The Goldbug Variations I
by Antal E. Fekete
Professor Emeritus, Memorial University of Newfoundland
March 25, 2005
Overture
This is a rejoinder to a piece of the same title by Paul Krugman,
MIT professor (now at Princeton) and staff writer of The New York
Times. It was posted on the internet on November 22, 1996,
with a note saying that it was to be composted two weeks later,
on December 6. It wasn't. I came across it a few weeks ago while
surfing the internet. At first I thought that it fully deserved to
be composted in short order. But on second thought I decided that
it called for a careful rejoinder. Bad-mouthing the gold standard
is a periodically returning pastime for mainstream economists. Their
arguments have never been put to rest by an authoritative rejoinder,
which I therefore venture to present.
Krugman's piece was part of a series entitled "The Dismal Science".
If I continue with these variations, which I am rather tempted to
do, then I shall call my series "The Dismal Monetary Science". I
apply this name to the monetary science, so called, of the Krugman
variety, more precisely, the demand-side theory of money according
to Lord Keynes, as well as the Quantity Theory of Money according
to Nobel laureate Milton Friedman, also known as monetarism.
In what follows quotations from Krugman are under the caption "Recitativo",
and my rejoinder under "Rondo".
Recitativo
The legend of King Midas, the original goldbug, has been generally
misunderstood. Recall that his prayers were answered by the gods:
everything he touched turned into gold. The catch was that "everything" included
food and drinks as well, and the poor king was starving to death
as his system could not ingest gold. The gods wanted to teach him
a lesson. Most people think that the lesson was in the perils of
avarice. This is a mistake. Midas' true sin was his failure to understand
monetary economics. What the gods were telling him was that gold
was just another metal. If it sometimes seemed to be more, that was
only because society has found it convenient to use gold as a medium
of exchange - a bridge between other, truly desirable, objects.
Rondo
Krugman is cutting down the difference between "sometimes" and "always" to
microscopic size. Gold has been the preferred means of exchange since
time immemorial. After barter was phased out as inefficient, and
after a relatively brief period of experimentation with other goods
such as oxen, shells, and tobacco to mention but three of them, the
marketability of gold (and silver) snowballed relative to that of
other contenders. Gold became king, and silver the queen. Gold would
still be king but for a coup d'etat overthrowing the Constitutional
monetary order in the United States and imprisoning the king.
In 1933 it took all the violence and duplicity a government could
muster against its own subjects to grab the gold belonging to the
people. There was wholesale confiscation of monetary gold, under
false pretenses. No sooner had the U.S. government laid its hands
on the people's gold than it wrote up its value. This piece of chicanery
was used to conceal the act of robbery. People were "compensated" for
the confiscated gold in the form of paper money. In 1935 the Supreme
Court of the United States dismissed charges that value was taken
from the people without due process of law arguing that paper money
continued to have the same purchasing power as gold coins. This flies
in the face of the fact that the loss of purchasing power of the
dollar abroad was instantaneous. Domestically it was gradual and
by the 35th birthday of the irredeemable dollar it amounted
to 90 percent, an unprecedented monetary destruction in the history
of the republic up to that point. (Much worse was to follow during
the next 35 years.)
Gold's forcible removal as the monetary metal was done in two convenient
steps, 35 years apart. (1) In 1933 the U.S. government defaulted
on its domestic monetary obligations, including the dishonoring of
the promise printed on every Federal Reserve note, to pay bearer
gold coin of the specified weight and fineness upon demand, and the
repudiation of the gold-bonded public debt held by its own citizens.
