10. The Gold Standard in Theory and Myth

Okay, today's lecture, this afternoon's lecture, is on the topic of the gold standard in theory and in myth. And the mythology of gold, as we might call it, really grew up with John Maynard Keynes. Actually, myths started to develop about the gold standard even before Keynes wrote in the 1930s. They began to grow up with the quantity theory at the turn of the century, including Irving Fisher.

In today's world, in the post-World War II era, the mythology of gold substitutes for any sort of sound analysis of the gold standard. So what I want to do is to give some of the more prominent myths and then to show how they are not based on sound theoretical reasoning, at least in the Austrian point of view. And then I want to talk a little bit about the plans for a transition back to the gold standard and some of the difficulties that we will face in such an endeavor. Let me just show you some of these myths.

Okay, these are the six myths I'll deal with. The first is that the gold standard is unable to accommodate the monetary needs of a growing economy. Since our economy is growing from year to year, it is said that we require an increased money supply to accommodate the exchange of these additional goods. Secondly, under the gold standard, the quantity of money is arbitrarily determined.

That is, it's determined by the costs of mining and by other factors that may influence the demand for money, or rather the demand for the use of gold as a non-monetary commodity. It's not in any sense planned in a rational way. That's what this means to say. Thirdly, the gold standard is a government price-fixing scheme writ large.

This is a particularly monetarist critique that setting a fixed price of gold between the dollar and a unit of gold is nothing but a price-fixing scheme and why would Austrians who believe so passionately in the free market fall victim or advocate such a scheme. Fourth, the gold standard subjects the country to alternating bouts of inflation and deflation. That is, the money supply depends almost solely on what is happening to the balance of payments in the country. So if you have a surplus in the balance of payments, gold flows in, your money supply increases.

Whereas a deficit will result in a contraction of the money supply and with corresponding effects on the price levels of those countries. Fifth, the gold standard involves high costs in terms of resources devoted to gold mining as well, and even more importantly, as a sacrifice of productive uses of gold in industry, for example, in electronics, in dentistry, in jewelry. And sixth and last, the gold standard results in high interest rates that discourage investment and retard economic growth. This is a particular critique of Keynes of the gold standard.

Well, I think basic supply and demand analysis in most cases will show us that these are certainly just myths and are not correct representations of how the gold standard actually works. So let me start with the first myth, the fact that the gold standard is unable to accommodate the needs of a growing economy. We might begin by pointing out that the decade in which we've had one of the greatest rates of growth in the United States was in the 1880s. And I have some statistics here regarding that.

So historically, it's certainly not true that the gold standard stunted growth. In fact, throughout the 19th century and up until World War II, a mild deflationary trend prevailed in the industrialized nations. So despite the rapid growth that occurred as country after country industrialized in the 19th century, we had a gold standard in place. And this certainly didn't prevent that rapid growth.

To go on, the reason for this was that the supply of goods did outstrip the supply of gold money. And yet there was growth and falling prices at the same time. And, for example, in the U.S. from 1880 to 1896, the wholesale price level fell by about 30% in 16 years.

That's about 1.7% per year. And those figures come from Friedman and Schwartz. At the same time that the price level was declining, they had, as you would have gone back to gold in 1879, at the same time that we had a decline in the price level, real income rose by about 85% or around 5% per year. One of the most rapid prolonged rates of growth in U.S.

history. Aside from infrequent discoveries of major new sources of gold, this inflationary trend was only interrupted during periods of major wars, such as the Napoleonic Wars that Britain fought as I said, 1797 to 1821. Britain had gone off the gold standard and as a result did experience rapid inflation. And also, of course, the U.S.

during the Civil War. But yet, after they returned to the gold standard, prices then continued to fall. And that didn't impede growth. Well, that's the history of it.

And there are many other instances of increases or high rates of growth coinciding with the gold standard. But what about the theory? Well, the theory can be explained, I think, with a simple supply and demand diagram in which we put the money, total stock of money in the economy on the horizontal axis, and the purchasing power of money, the value of a money unit, or to put it another way, the amount of various units of goods that can be purchased by a unit of money. We put that on the price axis.

That's equal to 1 over P. So, for example, if you pay $10 for a compact disk, well then the value of money in terms of the compact disk is one-tenth of a compact disk. If a personal computer costs or has a price of $1,000, well then the value of a dollar in terms of personal computers is 1,000th, one-one-thousandth of a personal computer. So, as we said earlier in the week, the purchasing power of money is an array of alternative quantities of goods that can be purchased by a unit of money, in this case the dollar.

