold standard, the only way for the monetary base to grow is through the addition of newly mined gold. Accordingly, if long term monetary growth from 2 to 3 percent is desirable, the price must be sufficiently high to stimulate annual new production in this amount. This simple fact seems to have escaped the advisors who suggested a price of $250-$300 to President Reagan.
In its authoritative Gold 1991, Gold Fields Mineral Services reports that average Western world cash costs in 1990 were about US$265 per ounce. Total mining costs, including overhead and depreciation, were almost US$325 per ounce. In South Africa, which accounted for about 35 percent of Western production, average cash costs were almost US$310, and average total costs were over US$350. Costs are higher yet if total industry finding costs are added, but there are no hard figures. Knowledgeable analysts of the North American gold mining industry have estimated industry-wide finding costs at from $100 to $200 an ounce.
Another good starting point is the gold coverage of the currency. Traditionally, under fractional reserve banking as practiced in the United States and Great Britain, banks that issued gold-redeemable currency held gold reserves equal to not less than 40 percent of their notes (currency) outstanding. When the Federal Reserve System was established, this requirement was imposed by law. While 40 percent cover was sufficient during normal times, higher percentages of cover became necessary if the soundness of a bank or banks were drawn in question.
At the end of August 1991, the gold reserves of the United States were just over 262 million ounces, the total amount of U. S. currency outstanding was $293.4 billion, and the total monetary base was $341.1 billion. Based on these figures, to provide 40 percent cover for the currency, a gold price of almost $450 would be necessary. Full coverage would require a price
in excess of $1100. Forty percent cover for the entire monetary base, not just the currency, would require a gold price over $520. Calculations of this type can be made for any currency. They are probably more useful for countries that have historical experience with gold-backed currency and continue to maintain significant national gold reserves, such as the United States and the major industrial nations of Western Europe.
In countries with central banking, as most are today, the financial condition of the government is an important consideration. Under free banking, private banks issue the gold-redeemable notes that circulate as currency. But under central banking, these notes are issued by a government-sponsored central bank.. In the first case, the soundness of the currency depends upon the soundness of the various private banks. In the second, it depends as a practical matter on the soundness of the government's finances since the central bank, in addition to issuing currency, also serves as the government's banker. Apart from its gold, the central bank's assets are primarily debt obligations of its sponsoring government. If these obligations are of doubtful worth, the central bank's gold reserves must shoulder a heavier burden. If the same amount of gold must then support the same amount of currency, but at a higher percentage of gold cover, the gold price must be raised.
In a country with free banking, the basic soundness of the banking and financial systems is critical. It is also important in a country with central banking. Central banks ordinarily serve as lender of last resort to the private banking system, and are expected to come to the rescue of private banks and other financial institutions that become temporarily illiquid. In theory, though not always in fact, central banks do not rescue insolvent institutions. Again, there is a possibility that the asset side of the central bank's balance sheet will be compromised, putting an increased burden on its gold reserves.
Since a gold standard requires imbalances in international payments to be settled in gold, a country's net balance of payments, including both trade and capital accounts, is also an important consideration. Any net outflow of gold will reduce the amount of gold available to support the domestic money supply, forcing either a contraction in the money supply or a higher price of gold.
Another approach might be to take the dollar gold price at some time in the past when the United States was on the gold standard and adjust it for intervening inflation. As suggested previously, this approach could give a dollar gold price quite close to the current market price of $350 an ounce. But there are several problems. An appropriate inflation index and base period must be selected. Many people believe that official, government-prepared consumer price indices often understate the true amount of inflation. The base period must be one where a true gold standard was operating without artificial distortions, which probably means a date prior to World War I.
Of perhaps more significance is the problem of increased productivity. Even with relatively high levels of inflation, the prices of some things decrease as we learn to make them more efficiently. With more stable money, the prices of more items would decrease. Gold mining, too, may benefit from increased productivity, as it has done in recent years. But there is no reason to think that increased productivity in any single industry, be it gold mining or some other, will always match the general level of increased productivity in the whole economy.