To be sure, it was repudiation. If you contract debt payable in gold,
and then at maturity you pretend to pay off your debt with another
promise payable in never-never land in the never-never future, then
you have repudiated the debt, haven't you? And the pretense that
you have discharged the obligation has made the repudiation worse,
hasn't it? (2) In 1968 the U.S. government defaulted on its gold
obligations to foreigners as well (the initial de facto gold
embargo was made official in 1971). To add insult to injury, the
U.S. government (after some behind-the-scenes arm-twisting) put a
gag-order into effect. The injured party was not allowed to call
a spade a spade. An international obligation, solemnly agreed to
at an international conference enjoying the widest publicity, duly
ratified by Congress and subsequently affirmed by four sitting Presidents,
was unceremoniously and unilaterally abrogated by a stroke of the
pen. Foreign creditors of the United States, the primary victims,
were not allowed to say "ouch". They were ordered to call it an "enlightened
monetary reform," dropping nothing more substantial than the trappings
of a "barbarous relic", in the words of John Maynard Keynes. Such
a level of bad faith in monetary dealings, compounded by the gag-order,
was surely unprecedented in the financial annals. Previously a defaulting
government had to bear the shame, and live it down before it could
rejoin the exclusive club of credit-worthy nations. Now the offender's
deserts were not only high praise for a courageous deed in fighting
superstition, but also license to keep on plundering its neighbors'
natural and human resources through the fiat money system.
Even today textbooks refrain from calling the 1933 and 1968 repudiation
by its proper name, default. A new breed of professors, including
Krugman (who was born after these defaults have taken place) lionize
the U.S. for cheating its domestic and foreign creditors, and plunging
the nation and the world into the worst experimentation with fiat
paper. Some dismal monetary science, indeed!
Recitativo
There are other possible mediums of exchange beside gold, and it
is silly to imagine that this pretty, but only moderately useful,
substance has some irreplaceable significance.
Rondo
It is incredible that this monetary economist has apparently never
heard of marginal utility. Every substance, in addition to its main
applications, has a marginal application (which determines its marginal
utility), as well as several submarginal applications. Bread, for
example, has its main application as staple food for humans. The
marginal application of bread was inadvertently found by Queen Marie
Antoinette of France who later paid with her head for her discovery
on the scaffold during the French Revolution. When she had heard
that people had no bread to eat, she asked: "Well, why don't they
eat cake?" Accordingly, the marginal utility of bread is determined
by its marginal application which is to be eaten for dessert, instead
of cake, if you have it. But bread could also serve as fodder to
animals, and it could be used as fertilizer of agricultural land.
If it isn't, it's because it is far too valuable for these "submarginal" applications.
It is no different with gold. Its main application is to serve as
the monetary metal. Marginal application is in jewelry. But the list
of the submarginal applications of gold is endless, thanks to its
fine physical and chemical properties such as malleability, ductility,
conductivity, non-corrosiveness, among others. It is the last-mentioned
property of gold which Lenin's fertile imagination used, dangling
it before the hungry eyes of his starving subjects, to illustrate
the blissful conditions prevailing under Communism. Lenin observed
that there was no better material with which to plate public urinals.
It was precisely this application to which the "capitalist metal" would
be put after the final victory of Communism, Lenin said. You may
object that gold is far too valuable for this submarginal application
and, as a consequence, the gold plating of public urinals would be
picked just as quickly as they were installed, by the beneficiaries
of the Soviet paradise. Lenin, of course, would have an answer ready
to meet this objection. The Cheka (secret police) would take care
of saboteurs who picked the gold plating of public urinals, and would
shoot them on sight. To say that gold is only moderately useful betrays
ignorance of Himalayan proportions. Ignorance of technology but,
no less, ignorance of microeconomics.
Whether gold is irreplaceable or not as money remains to be seen.
It will not be decided by quacks and imposters posing as doctors
who have banned the use of gold as a thermometer, expecting that
the patient will not run a temperature if he remains blissfully ignorant
about his feverish condition. Can it be reasonably doubted that the
patient, if he survives, will chase the quacks away, and rehabilitate
the thermometer to its former use?
Recitativo
There is a case to be made for a return to the gold standard.
It is not a very good case, and most sensible economists reject it,
but the idea is not completely crazy. On the other hand, the ideas
of our modern gold bugs are completely crazy. Their belief
in gold is, it turns out, not pragmatic but mystical.
Rondo
I do not speak for the gentlemen named by Krugman as "modern gold
bugs" but I am happy to present the case for the gold standard as
I see it. I am prepared to submit it for general discussion before
any competent and impartial forum to judge whether it is "completely
crazy" or not.
