The following pearl is written by Dr. Keith Weiner.  The sweeping irrationalities of the anti-gold barbarians are mounted on a pike as a warning for all.

Open Letter to Mercatus Center

Patrick Horan
Program Manager for Monetary Policy
Mercatus Center
Via Internet

Dear Mr. Horan and Mercatus:

It just came to my attention that on 20 July you wrote an article prompted by the then-upcoming Senate Banking Committee vote on Judy Shelton for a seat on the Board of Governors of the Federal Reserve. You ask the question: Is a Gold Standard Practical Today? The question is more urgent than ever. But your answer does not really answer the question.

The lede of your article asserts without evidence, “Despite the strengths of a gold standard system, there are better alternatives.” And in the first paragraph, you commit a logical fallacy that you reuse later in the article, “…it would be immensely difficult to implement in today’s world of modern central banks.”

You have reversed the cart and the horse. You take central banks as a fact of nature, and ask if the gold standard would fit. Instead, you should ask if central banks fit the needs of market participants in a free society.

The Soviet Union (also Mao’s China, North Korea, Cuba, and Venezuela) have proved that central planning is impossible. Even something as simple as corn. To grow corn, you just plant seeds in fertile soil, and wait. Yet every country that attempted to centrally plan it, has starved.

Economists all know this. Mercatus is articulate when it comes to price-fixing schemes for agricultural commodities, wages, rents, etc. Yet when it comes to money, you say that “there are better alternatives” to a free market.

Here is your next error. “Under a gold standard, a country sets the price of a fixed unit of gold in terms of its own currency…” Actually, in a gold standard, gold is money. Prices are specified in money terms. Money itself does not have a price. To grasp this, think of any of the fundamental units in physics. For example, how many meters long is a meter? To ask what is the price of money, is similarly invalid.

In a free market, there is no doubt that when you deposit money (i.e. gold) in a bank, you have a right to the return of the same amount of money (gold). And it is useful to have a standardized unit of account, so everyone can trade based on the knowledge that a “dollar” is the same amount of gold at Bank A vs at Bank B. This is not a price-fixing scheme, any more than an Internet standard that says long messages should be broken into 256-byte packets is a scheme to limit how much you can say.

Next you object that “exchange rates between countries are fixed.” Let’s drill into this. Suppose one country defines its dollar as 0.05oz gold. And another defines its franc as 0.29g of gold. It is true that people must convert from ounces to grams, to calculate how many francs to a dollar. But this is no problem.

“Most economists, however…” Is appeal to consensus supposed to be a scientific approach? How about appeal to reason?! When the government doles out money to academics, a curious coincidence develops. Most academics promote the party line. I will bet an ounce of fine gold against a soggy dollar bill, that Mercatus has a paper or two in its archive which looks at this kind of bias.

You continue “[economists] are critical of a gold standard precisely because it constrains a central bank’s discretion…” Discretion to do what? To rule. One term for what central banks have done to retirees is “financial repression.” Just ask anyone who is trying to live on his savings, what he thinks of zero interest rate policy.

The government and its cronies love it. Those who speculate on assets, and those whose pay is tied to asset prices such as CEOs and bankers, love it. But there is a lender for every borrower. Those who depend on interest hate it. Keynes called for their euthanasia, and that is what central banks have inflicted.

You continue “…gold standard advocates may believe deflation brought on by a gold standard is desirable…” Speaking of bias, the term brought on carries the baggage of its connotation of being the cause of something bad. Like an illness.

Of course, industry is always becoming more efficient. So if we had a money that was not being debased, prices would fall with the cost of production. In my article for Forbes, I showed that the real resources required to produce a gallon of milk were reduced by about 90% between 1965 and 2012. Isn’t it logical that the price of milk would fall about that same amount?

Yet you use another pejorative term—deflation—to describe this. Improved efficiency and hence prices is not to be feared. Of course, deflation is scary, not because of efficiency improvements, but financial crises. When the banking system is collapsing, and unemployment is skyrocketing, prices fall. The phenomenon of mass credit default should not be confused with the phenomenon of improving productivity. To avoid this confusion, they should not be given the same word.