Let's take a simple example. Let's say the quantity of gold at a given point in time is fixed, and so we grow a vertical supply of money, M, let's have M as money supply. And we have a certain demand for money, a certain amount of money that people wish to hold and wish to purchase with their labor and other goods that they're selling. And let's say that the money supply in billions of dollars is $100 billion.

Now what would happen if suddenly we had a 10% increase in the supplies of goods and services produced in this economy? Well, in effect, the sellers of those goods would want to sell those goods at going prices. That would mean you would need 10% more money for the economy to be able to absorb those goods. So in effect, this is the money demand before growth, MD1.

In effect, what would occur is that the demand for money would increase. So now the demand for money would be 10% greater. So now you would have quantity demand for money at the given purchasing power of money, at the given amount that the money can purchase, TPM1, it would now be $110 billion. But there's no Fed to create this additional $10 billion that we need.

So how did the gold standard handle that? Very simply, if I can direct your attention for a moment to the high-tech industries in the last 20 or 30 years, how did they handle the fact that the supply of personal computers and software and so on was increasing so rapidly that it was outstripping even the inflationary rate of growth of the money supply caused by the Fed in the 80s and 90s? Well, how did those additional computers get sold? The point is that because of the technological advances and increase in investment in those industries, costs fell, so that when the supply of computers increased on the market, their prices fell.

So, again, to give you an idea of the magnitude of this fall, we can go back to history, recent history in this case, and I believe I do. Yes, I do. A mainframe computer sold for $4.7 million in 1970, while today one can purchase a personal computer that is 20 times faster for less than $1,000. So we have substantial price deflation in high-tech industries, and that did not impair the growth of those industries, this fall in prices, because it corresponded to falling costs due to technological advances.

In fact, we can point out that there was an enormous expansion of profits, productivity, and output in these industries. This is reflected in the fact that in 1980, computer firms shipped a total of just about one-half million PCs, while in 1999, their shipments exceeded 43 million units, so it increased 86 times. And that's despite the fact that quality-adjusted prices had fallen by over 90%. So the point is here, as people bring their goods to market, there's been an increase in the supply of goods because there's been technological improvement, as I said, at lower costs.

They bring these goods to market. What happens is exactly what happens in the high-tech industries, except it happens economy-wide. Or not necessarily economy-wide, in those industries in which you have growth. So their prices will begin to fall.

As their prices fall, each dollar will be able to purchase more of that particular good than it did before. So there's an excess demand for money, a shortage, so-called shortage of money, but it's only temporary on the market. What happens is that as the value of each dollar increases, we move up along the demand curve to this point, so that at the end of the process, prices are 10% lower, or roughly 10% lower, and the purchasing power of money is roughly 10% higher. So each gold dollar can now purchase 10% more than it did before If you look over a prolonged period of time, you'll find that the supply of gold does react to an increase in demand for gold.

It takes a while to do that. So we have the purchasing power of money here again, and we have the whatever the purchasing power may be at a given point in time, equilibrium purchasing power, and a certain money supply here. Let's just call it M1 as the money supply. This is the money supply.

This is the money demand. M is the quantity of money at a given point in time. All right. Let's say for a moment that there is a decrease in the cost of supplying gold.

A better technique is discovered for abstracting gold from the ore, or possibly better mines are found from which it's easy to extract the gold. For whatever reason now, you suddenly have a decrease in the cost of mining gold. What would that mean? That would mean now that you would have an increase in the supply of gold, as in any other case of any other industry in the economy.

So you would have a shift to the right of the supply curve, the MS prime, let's say. You'd have more gold in the economy, and as a result, prices would rise. Purchasing power too. Now, how would this come about?

What would happen is that as the price of extracting gold from the ground dropped, that would mean that you would have a situation where an ounce of gold could be purchased from the ground, could be gotten from the ground for less than an ounce of gold that you have to pay in wages. So now you would have higher-wage workers paying them the going wage rates, and there would be a higher profit, in other words, to producing gold. Just as it would be if the price of apples fell or if the price of computers fell, you would expand the industry. And so gold mining would expand, and what would happen is that more gold would come out of the ground, and the price of gold, or the value of gold, would drop.

In other words, there would be more gold in circulation, drive prices up. But that's not the only, or not the end of the effect. Some of that additional gold, since gold is now cheaper, as the price of, for example, jewelry goes up and so on, it would now be more profitable to produce jewelry and more profitable to use gold in dentistry, because those prices have risen. So part of the new gold would go to directly satisfying consumer wants, and part of it would go into the money supply.

