Whither Gold? Part 1
|Antal E. Fekete|
Winner of the 1996 International Currency Prize
Sponsored By Bank Lips
Antal E. Fekete
Memorial University of Newfoundland
St. John's, CANADA A1C 5S7
The year 1971 was a milestone in the history of money and credit. Previously, in the
world's most developed countries, money (and hence credit) was tied to a positive
value: the value of a well-defined quantity of a good of well-defined quality. In 1971
this tie was cut. Ever since, money has been tied not to positive but to negative values
-- the value of debt instruments.
This innovation has had two immediate consequences, both of which are pointedly
ignored in the technical and scholarly literature on the subject: (1) the power to
reduce the world's total debt in the course of normal payments has been lost: total
indebtedness can now be reduced only through default or through currency
depreciation; (2) countries have lost the option to balance their current accounts with
the rest of the world: each country has to cope with unending deficits.
The exception is a couple of countries that have been coerced into holding the debt of
the world, upon which the burden of default and currency depreciation will eventually
fall: Germany and Japan. As a result of these two features the world's monetary
system, which previously was patterned on the model of an anchor, is now patterned
on the model of a weather vane. As the tide of unpaid and unpayable debt grows, so
the value of money ebbs.
That we have lost the facility to reduce the world's total indebtedness without
resorting to default or monetary depreciation becomes clear at once if we consider
the fact that a debt of x dollars can no longer be liquidated. If it is paid off by a
check, the debt is merely transferred to the bank on which the check is drawn. The
situation is no better if it is paid off by handing over x dollars in Federal Reserve
notes, ostensibly the ultimate means of payment. In this case the debt is transferred
to the U.S. Treasury, the ultimate guarantor of these liabilities. But substituting one
debtor for another is not the same as liquidating the debt. The very notion of `debt
maturity' has lost all reasonable meaning previously attached to it. At maturity the
creditor is coerced into extending his original credit plus accrued interest in the form
of new credits, usually on inferior terms. It is true that the option to consume his
savings remains open to him -- but is it not a strange monetary system, to say the
least, which forces the savers to consume their savings whenever they are dissatisfied
with the quality of available debt instruments, or with the terms on which they are
Mainstream economic orthodoxy teaches that a depreciating currency is a boon to
the country, and a valid tool in the hands of the government to increase
competitiveness and thus to reduce or to eliminate the current account deficit. A
debased currency makes the country an attractive place for foreigners in which to
buy and an unattractive place in which to sell. Exports are boosted, imports curtailed;
thus the deficit is narrowed.
This is one of the most pernicious doctrines ever concocted -- as demonstrated both
by theory and practice. Deliberate currency depreciation puts the country at a clear
disadvantage, causing its terms of trade to deteriorate. As all items for export have
imported components, no one can maintain for long low export prices in the face of
ever rising cost of imports. This theoretical remark is fully borne out by history as
shown, for example, by the experience of the United States during the past 25 years.
As the American government has been crying down the (yen) value of the dollar, the
terms of trade of the U.S. vis-a-vis Japan is greatly undermined, creating an
unending stream of trade deficits which the Japanese are obliged to finance. To be
sure, the Japanese are also depreciating the value of their currency. But as long as
they do it at a lower rate, which is what the Americans demand that they do, Japanese
trade surpluses will continue unabated.
The grievous faults of the prevailing monetary arrangements raise serious questions
about the regime's stability and durability. The governments are busily constructing
an enormous Debt Tower of Babel, apparently without giving the slightest thought to
the wisdom or safety of their construction. The year 1996 marks the twenty-fifth
anniversary of the Brave New World of reckless debt breeding. A quarter of a
century is not a great length of time in the course of history. But it might be
sufficiently long to warrant an examination of this deliberate policy of heaping more
debt upon unpaid and unpayable debts.
Has the policy of unbridled credit expansion, blindly embraced by the governments
of the world some 25 years ago, served the people well? Or do the negative results of
this experiment call for a more careful examination of the principles involved than
hitherto provided? The question is not raised, and the anniversary is being ignored by
the opinion-makers. A great deal of obfuscation surrounds the issue.
