Part II: The Allure of Interventions and their Futility
Intervention is not a new phenomenon. In the nineteenth century a few state governments manufactured “inconvertible paper currency” directly, and most did so indirectly by sanctioning printing by designated banks. Fiscal stimulus was common; very large budgets were expended by states to build roads, canals, and railroads. These worked for moments in time, but legislative and banking experiments ended dreadfully. Although we remember these happenings by their most horrific panics, “of 1819” and “of 1837,” both these chapters of history enjoyed more than one peak, thanks to forbearance through “internal improvements” and continued production of “inconvertible currencies.”
After the specie suspension of 1814, false prosperity resumed until the panic of 1819. In response to that crisis, many states intervened in money markets with the “loan office” solution, which compelled creditors to accept certain sanctioned state bank notes for payment in lieu of specie, an ironic stance since these creditors had issued paper for gold deposits in the first place for the purchase of lands. These interventions helped kick-start the system for a while. Missouri, after seeing five-sixths of its money supply vanish, directly issued “inconvertible currency” that could be accepted for tax liability.
Anti-bullionists such as Thomas Law, husband to Martha Washington’s daughter, proposed socialization of banking by backing national currency with Treasury debt. Treasury Secretary Crawford proposed a similar scheme until he recanted when he realized this arrangement would encourage the government to issue too much money, and Treasury bonds would inevitably fall in value.
Likewise, after a downturn caused by the withdrawal of government deposits from the second US bank in 1834 (following Jackson’s veto in 1832), in response to stimulus and expanded state banking, asset and commodity prices rose for several years. Then a devastating collapse in 1837 plunged the nation into a seven-year depression.
The Illinois legislature allocated $12 million in 1838 for boondoggles, widening and deepening every stream, for example connecting the Illinois River with Lake Michigan. Wrote President Lincoln’s personal secretaries George Nicolay and John Hay that the result of these “brilliant schemes (was) a load of debt that crippled for many years the energies of the people, a few miles of embankments that the grass hastened to cover, and a few abutments that stood for years by the sides of leafy rivers, waiting for their long delaying bridges and trains.”1
New York City, which in the late 1830s was the leading commercial city in the United States and the second most important in the world, accounted for two-thirds of all import duties.2 Its banks were first in the nation to suspend gold convertibility in 1837, starting a cascade among most other cities – many such as Philadelphia were more highly leveraged.
The state of New York moved towards resuming depositors’ rights to reclaim their money through a new state banking law the following year that stimulated the opening of new banks capitalized with engraved and printed circulating notes “in the similitude of bank notes in blank” that were issued by the state when the new entities bought a like amount of state debt.3 By January 1842 New York State teetered on the verge of bankruptcy, with fiscal stimulus such as the enlargement of the Erie Canal and monetary policy being contributing factors.
The Global Experience
What has been a dollar problem could now become a truly global experience. Nations less indebted than the U.S. or Japan may have room for more borrowing, as their over 20% money growth statistics belie. But their growth would necessarily be autarkic, and the loss of foreign trade could wipe out equity at the base of their inverted pyramid of banking leverage, much as Smoot-Hawley might have in the 1930s, as argued by Thomas Rustici in his new book, Lessons from the Great Depression. This may be what is unfolding in China. That country has used stimulus to produce, for example, an entire nearly uninhabited city, Ordos. A remarkable Al Jazeera video that tells that story is on the ConservativeEconomist.com web site. Or, at the very least, consider the destruction in value that has been ongoing to holders of Indian rupees, which have been depreciating rapidly against gold for as long as they eye can see, shown in this chart:
While the United States is all loaned up, China, India and other emerging nations are not, and they have been behaving much like America did in the 1970s, when banks printed money lavishly and caused consumer prices to escalate. The developing world has benefitted from the United States having converted its economy from a manufacturing power into a financial services and real estate centric marketplace. Roughly eight percent annual money supply growth since 1971 when Nixon broke America’s promise to redeem dollars with gold has facilitated a moral hazard that would entice its citizens with a one-way bet to borrow and buy real estate, diverting capital away from building factories.
The hollowing out of productive enterprises and the structural trade imbalance would export dollars to the BRIC nations, constantly signaling to their monetary authorities that they had more reserves upon which to pyramid monetary growth. No matter how much credit they created, like the Roman generals refreshing the imperial treasury with war booty from conquests, their monetary base would grow rapidly underneath. In the United States, however, the monetary base would remain flat, and we would become increasingly indebted.