The gold standard has nothing to do with stabilizing the price level
that is neither possible, nor desirable. It has to do with the stabilization
of the rate of interest at the lowest level compatible with savings
and production, which is both possible and utterly desirable. Under
a gold standard there is no bond speculation, just as there is no
foreign exchange speculation. There are no derivatives markets in
interest-rate futures the size of which, as measured by the liabilities
of speculators, is in the hundreds of trillions of dollars,
which is more than the market capitalization of the entire globe (or
soon it will be). Under a gold standard talent must find outlet in
productive enterprise rather than in gambling.
Bond speculation is the heel of Achilles for the regime of irredeemable
currency, that will cause its self-destruction in due course. Like
an incubus, it sucks all the economic resources of the world, and
robs it of the best talent. The tricksters who grabbed the gold belonging
to the people of the United States and its foreign creditors were
unaware that their looting would let the genie of destruction, bond
speculation, out of the bottle. How can we explain this colossal
oversight?
Interest rates were stable under the gold standard, and the small
variation in bond prices did not admit a profitable opportunity to
speculate in bonds. But bond speculation started as soon as the gold
anchor was cut in 1971, on the dot. The "brain trust" of apologists
for irredeemable currency can develop theories about bond speculation,
suggesting that it has a stabilizing influence on interest rates,
just as commodity speculation has on the prices of agricultural goods.
Let us bypass, for the sake of argument, the fact that this stabilization
was automatic under the gold standard. Any effort to prove that speculation
has an analogous stabilizing influence in both the commodity and
the bond market is doomed to failure. It ignores the fact that the
supply of bonds is controlled by man, in contrast with that of agricultural
goods which is controlled by nature. The analogy is flawed beyond
the hope of repair. Commodity speculation is self-limiting. It is
limited by the size of available supply. By contrast, bond speculation
is not self-limiting. It is self-aggrandizing. The more it grows,
the more bonds will be printed. Or, to save the cost of printing,
the more bond-derivatives (futures, call options, put options, options
on futures, etc., ad libitum) will be invented. Thereby an
avalanche is set into motion which will bury innocent villages down
there in the valley. There is nothing that the protagonists of "managed
money" can do about it. Bond speculation introduces distortions into
the economy that will inevitably cause the downfall of the regime
of irredeemable currency. It may or may not be through runaway inflation
as in France during the last decade of the eighteenth century. It
may be through runaway deflation. In either case, there will be enormous
economic pain.
What Krugman calls "mystical", Keynes called "psycho-pathological".
Another famous quotation from him is that "the desire to palm gold
is a human aberration that the economist passes on to the psycho-pathologist
for study with a shudder." Well, gold is the ultimate means
of payment, such as the regime of irredeemable currency hasn't got
and will never get. Gold is voluntarily accepted in final settlement
of debts by all creditors. In this capacity, gold can be applied
as the agent of the bubble-test. If an individual wanted to make
sure that he would not be victimized in a check-kiting scheme, all
he had to do was to demand that his check be paid in gold coin. Why
is the joy one feels over one's ability to frustrate would-be criminals "psycho-pathological"?
What is "mystical" about one's desire to protect oneself against
check-kiting?
The litmus-test to find out whether a monetary economist serves
the cause of the search for and dissemination of truth, or whether
he has a hidden agenda such as to cover up for the looting of the
people's gold, is to engage him in a discussion on the subject of
interest rates under the regime of the irredeemable dollar as opposed
to the gold dollar. Apologists for the gold-looting invariably wriggle
out.
I hereby challenge Paul Krugman to open the columns of The New
York Times for such a discussion.
References:
Andrew White, Fiat Money Inflation in France - The Duke Endowment
Edition, 1933
Paul Krugman, The
Gold Bug Variations - The Gold Standard and the Men Who Love It
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Dr. Antal E. Fekete is an economist and monetary theorist, born
and raised in Hungary, who taught for many years in Canada. He also
worked in the Washington D.C. office of Congressman W.E. Dannemeyer
for five years on monetary and fiscal refom until 1990. Since 2001
he has been consulting professor at Sapientia University, Cluj-Napoca,
Romania. In 1996 Professor Fekete won the first prize in the International
Currency Essay contest sponsored by Bank Lips Ltd. of Switzerland.
He is the author of numerous scholarly articles and the widely read Monetary
Economics 101. His articles are archived at www.goldisfreedom.com.