I wrote for Forbes about the nomination of Janet Yellen as Fed Chair, and outlined her theory of labor:

1. Disgruntled employees don’t work hard, and may even sabotage machinery.
2. So companies must overpay to keep them from slacking.
3. Higher pay per worker means fewer workers, because companies have a finite budget. Yellen concludes—you guessed it:
4. inflation provides corporations with more money to hire more people.

I characterized this as frivolous. But your article follows the same logic, “Since employers generally tend to avoid cutting workers’ wages because wage cuts can hurt worker morale, companies nevertheless will lay off workers…” Yellen and you both use this to support an inflationary central plan imposed by central banks.

I must say something now, not as economist to economist, but as businessman to economist. Before you publish how businesses behave in your imagination, I encourage you to go out and ask a few how they behave in reality. What you said is not just wrong, but obviously wrong. In the economic lockdown following COVID, I’ve lost count of how many businesses I’ve spoken to, or read about, which cut salaries.

You double down on this error, and illustrate the contradiction in Yellen’s and your argument with, “vicious cycle where prices continue to fall as employment levels and demand for goods and services fall.” In the previous sentence, you said this outcome occurs because businesses were reluctant to cut wages. Now you say that employment is falling, glossing over the fact that when joblessness is up, wages on offer go down. Rising unemployment is the same thing as falling wages (at least if there are not laws that attempt to prevent it).

In economics terms, the marginal employer is the employer who hires more workers on a downtick in wages. In business language, every company wants to hire more people, but price matters.

Next you say, “…former Federal Reserve economist David Wilcox argues that a gold standard prevents a central bank from cutting interest rates to make borrowing easier in order to provide stimulus…” This, sir, is a feature not a bug. And how does David Wilcox know what the right price of borrowing is? The same way that Gosplan knew the right price of corn in the Soviet Union.

I am glad you mentioned that there were different kinds of systems, all of which are referred to by the same term “gold standard” (kind of like referring to credit collapse and efficiency gains by the same term “deflation”).

Unfortunately, you add to the confusion by saying that the “purest” gold standard, prior to 1914, “…required no coordination on the part of central banks.” That is an odd way to put it. As well, one might say that “a seller and buyer of corn require no coordination on the part of Gosplan.”

Instead of calling these various different systems, “classical”, “interwar”, and “Bretton Woods” systems, it is more helpful to call them by names that denote their essential characteristics.

Prior to the creation of the Fed in 1913, the US had a gold coin standard (as did much of the world). This means that people had the right to withdraw their gold coin, if they did not like the rate of interest on offer at the banks (or the risk). This is a vital feature! Imagine a restaurant where you had no choice. You must keep paying every day, no matter what kind of slop they slapped onto your tray. I recall the student dining hall back when I was in college. They were exactly like that. Even the cheapest restaurant has to do better, because its customers have a choice.

This right gives teeth to the savers’ time preference. If the interest rate goes below it, they withdraw their gold coins. Which forces the banks to sell assets, causing a drop in the bond price. Which is the same thing as a rise in the interest rate. Free markets have negative feedback loops (the same as I described in the labor market above). But when a central planner takes over, it is like putting a penny in the fusebox. Sure, it may seem convenient that the TV does not shut off when your daughter uses her hair dryer while your son is cutting wood in the garage—until the house catches on fire.

After WWI, the rest of the world switched to a gold bullion standard. This is a very different animal. Sure, the banks still had gold backing. But the people lost the right to redeem their deposits and take gold coins home. Only if one had enough money to withdraw a 400-ounce bar, could one take the gold home. But 400 ounces then, as now, is a large sum of money. Very few individuals had the cash balance to do it. So the system changed character in a number of obvious ways, and many more not so obvious (for example, in Europe they stopped trading in Real Bills).

In the US, we kept to a gold coin standard but after 1913 we had a centrally banked gold standard. The Fed quickly turned to buying government bonds. In so doing, it destabilized the interest rate.

This so-called gold standard was unsustainable. One by one, each country abandoned it. In 1933, President Roosevelt forced US citizens to turn in their gold and made it a crime to own gold. The dollar became irredeemable to Americans, though it was still redeemable to foreign central banks.