Officially, the topic is off limits to scholarship and research. Anyone who dares to
question the legitimacy of the world's present monetary arrangements, or challenges
the doctrine that the regime of irredeemable currency represents `progress' over
`obsolete' metallic monetary regimes, is browbeaten; his reward is official ostracism.
Professional standing is reserved for those who pay lip service to the dogma that
`emancipation' from a metallic monetary standard was a progressive, even necessary,
This essay attempts to defy the odds. It intends to show that the essence of the gold
standard is not to be found in its ability to stabilize prices (that is neither desirable
nor possible). It is to be found in its ability to stabilize the interest-rate structure at
the lowest level compatible with economic conditions, and thereby to keep debt
within limits. In the absence of a gold standard, efforts to keep the rate of interest
under control are doomed.
Rising and gyrating interest rates bring about a wholesale destruction of values, as
can already be seen in the bond and real estate markets (not to mention the Japanese
stock market). Further delay in putting the cancer-fighting gold corpuscles back into
the monetary bloodstream may bring about a credit collapse and chaotic conditions
in the world economy, eclipsing the memory of the Great Depression.
1. A Brief History of Money
It was Carl Menger who in his epoch-making book Grundsätze der
Volkswirtschaftlehre (first published in 1871) elucidated the origin of money in
terms of an evolution from direct to indirect exchange. Menger introduced the
Principle of Declining Marginal Utility asserting that anybody acquiring subsequent
units of the same economic good will earmark the last unit for uses with lower
priorities than those assigned to previously acquired units.
This is paraphrased by saying that the marginal utility of an economic good is
declining. It is possible to rank goods according to the rate of decline in marginal
utility. The economic good with a marginal utility declining more slowly than that of
any other is destined to become money.
Constant marginal utility
In fact, the decline in the marginal utility of money is so slow that it may be
considered negligible, so that the marginal utility of money is constant. In 355 BC a
keen observer of antiquity, Xenophon, in his work Ways and Means, a Pamphlet
on the Revenues of Athens, described what we herein call the constant marginal
utility of money in these words:
"Of the monetary metal, no one ever possessed so much that he was forced to cry
"enough!" On the contrary, if ever anybody does become possessed of an
immoderate amount, he finds as much pleasure in digging a hole in the ground and
hoarding it as in the actual employment of it. And, from a wider point of view, when
the state is prosperous, there is nothing that people so much desire as money. Men
want money to expend on beautiful armor, fine horses, houses, and sumptuous
paraphernalia of all sorts. Women betake themselves to expensive apparel and
ornaments. Or, when the states are sick, either through barrenness of corn and other
fruits or through war, the demand for current coin is even more imperative (whilst the
ground lies unproductive) to pay for necessaries or for military aid. And if it be
asserted that another metal is after all just as useful as the monetary metal, without
gainsaying the proposition I may note this fact, that with a sudden influx of the
former, its value is depreciated, while causing at the same time a rise in the value of
the latter. "
The practical significance of the constant marginal utility of money can best be seen
through examples. The government may open the Mint for the free and unlimited
coinage of a certain metal only if the marginal utility of that metal is constant.
Equivalently, the Central Bank may post fixed bid/asked prices for an economic
good only if it has constant marginal utility. This quality alone will guarantee an
orderly and controlled flow of the metal into circulation in the form of coined money,
and will make the orderly exchange of coined money for credit instruments possible.
If the government violates this principle, then the Mint and the Central Bank will be
buried under an avalanche of inferior metal.
