Whither Gold? Part 3
Antal E. Fekete

The curse of unemployment

The amount of R&D capital being accumulated by the partnership of the annuitant and
the inventor is the most critical indicator of the future shape and health of the economy.
In the final analysis, this is what makes the difference between a progressive and a
retrogressive economic system. The presence of chronic unemployment in the
economy indicates that inventors are being hampered by social or institutional
arrangements in their efforts to form R&D capital.

From this perspective, the government-run compulsory social security and
unemployment insurance schemes appear highly retrogressive. Apart from the
dubiousness of the procedure whereby the government spends the net premium
income on current consumption while letting future taxpayers shoulder the burden of
disbursing the retired population, and of the procedure whereby the government pays
able-bodied people for not working, there is also the sinister problem of depriving the
inventor from his traditional source of financing. The inventor is condemned to
idleness; at any rate, his efficiency is greatly reduced, and his talents are wasted. The
government-sponsored `safety nets' are retrogressive because they represent the
dissipation of the annuitand's income and the annuitant's wealth, without any
redeeming feature as to promoting capital accumulation, in particular, the accumulation
of R&D capital.

This completes the description of the square model of the capital market, where the
four corners of the square represent the annuitand, the inventor, the annuitant, and the
entrepreneur. The two kinds of partnership that arise in this model correspond to the
formation of (1) entrepreneurial capital, embodied in the partnership of the annuitant
and the entrepreneur, and (2) R&D capital, embodied by the partnership of the
annuitand and the inventor. Often these partnerships are concealed under family

The father is the annuitand (later, annuitant) and the sons the entrepreneur and the
inventor. The family is the primitive social unit, providing the framework for the
exchange of income and wealth among its members, as the need may arise. The square
model of the capital market is a great conceptual improvement over the diagonal model;
still, there is room for further improvement.

A short course on capital formation

Zero interest means direct conversion of income into wealth. As a total denial of
incentives to exchange income and wealth, it forces the annuitand and the annuitant to
revert to atavistic methods of conversion via hoarding and dishoarding the most
hoardable commodity. At zero interest there will be no exchange, only conversion of
income into wealth. The point is that the annuitand and the annuitant do have a choice.
In the absence of incentives they will forgo exchange but will go ahead and make the
conversion, as planned, through other means. The same choice, however, is not
available to the entrepreneur and the inventor.

Unlike the annuitand and the annuitant, they are fully dependent on the agency of
exchange and credit if they want to make the conversion. The square model of the
capital market reveals that the exchange of income and wealth is inherently asymmetric.
While the annuitand and the annuitant can still satisfy their need to convert if the
exchange fails, the inventor and the entrepreneur cannot. For them it is: no exchange --
no conversion. The impairment of bargaining power brought out by the square model
of the capital market will be assuaged as we pass to the pentagonal and hexagonal
models. These models describe the real world more faithfully. Yet it must be clear that
the impairment can never be completely removed. The most important consequence of
this asymmetry is that the rate of interest can be low, but will always remain positive.

The inventor and the entrepreneur can, of course, improve their bargaining position to
some extent if they form a partnership whereby the former provides the income needed
by the latter. As a result, they will be net long on future wealth, and net short on present
wealth. In order for the partnership to be viable, they must find a third partner who is
willing to provide the needed credit in exchanging present for future wealth.

This need has led to the rise of a new actor in the drama of human action. He is the
capitalist, and his entry heralds the advent of the pentagonal model of the capital
market. The rise of the capitalist is hereby explained not in terms of exploitation, but in
terms of services which only a specialist can provide. These services are demanded by
the partnership of the marginal inventor and the marginal entrepreneur. The marginal
inventor (entrepreneur) is the one who has just missed his chance to form a partnership
with the annuitand (annuitant). Without the services of the capitalist, marginal talent
would be wasted. Thus capitalism is seen as a social system which allows individuals
to specialize in the exchange of present wealth for future wealth, in order to enlarge the
scope for entrepreneurial and inventive talent. Much of this talent was lost to society
before the advent of capitalism.

The triangular partnership of the entrepreneur, the inventor, and the capitalist is the
most potent and dynamic force in the economy which society has heretofore produced.
Ludwig von Mises considers the individuals in this partnership the "most progressive
elements in society", benefiting the nonprogressive majority in every possible way. The
particular combination of talent, brain and will-power represented by the threesome
heralds a new epoch of progress, far beyond the capabilities of individual talents if
employed in isolation. There has been many an inventor since paleolithic times whose
genius has been wasted.

