“Gold is money,” the gold bug tells the dollar enthusiast.
“Gold is money, you say?” the dollar enthusiast responds. “Then go to a supermarket with a gold coin and try to buy something. See if it works!”
It’s a challenge I’ve heard countless times. It's time to slay this dragon. Here is my retort.
“The dollar is money, you say? Then go to a supermarket with dollars when dollars can no longer be exchanged for any amount of physical gold at all, and try to buy something. See if it works!”
The answer is it won’t work. Once a dollar, or any paper currency, can no longer be exchanged for any amount of physical gold, that currency becomes entirely worthless. This is not an empirical observation, but a deductive, inescapable, logical truth. How so? Why, if the dollar cannot be exchanged for any amount of physical gold, must it be entirely worthless?
In order to answer that question, we can start with an observation from Nobel Prize-winning Austrian School Economist F.A. Hayek. He was once asked why he chose free market capitalism as the system that had solutions instead of socialism. His answer began this way (and I encourage all to watch this 3m25s clip):
“I regard as my one discovery in economics… the idea that the price system is really essential as a guide to enable people to fit in to an order… It shows for example why an orthodox classical economist or even a Marxist can never understand the functioning of the market. They believe it’s the costs which determine prices. The truth is exactly the opposite. It’s prices which determine how much costs they ought to involve.”
And so what? Here’s what. Hayek continued with this zinger:
“I sometimes say, no real discovery has ever been made in economics. There are no discoveries to be made. It’s a question of using common sense knowledge and recognizing its significance. Of course, we are guided by prices. That prices are determined by the actions of millions of people everybody knows. But to put it in the right form and to see that it is the price by which the knowledge of thousands and millions of people can be conveyed to others and serve as a guide to them was just a new way of putting ideas together.”
And so, in the spirit of Hayek and the positivist logic-based Austrian School of Economics, I aim to take this singular “discovery” of Hayek’s, namely that free market prices put people into a productive order, and reapply it to the field of monetary economics in order to prove that gold must be money not only in the past but now in the present, and that being the case, prove that the US dollar only has any market value insofar as it is still a functioning gold substitute.
We can start by moving to another Austrian School economist, Hayek’s teacher Ludwig von Mises, in order to debunk the entire concept of a “fiat currency” in the first place as a pure logical impossibility.
If free market prices put the world into a productive economic order by assessing relative scarcities and demands, and prices are dictated by the economic actions of millions of individual people, it follows that free market prices cannot possibly be dictated by fiat from above. Hayek’s teacher, Ludwig von Mises (left in picture), made this case indirectly through his Monetary Regression Theorem.
The simplest way to put the Regression Theorem is this. People wake up in the morning. They wake up generally knowing about how much work they have to do, how much money they have to earn, and how much money they have to spend, in order to accomplish their goals for the day, whatever those goals may be. How do they have all this information? The only way any of us have this information is by basing our assumptions of what today’s prices are, on yesterday’s array of prices.
Sure, prices continually adjust as the supply of and demand for anything always is shifting, and this constant shifting leaves room for both entrepreneurial gain and loss. Gain if movements in prices are predicted correctly, and loss if incorrectly. Still, without a basic reference to the immediate past as a starting point, prices would be completely meaningless and would not convey any economic information at all. Production and the division of labor would break down completely. Economic order would turn into chaos. Mass starvation and rioting would result.
Any and all prices for any and all things must by force of logic be referenced to the past, and this temporal regression must continue uninterrupted, fluid, all the way back to when money first evolved in the marketplace and indirect exchange for goods and services first became a thing in human society.
Here’s how it started. At some point in human economic history, gold and silver began to be used in barter as useful metals in exchange for other stuff. After a great many exchanges of gold and silver for other goods and services, a general estimate for what these metals could be exchanged for and how much, began to organically be established. In this way, gold and silver evolved to enable indirect exchange and trade, rather than strictly barter. Why these metals? Simply because they were available, divisible, stable, sufficiently rare, and inherently useful.
That last point, inherent usefulness, is crucial, because without it, the exchange of gold and silver for things in a barter system would never have started in the first place.