In either case, you would have a higher price level, but you would also have more goods that would be produced by gold. So society would benefit. That would occur with any sort of a particular good, whether it's gold or any other type of commodity. Now, why is that arbitrary?

Why do they say that the quantity of money is arbitrarily determined? It's not arbitrarily determined. It's determined by the market. On the other hand, let me draw here.

If you had an increase in the demand for gold, prices would fall. And as prices fell, the prices of those inputs or resources that you used to mine gold would fall. So you'd have a fall in the prices of capital goods, a fall in the prices of the various raw materials and energy that you used to mine gold. What would that do to gold production?

In the long run, it would be more profitable to mine gold from the existing mines using the existing techniques. So when there's an increase in demand for gold, in the short run, yes, prices fall, but in the longer run, what tends to happen? As those prices fall, it spurs, or stimulates, the development of new sources of gold and also stimulates the production from existing gold mines. And as a result, you get an increase in the supply of gold that pushes prices up back towards their former level.

Now, what's so arbitrary about that? That's not arbitrary. Basically, what the critics of gold call arbitrary, it simply means that the quantity of gold is not determined by governments. It's determined by people's demand for gold, and it's determined by the cost of gold, based on technology and the availability of specific resources such as gold mines.

I don't see that as arbitrary one bit. Thirdly, what about this whole idea that gold is a government price-fixing scheme on a large level? This is a particular criticism of bimetal Friedman of the gold standard. But in fact, under a genuine gold standard, there is, it's not price-fixing.

If we go back to the 19th century, when we had genuine gold standards existing in most of the world, or silver standards, but let's focus on gold, we have a situation where for at least about 100 years in the U.S., from 1834 until 1933, the dollar was defined legally as equal to 1/20th of an ounce of gold. That's not price-fixing. When people bought their gold into banks, that meant that they formed a contract with the bank to return their property when they redeemed the banknote. The banknote itself was not money under genuine gold standards.

It was a receipt that permitted you to redeem that note for money. You could use it as a money substitute in exchange because it was more convenient. But in itself was not the money, and people understood that. It's as if someone says the pink slip, the title to an automobile, which changes hands.

I can sell you my automobile, my Grand Prix Competition Series. I can sell you that. And here in Alabama, give you the pink slip. And the car could remain in New Jersey.

I could store it for you for a few months. I'd beat it into the ground at that point. But anyway, you wouldn't be deluded into believing that the pink slip, the so-called pink slip, which is the title to the car, is the car itself, okay? Obviously, it's the title to the car.

All right. So keeping that in mind, when all nations were on the gold standard, everybody had the same money, okay? They just used different names to designate their unit of money. So, for example, the British pound was equal to one-fourth of an ounce of gold.

The French franc was equal to one hundredth of an ounce of gold. And so on. So for about 100 years, the U.S. dollar, the exchange rate between the U.S.

dollar was $4.86 for one British pound. Why was that? That wasn't arbitrary. There was no price-fixing there.

The reason why that exists is because there was five times the amount of gold in a British pound, since the pound is one-fourth of an ounce, as there was in an American dollar, which was defined as 1/20th of an ounce. So under the gold standard, the fixed exchange rates between the different goods is no different than the fixed exchange rate -- okay, it's not really an exchange rate, but we'll call it that for the moment -- the fixed exchange rate between, let's say, a nickel and a quarter. A nickel is defined as 1/20th of a dollar. A quarter is defined as 1/4 of a dollar, or 1/4 of a dollar.

Therefore, five nickels exchange for one quarter. That's not an exchange rate. That's not a government price-fixing scheme. That's simply a result of the laws of arithmetic.

So Friedman is wrong under at least a genuine gold standard, and that's not true of the Bretton Woods system. And we'll talk about some other gold standards in which it would be artificial price-fixing. But under genuine gold standard, it is not a price-fixing scheme. Fourth, the international gold standard subjected countries to alternating bouts of inflation and deflation.

For example, if the U.S. were to run a surplus of the gold standard, gold would flow into the country. It would increase the money supply and drive prices up. The country that was losing gold, that had a deficit, let's say that was Great Britain, would find that its money supply is shrinking because gold is flowing out of the country, and therefore its prices are falling.

But we have to ask ourselves, why do these deficits and surpluses occur? Are they an act of God? No, of course not, okay? Let's take the United States.