This in fact happened in the 1870's. People continued to overwhelm the mints and
central banks of the Latin Monetary Union with silver, while draining away their
gold. In the end the governments threw in the towel, closed the mints to silver, and
instructed their central banks to stop the deluge by lowering the price of silver in
terms of gold. In doing so the governments were eating their words, as this
effectively demonetized silver -- something they had said they would never do. The
demise of bimetallism is an interesting episode in monetary history, yet it is not well
understood by authors. Ludwig von Mises writes in Human Action:
In the second part of the nineteenth century more and more governments deliberately
turned toward the demonetization of silver . . . The important thing to be remembered
is that with every sort of money, demonetization -- i.e., the abandonment of its use as
a medium of exchange -- must result in a serious fall of its exchange value. What
this practically means has become manifest when in the last ninety years the use of
silver as commodity money has been progressively restricted (op.cit., PP 428-9).
This appears to confuse cause and effect. In reality, the demonetization of silver was
not the cause but the effect of the decline in the relative value of silver. Moreover, it
was not the governments but the markets that did the demonetizing. Elsewhere in the
same book Mises confirms this:
"The emergence of the gold standard was the manifestation of a crushing defeat of
the governments and their cherished doctrines. In the seventeenth century the rates at
which the English government tariffed the coins overvalued the [gold] guinea with
regard to silver and thus made the silver coins disappear. Only those silver coins
which were much worn by usage or in any other way defaced or reduced in weight
remained in current use; it did not pay to export and to sell them on the bullion
Thus England got the gold standard against the intention of its government. Only
much later [did] the laws make the de facto gold standard a de jure standard. The
government abandoned further fruitless attempts to pump silver into the market and
minted silver only as subsidiary coins with a limited legal tender power . . . . . Later
in the course of the nineteenth century the double standard resulted in a similar way
in France and in the other countries of the Latin Monetary Union in the emergence
of de facto gold monometallism. When the drop in the price of silver in the later
seventies would automatically have effected the replacement of the de facto gold
standard by the de facto silver standard, these governments suspended the
[unlimited free] coinage of silver in order to preserve the gold standard (op.cit.,pp
It would be more accurate to allude to government efforts "to pump silver back into
the market" -- silver that people were dumping at the doorstep of the mints. It was, of
course, not any affection for gold, nor lack of affection for silver, that caused
governments to abandon the latter. Governments were silverite by instinct.
Moreover, bimetallism had been a lucrative, if illegitimate, source of revenues to
them. They fought a fierce rear-guard action. But at one point they realized that the
battle to save bimetallism had been lost as silver no longer had the necessary
characteristic of a monetary metal: it no longer had constant marginal utility. Further
resistance to market forces would have meant unsustainable losses. The lesson from
this historical episode is that the hands of the governments can be forced by the
people. It was the market that brought about the de facto demonetization of silver in
the 19th century. The writing is on the wall that it may bring about the
demonetization of irredeemable currencies in the 21st.
The fixed bid/asked prices the Central Bank may post for the monetary metal, gold,
are also called the lower/upper gold points, respectively. These points are not
determined arbitrarily; they are, in fact, market prices. The upper gold point is closely
related to the gold export point above which the standard gold dollar is worth more
in melted than in coined form (making it profitable to export it); the lower gold point
is closely related to the gold import point below which gold is worth more in coined
than in bullion form (making it profitable to deliver imported gold to the Mint --
which explains how these points earn their names).
The most important consequence of constant marginal utility is the fact that the utility
of money is proportional to its quantity, and money is the only economic good with
this property. This fact was instrumental in the disappearance of barter. Because of
declining marginal utility, barter involves losses. One can minimize these losses by
bartering for goods with more slowly declining marginal utility. Clearly, the best
terms of trade are reserved for those who barter for (with) the good having constant
It is a misunderstanding to suggest, as Ludwig von Mises does (op. cit., p 404) that
the concept of constant marginal utility is contradictory because it is synonymous
with infinite demand. Rather, it is the concept of demand that is contradictory, and
should not be used in deductive science except, perhaps, in a metaphorical sense. The
appropriate interpretation of constant marginal utility is this: people are willing to
accept money in discharge of debt in unlimited quantities, not because they want to
hold wealth in the form of unlimited quantities of money, but because they
understand that the way to minimize the inevitable losses inherent in any exchange is
to execute it through the agency of money.