At the end of WWII, the US told its allies how the monetary system would work. Other countries were to treat the US dollar as if it were gold. And their own irredeemable currencies would be pegged to the dollar. This was not at all the same as the gold coin standard, where a currency unit was not a price but a standardized deposit. After WWII, there were no gold deposits, only a price-fixing scheme. Like all price-fixing schemes, this one failed.

In 1971, on the advice of Milton Friedman, President Nixon defaulted on the obligation of the US government to redeem dollars presented by foreign governments. Even Keynesian economist Paul Samuelson thought Nixon would just set a higher price of gold. But Friedman urged Nixon to plunge the world into the regime of irredeemable currency, “in which central banks have full control over the stock of money…”

You say that, “Unless we abolish central banks (an unrealistic proposition)…” and then right after that “it seems unlikely that a current-day version of a gold standard would work well.” I think you need to pick which horse you want to ride. Are you saying that it is realpolitik to advocate for central planning because, hey, go with the flow? Or are you saying it is impractical to have a free market, because it won’t work?

You then assert that nominal GDP targeting will work well. I have written before about some of the frivolous ideas behind this idea.

You conclude with, “…nominal GDP targeting is one realistic way to do the sort of rules-based monetary policy that gold standard advocates want…” But earlier you said, “[economists] are critical of a gold standard precisely because it constrains a central bank’s discretion…”

Pick one. Is a central bank better than the gold standard because it gives central planners the discretion which you assert “is important, especially during times of crisis”? Or is a central bank doing nominal GDP targeting just like a gold standard—i.e. constraining the discretion of the central bank, only it’s just more realistic?

This is a pivot. Two mutually-contradictory arguments offered because both seemingly lead to the desired conclusion.

And a central bank that centrally plans based on rules is a false alternative to a central bank that centrally plans based on discretion is a false alternative. The way cherry-flavored cyanide solution is a false alternative to strawberry-flavored cyanide solution.

Martin Luther King said something important:

“Cowardice asks the question – is it safe? Expediency asks the question – is it politic? Vanity asks the question – is it popular? But conscience asks the question – is it right? And there comes a time when one must take a position that is neither safe, nor politic, nor popular; but one must take it BECAUSE it is right.”

You argue that “it would be better for gold standard supporters to avoid ‘making the perfect the enemy of the good’ and pursue more achievable options such as nominal GDP targeting.” This is what Dr. King characterized as expediency.

Your article ended with a call to action. I, the gold standard advocate, should join you in advocacy of a GDP-targeting central bank because it’s politic.

So I end my letter with my own call to action. You, the advocate of a GDP-targeting central bank, should join me in advocacy of a free market in money and credit, because it’s right.

This is a neatly, clearly and precisely written article explaining why it is that we are on the cusp of the most severe depression ever.  Though that is my claim, not Keith’s.

Highly recommended reading.  The whole Report is HERE.

June 22, 2020/2 Comments/by Keith Weiner

We are reading now about possible regulations for air travel. In brief: passengers might be forced to spend hours at the airport. Authorities will perform medical checks, including possibly needles to draw blood, no lounges, no food or drink on board the plane, masks required at all times, and even denied the use of a bathroom except by special permission.

We would wager an ounce of fine gold against a soggy dollar bill that people will hate this. The majority of vacationers will not want to fly. A holiday is supposed to be fun, and air travel promises to be a lot less fun that it was in March.

Even business travel will be discovered to be a lot more discretionary than previously believed. Forgetting continuing education and conferences chosen in tourist hotspots such as Las Vegas and Maui, even business meetings may be done remotely (they already have been, for three months). Going farther, we would expect major corporations to set policies that employees will not be required to travel except when specifically directed by a senior executive. No large employer would want to face a wrongful termination lawsuit from an employee who balked at being stuck with a needle.

If air travel is only for people who absolutely, positively have to visit faraway places, it will be a much smaller market than it was. This will have some big consequences.

What Kind of Consequences?

The airlines have far too much capacity. They must break leases on their gates at the airports (as will rental car companies). This means that the airports will find they cannot service their bonds. Likewise the restaurants and stores in the airports—which had increasingly become like malls in many places—will break their leases and default on the loans they used to pay for their buildouts.