The fact that someone down the line of gold or silver exchange would be able to use the metals themselves is the nexus from which these metals evolved as monies. Generally speaking, gold was used for large or wholesale transactions, and silver for retail. An array of prices for goods and services in gold and silver terms began to develop, and the nexus point of the monetary regression chain of all monetary prices to this very day found its origin. It was not an instantaneous process. It took hundreds, if not thousands of years, from a single kernel of barter exchange into a gradually larger and more complex economic order based on an ever-expanding array of free market prices denominated in weights of gold and silver.
Fast forward a few thousand years, and storage services called banks evolved for these metals. Banks would issue certificates of storage and secure people’s gold. These paper certificates began to be used as gold substitutes. This is how the US dollar was born, as a substitute for gold. Eventually, banks figured out they could just issue the same substitutes for nothing and just buy things for themselves with the substitutes. More and more of these unbacked substitutes were printed, and inflation was born.
Fast forward to 1934 and there were too many gold substitutes in the form of dollars to redeem gold at $21 per ounce anymore, so Roosevelt moved the exchange rate between gold and its substitute up to $35. Through this process of devaluation of the gold substitute, the original regression chain back to gold’s origin as money still remained intact. Intact with a big disturbing bump in the road from $21 to $35 per ounce of money overnight but the car kept driving, still basically intact. This allowed prices to maintain some basic fluidity with the original causal chain, but of course, there were plenty of production adjustments that had to be made to put things back in a smooth working order. Those adjustments were very painful, but they were necessary to keep any form of economic order intact.
Fast forward to 1971, and there were so many of these dollar gold substitutes that President Nixon stopped redeeming gold for dollars even at $35 an ounce.
From this point in history, monetary linguistics got seriously muddled and three twisted linguistic pretzels in monetary parlance began to proliferate in an attempt to mask what had just happened. Here are three of the biggest linguistic pretzels that even the purest of gold bugs, myself included, have twisted themselves into:
Here's my attempt at untwisting these pretzels.
Let’s take pretzel #1. “Nixon took the dollar off the gold standard.” By Hayek’s logic of what prices are in the first place, and Mises’ logic pointing out the necessity of an unbroken chain of prices going back to the monetary nexus origin point, it's completely impossible to both take the dollar off the gold standard and at the same time have a functioning dollar-based array of prices. Even after Nixon stopped redeeming gold at $35 an ounce, the monetary regression chain nevertheless remained intact the entire time and still does, because dollars can still be exchanged for gold at about $1,750 an ounce or so.
The dollar never went off the gold standard. It simply went off a static $35 exchange rate per ounce. To really and truly take the dollar off the gold standard would be to destroy the dollar as a functioning gold substitute entirely, destroying its market value. Clearly, that has not happened yet, as the dollar still functions.
Here we come to pretzel #2, “closing the gold window.” If the dollar is still on a gold standard in that it can still be exchanged for gold at $1,750 an ounce, that, itself is the gold window. The gold window remains open for the dollar, ever so narrowly.That window continues to shrink, but it is still open.
If the window linking gold and the dollar were to close entirely, meaning if it were to become impossible to exchange any amount of dollars for any amount of gold at all, then the dollar must become entirely worthless for the same reason. Severing the dollar's link to gold would make dollar prices for anything completely meaningless, and therefore unable to convey any meaningful economic information at all. The dollar would be unable to be exchanged for anything at any rate.
Here we come to pretzel #3, the biggest pretzel of all. “The dollar became a pure fiat currency.” Absolutely impossible. Prices must always link back to the past as a starting point for assessing relative supplies and demands for goods and services. Prices cannot possibly be dictated by fiat. They must be constantly renegotiated by billions of individuals based on what they knew prices were the day before. All of these people have dispersed economic knowledge about the supply and demand of billions of goods and services across the planet. This knowledge cannot possibly be concentrated into a power committee and dictated by fiat from above.
The dollar is emphatically not a fiat currency. There is no such thing as fiat currency at all.The dollar remains a gold substitute, and as a still-functioning (yet ever more inflated) gold substitute, that essential link to the past through gold remains intact. For that reason alone, prices still make some level of economic sense and the global economy continues to basically function.
Now, yes, there is indeed an element of “fiat” in the dollar in terms of force, and that element is the government’s monopoly privileges in creating more of these substitutes, so-called “legal tender laws.” I used to mistakenly believe that the value of a so-called “fiat currency” was inherent in its legal tender status, namely resting in the government’s ability to force you to use it in payment of taxes. I only recently realized that this is also a logical impossibility.
