The price of gold has recently been making another of its upward moves.
These upward moves have been beaten back so consistently over the last
22 years that there is not much interest by the financial press or investors.
But there will come a day when the threat of central banks to sell gold
– which they sell mainly to each other – will no longer scare gold buyers.
They will start taking delivery of their futures contracts. That will
change everything.
If officials in the central bank of China ever decide to use the bank's
enormous supply of dollar reserves to start buying gold, they will make
their bank the dominant central bank on earth. At some point, they will
do this. They will finally understand how vulnerable the G-8 nations
are to a determined central bank that wishes to get its corporate hands
on the West's gold.
If Chinese central bank officials should also demand physical delivery
of their gold bars from the vault in the New York Federal Reserve Bank,
they will announce to the West, "Your days of wine and roses have ended.
Call this revenge for the opium wars." They will have achieved a symbolic
victory over the West in general and the United States in particular.
The Chinese could do this tomorrow. I think they are likely to do it
sometime in this decade. When they do, they will become the dominant
central bank. I think this is what they want: symbolic affirmation of
their new-found international economic might. They are fast becoming
the 800-pound gorilla in the world's export markets. By 2010, they will
be that gorilla, if you count Hong Kong, which they control, Taiwan,
which has sent $180 billion in private investment into China since 1991,
and 40 million overseas Chinese, who serve as the middlemen in the expansion
of Chinese foreign trade.
The West's best chance of avoiding this transfer of international power
is to continue to educate younger Chinese economists in one or another
of the West's gold-hating graduate schools in economics. The professors
must teach the Chinese that gold is just another commodity, except that
it's a barbarous relic.
The year that China takes delivery of 1,000 tons of barbarous relic
is the year that China will replace Japan as the dominant nation in
what might be called the Greater East Asia Co-Prosperity Sphere.
JANUARY, 1980
Why has the price of gold trended lower since January, 1980? Part
of this drop was a reaction to the large price rise in 1978-80, which
had been driven by the inflationary policies of the Federal Reserve
System under the long-forgotten and unlamented Chairman of the Board
of Governors, G. William Miller. He was not an economist. He was a corporate
executive without any known understanding of monetary theory. His tenure
of office was brief: March, 1978 to August, 1979, but public confidence
had been lost. He was replaced by Paul Volcker, who adopted tight money
policies in October, after being persuaded by other members of the Board.
Meanwhile, OPEC had driven up the price of oil for the second time
in the decade, this time under Jimmy Carter. By 1979, there was deep
pessimism regarding Carter's political leadership and the economy. This
elected Ronald Reagan in 1980.
In late 1979, Iranians kidnapped the staff of the American embassy.
Throughout 1979, there was also Bunker Hunt's squeeze on silver, which
drove up the price to $50/oz from under $5 a year earlier. He had been
taking delivery of silver contracts all year, terrifying the shorts.
Poor Hunt. He was about to lose his second fortune. The first had taken
place in 1971, when Qadaffi had nationalized Hunt's oil holdings. As
soon as the Gulf sheikhs saw that Qadaffi had gotten away with this
massive theft, they decided to squeeze the West. That fabulously successful
oil squeeze began in 1973, the same year that Hunt began buying silver
futures at $1.95/oz. What stopped Hunt in 1980 was two-fold: Volcker's
tight money policies and the COMEX, which changed the rules. No further
purchases of silver future contracts were accepted by the exchange except
for shorts who were covering their positions. By March, 1980, the price
of silver was at $11. Hunt lost a billion dollars. He had to borrow
from the FED to cover his position. He then uttered those memorable
words, "A billion dollars just doesn't go as far as it used to." Silver
never has recovered.
The last two decades have seen a fall of the price of all raw commodities.
The nominal price of oil has stayed up, but price increases of finished
goods and services have dramatically lowered the purchasing power of
the dollar since 1980. It costs $2,150 to buy what $1,000 bought in
1980, according to the inflation calculator at the Bureau of Labor Statistics.
The percentage of American family incomes that is spent on food, for
example, has gone down year by year. So, all the metals have dropped
in price and have stayed down except for brief upward moves.
Is this a permanent feature of the West's economy? Those who think
that we are running out of raw materials say no. They are generally
not economists. Most economists say yes. They argue that improved extraction
techniques and resource-discovery techniques and technological substitutes
will continue to place a premium on the knowledge-service economy in
relation to commodities. Throughout the twentieth century, the economists
have been correct about this except during wartime.