Under the gold standard all the gold above ground is deemed to be on offer for
sale, as it is deemed to be in demand. The value of the unit weight of gold is
independent of the number of available units. By contrast, consider the value of the
unit weight of iron. Certainly not all the iron above ground is on offer for sale. The
first unit weight of iron has a much greater utility to its owner than the one acquired
last. The value of iron is determined by its declining marginal utility, making it
depend on the quantity available. The difference in the behavior of the two metals in
exchange is obvious.
Menger introduced the concept of marketability of goods (Absatzfähigkeit) in order
to elucidate the emergence of indirect exchange. A commodity with a lower rate of
decline in its marginal utility is more marketable than another with a higher rate. The
monetary commodity is the most marketable good, preferred by all market
participants, even if they have already satisfied all their personal needs for it. `Most
marketable' is synonymous to `having constant marginal utility'. There is no need to
quibble about the use of the word `constant' in this context.
The lowest rate of decline will result in a marginal utility that is constant for all
practical purposes, as the marketability of the commodity with that property will
`snowball' in time. The first gold coin received by an individual certainly has the
same utility to him as the last: he can exchange both coins on exactly the same terms.
The evolution of the monetary standard as the economic good with constant marginal
utility or highest marketability is the crowning event in the transition from direct to
indirect exchange, replacing the barter system with the monetary economy. The
subjective theory of value, which explains price formation as a convergence
phenomenon (as opposed to the quantity theory of money that explains price
formation as an equilibrium phenomenon) is a consequence of that evolution.
Convergence is a process, while equilibrium is state. The market is narrowing the
price range within which transactions take place, in response to the activities of
arbitrageurs. This analysis of price formation shows how the market process
ultimately translates marginal utilities into market prices.
The rise of indirect exchange has also made it possible for the first time to
distinguish between buyers and sellers. Under barter no such distinction could be
made. The emergence of money separates the buyers who give up and the sellers
who expect to receive the monetary commodity in the exchange. It is precisely his
command over the monetary commodity that puts the buyer in charge -- making the
sellers his servants. His control over the monetary commodity gives the buyer a
choice. He can buy, or he can refrain from buying. Sellers don't have the luxury of
choice. If they don't sell, then they admit to failure and have to drop out of the rank
of sellers. It is interesting to note that the regime of irredeemable currency attempts
to abolish this prerogative. It puts pressure on the buyers to buy indiscriminately,
before their buying power is further eroded by currency depreciation.
The role of plunder
There is a certain confusion prevailing among authors in regard to the objective
versus subjective nature of the value of money. It cannot be denied that all
economic phenomena, including the value of money, find their ultimate explanation
in the subjective value-judgments of individuals.
However, through a long chain of causation taking place over very long periods of
time, a cumulative economic process has lent an objective character to the value of the
monetary commodities. The value of a monetary commodity is the result of an
evolution that took millennia to complete. Consumers, producers, and other actors in
the economic drama tend to keep sizeable stores of the monetary commodity on hand
(partly because constant marginal utility makes money an ideal place where to park
The cumulative effect of this causes the combined stocks of the dispersed monetary
metal to reach a singularly high level, relative to the rate of annual production. As a
consequence, the stocks-to-flows ratio (total stocks divided by annual production)
eventually becomes a high multiple, quite unheard-of for other commodities. In the
case of gold this ratio has been estimated to be 50. This means that the total world
stock of gold is about 50 years' production at present rates of output. The same ratio
for a non-monetary commodity is usually a small fraction, at any rate, no higher than
1. The ratio 1 may be reached in case of staple food items harvested once a year, at
harvest-time. This means that society is not willing to carry in store more than a few
weeks' or months' supply of most economic goods. The only exceptions are the
As the stocks-to-flows ratio for the monetary metal is so high, the likelihood of an
upstart commodity displacing it is remote. In order to bring about such a change it
would be necessary to accumulate stocks -- a process that might take hundreds of
years. (The displacement of silver by gold in the second half of the 19th century was,
in effect, a case of monometallism replacing bimetallism -- not a case of one
monetary commodity replacing another, as explained above.)
