Why not return to gold as the national currency? by Ellen Brown

Since that question has come up often on Ellen Brown’s blog, a chapter from “Web of Debt” addressing it is posted below.

Chapter 37
THE MONEY QUESTION: GOLDBUGS AND GREENBACKERS DEBATE

“You shall not crucify mankind upon a cross of gold.” – William Jennings Bryan, 1896 Democratic Convention

At opposite ends of the debate over the money question in the 1890s were the “Goldbugs,” led by the bankers, and the “Greenbackers,” who were chiefly farmers and laborers.1 The use of the term “Goldbug” has been traced to the 1896 Presidential election, when supporters of gold money took to wearing lapel pins of small insects to show their position. The Greenbackers at the other extreme were suspicious of a money system dependent on the bankers’ gold, having felt its crushing effects in their own lives. As Vernon Parrington summarized their position in the 1920s:

To allow the bankers to erect a monetary system on gold is to subject the producer to the money-broker and measure deferred payments by a yardstick that lengthens or shortens from year to year. The only safe and rational currency is a national currency based on the national credit, sponsored by the state, flexible, and controlled in the interests of the people as a whole.2

The Goldbugs countered that currency backed only by the national credit was too easily inflated by unscrupulous politicians. Gold, they insisted, was the only stable medium of exchange. They called it “sound money” or “honest money.” Gold had the weight of history to recommend it, having been used as money for 5,000 years. It had to be extracted from the earth under difficult and often dangerous circumstances, and the earth had only so much of it to relinquish. The supply of it was therefore relatively fixed. The virtue of gold was that it was a rare commodity that could not be inflated by irresponsible governments out of all proportion to the supply of goods and services.

The Greenbackers responded that gold’s scarcity, far from being a virtue, was actually its major drawback as a medium of exchange. Gold coins might be “honest money,” but their scarcity had led governments to condone dishonest money, the sleight of hand known as “fractional reserve” banking. Governments that were barred from creating their own paper money would just borrow it from banks that created it and then demanded it back with interest. As Stephen Zarlenga noted in The Lost Science of Money:

[A]ll of the plausible sounding gold standard theory could not change or hide the fact that, in order to function, the system had to mix paper credits with gold in domestic economies. Even after this addition, the mixed gold and credit standard could not properly service the growing economies. They periodically broke down with dire domestic and international results. [In] the worst such breakdown, the Great Crash and Depression of 1929-33, . . . it was widely noted that those countries did best that left the gold standard soonest.3

The reason gold has to be mixed with paper credits is evident from the math. As noted earlier, a dollar lent at 6 percent interest, compounded annually, becomes 10 dollars in 40 years.4 That means that if the money supply were 100 percent gold, and if bankers lent out 10 percent of it at 6 percent interest compounded annually (continually rolling over principal and interest into new loans), in 40 years the bankers would own all the gold. To avoid that result, either the money supply needs to be able to expand, which means allowing fiat money, or interest needs to be banned as it was in the Middle Ages.

The debate between the Goldbugs and the Greenbackers still rages, but today the Goldbugs are not the bankers. Rather, they are in the money reform camp along with the Greenbackers. Both factions are opposed to the current banking system, but they disagree on how to fix it. That is one reason the modern money re-form movement hasn’t made much headway politically. As Machiavelli said in the sixteenth century, “He who introduces a new order of things has all those who profit from the old order as his enemies, and he has only lukewarm allies in all those who might profit from the new.” Maverick reformers continue to argue among themselves while the bankers and their hired economists march in lockstep, fortified by media they have purchased and laws they have gotten passed with the powerful leverage of their bank-created money.

Is Gold a Stable Measure of Value?

There is little debate that gold is an excellent investment, particularly in times of economic turmoil. When the Argentine peso collapsed, families with a stash of gold coins reported that one coin was sufficient to make it through a month on the barter system. Gold is a good thing to own, but the issue debated by money reformers is something else: should it be the basis of the national currency, either alone or as “backing” for paper and electronic money?