This scenario applies to commodities that are used in production. But
one commodity is not generally used in production: gold. From about
2,000 B.C. until today, gold has been used mainly as money. The issue
is: Used by whom?
THE INVENTION OF COINAGE
To facilitate exchange, a medium of exchange is crucial. Barter is
too inefficient. If you don't have what I want to obtain, or I don't
have what you want to obtain, there will not be an exchange unless a
third party steps in. He will get a high commission for his specialized
knowledge of markets.
Money reduces these commissions by making exchange between producers
easier, i.e., converting exchangers from producers into consumers. The
best definition of money was provided by Ludwig von Mises in 1912: the
most marketable commodity." Historically, the most widely acceptable
money commodities have been gold and silver. We read of the patriarch
Abram, "And Abram was very rich in cattle, in silver, and in gold" (Genesis
13:2).
Sometime between 700 B.C. and 635 B.C., the king of Lydia, in Asia
Minor, began producing the first coins. They were round, uniform, and
stamped with a lion's head, the symbol of the Lydian dynasty. This invention
was soon imitated by the Greeks. Originally, the coins were electrum:
silver and gold. Under King Croesis ("Creesis"), all of the Lydian coins
were gold. He was the famous king discussed by Herodotus, who made war
on the Persians and lost his empire. But his economic innovation reigned
until 1933. I think it will reign again, but that's another story. For
the story of Lydia's coinage, read Chapter 2 of Peter L. Bernstein's
book, The Power of Gold.
The world was re-shaped by that invention: the extension of trade and
the division of labor. Wealth increased. But there was another consideration,
one which became the basis of the visible destruction of the gold standard
in the 20th century. Lydia's invention carried with it an assertion,
an implication, and a symbol: the sovereignty of the State over coinage.
The stamp of the dynasty marked the coins as the monopoly of the State.
Civil governments have claimed this sovereignty over money ever since.
The stamp not only announced the coin's authenticity; it announced a
monopoly. He who counterfeited a coin by adding base (cheap) metals
was a violator of the State's exclusive right. The State had to authority
to bring negative sanctions against the violator – not on the basis
of his having committed a fraud, but on the basis of violating the exclusive
authority of the State to produce the coinage.
The practice of debasement had been condemned by the prophet Isaiah
two generations before the invention of coinage."Thy silver is become
dross, thy wine mixed with water" (Isaiah 1:22). His condemnation was
an extension of the law against false weighs and measures.
Ye shall do no unrighteousness in judgment, in meteyard, in weight,
or in measure (Leviticus 19:35).
But thou shalt have a perfect and just weight, a perfect and just
measure shalt thou have: that thy days may be lengthened in the land
which the LORD thy God giveth thee. For all that do such things, and
all that do unrighteously, are an abomination unto the LORD thy God
(Deuteronomy 25:15-16).
The presence of an authoritative stamp made a coin more acceptable
in trade. It reduced the product-seller's risk of not weighing or testing
the coins. The fact that the stamp was imposed by the authority of the
king did not, in and of itself, make the coin a monopoly instrument
of trade. What made it a monopoly was the decision of the king to monopolize
the production of coins. He did not authorize others to use his stamp
even when their coins matched the weight and purity of his coins. He
could have charged them a stamping fee for use on their coins – a trademark
fee, in other words. He refused. From that time on, civil governments
resisted the production of coins by private parties. Coins were deemed
an aspect of State sovereignty.
So, three separate analytical issues were involved:
(1) the reduction of transaction costs associated with small coins
compared to large ingots;
(2) the reduction of transaction costs associated with officially stamped
metal;
(3) the assertion of State sovereignty over coinage. The third was
not necessary to the first two.
THE FINAL COURT OF APPEAL
The judicial issue of sovereignty in the pre-modern world (say, pre-1660)
was the issue of divine right. The assertion of divine right was the
judicial-theological issue of the final earthly court of appeal. He
who possesses legal sovereignty cannot be sued, apart from his permission,
for he is judged by no human court. Sovereignty is why the U.S. government
cannot be sued without its permission, according the long-established
doctrine of "legal immunity." This is why there is so much political
pressure on the U.S. government to allow American or foreign citizens
to appeal to the World Court and other international jurisdictions above
the U.S. Supreme Court. To be the King of the Hill, a court must be
the final court of appeal. Without a world supreme court, there cannot
be world government.
The final judicial court of appeal for money is a nation's supreme
court. But the final economic court of appeal is the free market. A
court can determine what is lawful money. The free market determines
what is actual money. A civil government can legislate the price of
money: exchange rates between two forms of money; price controls on
goods. The free market will determine what the rates of exchange are
in actual exchanges: the black market rate of exchange.