Thus the hegemony of the monetary metal, once established, can hardly be
challenged. It is possible to argue that the value of gold, unlike that of other goods, is
objective. It is rooted in the objective fact that the world's accumulated stock of gold
is a high multiple of the annual flow of new metal from the mines -- a fact
independent of subjective value judgments. As already stated, this is not to deny that
ultimately value must be explained by subjective considerations; but in assigning a
subjective value to gold the human mind first must deal with the objective fact that
large and well-dispersed stocks of gold exist, relative to which the flow of new gold
from the mines is small.
The suggestion that the value of the monetary metal has often fallen, constant
marginal utility notwithstanding, reflects a confusion of ideas. Historical examples
cited in support of that suggestion are the dispersal of Persian gold after the sack of
Persepolis by Alexander the Great in 331 B.C., and the dispersal of the Inca's silver
and gold after the sack of Cuzco by Francisco Pizzaro and the conquistadores in
Both events have been followed by periods of pronounced and prolonged price rises
all over the trading world, making the impression that the monetary metals have lost
value. The pat explanation offered for this phenomenon is the quantity theory of
money. The value of silver and gold is no different from the value of other
commodities -- so the argument goes. They are determined by available quantity.
Whenever they become more abundant, as they did in 331 B.C. and again in 1533
A.D., these monetary metals suffer a loss of value.
However, the suggestion that the value of gold may decline under a gold standard is
preposterous. The length of a measuring rod in terms of itself as unit is always 1.
The correct interpretation of these historical episodes has nothing to do with the
quantity theory of money, which is a pernicious doctrine. An across-the-board
increase in prices is one thing, and loss of value of the monetary unit is another. The
former may occur in case of general scarcity, quite independently of the latter. In
analyzing these historical episodes we must carefully note the role of plunder in each
Wherever large stores of certain goods fall prey to plunder, scarcity results. The
prices of these goods rise, and will stay high as long as scarcity persists. An apparent
exception to the general rule is the plunder of stores of precious metals that is never
followed by a rise, but is often followed by a fall in value. Can this paradox be
reconciled with the Principle of Declining Marginal Utility? Well, I argue that the
value of gold cannot fall, any more than the value of other commodities can, as a
result of plunder. The key to the paradox is the fact that plunderers do not want gold
for its own sake -- just as the bank robbers do not want bank notes for their own
sake. What they ultimately want is a host of goods. Bank robbery is the quickest
way to loot society's store of marketable goods.
Likewise, when a large store of gold is plundered, it is economically equivalent to the
plunder of stores of all kinds of marketable goods. Thus, then, price rises in the wake
of plundering gold are explained by the subsequent scarcity of marketable goods.
Higher prices always and everywhere indicate greater scarcity of goods -- never a
greater abundance of gold.
Plunder -- modern style
In the same light I wish to examine the across-the-board price rises that occurred
under the gold standard in 1896-1921 and, again, in 1934-1968. These episodes are
no more explained by a greater abundance of gold than are those of 331 B.C. and
1533 A.D. The key to the understanding of these, surprising as it may sound, is also
plunder -- making marketable goods relatively scarcer. It is true that the plunder
involved is of a subtler kind than the brutal events of 331 B.C. and 1533 A.D. Subtle
or not, plunder remains plunder. Here is what happened.
As monometallism was gaining ground over bimetallism, there was a great increase
in gold prospecting and production. However, a funny thing happened to gold on its
way from the mines to the mints. Central banks hijacked it, in order to build a
credit-pyramid, up to twenty times as great, upon their increased gold reserve.
Without this interference from the banks there would have been no extra demand for
marketable goods and, hence, no price increases -- regardless how fast output of new
gold may have grown.
The new gold would have entered circulation in coined form. The Haberler-Pigou
effect, to be described in the next paragraph, would have prevented any
across-the-board price increase. The real cause of price increases in the inflationary
episodes of 1896-1921 and 1934-1968 was not the pronounced increase in gold
output. It was the unwarranted credit expansion engineered by the central banks that
hijacked the gold.