The steam turbine was invented in the first century A.D. by Hero of Alexandria; the
aeroplane in the fifteenth by Leonardo da Vinci. The efforts of pre-capitalistic
inventors, for the most part, came to naught, due to lack of capital and
entrepreneurship. The most ingenious technological inventions remain useless if the
capital required for their utilization has not been or cannot be accumulated. Capitalism
must be seen as the liberator of inventive talent, the creator of wealth and prosperity for
the benefit of all. Its creative formula is: the trinity of the entrepreneur, the inventor, and
the capitalist.

One cannot assess the merit of capitalism without explicitly recognizing the great and
durable reduction in the rate of interest it has brought about. Indeed, the only valid way
to bring down the rate of interest is to enhance the bargaining power of the inventor
and entrepreneur vis-à-vis the annuitand and annuitant through encouraging the
activities of the capitalist. If the capitalist is hampered in his activities, then the
annuitand and the annuitant will enjoy unrestricted monopoly power and the rate of
interest will be high. The capitalist is anxious to break this monopoly. As a result of
his competition, the rate of interest has been reduced from the extremely high levels
prevailing in pre-capitalistic times to a low level which puts all bona fide inventors and
entrepreneurs into business.

Even more remarkable is the fact that capitalism has accomplished the feat of reducing
the rate of interest without harming the annuitand and the annuitant. Every member of
society is a beneficiary of the lower rate of interest brought about by capitalism,
through the great increase in the availability of consumer goods at affordable prices,
not to mention the unprecedented increases in wage rates. Only with reference to
capital accumulation can we explain the practically inexhaustible list of prodigious
amenities, and previously unheard-of comfort and security, the high wage-structure, all
benefiting the common man, which is due solely to the lowering of the rate of interest
by rising capitalism.

Many of these great achievements have been frittered away since 1971, the year
governments of the industrialized world declared irredeemable currency to be `money'.
This declaration is directly responsible for the steep rise and gyration of interest rates
during the past twenty-five years, a phenomenon that was previously unknown. The
capricious increase in the level of interest rates has rendered a vast amount of capital
and labor submarginal, caused unemployment, made capital maintenance inadequate
and, ultimately, led to capital decumulation and destruction.

The Shylock-syndrome

The foregoing analysis of the phenomenon of interest in terms of exchanging income
and wealth is far superior to the conventional analysis in terms of exchanging present
for future goods. No one has ever exchanged an apple available today for 1 and 1/20
of an apple available a year from now (still less for 2 apples available 50 years from
now); so the problem of exchanging present for future wealth does not arise out of any
readily identifiable human need (except in the context of the activities of the capitalist
in facilitating the exchange of wealth and income, as discussed above).

Other than this residual activity of the capitalist, the exchange of present and future
wealth has no basis in reality. By contrast, the problem of exchanging income and
wealth arises out of natural and universal human needs: the need for educating the
young and the need of the elderly for an income. This exchange explains the
phenomenon and the nature of interest in terms of the division of labor, that is, by
reaching back to lasting fundamentals. Exploitation, or temptation to exploit one's
economically weaker brethren is not involved. Nor is odium or envy. The needs and
aspirations of market participants, from the annuitands to the capitalist, are harmonious
and complementary.

There is no need to detest the capitalist and to depict him as Scrooge, any more than
there is need to detest the heart surgeon and depict him as a butcher. They are both
specialists, and their role can be understood only in the context of the need for their
specialized services. The capitalist's role only emerges at the margin, after all natural
partnerships between the entrepreneur and inventor have already been formed.

Further advance at this point would not be possible without the services of a specialist,
specializing in arbitrage between present and future wealth. By contrast, if we look at
the problem of exchanging present for future wealth in isolation, before long the image
of Shylock and his pound of flesh is conjured up in the mind. Above all, it is this
Shylock-syndrome that socialist movements have been able to exploit with such
consummate skill, appealing to the authority of Aristotle. This view is nurtured by a
dismally inadequate understanding of the division of labor. As it appears to the
socialists, the contract between lender and borrower demands that the latter be a

Only in uniting in himself the talents of the entrepreneur and the inventor can he meet
the terms of his contract in full. How otherwise could he be expected to return a greatly
enhanced wealth to his creditor at the end of the loan period, without ruining himself?
Surely, the terms of his contract demanding a pound of flesh from any part of his body
was designed with the extinction of his life in mind.

What the socialists' view disregards is that the capitalist is not dealing with one
individual but with a partnership combining the talents and skills of two: the
entrepreneur and the inventor. Had Aristotle understood the problem of converting
income and wealth into one another, and its optimal solution via the agency of
exchange, credit, and the division of labor, the wind would have been taken out of the
sails of socialist agitation before it had a chance to cause so much mischief in the

Instant reward, instant penalty

Another merit of the pentagonal model is that it makes the process of capital
accumulation transparent. If we disregard the primitive accumulation of capital by the
artisan fashioning his own tools, a process that no longer plays an important role in the
economy of the industrial world, then we shall find that capital can only be formed in
one of three possible ways: through the formation of a partnership of (1) the annuitant
and the entrepreneur, (2) the annuitand and the inventor, or (3) the entrepreneur, the
inventor, and the capitalist.