Gresham's mid-16th century law says, "Bad money drives out good money."
This form of Sir Thomas's law is imprecisely stated. Here is the correct
version: "The monetary unit that is artificially overvalued by law will
drive out of circulation the monetary unit that is artificially undervalued
by law." This means that there will be a shortage of any artificially
undervalued currency. The best recent example was the U.S. dollar in
relation to Argentina's currency unit in December, 2001. The dollar
was artificially undervalued by Argentina's law. Almost no one could
buy dollars at the government's fixed exchange rate. There was a shortage
of dollars at the phony low price.
As always, government-enforced price ceilings create shortages (too
much demand). Government-enforced price floors create gluts (too much
supply).
The government can pass all the price controls it wants. The free
market will respond: shortages and gluts. Whenever you hear of a shortage
or a glut, think: "At what price?" Whenever a price is established by
law, the shortage or glut will remain until this legislated price randomly
matches the free market price, at which time, there is no further need
for the legislated price. Politicians do not understand that the final
court of appeal is the free market. The economy trumps the State. Governments,
by imposing added risk for the detection of an illegal transaction –
a voluntary exchange at free market prices – do raise transaction costs,
but governments cannot establish the price at which exchanges will take
place. There is no appeal beyond the free market. The market, not civil
governments, is sovereign.
Politicians rarely believe this. So, they play power games with prices.
By establishing by law which currency unit is acceptable for paying
taxes, politicians can determine which currency unit functions as money
in tax-related transactions.
But politicians cannot determine at what prices this tax/currency unit
will function as money. The free market – buyers and sellers of money
– establish the money prices of goods and services. Consumers, not governments,
are sovereign over the value of money.
COUNTERFEITING: LEGAL AND ILLEGAL
Gold has served as money in free markets for over four millennia.
Paper money was an invention of the Mongols less than a millennium ago.
Within a century, they had destroyed their currency. Commercial bank-created
money is less than six hundred years old. Central bank-created money
began in 1694, with the Bank of England.
Here is a nearly unbreakable rule: politicians serve their own self-interest
by paying off their constituents with money collected from their opponents'
constituents. When the taxation of their opponents' constituents threatens
to create a tax revolt, or the defeat of the incumbents at the next
election, or both, incumbent politicians seek ways to keep the money
flowing to their special-interest voting blocs without visibly taxing
their opponents' special-interest voting blocs.
The key word here is "visibly."
Monetary inflation is the preferred solution of politicians. The real
cause of the public's increased cost of living can be hidden from most
voters, who are economically ignorant, naive, and trusting. Price increases
can be blamed on profit-seeking speculators and capitalistic price-gougers.
If the currency system were exclusively private, then there could be
no element of sovereignty for counterfeiters. Counterfeiters could be
brought into a court of law and prosecuted for fraud: false weights
and measures. They could not claim that they are beyond the law, above
the law, and immune from law suits.
Governments can and do make these claims of immunity. They transfer
by law to central banks this same political sovereignty. This is why
the mixing of judicial sovereignty over money and economic sovereignty
over money eventually leads to fraud on the part of governments: monetary
debasement, either openly ("thy silver has become dross"), or through
the printing of more paper IOU's for gold or silver than there is metal
on reserve, or through the adding of digits in bank computers.
When a national government has established a State-run gold standard
by persuading the public to exchange their gold for the government's
IOU's of gold at a fixed price, then the public can retaliate against
future monetary inflation. Prices rise due to the increase in the money
supply. This would raise the money-price of gold, except that the government
or its central bank has promised to sell gold at an official price to
anyone who brings in an IOU. The demand for gold therefore rises at
the government's artificially legislated price. This is a rational response
of the IOU-holders. The government is subsidizing the price of gold.
Two groups want access to the promised gold:
(A) people who think the government will soon change the rules and
(1) stop paying gold for IOU's (default), or (2) reduce the amount of
gold that has been promised (devalue the currency);
(B) industrial or ornamental users of gold who want to take advantage
of the subsidy.
If the government wants to maintain full value of its IOU's for gold,
then it must stop inflating the currency. This will cause a recession:
the reversal of the prior policy of monetary inflation, and the restoration
or prices, especially of capital goods.
Politicians lose elections during recessions. "It's the economy, stupid."
So, they want the good times to continue to roll, which means the printing
presses must continue to roll. But then the gold reserves of the government
will be depleted.
What's a government to do?