The same is true of the California gold rush and other similar episodes. Prices of
goods and services rose in California in the wake of the 1848 discovery of gold
because of the scarcity caused by the influx of newcomers. But why did prices also
rise in New York and elsewhere a little later? Well, they did because of the
unwarranted credit expansion that the banks in New York and elsewhere constructed
upon the hijacked gold that was not allowed to flow into circulation. If anyone denies
this proposition, then he assumes the burden of proof that no credit expansion took
place following the California gold rush -- clearly an impossible task.
Consumers controlling the gold coin could effectively resist price rises either in
delaying purchases, or in buying alternative products and in shifting custom. An
across-the-board price increase would represent a capital loss inflicted upon holders
of the gold coin, who would scramble to recoup their losses by restricting purchases.
Voluntary restraint on consumption is the ultimate factor blocking price increases.
Note, however, that the Haberler-Pigou effect operates only on the gold component
of the money supply, but not on the credit component.
As far as the latter is concerned, restricting purchases is an empty gesture. It is true
that the holders of bank notes also suffer capital losses represented by the price rise
but, because they are creditors to the extent of their holdings of fiduciary media,
another group of people -- their debtors -- will have experienced an equivalent capital
gain. The stepped-up spending of the latter group will offset the spending restraint of
the former, and the net result is an across-the-board increase in prices. (For more on
the Haberler-Pigou effect see: R. Hinshaw, ed., Monetary Reform and the Price of
Gold, Baltimore, 1967.)
Abolishing the gold standard because it could not prevent price rises due to plunder
(followed by a collapse in prices) is akin to putting the bearer of bad news to death.
Gold was simply doing its job in reporting the extent of economic disruption caused
by plunder, credit expansion, flood, earthquake, war, etc. In no way can gold be held
responsible for the disruption itself.
Rumors about the death of the gold standard are grossly exaggerated. In 1930
Keynes correctly described the impact of the two great historic dispersals of gold on
the future monetary role of the metal in his book A Treatise on Money. He made a
convincing case that dispersal of gold from fewer to more numerous hands has
always been instrumental in promoting the monetary qualities of the yellow metal.
But Keynes went on to prophesy that the exact opposite would take place in the 20th
century -- probably having a fatal effect on gold's future prospect to continue as the
monetary metal par excellence.
What he referred to was the weaning of the public from the gold coin, the
concentration of gold in central bank vaults, and the unprecedented increase of bank
notes in circulation. We need not be surprised that Keynes avoided using the word
`plunder' to describe this process: he himself was the chief instigator of the trick of
"taking gold away from man's greedy palms".
However, Keynes' prophecy concerning gold's future fell short of the mark. Keynes
failed to foresee the coming of the third (and so far the greatest) dispersal of gold a
generation after his death in 1947. It took the form of a great official gold dumping,
ushered in by the U.S. Treasury gold auctions in 1974, followed by further auctions
of central bank gold under the aegis of the International Monetary Fund (IMF).
Later the auctions were suspended -- possibly because it was belatedly realized that
the U.S. Treasury and the IMF had made themselves the laughing stock of the
They were throwing away their most reliable asset in exchange for irredeemable
promises to pay -- at ludicrous prices to boot. Still, official holders such as Canada,
Belgium, and the Netherlands occasionally dump gold on the market. Moreover, in
1995 there was more talk about new IMF gold give-aways (ostensibly to raise funds
for economic aid to support the less developed countries). Thus the third great
dispersal of gold is still continuing. It may be confidently predicted that the ultimate
effect will be the same as that of previous historic dispersals: a reconfirmation of
gold's position as the paramount monetary asset of the world.
The irony is that the authors of these gold dumpings were the most ardent students
of Keynes, but they completely misunderstood the teachings of their prophet about
the consequences of gold dispersal. When all has been said and done, these authors
will appear as foolish as King Canute ordering the ocean to recede.
