Originality and the feeling of one's own dignity are achieved only through work and struggle.
Fyodor Dostoyevsky
I'll Be Celebrating Happy Capital Day Monday!
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| Courtesy FEE.org |
(my edits)
Young men who are not good in physics or chemistry or engineering major in economics.
- The smart economics majors become bankers.
- The less smart economics majors become economists
- The bankers hire smarter economists to tell the politicians what to think.
- The less smart economists go into financial journalism.
The GOP Platform and the Gold Standard
- The ones who are not smart enough to major in economics major in politics and become politicians.
There were reasons why I discussed Grover Cleveland in yesterday's post: first, I wanted to call attention to the kinds of characteristics and policies that I look for in a politician. Second, I wanted to call attention to the discussion of a sound currency and Cleveland's support of the gold standard.
Let me preface this by saying I am not by any means a gold bug; I do not own precious metals. This is not a financial investment blog. That being said, I remember one of the co-workers at an APL timesharing branch I used to work with around the time I started on my UH MBA part-time in the early 1980's. This was around the peak of the gold bubble. He was shaving (electric razor) in our office at the beginning of the workday, which I found odd; he sheepishly explained that he had been putting all his liquid assets into gold, forgot to pay his electric bill and got cut off.
The US Constitution gives the Congress authority to coin and regulate money (Article 1 Section 8) and requires the states to settle debts by gold or silver (Article 1 Section 10). The Coinage Act of 1792, among other things, set up a bimetallic standard of 15 silver grains to 1 gold grain.
This discussion requires an understanding of Gresham's Law. Basically the value of gold and silver can vary by supply and demand; they are used for purposes other than coinage, e.g., jewelry, industrial uses, etc. Thus, a fixed rate (like 15-1) is just like any government attempt to fix prices in a dynamic market. In essence, overvalued money chases undervalued money out of circulation (relative to the type of money). For instance, the ratio of 15:1 in 1792 overvalued silver. The net effect was to make silver coins the de facto standard coinage until 1834, when Congress changed the ratio to 16:1, which overvalued gold. The gold discoveries in California and elsewhere confirmed the overvalued status of gold coins and thus a de facto gold standard until the Civil War.
I'll give a very simple example of Gresham's law. In the 1960's the US debased silver coins (like dimes and half-dollars), i.e., mixed the silver with other, cheaper content. One of my brothers happened to be born the last year of silver dimes. My folks had a little pet bank we called "Mitchie". Every time my folks found silver dimes in their change, they fed them to Mitchie. Needless to say, the more valuable silver dimes quickly left circulation. Flash forward: the Hunt brothers tried to corner the silver market. Silver prices soared. (One figure I've seen is in 1980 a silver dime was worth $3.62 with silver at $50/oz.) My folks were able to redo their kitchen floor from Mitchie's proceeds.
The Civil War provides context for another common observation of commodity-backed currency: if and when nations are faced with a crisis (e.g., wartime or budgetary when tax increases are politically unrealistic), they often decide to go off a commodity standard and print fiat currency, e.g., greenbacks. (This is to prevent a run on the government's stock of the commodity backing the currency.) Then after the crisis they'll go back on the standard. (Germany, whose gold holdings backing its currency were depleted in the aftermath of WWI, experienced hyperinflation.)
There was a difference in our returning to the standard: we went from a bimetallic standard to an emerging international single metallic standard: gold in the so-called "Crime of 1873": no provision was made for a silver dollar. As Friedman points out, the international convergence on a gold standard quickly drove up the demand and price for gold: under Gresham's law and bimetallism, we would have returned domestically to a de facto silver standard. The global demand for gold and relatively tight supplies likely exacerbated deflationary pressures.
Of particular note is the emerging use of fiat currency (e.g., Civil War greenbacks); it is fairly clear that given the experience of Continentals and state-issued "bills of credit" that sentiment was against fiat currency at the time the US Constitution was ratified. The legal tender case for fiat currency in the post Civil War era, Hepburn, was held unconstitutional by SCOTUS, but a subsequent Grant-packed SCOTUS soon reversed it. Fiat money at this stage served as a proxy for commodity currency, e.g., you could exchange dollars for gold coins.
The "sound money" pro-gold standard vs. "free silver" battle was over farmers and others, with big loans and soft prices, wanting to expand the money supply, i.e., create inflation: in essence, the expectation was that inflation would push up crop prices and allow the farmers to pay back their loans with cheaper dollars. Of course, the farmers' discounted obligations would occur at the expense of bankers, and inflation would occur at the expense of consumers in general.
During the Depression we saw an unraveling of the Gold Bloc with gold runs on target weak currencies and fiscal deficits (wartime and/or state spending spending), and "beggar-thy-neighbor" currency devaluations and tariffs spawned trade wars. In the aftermath of WWII, there was a new system (the Bretton Woods system) of exchange rates in reference to the US dollar, linked to the gold standard. Nixon, facing mounting budget and trade deficits and a run on US-held gold backing the dollar, in mid-August 1971 announced that the US was leaving the gold standard.
The result was predictable: the related devaluation of the dollar made imports (including oil) more expensive, and inflation surged, resulting in a bull run for gold (which Americans were finally allowed to own again after FDR confiscated gold at old prices before he devalued the currency (i.e., raised the price of gold for international exchange)). Fed Reserve chairman Volcker finally broke inflation by raising interest rates to around 20%.
What conservatives (including Paul Ryan) and especially libertarians (like Ron Paul) are worried about is the excessive money supply growth in fiat currency, which in the long run is inflationary, a cruel indirect form of taxation adversely affecting all consumers; there is also an ethical issue of transferring wealth from savers and investors to borrowers.
This leads to the most intriguing development in the GOP platform of the creation of a commission to look at the feasibility of going back to the gold standard. The Fed has printed so many dollars over the past 4 decades I'm not sure that a standard can be reinstated (Churchill's issues with reestablishing at a former price in Great Britain duly noted), but the depreciation of the dollar is clearly unacceptable and is not in the interests of the consumer. What is important is that we restore banking to free market principles.
If I was attending the GOP convention, I would vote for the plank and thus send a message to the rest of America and the world that we are committed to a strong dollar.
Musical Interlude: My Favorite Groups
Toto, "I Won't Hold You Back". Another brilliant pop gem; my shower has heard this song a few times.
