by Steve Forbes
The twenty-first century gold standard would allow people to turn in dollars to the government to receive gold at a fixed rate and cash in their gold for dollars. Americans had that right, except in wartime, until 1933. They did not have it under the Bretton Woods system, when only central banks of other countries could redeem dollars for gold. This kind of convertibility, while not really necessary, would serve as one more safeguard to maintain sound money if the Fed does not do its legally mandated job of maintaining the dollar/gold ratio.
Instead of a formal gold cover of yesteryear, legislation for a new standard might specify that Uncle Sam would indeed be obliged to take dollars from all comers. In addition, the U.S. government would have to replenish its gold stocks if they fell below, say, 50 million ounces (the amount is 261 million ounces today). Washington’s gold holdings would be audited yearly, as would the Fed itself. For its services, government would convert currency to gold at a fixed fee of 2% or more so as not to compete with private dealers.
Other currencies would be pegged to the dollar.
If the United States went to gold, other countries would likely fix their money to the dollar, if only for convenience. Numerous countries in Latin America and Asia already try to keep their currencies closely aligned to the greenback because doing so makes trading and investing with the United States much easier. Part of the task at hand would be to make sure that their central banks understand how to defend their ties to the dollar. (We’ve seen repeatedly, as in the Asian crisis of 1997–1998, how central banks lack the knowledge of how to defend their currencies from speculative attacks.) Of course, if a country wanted to attach its currency directly to gold instead of the gold-backed dollar, it could do so. The result would be the same: stable exchange rates.
The Fed would have a role, at least for now.
The Fed would continue to act as a lender of last resort and deal with panics that might arise from a 9/11 type of event.
Common Concerns About Gold
If a gold standard offers so many powerful advantages, some may ask, why hasn’t the United States returned to it in the decades after Bretton Woods? One reason is that gold is ferociously dismissed by the Keynesians and monetarists dominating the policy establishment. Ronald Reagan, who created a Gold Commission in 1981, was a believer in sound money. Like John F. Kennedy, Reagan understood that, in the words of Kennedy, the dollar should be “as good as gold,” that a great nation must have a sound currency. Unfortunately he was unable to prevail over his advisors who, with the exception of the noted economist Arthur Laffer (of the Laffer curve fame), were almost unanimously opposed to gold. Had he done so, we might have a gold standard today.
The lack of real discussion has allowed myths and misconceptions about the gold standard to persist. Below we list several concerns that are frequently raised.
Gold shows too much price volatility to be a reliable anchor.
Opponents point to gold price fluctuations as proof that a gold standard would mean price volatility. In 2010 Chris Beam worried in Slate.com:
Gold is notoriously volatile—its price has doubled over the last two years. If the Federal Reserve were to simply fix the dollar to the price of gold on a given day and demand for gold changed drastically, it would wreak havoc on the economy. If the Fed pegs the rate too low, for example, people would want to trade their dollars for gold, forcing the Fed to raise interest rates in order to make dollars more attractive. Even if the Fed were to pick the rate correctly, it would still have to make adjustments based on the economies of the United States’ trading partners. If the dollar is growing in value, but another country’s currency is decreasing in value, yet both currencies are pegged to gold, something has to give—either one of the currencies has to inflate or deflate, or the exchange rate has to be adjusted.
Put aside the misunderstanding of exchange rates. (If two currencies are pegged to gold, their exchange rates, by definition, are fixed.) The writer doesn’t get the point about how the gold standard fundamentally operates. The price of gold is volatile only when it has no link to the dollar. Remember, gold’s intrinsic value makes it a refuge for investors fleeing unsound money. A good part of gold’s price reflects anticipated future inflation and sheer uncertainty about what is to come. If the dollar were sound, there would not be the flight into, or out of, gold.
In 1980, when people feared that the United States was incapable of controlling an ever-worsening inflation, the dollar price of gold soared quickly from $220 to $850 an ounce. When emotions calmed, the dollar price fell to $300 an ounce. Gold shot to a record high of $1,900 an ounce in 2011. Since then the precious metal has come down considerably.
It is possible to pick a gold price that neither fuels inflation nor attempts to turn the clock back too far in time as Great Britain did after World War I. As for the concerns about our trading partners, remember that nations of the world voluntarily adopted gold standards following the lead of Great Britain in the 1870s—and their economies boomed.
There is not enough gold to have a gold standard today.
Critics complain that the United States has only about 261 million ounces of gold with a market price of roughly $325 billion. The monetary base is over $4 trillion, and the most commonly used money supply measure, M2, stands at almost $11 trillion. The total of M1, the most liquid part of the money supply, is $2.6 trillion. If the dollar were pegged to gold at its current value, they say, we would have to undergo a savage deflation that would make the British experience of the 1920s look like a sedate picnic.