Goldbugs maintain that a gold currency is necessary to keep the value of money stable. Greenbackers agree on the need for stability but question whether the price of gold is stable enough to act as such a peg. In the nineteenth century, farmers knew the problem firsthand, having seen their profits shrink as the gold price went up. A real-world model is hard to come by today, but one is furnished by the real estate market in Vietnam, where sales have recently been undertaken in gold. In the fall of 2005, the price of gold soared to over $500 an ounce. When buyers suddenly had to pay tens of millions more Vietnamese dong for a house valued at 1,000 taels of gold, the real estate market ground to a halt.5

The purpose of “money” is to tally the value of goods and services traded, facilitating commerce between buyers and sellers. If the yardstick by which value is tallied keeps stretching and shrinking itself, commerce is impaired. When gold was the medium of exchange historically, prices inflated along with the supply of gold. When gold from the New World flooded Spain in the sixteenth century, the country suffered massive inflation. During the California Gold Rush of the 1850s, consumer prices also shot up with the rising supply of gold. From 1917 to 1920, the U.S. gold supply surged again, as gold came pouring into the country in exchange for war materials. The money supply became seriously inflated and consumer prices doubled, although the money supply was supposedly being strictly regulated by the Federal Reserve.6 During the 1970s, the value of gold soared from $40 an ounce to $800 an ounce, dropping back to a low of $255 in February 2001. (See Chart, page 346.) If rents had been paid in gold coins, they would have swung wildly as well. Again, people on fixed incomes generally prefer a currency that has a fixed and predictable value, even if it exists only as numbers in their checkbooks.

The tether of gold can serve to curb inflation, but an expandable currency is necessary to avert the depressions that pose even graver dangers to the economy. When the money supply contracts, so do productivity and employment. When gold flooded the market after a major gold discovery in the nineteenth century, there was plenty of money to hire workers, so production and employment went up. When gold became scarce, as when the bankers raised interest rates and called in loans, there was insufficient money to hire workers, so production and employment went down. But what did the availability of gold have to do with the ability of farmers to farm, of miners to mine, of builders to build? Not much. The Greenbackers argued that the work should come first. Like in the medieval tally system, the “money” would follow, as a receipt acknowledging payment.

Goldbugs argue that there will always be enough gold in a gold-based money system to go around, because prices will naturally adjust downward so that supply matches demand.7 But this fundamental principle of the quantity theory of money has not worked well in practice. The drawbacks of limiting the medium of exchange to precious metals were obvious as soon as the Founding Fathers decided on a precious metal standard at the Constitutional Convention, when the money supply contracted so sharply that farmers rioted in the streets in Shay’s Rebellion. When the money supply contracted during the Great Depression, a vicious deflatio-nary spiral was initiated. Insufficient money to pay workers led to demand falling off, which led to more goods remaining unsold, which caused even more workers to get laid off. Fruit was left to rot in the fields, because it wasn’t economical to pick it and sell it.

To further clarify these points, here is a hypothetical. You are shipwrecked on a desert island . . . .

Shipwrecked with a Chest of Gold Coins

You and nine of your mates wash ashore with a treasure chest containing 100 gold coins. You decide to divide the coins and the essential tasks equally among you. Your task is making the baskets used for collecting fruit. You are new to the task and manage to turn out only ten baskets the first month. You keep one and sell the others to your friends for one coin each, using your own coins to purchase the wares of the others.

So far so good. By the second month, your baskets have worn out but you have gotten much more proficient at making them. You manage to make twenty. Your mates admire your baskets and say they would like to have two each; but alas, they have only one coin to allot to basket purchase. You must either cut your sales price in half or cut back on production. The other islanders face the same problem with their production potential. The net result is price deflation and depression. You have no incentive to increase your production, and you have no way to earn extra coins so that you can better your standard of living.

The situation gets worse over the years, as the islanders multiply but the gold coins don’t. You can’t afford to feed your young children on the meager income you get from your baskets. If you make more baskets, their price just gets depressed and you are left with the number of coins you had to start with. You try borrowing from a friend, but he too needs his coins and will agree only if you will agree to pay him interest. Where is this interest to come from? There are not enough coins in the community to cover this new cost.

Then, miraculously, another ship washes ashore, containing a chest with 50 more gold coins. The lone survivor from this ship agrees to lend 40 of his coins at 20 percent interest. The islanders consider this a great blessing, until the time comes to pay the debt back, when they realize there are no extra coins on the island to cover the interest. The creditor demands lifetime servitude instead. The system degenerates into debt and bankruptcy, just as the gold-based system did historically in the outside world.

Now consider another scenario . . . .

Shipwrecked with an Accountant

You and nine companions are shipwrecked on a desert island, but your ship is not blessed (or cursed) with a chest of gold coins. “No problem,” says one of your mates, who happens to be an accountant. He will keep “count” of your productivity with notched wooden tallies. He assumes the general function of tally-maker and collector and distributor of wares. For this service he pays himself a fair starting wage of ten tallies a month.

Your task is again basket-weaving. The first month, you make ten baskets, keep one, and trade the rest with the accountant for nine tallies, which you use to purchase the work/product of your mates. The second month, you make twenty baskets, keep two, and request eighteen tallies from the accountant for the other baskets. This time you get your price, since the accountant has an unlimited supply of trees and can make as many tallies as needed. They have no real value in themselves and cannot become “scarce.” They are just receipts, a measure of the goods and services on the market. By collecting eighteen tallies for eighteen baskets, you have kept your basket’s price stable, and you now have some extra money to tuck under your straw mattress for a rainy day. You take a month off to explore the island, funding the vacation with your savings.