Debt creation does not create capital per se; it only shifts risks implicit in previously
existing partnerships, without necessarily producing new wealth. By contrast, the
formation of capital in any one of the three combinations described here does in fact
create new wealth. Furthermore, the pentagonal model establishes precedence and
control among the five actors in the drama of human action. Thanks to the existence of
these controls capitalism has become an instant reward/penalty system ensuring
unparalleled efficiency. (This, incidentally, may be another reason it is hated so by the

The priorities of capitalist society are not set by bureaucrats or by zealots with the
power of disposal over the fruits of the savings of others, but by the savers themselves
who stand to suffer losses if the project fails. Bureaucratic power under socialism
means that mistakes can be heaped upon mistakes without corrections being made.
Socialism lacks a feedback mechanism that alone can make timely corrections
possible. The hierarchy of controls under capitalism runs along the following lines.
The annuitant has veto power over the plans of the capitalist; the annuitant in concert
with the capitalist has veto power over the plans of the entrepreneur; the annuitand and
the capitalist in concert with the entrepreneur have veto power over the plans of the
inventor. The inventor has no veto power at all, but since there are more annuitands
than annuitants under the conditions of positive population growth, capitalist society
can employ even more inventive than entrepreneurial talent. The field is wide open for
the inventor.

A dynamic society tends to put a premium on new ideas. It has natural built-in
incentives for higher education and advanced studies, even in the absence of
compulsory schooling and government-sponsored research. It is these dynamic forces,
represented by net R&D capital formed by the annuitand and the inventor, which create
educational facilities and equip laboratories. The government can hardly do more than
formalize and standardize these. It certainly cannot guide their destinies -- that would
be the prerogative of their progenitor, the pentagonal capital market. A government that
pretends to do more, one that tries to dictate educational or research priorities, is far
from being progressive. It is, in fact, retrogressive -- as the present analysis shows.

The welfare state as we know it...

The pentagonal model of the capital market explodes the myth of the welfare state.
According to this myth the government can finance welfare projects by taxing away
some of the profits of the capitalist. However, the activities of the capitalist are
marginal, representing but the tip of the iceberg. The incomparably greater part of the
capital that society needs in order to provide annuity income for the aged is furnished
by less visible partnerships between the annuitant and entrepreneur, or the annuitand
and the inventor.

Social security eliminates, or at least severely curtails, voluntary exchange of income
for wealth, and thereby hampers capital accumulation. The welfare state confuses
charity with entitlement, and its huge commitments in putting social security benefits
on the basis of universality have no actuarially sound basis in finance. The making of
these commitments puts the very people out of business whose savings alone can
provide the wherewithal for the projected benefits. We cannot help but view the
capitalist economy as an integrated welfare-machine: individuals voluntarily exchange
goods against goods, goods against services, and income against wealth, increasing
welfare at every turn.

In the process they form voluntary partnerships representing the creation of new
wealth through the capitalization of income. The welfare state cannot invade one part of
this machine, taking over its functions, and expect that the other parts will go on
performing satisfactorily. This invasion means the forcible dissolution of partnerships,
and the dissipation of their capital. The assets disappear, yet the corresponding liability
in the consolidated balance sheet of the nation remains.

It will have to be balanced by printing government bonds, payable in irredeemable
currency. As long as the purveyors of goods and services continue accepting
irredeemable currency in exchange for real goods and services, the game of musical
chairs can go on. But as the capital structure of the nation is seriously eroded, the
production of goods and services become more costly, and producers suffer losses. At
one point they must raise prices or, if they can't, go out of business. Either way, the
benefits promised by the welfare state are jeopardized by currency depreciation and
destruction of capital. The welfare state must be seen against this background: it is an
accomplice in the scheme of currency debasement and, more ominously, in the scheme
to dissipate and destroy the nation's accumulated capital.

During the past year or so the leaders of several industrial nations have solemnly
announced the end of the era of big governments with big deficits, and started talking
about the need to down-size the welfare state. In view of the foregoing analysis, this is
certainly a positive development.

However, these leaders have failed to make the necessary connection between the
welfare state the promises of which are impossible to fulfill, and the regime of
irredeemable currency that can make every promise appear credible that vote-buying
politicians may care to make. The truth is that a meaningful review of the premises of
the welfare state must of necessity include a review of the premises of the regime of
irredeemable currency. Are our politicians ready for such a review?