The airlines will have to try to liquidate large numbers of airplanes. There will be no bid on most of them. Newer aircraft, with more efficient engines and more attractive interiors, will be retained. The others will go off to the boneyard. The bonds that financed all of this now-excess fleet will be defaulted.

The pain will fly up through the ecosystem. The airplane food service companies will be toast. The vendors that service soda fountains and refrigerators in restaurants in airports will freeze. Even the businesses that stand up racks of magazines at airport newsstands will fall over. Loans on the trucks, scissor lifts, and industrial kitchens will not be paid.

It Doesn’t End There

Moving farther upstream, what are the prospects for the manufacturers of airplanes, specialty airport service trucks, and scissor lifts? What of their parts suppliers? If any of those companies has debt, it will be defaulted.

Moving on to other parts of the airport, there are monorails that will seize for lack of demand. There are parking garages that will collapse for lack of cars paying $25 a day to park. Cleaning companies will kick the bucket.

Once passengers land, they travel by rental car, taxi, or Uber to a place where they can sleep. Usually a hotel. Hotels that depend on air passengers for a majority of their revenue—how many serve mostly people who drive?—will soil their beds one final time before they go off into the great goodnight.

A whole slew of upstream vendors, from carpet installers to plant nurseries, to colleges that turn out graduates in restaurant and hotel management will go down the river.

This leads us to the convention centers. Even if the airline business was not a lead balloon, the convention—which is pretty much the opposite of social distancing—would still be a dead letter. That means the companies who sell the paraphernalia for trade shows, like printed brochures, will fold. The manufacturers of exhibit booths will drop, the silkscreen companies who put corporate logos on pens and shirts will see red ink, and even the businesses who make the lanyards will be ripped up. Lighting companies will collapse like overloaded trusses.

There are many more companies not mentioned, and we could go farther upstream. But we will stop here, because we don’t want to belabor the point. We went this far, in order to paint a clear picture. There is a common element in every sad story above. No, it is not layoffs (though those are a human tragedy). Nor a drop in quality of life (which has already occurred).

We speak of bond defaults.

Bond Defaults Affect You

Many people may not care, because they do not own bonds. However, they should care if they have a pension, insurance policy, annuity, or a bank account. Institutions buy bonds, and now we are headed into unprecedented bond defaults.

If you manage a pension fund who owns some of those bonds, what do you do? If you are a pensioner who reads about this, what do you do?

The answer is as obvious as it is painful. Some of these creditors will, themselves, default If their asset goes *poof* then their liability is no good either.

Some may get subsidies. Keep in mind that the Federal Reserve can lend, but it cannot gift. Congress can dole out gifts, but how much can they get away with until voters get sick of it? We suspect far less than the amount needed to cover all this bad debt.

Assets Cannot Be Replaced With Liabilities

To a creditor, the loan is an asset. When it defaults, the asset loses value. The creditor cannot replace this asset by borrowing. If it borrows, then that loan would be a liability. Adding a liability does not fix the problem of losing an asset.

Pension funds may not be allowed to reduce the checks they pay to retirees. Instead, they will turn to employers—such as airport operators and scissor truck manufacturers—to pay more and attempt to shore up these underfunded funds. With their revenues dropping sharply, and debts of their own to try to service—not to mention laying off employees—these entities are fighting to avoid bankruptcy. Or they may already be in bankruptcy courts of their own.

The employers do not have nearly enough cash to make good on these pension obligations.

This is part of why we say the dollar is supported by the struggles of the debtors. Any analysis that begins and ends with quantity of dollars misses the quantity of debt, and the burden of every dollar of it rising with the falling rate of interest.

These banks, insurers, and pension funds—and their unhappy clients—will not be running out to spend trillions, bidding up consumer prices, and causing what most people think of as inflation. They will be cutting their consumption of real resources—including the paychecks of employees who consume real resources—in a desperate attempt to stay afloat.

The world is not dying the white hot death of nuclear explosion hyperinflation. It is dying the cold, dark death of drowning under a rising sea of debt.

A great educational article from the desk of Keith Weiner.  Find it in full HERE.