Adjusting the dollar gold price for inflation also fails to deal with differences in purchasing power parity between the dollar and other currencies. For example, most measures of purchasing power parity today show the dollar to be undervalued versus the major European currencies, meaning one dollar will buy more goods and services in the United States than one dollar converted to local currencies at current cross rates will buy in these countries. Since a gold standard tends to equalize the purchasing power parity of all currencies, maintaining the current gold price in those currencies implies a higher dollar gold price.
To look for the major industrialized nations to initiate a modernized gold standard expects a lot: a collective fit of honesty and common sense at the highest levels of several
governments. But there is another way that the markets might be utilized to nourish a modernized gold standard, and someday spread it to much of the world. A large country like Brazil or the former Soviet Union might institute meaningful free market reforms, including its own new currency fully convertible into gold at a fixed domestic price.
The problem of setting the gold price in countries which have no existing currency worthy of the name is not at all the same as in a modern industrialized nation. People in Brazil and the old Soviet Union are so hungry for sound money, and the barriers to having it are so great, that the local gold price on the black (free) market is substantially higher than the world gold price. Being gold producers, both countries have native gold that they could use for initial reserves. They also have the ability to generate in local currency some reasonable cost figures for mining gold. With this information, they should be able to peg a new local currency to gold, making sure that gold produced locally will be profitable - perhaps highly profitable in local currency terms - at the then current world price.
Assuming that the country sticks to its new free market economy and gold standard, what is likely to happen and how are world financial markets likely to react? If history is any guide, the economy will start to prosper and grow. Interest rates will start to fall. Foreign investors will become interested, and gold will begin to flow in as they purchase local currency for their investments. Gradually the monetary system of this expanding economy will absorb more and more gold, which will mean less gold on the world market. The world gold price will rise, and with it the international value of the local currency. But as the value of the currency rises, local interest rates will continue to fall, finally reaching the levels historically associated with credible gold-based monetary regimes of the past.
As other nations watch these developments, first one, then another, is likely to peg its own currency to gold. More gold will be taken off the world market, and the world gold price in currencies not fixed to gold will continue to rise. Countries will begin to realize that the longer they wait to join the new international gold standard, the higher the price at which they will have to do so. The dawning of that realization will give new proof to an old saying: "There's no rush like a gold rush."
And who will the big losers be? They will be all the politicians who could not abide the discipline of gold. Alan Greenspan once observed:(11) "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."
Truly great statesmen have understood, far better than Mr. Greenspan himself, the truth of this observation. They have recognized what most modern politicians and economists do not: that there is a moral dimension to money; that sound, honest money is the foundation of economic freedom; and that without economic freedom, individual liberty and the pursuit of happiness become a mirage. With more than their usual eloquence, America's greatest constitutional statesmen - Adams and Jefferson, Madison and Hamilton, Marshall and Story, Webster and Holmes - all condemned unlimited paper money for the constitutional abomination that the last twenty years have once again proved it to be: official theft.(12) When Napoleon assumed command after the hyperinflation of the French Revolution, the financial condition of the government was appalling. Yet he declared: "I will pay specie or pay nothing." He was true to his word, and after Waterloo, with foreign armies on her soil and heavy indemnities to pay, France, on a specie basis, experienced no great monetary distress.(13) After World War I, Winston Churchill, as Chancellor of the Exchequer, returned Britain to the gold standard at the prewar parity because he thought that to do otherwise was to cheat your creditors.(14)
It is not, therefore, surprising that the only American president to be driven from office for dishonesty is also the one who severed the dollar's historic link to gold - a link maintained in a more or less meaningful and credible fashion from the adoption of the Constitution in 1789 to August 1971. Nor is it surprising that this presidential action had the support of the only American treasury secretary ever to go through personal bankruptcy after leaving office.