The gold bond

Further division of labor saw the rise of a sixth participant, the investment banker, and
the emergence of what we may figuratively call the hexagonal model of the capital
market. Just as the rise of the capitalist was explained above in terms of the special
services he was to provide to the marginal entrepreneur and the marginal inventor, so
the rise of the investment banker is explained here in terms of the special services he is
to provide to the marginal annuitand and the marginal annuitant.

The marginal annuitand (annuitant) is the one who has just missed his chance to form
a partnership with the inventor (entrepreneur). Without the services of the investment
banker much of the marginal resources of society would be wasted. No two annuities
are alike, and trading them would be difficult or impossible in the absence of an
instrument readily exchangeable for either. The success of the capital market depends
on the availability of a versatile and standardized trading instrument which can be used
as (1) the standard of capital values, and (2) the balancing item of liabilities on capital

This instrument is the gold bond. It evidences debt payable at maturity in gold, and
provides an interest income till maturity, also payable in gold. The income is
represented by the coupons attached to the bond. The gold bond is traded in a broadly
based secondary market, and a sinking fund is established to make sure that its market
value does not erode with time. It is incumbent on the issuer of the bond to do
everything in his power to keep the market value of the bond stable, if need be, by
retiring some of the outstanding issue prematurely.

It is the price of the gold bond that determines the rate of interest. As prices, the rate of
interest is also an outcome of the market process. However, keep in mind that the bond
market is the epitome of a far larger and far more pervasive capital market
encompassing every conceivable exchange of wealth for income, most of which is not
readily visible. The investment banker's function is clearing and brokering: he matches
the various and varied demands thrown upon the capital market from its five corners.

He enters into partnership with the annuitand, the annuitant, the entrepreneur, the
inventor, and the capitalist, as the need may arise, through his specialized instruments
of mortgage and annuity contracts. He balances the net liability or asset arising from
this activity through his purchase or sale of the standardized instrument, the gold bond.
In effect, the investment banker is doing arbitrage between the six corners of the capital

The hexagonal model of the capital market opens up a great increase in scope for the
most successful combination of production: the triangle of the entrepreneur, the
inventor, and the capitalist. From now on they can form their partnership even if
unbeknownst to one another. The inventor need not waste time in seeking out a
congenial entrepreneur, nor the entrepreneur in finding a suitable inventor.

If the invention is good, and the enterprise is sound, they could immediately start
production on the most favorable terms through the good offices of the match-maker,
the investment banker. Nor does the capitalist have to remain wedded to the same
inventor and entrepreneur for the entire duration of the project. Through buying and
selling gold bonds he can always go after the project that appears most promising to
him. Thus the problem of forming optimal triangles is safely thrown onto the bond

The sterility of gold

Aristotle introduced the concept of natural law and concluded that taking and paying
interest on borrowed money violated it. Gold and silver are, by nature, sterile. Any
return to productive investment belongs to labor in full, no part of it ought to go to the
lender of capital resources. The Church embraced the notion of natural law, and the
usury doctrine became a Church doctrine. Roman Law was combined with the
teachings of Aristotle to become Canon Law.

The prohibition on interest was designed to protect the debtor but, to the increasing
embarrassment of the canonists, it had the exact opposite effect. It increased both the
cost and the risk of doing business. After the Code Napoleon, adopted all over
western Europe, had allowed the paying and taking of interest, the Church, too, decided
to abandon the old usury doctrine. It was quietly buried in 1830, when the Sacred
Penitentiary issued instructions to confessors not to disturb penitents who had lent or
borrowed money at the legal rate of interest.

Recently, mainstream economic orthodoxy has revived the old doctrine of Aristotle
about the sterility of gold. No textbook on economics that mentions gold at all fails to
add that gold is a barren asset, incapable of producing a return. Holders of gold are
portrayed as morons waiting for doomsday, unwilling or unable to do anything
constructive for society. This opinion is echoing Keynes who was the first economist
suggesting that there was something bordering on the neurotic involved in the desire to
hold a sterile asset. However, the neurosis is not on the receiving side of the anti-gold

Rather, it is on the giving side. Governments have pangs of conscience with respect to
their citizens and creditors, with whom they have broken faith on several counts.
Instead of making a clean breast of it, they have made it incumbent upon the economic
profession to develop new doctrines to cover up chicanery and duplicity, to justify
fraudulent bankruptcies, retroactive laws, devaluations and debt abatements. Politicians
and servile economists are still badmouthing gold as if it was a narcotic. They have
triumphantly declared that gold is `dead'. Yet the gold corpse still stirs, and it keeps
haunting the house of cards built upon irredeemable promises.