It is the task of the government and the legal system of the country, in order to
preserve civil conduct in the market place, to define the standard of weights and
measures, and to define the standard of value by issuing coinage and, in case of
non-performance on contracts or in case of fraud, to compel the delinquent party to
live up to his side of the bargain, through the use of the government apparatus of
coercion. However, this ideal has often been corrupted by governments misusing
their prerogative, in defining the standard of weights and measures capriciously, in
order to favor a minority at the expense of the majority. This type of government
intervention in the voluntary exchanges of market participants is no longer practiced.
Public opinion would not tolerate the arbitrary shortening of the standard unit of
length through the device of crowning an infant king, and declaring the length of his
foot the new standard.
Just how much this improvement in government policy is due to enlightenment and
proper sense of justice, and how much to the changing parameters of public
ignorance, can be decided only after considering the fact that it is still not below the
dignity of governments to tamper with the standard of value capriciously, in order to
favor a minority at the expense of the majority. Governments have found that the
level of general ignorance concerning the nature of value is such that public opinion
can suffer the affront of manipulating the standard of value.
Out of sheer ignorance, people meekly accept the consequences of this policy of
victimization. In fact, governments of the 20th century have carried the practice to its
ultimate. They have accomplished what no government in the long history of
civilization has been able to do, hard as they may have tried. Governments can now
tamper with the standard of value on a monthly, weekly, daily, or hourly basis with
impunity, through the instrument of irredeemable currency, and through open-market
operations in the foreign exchange and bond markets. Governments not only get
away with this dangerous prestidigitation: they are lionized for performing it. (Part of
the explanation for the anomaly of our "ignorance amidst informational bounty" is
the subtle control governments have over education -- but that is another story.)
Before the tampering with the standard of value was developed into the high art of
deception it is to-day, governments wishing to alter the terms of trade in favor of a
minority at the expense of the majority could only do so at their own peril. They
always had the prerogative to coin money. But in attending to this task governments
did not create money, still less wealth. An economic good becomes money only by
virtue of the public's preference in making its marginal utility constant. Governments
don't select the monetary metal: that is the market's prerogative. The government
stamp placed upon a piece of metal does not create value; all it does is to certify the
weight and fineness of the coin. The purpose of stamping is to obviate weighing and
the application of the acid test to each gold piece at every exchange. It is to facilitate
the circulation of coins by tale rather than by weight.
Whenever governments have resorted to debasing the standard of value by issuing
coins of a baser alloy, but with the same stamp, the same name, and the same outward
appearance of coins, they knew full well that they were engaging in a fraudulent
attempt to cheat the public. To the extent that it took time to expose the fraud,
governments have been making an illegitimate profit, and they have been enriching a
favored minority (the export merchants) at the expense of the unsuspecting majority
(the domestic consumers). But after the fraud is exposed, as sooner or later it must
be, the debased coins go to a discount representing the extent of debasement.
Governments have insisted that it is not the alloy but the stamp that has made the
coins valuable. They have declared it illegal to discriminate against light coins in
favor of the heavy ones. They have declared maximum prices. Violation of the `law
of maximum' has sometimes been made punishable by death. But as the
government's writ stops at the border, and people on the other side are free to
separate the light from the heavy coins as they see fit, the coin debasers are forced to
admit that their policy is a failure. However, tampering with the standard of value
continues. Techniques do change -- the intent to benefit a favored minority at the
expense of the unsuspecting majority does not.
Bimetallism -- stratagem to benefit a minority at the expense of the majority
As two precious metals, silver and gold, were used side-by-side as money,
governments declared a statutory bimetallic ratio at which the monetary metals were
to be valued at the Mint. We may bypass the question whether it was ignorance or
deviousness which motivated governments to enforce a rigid bimetallic ratio, in
pretending that value could be created or altered by legislation. Be that as it may,
bimetallism was dear to the heart of governments as it offered an opportunity to
tamper with the standard of value on a regular basis. This is how it worked.