The value of a currency has nothing whatsoever to do with its legal tender status. If it did, then the death of any and all currency with legal tender status would be impossible as well. Governments can always force anyone to pay taxes in whatever currency, and yet government currencies continue to die anyway.
What, then, is the purpose of legal tender laws in the first place? If they do not bestow value on a currency, what do they accomplish? Simple. Their purpose is to give government the exclusive ability to inflate the supply of gold substitutes so as to extract value from them as gold substitutes and take that value away from you. Governments force you to use their specific gold substitute because these gold substitutes, insofar as they are still functioning gold substitutes, already have value, and they want to extract this value from them through inflation.
In other words, legal tender laws exist because paper currencies, insofar as they are still functioning gold substitutes, have value in the first place, not the other way around.
Legal tender laws are the only reason you cannot walk into a supermarket with a gold or silver coin and buy food. Not because gold and silver are not money, but because legal tender laws require you to use only a specific gold substitutethat a government has monopoly privilege to issue by way of fiat force. In this way, the government can keep on inflating the supply and amassing resources to itself and away from the public.
But legal tender laws are not magic. They are not the Fountain of Youth, nor the Everlasting Gobstopper. Only so much value can be extracted from a gold substitute before it's completely rejected as such. In other words, before the substitute can no longer be substituted back into gold. In such a case, the monetary regression chain is completely severed, and the public has no choice but to return either to a different functioning gold substitute, or in the absence of that, to money itself, to gold, in order to continue on the original monetary regression chain so that prices have any semblance of economic meaning. There's no other alternative. Otherwise, the division of labor breaks down entirely and you have complete and utter chaos.
What about other currencies that are not the dollar? They fit into two separate and distinct categories. Some currencies also are gold substitutes in their own right, where a central bank does have some amount of gold reserves backing them, say like the Euro. Others, like the Canadian Dollar or the Israeli New Shekel, are simply dollar substitutes. Why? Because the Bank of Canada and the Bank of Israel have no gold reserves whatsoever. They have dollar reserves, and so the value of the CAD and the ILS rests solely on the dollar’s continued exchangeability with gold.
These two currencies continue the Misesian regression chain in this way back to the monetary nexus origin point, though the reed connecting them to it is increasingly oblique, thin, and unstable.
What is bitcoin then? Like the ILS or the CAD, bitcoin is nothing but another dollar substitute. It has zero gold backing whatsoever. True, there's no element of "fiat" in bitcoin because it is not even legal tender, but that does not make it money. When Bitcoin first came into existence, it was immediately indexed to the dollar. This was the only way Bitcoin could have possibly continued the Misesian regression chain from which all money, money substitutes, and substitutes for those substitutes, draw their market value. Bitcoin is not, and never was, its own regressive monetary chain.
As for Bitcoin’s ever-rising exchange rate with the dollar, its dollar price is completely irrelevant to the nature of what the thing actually is. As a dollar substitute, the source of bitcoin’s value depends entirely on the dollar’s continued functionality as a gold substitute. Once the dollar loses its exchangeability with gold, that chain is broken, Bitcoin’s exchange rate with the dollar becomes entirely meaningless, and bitcoin falls into the monetary abyss.
Along these same logical lines, we can start to untwist other linguistic pretzels in monetary parlance. Here’s another biggie: “The dollar is backed by the full faith and credit of the US government.”
No, this is also completely impossible. The dollar is backed by gold. It's the US Treasury market alone that's backed by the full faith and credit of the US government. We know this because if the US government were to default on all its debt tomorrow and simply stop paying anything, the dollar itself would continue to function as a gold substitute (assuming there is gold in Fort Knox of course). The US Treasury market, however, would crash completely.
Another linguistic pretzel that gold bugs mistakenly use: “Gold should be remonetized.”This phrase makes no sense because gold is money now. When you use dollars to buy things, you are using gold. Gold cannot be “remonetized” if it is already money.
What can happen though is that the public can completely reject the dollar as a gold substitute, or in other words, the public could demonetize the dollar or at least devalueit to a new, much lower monetary exchange rate with gold. This would certainly stop the ongoing inflationary process cold. But gold can never be “remonetized” as gold is already the monetary nexus point for the entire Misesian regression chain that gives any price array in the world any economic meaning at all.