The phrase `sterility of gold' needs to be scrutinized. For Aristotle it meant that gold,
unlike corn, cannot be sown in the soil in order to harvest more gold later. His
condemnation of usury was dictated by what he conceived to be natural law.
Mainstream economists mean something else by that phrase. They admit that even
corn is sterile in the sense of Aristotle. To reap a harvest takes more than seed corn and
soil. Capital in the form of fertilizers, tilling and harvesting tools must also be
introduced, along with human labor, in order to make the seed corn productive. Seed
corn is just one of the numerous factors of production, and only the full complement
of all these factors can be considered productive.

And, since all these factors can be purchased with money, it is well-understood that
money can be productive in the hands of the entrepreneurs. This fact is reflected by the
willingness of banks to pay interest to depositors on money they pass along to
producers. In this sense it is admissible to say that money is productive: it can earn a
return. Mainstream economists do not deny that gold was productive, in this
generalized sense, under the gold standard. But they insist that, with the advent of the
new millennium, gold has forever lost its former productive power to the irredeemable
bill of credit. Gold has become sterile again. It can earn no return -- only irredeemable
bills of credit can.

It is important for us to realize that every word of the doctrine on the sterility of gold is
an outright lie. Not only can the owner of gold earn a return in gold on his holdings
even under the regime of irredeemable currency, but gold is the only form of tangible
wealth that can be lent out at interest and that is in constant demand as such. There
is a lively gold loan market in the world: gold is put out in loans and is borrowed at
interest on a regular basis. It is used in financing great capital projects as well as trade
-- in the same way (although not on the same scale) as it always did under the gold

Under these loan contracts both principal and interest are payable in gold. Nor is this
something new: gold lending has continued uninterrupted in countries where the
necessary legal protection of contracts involving gold loans has not been abrogated.
`Demonetization' did not succeed in abolishing the lending and borrowing gold at
interest, it only abolished the truth about it. Even students of economics are deliberately
kept in the dark about the existence, functioning, and extent of these gold loan markets.

The reasons for this obscurantism are not hard to find. The rate of interest on gold
loans is low and stable. The much higher and more volatile rates of interest payable on
loans made in irredeemable currency could not stand comparison with it.
Dissemination of truth could raise awkward questions about the legitimacy of the
present monetary regime. People might inquire why they cannot have a monetary
system that would automatically guarantee the lowest possible rate of interest.

3. The Redistribution of Losses

The gold bond is essential to the theory of interest presented in this essay. The
formation of the rate of interest under a regime where interest is payable in
irredeemable currency is an entirely different matter. The central bank's attempt to keep
a lid on the rate of interest is doomed, as this effort incorporates the contradictory aims
of monetary policy and interest-rate policy. Open market operations in bonds can
indeed be used to lower the interest rates that are high due to currency depreciation.

The central bank goes into the open market and buys government bonds. As a result
bond prices go up or, what is the same, interest rates go down. But the flipside of this
is that now there is even more irredeemable currency in circulation. This cannot help
but make the pace of currency depreciation increase. Yet it was the fast depreciation of
the currency that was responsible for the high interest-rate structure in the first place.
In other words, while the central bank is fighting a side-effect of the disease, it only
makes the root cause more entrenched.

Furthermore, under the regime of irredeemable currency malevolent bond speculation
overwhelms and strangles benign bond arbitrage. Recall that under the gold standard
there was no bond speculation -- none whatever. There was only arbitrage between
different maturities, keeping the yield curve in good shape.

The price of bonds, and with it the rate of interest, was remarkably stable, precluding
profitable speculation. But when governments left the path of monetary and fiscal
rectitude and started passing retroactive laws, declaring fraudulent bankruptcy,
devaluing the currency under false pretenses, reneging on gold clauses enshrined in
their bond obligations, and embracing the policy of debt abatement -- they threw the
value of their outstanding bonds to the winds. The arbitrageurs responsible for
maintaining stability in the bond market are gradually forced to vacate the field. Their
place is being taken over by speculators who thrive in volatile markets. The entire
character of the bond market and bond trading has changed beyond recognition.

The rational basis upon which bond values rest was overthrown when
gold-redeemability of the currency was abolished. The fanatic denial of this fact is
central to mainstream economic orthodoxy. Nevertheless, the disappearance of
predictable arbitrage and the advent of unpredictable speculation make for violent and
increasing fluctuations in the rate of interest, throwing the capital markets into a

No longer does the propensity to save regulate the availability of long-term credit
through the mechanism of the interest-rate structure. The regime of irredeemable
currency is characterized by a chronic paucity of savings -- regardless how high the
rate of interest may go. Savers are not blind to the fact that their savings, denominated
as they must be in a depreciating currency, are continually and systematically
plundered. Their protector against plunder, the gold coin, has been ousted from the

But the savers are not entirely defenseless, and they can fight back. They could
consume their savings before further depreciation takes its toll. More ominously, they
can extend their consumption beyond the limits set by existing savings, if they plunge
into debt in an effort to turn a bad situation, created by the depreciating currency, to
advantage. It can hardly be doubted that a lot of this is occurring in the world today.