The public would deliver the overvalued metal to the Mint, making this metal the de
facto monetary standard, while using the undervalued metal for payments abroad
where it commanded a higher value. In this way one monetary metal always appeared
to be abundant, while the other appeared to be scarce before disappearing altogether.
It was the inconvenience to trade caused by the abundance-cum-scarcity of
bimetallic coinage that gave occasion to repeated tampering with the standard. To
grant relief, governments would alter the bimetallic ratio in favor of the scarce metal.
This would cause the abundant coins to become scarce and the scarce coins to
become abundant. The wrong shoe was now on the other foot, and the game of
changing the bimetallic ratio could start all over again.
It should be clear that whenever a change in the standard unit of value is proposed,
some people stand to gain (namely those net long in the metal to be overvalued, or
net short in the metal to be undervalued by the impending change), while others stand
to lose (namely those net long in the metal to be undervalued, or net short in the
metal to be overvalued). Since the general public is always long in the metal to be
undervalued, it is always on the losing side. A minority of insiders with advance
knowledge of the timing and extent of the devaluation stands to gain from it at the
expense of the general public. Yet the game of dropping one shoe after the other,
only to repeat the trick afterwards, was wearing one shoe thin faster than the other.
The alternating standard resulted in a progressive depreciation of silver in terms of
In antiquity the gold/silver ratio was about 10. Five hundred years ago, at the time of
the discovery of America by Columbus, the ratio was still only 11. The decline in the
value of silver continued during the next three hundred years. On April 2, 1792, the
U.S. dollar was defined as 371.25 grains of fine silver or 24.75 grains of fine gold.
This was bimetallism at the ratio of 15 at a time the market ratio was closer to 15,
thus overvaluing silver and putting the dollar on a de facto silver standard. On June
28, 1834, the U.S. Congress increased the official bimetallic ratio from 15 to 16.
This new ratio was higher than the market ratio, overvaluing gold and putting the
dollar on a de facto gold standard. By 1870 the accelerating decline in the value of
silver threatened the U.S. Mints with a deluge of the silky metal. To meet this threat
Congress in the Coinage Act of 1873 dropped the standard silver dollar from the list
of coins that could be minted freely on private account. Thereafter, silver was to be
coined at the pleasure of the government. This would have put the dollar on a de
jure gold standard, had the U.S. Mints been open to gold. But they were not. In
1873 the U.S. government still maintained a regime of irredeemable paper currency,
the greenbacks -- a legacy of the Civil War. This fact explains why the 1873
demonetization of silver went unnoticed by the general public, including the powerful
The fall in the value of silver continued to accelerate as the gold/silver ratio rose from
16 to 19 by Resumption Day in January 1879, when the U.S. government reopened
the Mint to gold, and resumed gold convertibility of the greenback. Thereafter the
value of silver was falling precipitously, the gold/silver ratio almost reaching 40 by
the turn of the century. The silver lobby woke up and started crying `bloody murder',
bitterly denouncing `the crime of 1873'. During the 1896 Presidential election
campaign the Democratic candidate, William Jennings Bryan, in his famous `cross
of gold' speech on the stump, pledged to return the country to a bimetallic monetary
standard. He failed to understand, as did most other observers, that demonetization
was the effect rather than the cause of the collapse in silver's value.
With the demise of bimetallism in the 1870's the ability of the government to benefit
a minority at the expense of the majority was greatly curtailed -- albeit not for long.
Hijacking gold on its way from the mines to the mints by the central banks opened
up new possibilities for credit manipulation, making it easy for governments to
defraud the unsuspecting majority in favor of a minority.
In our days the deception that governments can create value and wealth out of thin
air, through a judicious monetization of their own credit, is an article of faith at
virtually all chanceries and universities. The opposing view, represented by this
essay, that credit manipulation cannot create but can indeed destroy capital, and so it
cannot lead to prosperity but can ultimately pauperize the entire society through
credit collapse, as it did during the Great Depression, appears to be but "a lonely cry
in the wilderness" (Isaiah, xl: 3).