Franklin Roosevelt's answer was two-fold:
(1) confiscate the gold of American citizens in 1933, and, once the
gold had come in and had been turned over to the privately owned Federal
Reserve System,
(2) raise the price by 75% in 1934, thereby transferring to the FED
a huge windfall profit. The FED's monetary base rose because of the
higher monetary value of its newly received gold, so commercial banks
created new credit money to take advantage of these increased central
banking reserves. The result was the economic recovery of 1934-36. But
when the FED raised bank reserve requirements in 1936, thereby reducing
the increase of bank credit, this produced the recession – a whopper
– of 1937.
http://www.independent.org/tii/news/990500Timberlake.html
Because the government also raised taxes in 1936, this added to the
economy's woes: a double-whammy.
After 1932, Americans were no longer able to pressure the government
to change its monetary policies. They lost the right of redemption.
This abolition of the public's right of redemption had been the decision
of European governments, 1914-1925, in response to the war: a suspension
of gold payments. Whenever a major war broke out in Europe, governments
suspended gold redemption. Why? Because they planned to inflate the
money supply to pay for the war. It happened during the Napoleonic wars.
It happened in 1914. In between, 1815-1914, Europe enjoyed a century
of price stability.
The public's right of redemption of gold serves as a veto on the government's
expansion of fiat money, or the central bank's expansion of credit money.
Until the right of redemption is suspended by the government, the public
holds the strong hand.
Every government-run monetary system is a compromise with the free
market. Every government-run gold standard is based on promises: IOU's
issued for gold at a fixed price. Such a promise is no better than the
promise of politicians. The government can always invoke its sovereign
right to change the rules. It can legally renege on its promises. It
is judicially sovereign.
The war against gold is part of the larger war of political sovereignty
– the State's self-imposed immunity from law suits – against free market
sovereignty. In this case, it is a war by the politicians against the
public's right to select whatever they as individuals want to use as
their currency unit, and their right to bring counterfeiters to justice
in the State's courts. Private, profit-seeking counterfeiters have no
immunity from law suits, unlike legalized private counterfeiters (central
bankers).
In the case of the law suits brought by Americans against the Roosevelt
Administration in 1933, the Supreme Court refused to hear the cases.
(The most detailed account of this subterfuge should be available in
March: a 1,600-page book on the Constitutional history of the dollar,
written by Ed Viera, author of a shorter, earlier edition of this book,
Pieces of Eight. Viera is a Harvard-trained lawyer who has devoted his
career to the money question. He is also an Austrian School economist.)
Every gold standard that is established by a civil government is a
pseudo-gold standard. It is no better than a government promise, a government
that claims sovereignty over money, i.e., legal immunity from prosecution
for breaking its promise to redeem gold for its earlier IOU's.
When it comes to gold standards, only one is real: a gold standard
that has developed through voluntary exchange on a free market, in which
counterfeiting is exclusively private and illegal under the statutes
governing fraud. Under such a legal order, no one may lawfully issue
more receipts for gold or silver than he has metal in reserve to deliver.
Every warehouse receipt for the monetary commodity must be backed 100%
by the amount of metal specified in the receipt, which is a legal contract.
Any issuing of more receipts to the metal than there is metal in reserve
is counterfeiting: dishonest weights.
Any form of gold standard in which the civil government is the issuer
of warehouse receipts for metal is inherently a temporary measure. The
promise of "full redemption on demand" is no more reliable that the
promises of politicians. The guarantee is just one more government con
job to separate the public from its wealth – in this case, gold. It
is a sucker's play. And do the suckers love to play! Paper receipts
for gold. How convenient: no more heavy lifting. And it's 100% guaranteed,
free of charge, by the government. What a deal! It's something for nothing!
With the government as the fiduciary agent, the deal has always been
nothing for something. This is why, in the 20th century, the central
banks wound up with most of the world's gold.
When someone tells you that he is for "the gold standard," think one
word: sovereignty. If, in the proposed version of the gold standard
that someone is pitching, any agency of civil government is the sovereign
guarantor of warehouse receipts to gold, redeemable on demand, I strongly
suggest that you keep your hand upon your wallet and your back against
the wall.
WHO VETOES WHOM?
With any pseudo-gold standard, the government retains the right to
veto any attempt by the public to veto the government's monetary policies.
When holders of government IOU's for gold begin to present their IOU's
and take home their gold, the government can intervene and refuse to
pay. Remember, it is not the government's gold; it is the IOU-holders'
gold. Anyway, that was what was originally promised. But agents of governments
lie. This is their primary function operationally in every democracy:
to deceive the citizenry. A pseudo-gold standard allows undeceived citizens
to call the deceivers' bluff until the government publicly reneges.