Crossing the wires at the traffic light

The regime of irredeemable currency creates a disharmony between individual and
society, where harmony has reigned before. Through a false incentive system, this
regime inhibits capital accumulation and, ultimately, it promotes capital consumption.
The need to convert income into wealth is overtaken by the need to protect oneself
against plunder.

The propensity to save is corrupted by the false view that savings can be substituted by
debt. While there are natural limits to debt-creation under a gold standard, all such
limits have been thrown to the winds under the regime of irredeemable currency. The
volume of total debt increases exponentially as interest paid on the old debt is
immediately converted into new debt. The mechanism to liquidate debt has been
dismantled. Debt can no longer be liquidated, and at maturity it is dumped into the lap
of the government.

As for the government, there is simply no way to retire its debt. Redeeming a
government bond in irredeemable currency merely replaces interest-bearing debt by
non-interest-bearing debt (that is, by a less desirable form of debt, making the
debt-pyramid even more unstable). In the meantime total debt is increasing
exponentially, following the law of compound interest. The inordinate growth of the
Debt Behemoth and the ongoing capital destruction inevitably lead to a credit collapse.

The forcible removal of gold from the heart of the credit system in 1971 was
ill-advised. It brought about a radical change in the character of the bond market. It
drove out the arbitrageur, and invited in the bond speculator. The regime of
irredeemable currency crosses the wires at the traffic light. It sends the red signal to
producers when the green signal is intended. High interest rates beget even higher
interest rates, as speculators keep betting on lower currency and bond values.

Threatened by ever higher interest rates, producers are confronted with endless capital
losses. This is a regime of hot money jumping around nervously from place to place,
seeing no safety anywhere, but going from places that seem unsafe to places that, for
the moment, seem less unsafe. This is a regime under which men are afraid to make
long-term plans, or to grant long-term commitments. This is a regime that encourages
farmers to eat the seed corn, the dairy-man to slaughter the milch-cow for the meat, and
the orchard owner to cut down his fruit trees for firewood. This is a regime of junk

The degeneration of the bond market into a casino where gamblers run riot pronounces
a most devastating verdict on the regime of irredeemable currency. Previously all
owners of capital, including the speculators, were subjected to the same discipline, and
were constrained in their activities by a market process making them servants of the
general public.

If they correctly anticipated changes caused by the uncertain future, speculators would
reap profits. But if they failed to do this, then they would suffer losses and, unless they
mended their ways in time, they would lose their capital to others who were better at
serving the public. Now, under a new dispensation granted by the regime of
irredeemable currency, speculators can be self-serving without the obligation to
promote the general welfare. They grow fat on the sweat and blood of the public. All
they need to do in order to make a killing is to out-guess government bureaucrats
whose job it is to manipulate currency and bond values.

The dance of the derivatives

In the economic literature it is customary to make a distinction between stabilizing and
destabilizing speculation. The distinction is spurious. All legitimate speculation is
stabilizing, if by `legitimate' we understand speculation addressing risks inherent in
nature (e.g., weather, natural disasters, etc.) By abuse of language, the word
`speculation' nowadays is applied to market activity that addresses risks presented not
by nature but by arbitrary government action. However, a word already exists in the
dictionary to describe this kind of activity, namely, gambling.

Properly understood, under the regime of irredeemable currency participation in
foreign exchange and bond markets (including derivative markets in futures and
options) is not speculation but gambling. The risks involved have been artificially
created by arbitrary measures. Just as increased participation at the roulette table
cannot reduce the risks of betting (and can often increase them) increased `speculation'
in the bond markets cannot reduce price fluctuations (but is more likely to increase

Under a gold standard speculation in grains is economically justified by the existence
of future uncertainties presented by nature. In the case of an unexpected crop failure or
bumper crop the price disturbance is minimized by the presence of a speculative
supply or demand. No such justification for bond speculation can be offered. All the
risks are wholly artificial and cannot be reduced by inviting speculative participation.

On the contrary, price-swings are likely to increase along with increased participation.
This is a case of pure gambling. The linguistic innovation of calling it `speculation' will
not change its nature. Government economists suggest that the derivative markets in
interest-rate futures have the same salutary effect on interest rates as future markets in
grains have on grain prices. There is not the slightest evidence to support this claim.