When you need extra tallies to build a larger house, you borrow them from the accountant, who tallies the debt with an accounting entry. You pay principal and interest on this loan by increasing your basket production and trading the additional baskets for additional tallies. Who pockets the interest? The community decides that it is not something the tally-maker is rightfully entitled to, since the credit he extended was not his own but was an asset of the community, and he is already getting paid for his labor. The interest, you decide as a group, will be used to pay for services needed by the community — clearing roads, standing guard against wild animals, caring for those who can’t work, and so forth. Rather than being siphoned off by a private lender, the interest goes back into the community, where it can be used to pay the interest on other loans.

When you and your chosen mate are fruitful and multiply, your children make additional baskets, and your family’s wealth also multiplies. There is no shortage of tallies, since they are pegged to the available goods and services. They multiply along with this “real” wealth; but they don’t inflate beyond real wealth, because tallies and “wealth” (goods and services) always come into existence at the same time. When you are comfortable with your level of production — say, twenty baskets a month — no new tallies are necessary to fund your business. The system already contains the twenty tallies needed to cover basket output. You receive them in payment for your baskets and spend them on the wares of the other islanders, keeping the tallies in circulation. The money supply is permanent but expandable, growing as needed to cover real growth in productivity and the interest due on loans. Excess growth is avoided by returning money to the community, either as interest due on loans or as a fee or tax for other services furnished to the community.

Where Would the Government Get the Gold?

In the real world, with no treasure chest floating ashore, a government that tried to switch to an all-gold currency would face another challenge, and this one would appear to be insurmountable: where would it get the gold? The metal would have to be purchased, and what would the government use for this purchase if Federal Reserve Notes were no longer legal tender? In the worst-case scenario, the government might simply confiscate the gold of its citizens, as Roosevelt did in 1933; but when Roosevelt did it, he at least had some money with which to pay for it. If gold were the only legal tender, Federal Reserve Notes would be worthless.

Assume for purposes of argument, however, that the Treasury did manage to acquire a suitable stash of gold. All of the above-ground gold in the world is estimated at less than 6 billion ounces (or about 160,000 UK tonnes), and much of it is worn around the necks of women in Asia, so acquiring all 6 billion ounces would obviously be impossible; but assume the U.S. government managed to get half of it. At $800 per ounce (the December 2007 price), that would be around $2.4 trillion worth of gold. If all 12 trillion dollars in the money supply (M3) were replaced with gold, one troy ounce would have a value of about $4,000, or 5 times its actual market value in 2007. That means the value of a gold coin would no longer bear any real relationship to “market” conditions, so how would this laborious exercise contribute to price stability? If the goal is to maintain a fixed money supply, why not just order the Treasury to issue a fixed number of tokens, declare them to be the sole official national legal tender, and refuse to issue any more? The government could do that; but again, do we want a fixed, non-inflatable money supply? As long as money is lent at compound interest, keeping the money supply “fixed and stable” means the lenders will eventually wind up with all the gold.
Some gold proponents have proposed a dual-currency system. (See Chapter 35.) The fiat system would continue, but prudent people could convert their funds to gold coins or E-gold for private trade. The idea would be to preserve the value of their money as the value of the fiat dollar plunged, but what would be the advantage of trading in a gold currency if the fiat system were still in place? Why not just buy gold as an investment and watch its value go up as the dollar’s value shrinks? The gold could be sold in the market for fiat dollars as needed. Again, you can capitalize on gold’s investment value without having to use it as a currency.

The “Real Bills” Doctrine

If using gold as a currency is plagued with so many problems, why did it work reasonably well up until World War I? Nelson Hultberg and Antal Fekete argue that gold was able to function as a currency because it was supplemented with a private money system called “real bills” – short-term bills of exchange that traded among merchants as if they were money. Real bills were invoices for goods and services that were passed from hand to hand until they came due, serving as a secondary form of money that was independent of the banks and allowed the money supply to expand without losing its value.8

The “real bills” doctrine was postulated by Adam Smith in The Wealth of Nations in 1776. It held that so long as money is issued only for assets of equal value, the money will maintain its value no matter how much money is issued. If the issuer takes in $100 worth of silver and issues $100 worth of paper money in exchange, the money will obviously hold its value, since it can be cashed in for the silver.