“To help clarify our point, let’s go through the mechanics of this. Step one, a commercial bank borrows $1 million. Step two, the bank buys a bond. That is, it gives up $1 million in cash, and gets a $1 million bond in exchange. Step three, the Fed borrows $1 million. Step four, it buys the bond. That is, it gives up $1 million in cash to the commercial bank, and gets the $1 million bond in exchange.

“The act of borrowing and the act of buying are combined in one step with the Fed. It’s simple but it’s so hard to see, because people think of the dollar as money. However, the dollar is actually the Fed’s liability. When a bank sells a bond to the Fed, it prefers the Fed’s liability to the bond. If the bond is a Treasury bond, then why would the bank prefer the Fed’s credit to the Treasury’s credit?

“There is not so much difference between the two. Both are government credit. The Treasury pays interest (barely) and has a maturity that is a date in the future. By law, the Fed’s credit is a current asset, that is, zero maturity. And it may be used to pay all debts.

“To sell a bond is to exchange one credit paper for another.”

Carl Menger was a brilliant economist who set the foundations for the Austrian School of Economics.  He also perpetuated one of the great errors.

Gold is not money because it is ‘the most marketable good’.  Menger’s mistake continues to be repeated by many otherwise fine thinkers.  It is based on the misconception that money’s primary role is that of a medium of exchange.  That is where the expression ‘the most marketable good’ comes from.

It was surmised that Gold became money because over a huge span of time people showed their preference for it in the marketplace as their medium of exchange.  They favoured it over salt, fish, cows, copper etc.

That error has had profoundly negative consequences.  If money is just a medium of exchange, then governments are free to issue pieces of paper (cotton/plastic these days) with numbers printed on them and force them into circulation via legal tender laws.  This they have done – in every country in the world.

A good is properly defined ‘an exchangeable, quantifiable value’.  How is it quantified?  By being measured.  What does the measuring?  The same as does the measuring in any science: the most stable value available in the pertinent genre.  As a litre/pint measures liquid volume, a metre/yard measures distance and the speed of light measures time, so Gold measures value.

Because the Stock-to-Flow ratio gives Gold the most stable value available, it performs the role of measuring value in the marketplace.  Today, we appear to measure the value of goods using paper money, but the value of paper money is, and always has been, set by Gold.  You just have to turn the conventional dollar ‘price of Gold’ chart upside down and back-to-front.  Then you will see (through the paper) the (dwindling) value of the dollar.  Paper money is the de facto measure, but Gold remains the de jure measure.

To return to the definition of a good (an exchangeable, quantifiable value), if money is doing the measuring, then it cannot also be the measured.  Therefore money cannot be a good.  To claim that money is a good, denies its role as the measure of value.

But not only is Gold (in monetary form) not a good, it is also not very marketable.  Even under the Gold standard, it was very difficult to buy or sell day-to-day items using Gold, because the value of the goods rarely approached anywhere near that of the measure.  Popping down to the shop to buy a loaf of bread with an ounce of money was going to give the shopkeeper a problem.  He could use the Gold to measure the value, but he did not have sufficient change in his till to accept it as the medium of exchange.

That is why silver was commonly used as money’s surrogate.  Silver’s value was not stable, but it was more stable than anything except Gold.  And that value was small enough (and still fungible, durable and divisible) to be useful in the everyday marketplace.

The most marketable good is not Gold; it is silver.

So what is money’s primary role?  The reason that a known weight and fineness (purity) of Gold became money, is that not only is it a stable value, but it holds that value into the future with more stability than anything else.  That, and that only, is the reason that Gold became money.  It is a store of stable value over time.

That is why people preferred Gold.  Once they had accumulated enough surplus silver or cows, they swapped it for Gold.  Only then was their excess wealth secure.  In that manner, did the world’s first real accumulations of wealth begin.  Those accumulations of wealth, beginning in Ancient Egypt, are the bedrock of today’s high-tech, low cost world.

Gold’s stability of value is why governments disapprove of it and seek to replace it.  Nothing that they introduce in its stead holds its value over time.  That is perfect for those with the intent to degrade the debt notes that they offer.  And that is why they perpetrate the myth that money is just a medium of exchange.  To agree with that belief is dangerous to your financial health.

Money has a far greater stature than that of the ‘most marketable good’.