What they don’t recognize is that what makes gold work is not its supply, but rather its ability to provide a stable yardstick of value. You don’t need to have piles of this precious metal for a gold standard to work. Even during the heyday of the classical gold standard, no country ever had 100% gold backing for its money. Great Britain often had very low amounts of gold backing the pound, and the amount there and in other countries varied widely. (As we’ve said, you don’t even need to own an ounce of the yellow metal to have your currency linked to gold.) Previously we explained how a twenty-first century gold standard would work with our current supply. If the United States decided to have convertibility—to give people the legal right to redeem dollars for gold at a fixed rate and vice versa—the U.S. government still has enough of the metal to make such a system work, even with the Fed’s bloated balance sheet.
A gold standard would be too rigid.
The misconception here is that a vibrant economy would be held back because a fixed gold price would tie government’s hands, preventing growth in the money supply. Gold, however, is far less rigid than critics perceive.
From 1775 to 1900 the U.S. population grew from 4 million to 76 million. During that time, America’s mainly subsistence agricultural economy blossomed into an industrial colossus. In the process, the global supply of gold increased a little more than threefold while the money supply in the United States mushroomed 160-fold even though the dollar was fixed to gold.
A gold standard allows the money supply to expand naturally in a vibrant economy. Remember that gold, a measuring rod, is stable in value. It does not restrict the supply of dollars any more than a foot with 12 inches restricts the number of rulers being used in the economy.
What if a crisis like a major financial panic demands an emergency injection of liquidity? The Bank of England developed the concept of the lender of last resort back in the 1860s under the classical gold standard. The Federal Reserve could easily fill the same function today if the United States reestablished a gold standard. At its discount window, banks could still put up sound collateral for emergency loans, preferably at an above-market interest rate so the borrowing institution would liquidate the loan as quickly as practicable. But such an event under a gold standard would be far less likely. As noted monetary expert Nathan Lewis wrote on Forbes.com, stable money has never caused a financial crisis.
Gold helped bring on and prolong the Great Depression.
The antigold narrative also blames the precious metal for the Great Depression. Supposedly, fears of creating a run on gold in Great Britain kept the United States from raising interest rates to curb its overheating stock market during the 1920s. The result, allegedly, was a credit bubble and falsely inflated economy that brought about the crash of 1929. Afterward, gold ostensibly kept governments from reviving their sliding economies.
Hogwash. The Great Depression was the tragic consequence of the Smoot-Hawley Tariff Act enacted by the United States in June 1930. Equity markets try to anticipate the future. This dreadful legislation was unprecedented, imposing an average 60% tax on over 3,000 import items. When it appeared that a destructive tariff of historic proportions might pass Congress, the stock market cracked and then crashed in September–November 1929. When, for a brief time, the tariff bill appeared it might falter, stocks rallied mightily, ending 1929 almost where they were at the beginning of the year. Then the monster came to life again and the slide resumed. Other countries, of course, noticed what was going on and prepared retaliatory measures.
The enactment of the Smoot-Hawley Tariff Act set off a worldwide trade war that was as disruptive to global commerce as the beginning of hostilities in 1914. Policy makers didn’t know what hit them. Their responses, primarily tax increases, compounded the downturn. Great Britain raised income taxes in 1930 and again in 1931. Germany, particularly hard hit because it was dependent heavily on trade, imposed draconian taxes, deepening the slump. The United States passed a bill of massive tax hikes in the spring of 1932 that was made retroactive to the beginning of the year. Income tax rates were boosted astronomically, with the top rate going from 25% to 63%. Epitomizing the folly of it all was a stamp tax on checks, thereby encouraging people to withdraw cash from already beleaguered banks. This draconian legislation even included numerous increases of excise taxes on items such as candy and movie tickets.
Critics respond that when Great Britain went off the gold standard in late 1931, its downturn ended. Of course, as we have noted, devaluation can initially deliver a boost. But this eventually deepened the devastation by escalating the trade war. After London’s devaluation, at least 20 countries quickly followed suit. The United States did the same in 1934, as did Italy and Belgium; France finally devalued the franc in 1936. These beggar-thy-neighbor devaluations, as they were called, were ultimately damaging to the global economy. In the end there were no winners. The experience compelled allied and neutral nations to convene in Bretton Woods, New Hampshire, in 1944 and create a new gold-based international monetary system.
A gold standard would be undermined by speculators.
Critics question whether it is possible to maintain a fixed dollar/gold rate in today’s global markets, in which computer technology makes possible giant trades and sophisticated speculators have access to vast resources. In 1992, for example, the British pound was tied to the German mark. Speculators led by George Soros attacked sterling by borrowing pounds and then selling them to buy marks. When it appeared that Great Britain, to save the pound, might need to raise interest rates as much as 100%, the humiliated government caved and it floated the pound. Soros and others then sold their marks for a greater number of pounds than they had borrowed, pocketing billions in profits.
Wouldn’t a gold-based dollar be similarly vulnerable? The answer is: not if nations know how to defend their currencies. How can they do this? By using their reserves to buy their currency and maintain its rate by reducing the monetary base.
In early 2009 the Russian ruble faced a speculative assault. Russia then bought rubles, its monetary base declined, and the attack on the ruble failed. The United States has plenty of assets to mount a Russian-style defense against an attack on a gold-backed dollar.
Setting a fixed dollar/gold ratio is price fixing and therefore anti–free market.