For Whom Does the Gold Bell Toll?
Karl Marx dreamt of a world in which there was no money, for money was the tool which extracted and stored the added value of labor for the enjoyment of exploitative capitalists. Instead, the state would keep track of production at all levels of the economy, planning investment and exchanges of output among citizens. Lenin thought gold might be better used to adorn public bathrooms.
In the twentieth century capitalist system, gold was demonetized and devoted to the adornment of women, and to a lesser extent, men. In its place was installed a centrally planned supply of money, which by being programmed to lose some of its value each year caused all who would hold it to wish to disgorge it to accumulate assets instead. And in fact, they would not only disgorge it, but yearn to be in a state of owing it. They would strive to have a large negative balance of it channeled into real estate, such that the burden of servicing it even with rock-bottom interest rates would challenge getting by with the necessities of life. This would drive the price of land sky-high, while everyday items might even fall in price thanks to Wal-Mart or the integration of Chinese production into global trade.
To the Marxist or the modern day capitalist, gold has little utility. It is valueless in the eyes of fiat inflationists like Warren Buffett. But it is this quality that makes it ideal as an intermediary substance between us, because its supply and demand is most distant from shortages or sudden shifts in demand such as would affect oil or copper, for its cumulative production since the dawn of time still might circulate. Gold won’t disintegrate like deposits backed by real estate would. And it wouldn’t grow like a cancer, like the money supply did post 1971, or for that matter since the founding of the Fed in 1913, or the invention of bank money by the Hamiltonians that circumvented the constitutional edict that money was silver and gold.
So for whom does the gold bell toll, and why is not its ringing heard? Why has its rise during the first and second phases of its bull market begun in the twenty-first century defied skeptics, when unlike the 1970s inflation is not apparent, but financial pandemonium emerged unexpectedly instead? Why do so many have faith that the Fed can exit from its strategy of having injected $1.3 trillion of reserve bank credit into a beleaguered financial sector? Why is there another view that leaving in these reserves would cause rampant inflation, rather than merely validate the rise in asset prices already achieved? Or, for that matter why wouldn’t leaving in these reserves merely confirm the lack of deflation that otherwise would have occurred when $2 per hour labor was integrated into the global supply chain, as described in the contrafactual case in Part I of this essay?
A yawning gap between the broad money supply and the market value of above ground stocks of bullion has developed since the Fed was chartered in 1913. Consequently, the potential reward from a relative change in wealth for holders of gold compared to holders of paper or commodities has never been greater than it has now, should the deflationary force of labor globalization destabilize the banking system and reveal once and for all how untenable and destructive the fiat currency system is. But still those who cling to paper do not hear their bell tolling. If we were to validate with a 20 percent gold backing the $14 trillion printed so far, 95 percent of which has been created since Nixon closed the gold window, the price of bullion would rise to over $10,000 per ounce.
The gold bell tolls. It is calling socialists, Marxists, and capitalists who have commandeered the power of the state to reassure mankind that unbridled monetary production has no unseen effect upon its users, even if they have kept a solemn promise to maintain a low inflation rate. Gold is a commodity that is least like all the others used in trade, but it possesses characteristics that have made it the ideal selection as a vessel for wealth for thousands of years: Scarcity, yet existing in large enough quantities for use in exchange. Cumulative production that far exceeds annual mine output. Durability. Easily identifiable. Homogeneity. Divisibility. These characteristics are lacking in electronic and paper money, and these failings have produced inequity, impoverishment, and waste of public resources on a scale that no amount of regulation could harness, regardless whether one speaks of the twenty first century or the nineteenth.
1 Paul M. Angle, ed., The Lincoln Reader, New York: Da Capo Press, 1947, p.102.
2 Reginald Charles McGrane, The Panic of 1837, University of Chicago Press, 1924, pp.100-101.
3 C.Z. Lincoln, Constitutional History of New York II, Rochester, 1905-8, pp. 42-3.
In Part I of “For Whom the Gold Bell Tolls,” William Baker writes of the three phases of the gold market in the twenty-first century, perceptions of inflation and deflation, and how gold can become a preferred medium of exchange when money substitutes falter in value.
An unabridged version of the entire essay is available on the Conservative Economist web site.
William Baker is the author of “Endless Money: The Moral Hazards of Socialism” (John Wiley, 2010).
Disclosures: Long and short equities. Long gold, gold derivatives, and gold equities.
Disclosure: Disclosures: Long and short equities. Long gold, gold derivatives, and gold equities.