Likewise, if the issuer takes I.O.U.s for $100 worth of corn in the future and issues $100 worth of paper money in exchange, the money will hold its value, since the issuer can sell the corn in the market and get the money back. Similarly, if the issuer takes a mortgage on a gambler’s house in exchange for issuing $100 and lending it to the gambler, the money will hold its value even if the gambler loses the money in the market, since the issuer can sell the house and get the money back. The real bills doctrine was rejected by twentieth century economists in favor of the quantity theory of money; but Wikipedia notes that it is actually the basis on which the Federal Reserve advances credit today, when it takes mortgage-backed loans as collateral and then “monetizes” them by advancing an equivalent sum in accounting-entry dollars to the borrowing bank.9

Professor Fekete states that the real bills system works to preserve monetary value only when there is gold to be collected at the end of the exchange, but other commodities would obviously work as well. One alternative that has been proposed is the “Kilowatt Card,” a privately-issued paper currency that can be traded as money or cashed in for units of electricity.10 The nineteenth century Greenbackers relied on the real bills doctrine when they contended that the money supply would retain its value if the government issued paper dollars in exchange for labor that produced an equivalent value in goods and services. The Green-back was a receipt for a quantity of goods or services delivered to the government, which the bearer could then trade in the community for other goods or services of equivalent value. The receipt was simply a tally, an accounting tool for measuring value. The gold certificate itself could be considered just one of many forms of “real bills.” It has value because it has been issued or traded for real goods, in this case gold. Some alternatives for pegging currencies to a standard of value that includes many goods and services rather than a single volatile precious metal are discussed in Chapter 46.

The NESARA Bill: Restoring Constitutional Money

One other proposal should be explored before leaving this chapter. Harvey Barnard of the NESARA Institute in Louisiana has suggested a way to retain the silver and gold coinage prescribed in the Constitution while providing the flexibility needed for national growth and productivity. The Constitution gives Congress the exclusive power “to coin Money, regulate the Value thereof, and of foreign Coin, and fix the Standard of Weights and Measures.” Under Barnard’s bill, called the National Economic Stabilization and Recovery Act (NESARA ), the national currency would be issued exclusively by the government and would be of three types: standard silver coins, standard gold coins, and Treasury credit-notes (Greenbacks). The Treasury notes would replace all debt-money (Federal Reserve Notes). The precious metal content of coins would be standardized as provided in the Constitution and in the Coinage Act of 1792, which make the silver dollar coin the standard unit of the domestic monetary system. To prevent coins from being smelted for their metal content, the coins would not be stamped with a face value but would just be named “silver dollars,” “gold eagles,” or fractions of those coins. Their values would then be left to float in relation to the Treasury credit-note and to each other. Exchange rates would be published regularly and would follow global market values. Congress would not only mint coins from its own stores of gold and silver but would encourage people to bring their private stores to be minted and circulated. Other features of the bill include abolition of the Federal Reserve System, purchase by the U.S. Treasury of all outstanding capital stock of the Federal Reserve Banks, return of the national currency to the public through a newly-created U.S. Treasury Reserve System, and replacement of the federal income tax system with a 14 percent sales and use tax (exempting specified items including groceries and rents).11

The NESARA proposal might work, but if the government can issue both paper money and precious metal coins, the coins won’t serve as much of a brake on inflation. So why go to the trouble of minting them, or to the inconvenience of carrying them around? The problem with the current financial scheme is not that the dollar is not redeemable in gold. It is that the whole monetary edifice is a pyramid scheme based on debt to a private banking cartel. Money created privately as multiple “loans” against a single “reserve” is fraudulent on its face, whether the “reserve” is a government bond or gold bullion.

Precious metals are an excellent investment to preserve value in the event of economic collapse, and community currencies are viable alternative money sources when other money is not to be had. But in the happier ending to our economic fairytale, the national money supply would be salvaged before it collapses; and what is threatening to collapse the dollar today is not that it is not backed by gold. It is that 99 percent of the U.S. money supply is owed back to private lenders with interest, and the money to cover the interest does not exist until new loans are taken out to cover it. Just to maintain our debt-based money supply requires increasing levels of debt and corresponding levels of inflation, creating a debt cyclone that is vacuuming up our national assets. The federal debt has grown so massive that the interest burden alone will soon be more than the taxpayers can afford to pay. The debt is impossible to repay in the pre-Copernican world in which money is lent into ex-istence by private banks, but the Wizard of Oz might have said we have just been looking at the matter wrong. We have allowed our money to rotate in the firmament around an elite class of financiers when it should be rotating around the collective body of the people. When that Copernican shift is made, the water of a free-flowing money supply can transform the arid desert of debt into the green abundance envisioned by our forefathers. We can have all the abundance we need without taxes or debt. We can have it just by eliminating the financial parasite that is draining our abundance away.