One more: Gold is a competitor to the dollar.Or conversely, the dollar is a competitor to gold. This also is impossible. The dollar is gold. Gold cannot compete with itself. Neither is the euro a competitor to gold, or to the dollar, or the yen, or the Swiss franc. All of these currencies are all just gold substitutes as well, as all of the central banks controlling their issue have some degree of gold reserves. The only thing in competition among these gold substitutes is their comparative rates of inflation over the gold they are substituting, which is why all of these currencies have lost almost all of their gold value since 1971. Almost all. At the point they lose all of it, they are dead.
What then is a competitor to gold? Silver. Both gold and silver are money. Silver is retail money. Gold is wholesale or for large purchases. As a competitor to gold, silver’s exchange rate with gold continually fluctuates, depending on its supply and demand relative to gold.
From here we can understand why banks manipulate the price of gold to begin with. It's very simple how they do this. All they do is sell more gold futures contracts into the market than there is gold to back them. The mechanics can get complicated as to how this is pulled off, but the principle itself is quite simple.
The inflation factor in the gold futures market above the available supply is now 2.394, or about 240%. (See red box above.) All this is another form of inflation, but one that tugs the dollar’s purchasing power back from the brink by sustaining the illusion of an open and stable gold window. The more people that actually use this window to obtain physical gold, the harder it becomes to keep it forced open.
These moves by bullion banks I do not believe consciously stem from a coherent theory of money as laid out here, but vested interests and market forces have a way of working things out organically. Call it Adam Smith’s Invisible Hand from Hell if you will.
The gold window cannot remain forced open at this exchange rate forever. The supply of gold substitutes continues to skyrocket at unprecedented rates around the world and not just the supply of dollars. All of these gold substitutes are vying for the same homogeneous gold supply across the world. I believe what will cause the public to dump government-issued gold substitutes and revert to money itself instead, is an obvious and sustained rise in the cost of living in gold substitute terms like we saw in 1980.
But I also believe there's something we can do to hasten this process of ending inflationary finance for good. The hard money community must unite around logical principles of what money is and take aim together. We need to stop these Bitcoin games, get out of this complete nonsense now, and use profits to attack the gold window and finally close it for good. These games with bitcoin and cryptocurrencies on the assumption that they are money will all end in tears and sadly probably suicides because bitcoin cannot possibly be money. Bitcoin is a dollar substitute, and you cannot end inflationary finance by buying a dollar substitute. If you want to speculate on bitcoin with some change, go ahead, but we need all main firepower concentrated on physical gold and silver now.
Gold and silver ETFs, unallocated and pool-allocated bullion accounts, only serve to trap monetary demand into still more paper that tracks the gold dollar exchange rate for the purpose of accumulating still more dollars. Gold and silver ETFs and unallocated accounts are nothing but another dollar substitute in that sense. If the dollar can no longer be exchanged for any amount of physical gold, cashing out of a gold or silver ETF in dollars will not accomplish anything for its holders who are not powerful banks authorized to redeem gold or silver baskets from any given ETF. And it is very likely that standing for delivery on an unallocated or pool-allocated bullion account would not be possible.
We are in the bottom of the 9th of this game now. It’s a game for all the gold and silver marbles, for all the real money left in the world. It’s a game for money itself. It’s a game to end monetary tyranny, a game for human liberty and honest finance. We need all efforts concentrated on gold and silver in order to stop inflationary finance once and for all. Not GameStop, not bitcoin, and not tech stocks or real estate. We need to concentrate on money itself.
If you distrust the dollar as a gold substitute, then join us, buy some coins, take them off the market, do whatever you can, put the squeeze on the dollar, and help us close the gold window once and for all.
Eventually, this will happen anyway, and when it does, Bitcoin will go to zero in real terms by logical necessity. The question for the hard money community and those who understand the evils of inflation, is what side do you want to be on when the dollar is finally demonetized as a gold substitute once and for all?
Use your heads. Use logic. And choose wisely. Choose physical gold and silver.
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This article was written by
I invest in the light of Austrian Business Cycle Theory and cover monetary trends for the purpose of timing the credit cycle. My marketplace service The End Game Investor helps subscribers manage the risks of, and profit from the ongoing fiscal and monetary crisis precipitated by the COVID-19 pandemic. I use gold, silver, and associated stocks and investment vehicles in a low-risk high-return setup.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I own physical gold and silver.