This is why any gold standard is hated by all modern political liberals
and most conservatives: it places a veto in the hands of citizens. The
overwhelming majority of the intellectual defenders of State power dismiss
the gold standard as a barbarous legal institution based on a barbarous
relic. Why barbarous? Because it places a veto in the hands of the barbarians:
citizens and non-citizens who can legally buy up the IOU's with depreciating
paper money and then launch a gold run on the government's treasury
or the government-licensed counterfeiters: central banks and their clients,
commercial banks.
The monetary skeptics announce, "There's gold in them thar vaults!"
When the gold flows out, the day of reckoning draws closer for the purveyors
of counterfeit IOU's for gold. The counterfeiters grow desperate. "Their"
gold is now being demanded by barbarians – arrogant citizens who think
that a government promise is worth its weight in gold. Finally, the
counterfeiters end the illusion of their pseudo-gold standard. They
had persuaded the public to sell the government their gold in exchange
for IOU's. Then the government defaults. "Tough luck, suckers!"
This has been going on for three hundred years. The suckers – IOU-holding
citizens – never learn. We are more trusting of known crooks (legally
immune politicians) than money center bankers are who lend money to
Latin American dictators.
CONCLUSION
The public trusts the government, which claims judicial sovereignty:
immunity from law suits. The public also trusts Alan Greenspan. The
American public has not had legal government-issued or bank-issued IOU's
to gold in their collective hands since 1933. They have voluntarily
renounced the power of the veto. It has been even longer for most Europeans.
The economic veto over monetary policy has been transferred by the
market to bond speculators. There are fewer of them than citizens who
used to hold gold coins. But they do have a lot of power. They are hated
by the government. The Street.com's Daniel Gross reminded us in November,
2001:
In 13 years at the helm of the Fed, Greenspan has built up an enormous
amount of credibility and clout – in Washington and New York. His
actions in controlling the movement of interest rates have been credited
with making or breaking the past two presidencies. George Bush – the
elder – explicitly blamed Greenspan for dooming his one-term presidency
by not cutting rates quickly enough in 1991. "I reappointed him, and
he disappointed me," Bush said.
Greenspan, on the other hand, made Clinton's presidency. The Fed
Chairman strongly suggested, early on, that the president focus on
deficit reduction because that would please him and, in turn, the
bond market. Clinton exploded: "You mean to tell me that the success
of the program and my reelection hinges on the Federal Reserve and
a bunch of [bleeping] bond traders?" But with the market-savvy Robert
Rubin whispering in his ear, Clinton chose the path of budgetary restraint.
Greenspan ratified his 1993 budget plan, and the rest is economic
history.
In today's political/investing culture, it is difficult for policymakers
to make much progress without the cooperation of the bond market.
And because the bond market regards Greenspan as an oracle par excellence,
the 74-year-old former devotee of Ayn Rand now occupies the catbird
seat.
http://www.thestreet.com/comment/ballotdance/1164057.html
The bleeping bond traders today are called "bond vigilantes." This
name fits. Vigilantes in the old West used to string up suspected malefactors
when the government refused to prosecute, or when, in some cases, the
people at the end of the ropes were the local government. For politicians,
the free market's speculators who publicly expose the government's monetary
policies as detrimental to the public are regarded by the government
as barbarians or vigilantes.
Politicians hate any veto power held by the public. Bond market speculators
are exercising a veto on behalf of the public. The government will do
what it can to bankrupt them, hamper them, or in some way remove their
veto power. But, in the long run, there is no escape. The free market
will veto bad economic policies. The free market, not the State, is
economically sovereign. Economic sovereignty trumps judicial sovereignty
in the long run.
Keynes dismissed the long run. "In the long run, we are all dead."
Well, Keynes is dead, and his theoretical legacy is dying. But, for
the moment, the rival sovereignties are about equally matched: market
vs. State.
But if the Chinese central bank ever starts exchanging Western currencies
for gold, and then demands physical delivery, the West's central banks
will face something more ominous than a handful of private gold bugs.
It will face a rival that has the money to drive up the price of gold
to 1980-levels. If Western central banks try to thwart this price rise
by selling gold, the Chinese will smile. "Almond eyes wish to subsidize
our purchase of gold? We accept!" The West would then be between a rock
and a 24-carat hard place.
If you want to know what the "yellow peril" is in central banking circles
these days, this is it.