The effort to smooth out interest-rate fluctuations under the regime of irredeemable
currency by creating more opportunities for bond speculation and for trading
derivatives in interest-rate futures is doomed. Opening ever more derivative markets
will backfire. More gambling creates more uncertainty, not less. The regime of
irredeemable currency is characterized by insufficient capital accumulation or
maintenance and, ultimately, by capital destruction. It cannot be rescued by legalizing

The `Dance of the Derivatives' of 1994-95 gave a foretaste of what is to come. Banks,
commission houses, pension funds, and even municipal governments are known to
have gambled and to have suffered grievous losses, some irreparable. Observers
blamed the debacle on inept or dishonest traders. A more adroit analysis would,
however, show that disaster had to strike in any case. The same thing would have
happened even if traders had been meticulously following the traditional methods of
hedging and arbitrage.

The truth is that the old rules no longer apply. Once the sheet anchor of gold has been
removed, the character of the game has changed beyond recognition. Previously gold
acted as the policeman keeping speculators in line. Because of the presence of gold in
the system, the speculators could gang up in order to bid up commodity prices, or to
drive down foreign exchange rates and bond values, only at their own peril. Their
bidding would immediately be confronted with relentless arbitrage, exacting a heavy
penalty for reckless bidding. Arbitrageurs could count on gold, the policeman of the
system, in resisting recklessness in speculation.

But with the policeman fired and no replacement commissioned, speculators can gang
up with impunity, induce and ride price trends unilaterally, until they are ready to make
a killing. Speculation has become malignant. Speculators ran up the price of sugar to
75 cents a pound and that of crude oil to $42 a barrel -- and made money all the way
up. They drove down the price of a $1,000 Treasury bond to $500 and the yen-price
of the U.S. dollar to 78 -- and made money all the way down. And they made a killing
when they sold sugar at 75 cents, crude oil at $42; and when they bought Treasury
bonds at $500, the U.S. dollars at 78 yens.

During these episodes arbitrageurs have been conspicuous only by their absence. They
are intimidated in the absence of the police, and are gradually withdrawing their
services. When the last arbitrageur abandons the market, the speculators will have a
field day. They will bid commodity prices up to the sky, and drive currencies and
bonds to the ground. Without the guarantees of the gold standard, no arbitrageur will
be able to oppose the speculators when the bull-run in commodities and the bear-run in
securities start in earnest.

Sweeping losses under the rug

The term `redistributive society', as it is used by both its protagonists and antagonists,
refers to the redistribution of wealth and income -- after they have been produced.
More ominously, a movement to redistribute future losses is afoot. If successful,
losses will be perpetuated and passed on to society. The scheme will allow the indolent,
the inefficient, the inept, and the consistent loss-maker to continue in business
indefinitely at the expense of the industrious, the efficient, and the profit-conscious.

But if the distinction between profit and loss is obliterated, society's internal
communication system may be falsified. Ultimately, production would be thrown into
confusion. The leitmotif of our chrysophobic age can be described as a parade of the
loss-makers. The profit-conscious must be cowed into submission. The gold standard
is anathema to the lobby of the loss-makers, as gold puts profit and loss into the
sharpest focus, separating the adept from the inept, the industrious from the indolent.
The lobby wants a system under which distinction between profit and loss becomes
fuzzy, inefficiency can be covered up, and ineptitude entrenched.

What is true for firms is also true for governments. The post-war monetary system is a
creature of the victors, in particular, of the U.S. and the British governments. Its thinly
veiled purpose is to accommodate indolence and ineptitude in international trade. Its
authors have openly advocated a monetary system that gladly tolerates deficits, and
unhesitatingly penalizes surpluses on current account. In practice the vanquished,
especially the German and the Japanese governments, were forced to make their central
banks a dumping ground for an endless stream of unwanted paper issued by the
victors. The `unlimited demand' thereby created for U.S. Treasury issues makes the
illusion in the public mind that the millennium of irredeemable currency has indeed
arrived at the long last.

We should be well-advised not to fall victim to this hoax. We should not be misled by
the docility of the German and Japanese governments in playing faultlessly their
preassigned role in the farce. They have absorbed losses counted in trillions, without
ever saying "ouch". The Japanese started accumulating irredeemable paper when it cost
them 360 yens to buy one dollar -- as opposed to the 1995 low of 78 yens to the
dollar. The corresponding figure for the Germans is 4 1/2 marks to the dollar initially
-- as opposed to the 1995 low of 1 1/3 marks to the dollar.

The Germans and the Japanese are still sitting on mountains of paper losses that
nobody is reporting, still less willing to discuss. Yet it is the destiny of paper losses
that sooner or later they must be realized. Could it be that the collapse of the stock
market in Japan earlier in the decade, the present banking crisis there, and the recent
weakening of the German financial structure, are signs of the beginning of the end?
Losses are a stubborn thing. They refuse to go out of existence, no matter how docile
the victims of the redistribution of losses may be. This is a dangerous game of
deception that governments can continue playing only at their own peril.