The fate of the dollar since 1971 is part of a larger picture that includes the explosive growth of public and private debt in the United States and elsewhere, an increasingly casino-
like atmosphere in the world's financial markets, and ever larger financial scandals implicating officials at the highest levels of government and private business. It all brings to mind Lord Byron's lines:(15)
There is the moral of all human tales:
'Tis but the same rehearsal of the past,
First freedom, and then glory -- when that fails,
Wealth, vice, corruption -- barbarism at last.
1. R. P. Lowry, Good Money (Norton, 1991).
2. See, e.g., R. L. Bartley (editor), "The Great International Growth Slowdown," The Wall Street Journal, July 10, 1990, p. A16; R. M.. Bleiberg (editorial page editor), "Floating Rates Sink - The World Economy Needs a Fixed Standard of Value," Barron's, Oct. 2, 1989, p. 11.
3. So far as the author is aware, gold libor is not reported daily in any widely available financial newspaper. During 1991 gold libor has retreated to more traditional levels. Since December 4, 1990, the Financial Times has reported on a daily basis the gold lending rate in dollars. This rate is not the same thing as gold libor. Gold libor is the interest rate on gold loans in which both principal and interest are repayable directly in gold, thus putting the borrower at for any changes in the price of gold. The gold lending rate in dollars is the interest rate on gold loans where interest is payable in dollars based on the dollar value of the loan. Since gold loans are ordinarily made only to the most credit-worthy borrowers in search of the lowest interest rates, the gold lending rate in dollars, like the contango, tends to approximate the treasury bill rate.
4. Most arbitrage in the gold and currency markets is carried out by major banks and bullion dealers having top credit ratings and able to borrow short term money at the lowest rates. What is more, in this example the arbitrageur can put up both the gold and the futures contracts as collateral.
5. J. Wanniski, "Gold-Based Ruble? Two U. S. Economists Urge Hard Money on the Soviet Union," Barron's, Sept. 25, 1989, p.9; W. Angell (interview), "Put the Soviet Economy on Golden Rails," The Wall Street Journal, Oct. 5, 1989, p. A28.
6. A. Reynolds, "Gold and Economic Boom, Five Case Studies, 1792-1926," in B. Siegel ed., Money in Crisis (Ballinger, 1984).
7. A. Greenspan, "Gold and Economic Freedom," in A. Rand, Capitalism: The Unknown Ideal (New American Library, 1966), p. 94.
8. See, e.g., "Greenspan's Retention Emboldens Fed Hawks To Keep Money
Tight," The Wall Street Journal, July 11, 1991, pp. A1, A4.
9. Figures from IMF, International Financial Statistics.
10. For an interesting analysis of the relative merits of free banking versus central banking, see R. M.. Salsman, Breaking the Banks: Central Banking Problems and Free Banking Solutions (Amer. Inst. for Econ. Res., 1990).
11. A.. Greenspan, "Gold and Economic Freedom," in A.. Rand, supra, Capitalism: The Unknown Ideal, p. 89.
12. See, e.g., Works of John Adams, vol. X, p. 376 (Adams-Jefferson correspondence on the subject); The Federalist Papers, No. 44 (Madison) (Modern Library ed. at 290-291); Craig v. Missouri, 29 U.S. (4 Pet.) 410, 442-443 (opinion of the Court by Marshall, C. J.); J. Story, Commentaries on the Constitution of the United States (5th ed., 1891), vol. 2, ss. 1118-1119, 1360, 1372; "Speech on the Specie Circular," Webster's Works (9th ed., 1856), vol. IV, pp. 270-271; Comments by O. W. Holmes in 4 Am. Law. Rev. 768 (1870), 7 Am. Law Rev. 147 (1872), 1 Kent's Commentaries (12th ed., 1873) 254.
13. The story of the French assignats is nowhere better told than in the essay Fiat Money Inflation in France by Andrew Dexter White, founder and first president of Cornell University, who wrote and read it to members of the House and Senate in 1876 in connection with the Congressional debate over the resumption of specie payments.
14. See M.. Mayer, The Bankers (Balantine, 1974), p. 467.
15. Childe Harold, IV, cviii.