Having fixed weights and measures is essential for fair and free markets. We don’t let markets each day determine how many ounces there are in a pound or how many inches there are in a foot or the number of minutes in an hour. Money, similarly, is a measure of value.
Setting a new gold/dollar ratio is too difficult.
Gold standard critics commonly cite the painful deflation that roiled Great Britain in 1925 after it made the mistake of pegging the pound to gold at its pre–World War I gold price even though wartime inflation had more than doubled the cost of living.
This mistake could have been avoided had Great Britain simply fixed the pound to gold based on postwar values. Compounding the government’s error was that it left in place its high wartime taxes, which also depressed the economy. When it comes to setting a gold/dollar ratio, one needs to remember the famous quote from Thomas Wolfe: “You can’t go home again.”
A gold standard for the U.S. dollar has to be based on present-day values. The ratio shouldn’t be fixed at, say, $35 an ounce or even the $350 that prevailed for much of the 1980s and 1990s.
The challenge in setting the price today, however, is that people in the last few years have been buying gold out of fears of inflation. The answer should be calculations that take into account forward markets in gold, in addition to the price of inflation-protected bonds. The key is to avoid too low a ratio. To ensure that nominal wages don’t fall, a slightly high ratio is crucial. Whatever the method used, the key is to set a price so people know what the rules are and the economy can get growing again.
The gold standard isn’t perfect. No system is perfect. But stable money has never ever brought about the systemic financial and monetary crises caused by fluctuating money. If we are ever going to meet the challenges and avert the crises that face us today, gold is the best hope there is.
THE NUGGET
Gold remains the monetary Polaris. Every alternative has failed.
CHAPTER 7
Surviving in the Meantime
Protecting Your Assets from Unstable Money
Sell them and you’ll be sorry,
Buy them and you’ll regret,
Hold them and you’ll worry,
Do nothing and you’ll fret.
—OLD WALL STREET SAYING QUOTED IN Investing in One Lesson BY MARK SWKOUSEN
BY THIS TIME, YOU’RE PROBABLY WONDERING WHAT NOW? As you read this book, the value of your wealth is eroding. If you had $100,000 in cash in 2000 and did absolutely nothing, it would have been worth only around $74,000 in 2013. That’s right, the value of your money would have declined by about 26%. And that is with the last decade’s supposedly low rates of inflation.
We believe that the economic and social consequences of the continuing destruction of the dollar will sooner or later force the world to reawaken to the necessity of stable money. But that hasn’t happened yet. The question is what to do in the meantime.
The primary objective of investing today should not be about getting rich but preserving what you have. It is about survival. Ironically, one of the unintended consequences of the Fed’s manipulation of money is that it has made traditional wealth preservation through savings accounts untenable. You can’t just park your money in banks that barely pay interest. Washington policy makers constantly decry the evils of risk, but their regulations, not to mention the Fed’s artificial suppression of interest rates, have forced all of us into vehicles and strategies with higher levels of risk in order to preserve our money.
The next question is: What is the best way to do it? Contrary to what some “experts” suggest, there’s no surefire formula. Consider this grim reality: most professional money managers underperform the market. Few mutual funds consistently beat the Dow or the Standard & Poor’s 500 Index (S&P 500). Since managers and individual investors make up the market, by definition they can’t as a class exceed it. Unlike the situation at Garrison Keillor’s Lake Wobegon, everyone can’t be above average.
In the mid-1970s, when inflation was raging in the United States and around the world, Forbes magazine featured on its cover a block of ice in the desert sheltered by an umbrella. The tit
le read: “Inflation: How to Protect Your Capital.” In the first paragraph of the story we quickly confessed: “We cannot tell a lie. Given our tax laws and today’s virulent rate of inflation, there is no reliable way for the individual investor to hang on to his capital, let alone expand it by investing. Hold on to your pocketbook if anyone tells you otherwise.”
That unsexy but wise advice still holds true today. In an environment of monetary instability, the only sure thing is uncertainty. Even the smartest investors, though, can’t avoid being hurt by economic disruptions caused by the unnecessary and unexpected missteps of government. In the ferocious volatility of the last decade, John Paulson, who famously made billions trading in derivatives by foreseeing the subprime collapse, eventually stumbled in 2011 and 2012.
Good News in the Near Term, but. . .
With the Fed’s taper and its higher interest rates increasing the availability of credit, expectations in the near term are for a continuation of the recovery. Banks swollen with those astronomically high reserves have begun to resume lending. Whether this leads to the inflation that some fear depends on what happens at the Fed. Forbes.com contributor Louis Woodhill has accurately observed, “Right now, the Federal Reserve is conducting a completely discretionary monetary policy. . . . No one can accurately forecast a whim.”
The stealth tax of inflation, however, is far from the only wealth destroyer that can eat away at your money. Others include the new taxes and regulations from the Affordable Care Act or the financial asset seizures by government that are becoming an alarming global trend. The kind of looting of people’s assets that happened in Cyprus is also happening in other countries. There have even been calls in the United States for restrictions on retirement accounts—401(k)s—despite the fact that they are personal property.