4. Whither Gold?

Gold in the monetary system makes for stability and efficiency. One cannot disparage
either of these virtues any more than one can disparage motherhood. A low and stable
interest-rate structure, in particular, cannot be achieved without making credit
gold-bonded. This elementary truth is now in the public domain, even though our
universities have been somewhat tardy in accepting it. But the U.S. Congress would be
well within its constitutional authority if it provided monetary leadership in the world.
It is possible that a majority of members in that body will come to realize that, in order
to be master in their own house, they must get hold of the wildcard in the pack. If they
want to control the budget deficit, they must regain control over the cost of debt
servicing -- the very wildcard they haven't got. In order to get hold of the wildcard,
Congress must once more make the public debt gold-bonded.

As debt payable in irredeemable promises is being phased out, and gold-bonded debt
is being phased in, the interest-rate structure will be stabilized at the lowest level
compatible with the state of the economy. Only then can a meaningful program of
deficit and debt reduction be implemented. As long as the wildcard is out, a collapse in
the bond market will remain a constant threat, as sky-rocketing interest rates can
frustrate any plan for deficit reduction.

The expertise in how to execute the transition exists within the Halls of Congress. In
1989 Representative William E. Dannemeyer of California (now in retirement)
pioneered a scheme of deficit reduction based on the idea of turning
short-term/high-cost debt by long-term/low-cost debt. The miracle of turning water
into wine can be accomplished by making the debt gold-bonded. Presently Senator
Bennett of Utah is championing a similar plan. With the aid of gold the Debt
Behemoth could be reined in -- provided the political will and statesmanship is there.

How to cork the genie in the bottle

Why is gold relevant to-day? Clemenceau's saying that "war is too important to leave
to the generals" may be paraphrased as "interest rates are too important to leave to the
central bankers". The genie of interest rates has been let out of the bottle and nobody,
not even Aladdin Greenspan, can tame it. There is too much destruction and
uncertainty in the world caused by gyrating interest rates. It is time to put the genie
back into the bottle, and cork it.

This is where gold comes in. Only a golden cork will do. The genie has learned how to
sneak through corks made of paper. We don't even have a coherent theory of interest
without reference to gold. Under the regime of irredeemable currency interest is merely
bribe-money, trying to persuade reluctant holders of irredeemable promises to hang on
awhile longer. The maturity structure of the U.S. public debt is contracting. Clearly
this process cannot continue indefinitely. The size of the bribe expected increases with
the amount of the fast-maturing debt.

Gold cannot be wished away from the credit system. It is there, like it or not. Gold is
the only conceivable standard of borrowing. The lowest rate of interest is available for
gold-bonded debt -- and for no other. Loans payable in irredeemable currency carry
progressively higher rates of interest. How high they go depends on public fear of
currency depreciation.

Paradoxically, gold's importance is growing while its dispersal from official hoards
and the mines continues apace. Dispersed gold represents latent power, far greater in
scope than its nominal market value, as sound credit can be built only upon a gold
base. When the dispersal of gold reaches a certain threshold (nobody knows where
exactly this threshold is), a metamorphosis of money will take place. Gold will reclaim
its throne as constitutional monarch in the monetary and credit system of the world.

Unfortunately, the transition may not be trouble-free. Procrastination in overdue
monetary reform brings with it the danger of a credit collapse -- similar to that
experienced under the Great Depression of 1929-39, causing widespread economic
pain in the world. Educating public opinion to look at gold as a gift of Prometheus,
rather than Pandora's box, after 75 years of vicious chrysophobic agitation and
propaganda, presents us with a formidable task. Yet we must do what we can to
disseminate the truth about gold.

The consequences of the alternative, a credit collapse engulfing the entire world, are too
horrible to contemplate.


Carl Menger: Grundsätze der Volkswirtschaftlehre, first published in 1871;
American edition: Principles of Economics, New York University Press, 1980

Ludwig von Mises: Human Action, Chicago, 1972

F. A. Hayek: Commodity Reserve Currency, Economic Journal, vol. LIII, no 210
(1943), reprinted in Individualism and Economic Order by F. A. Hayek

John Maynard Keynes: A Treatise on Money, in two volumes, London, 1930

Robert Hinshaw, ed.: Monetary Reform and the Price of Gold, Baltimore, 1967
(Conference proceedings; see Robert Mundell's contribution)

Milton Friedman: Money Mischief, New York, 1992.

Richard M. Salsman: Gold and Liberty, Great Barrington (American Institute for
Economic Research) 1995.

October 29, 1996.

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