The United States, this is the world was on the gold standard, the United States today is a single currency area using dollars. Do we worry about or even know whether, for example, New Jersey has a deficit or a surplus with California or whether Nebraska has a deficit or surplus with Indiana? Fortunately, state governments don't keep those kinds of statistics, so no one worries about them. If they did, of course, then people would be worrying about the balance of payments in their town and so on.

The point is this. Let's say that there's an increase in output in California, an increase in productivity because of the high-tech industries in Silicon Valley. That's a good example, I would say. And on the other hand, there's a fall in output or a fall in demand for output from Michigan because U.S.

cars are no longer in demand. Well, Michigan's imports, or I'm sorry, Michigan's exports, the things that they sell to the rest of the country, would begin to decline. On the other hand, California's exports to the rest of the country, the computers and software they sell to the rest of the country, would increase. Michigan's citizens and so on would find that they had fewer dollars as their incomes fell.

California citizens, on the other hand, would find they had more dollars. So money would be redistributed from Michigan to California, but that's not deflation. Or deflation in Michigan, inflation in California. That's simply a result of the fact that the demand for output in a certain area has fallen and therefore people's incomes in that area have fallen and people want to hold less money when their incomes are less, so that Also, so it's fractional reserve banking that causes the added deflation or added inflation.

It's not the gold standard itself. Under a pure gold standard, the whole world is a closed system, and as part of the world gets richer faster than other parts of the world, gold flows away from the parts that are lagging behind to those parts in which the income is increasing. The gold itself doesn't cause people to be richer or poorer, the inflow of gold. It's a result of that, okay?

And it's the same thing with your household, right? If your income increases, it's because whatever you're selling has become more valuable, and therefore, the consequence of that is that you get an increase in your money income, and you hold a larger proportion, or you hold more money income over the year than you would have, okay? All right, what about the fifth objection to the gold standard? That it allegedly involves extremely high costs in terms of resources, resources both that are used to mine new gold as well as the opportunity cost of using gold not in jewelry or dentistry or in electronics, but using it as money, okay?

Adam Smith was one of the first economists to claim that the gold standard had a high resource cost. Believe it or not, the early Ludwig von Mises actually accepted this. What Adam Smith said was the following, replacing gold with paper money is like replacing a highway that goes through fertile land with a highway in the sky, okay? So use that analogy.

Because a highway in the sky wouldn't have the opportunity cost of causing land that could have been used to grow various crops now to be used for a road, okay? And the materials that are used in the road could also be used for other uses. So Smith basically said this, as we, now he was a fan of the gold standard, but he wanted a fractional reserve gold standard. He was very comfortable with that.

He says, as we print more paper money and drive prices up in Great Britain, we send gold out of the country in exchange for capital goods. And that makes us more productive. So the paper money, in effect, allows us to create capital goods by pushing gold out of foreign countries in exchange for these capital goods that make our labor more productive, okay? And that was his argument.

The French economists always rejected that argument. And later on, von Mises did, and of course, Rothbard did. There's a couple of responses to this argument, okay? The first response is, well, even if gold standard has high resource costs, those high resource costs are justified as a way of preventing the government from inflating.

If you lived in a world where, let's say, you could trust governments, right, which is a never-never land, not to inflate the money supply, not to do what's natural and try to increase spending and buy votes by simply printing new money. If you lived in that kind of a world, all right, well, then you might say, well, we really don't need a gold standard. We don't live in that kind of a world, okay? Economists in the 19th century used to look on the gold standard as golden handcuffs to tie the hands of government and prevent the government from printing new money.

It's like saying, you know, if we could just get rid of, let's put it this way, there's very high resource costs, a lot of resources tied up in steel bicycle locks, okay? If we got rid of the steel bicycle locks and simply put a piece of paper around it and wrote lock on it, wouldn't we have all the steel to produce other things that are useful to human beings? Well, if you lived in a world where no one stole bicycles, yeah, sure, that's not the case in New Jersey, okay? We put two locks on our bikes.

All right. Okay, so first of all, even if there are high resource costs, okay, think of it as buying insurance against inflation. But secondly, as Roger Garrison has pointed out, these are economists that are making this point, and they're not taking into account the alternatives, okay? Remember, you have to compare institutions.

What about the resource costs of paper money that causes the economy to go through a business cycle in which you have inflation and misdirection of capital that is then revealed in a recession and layoffs of workers, okay? I would venture to say the resource costs that we suffered from paper money business cycles, business cycles that are induced by paper money, are greater than the resource costs of a gold standard, okay? But beyond that, and actually this is Roger Garrison's point, what happened in the, when we had stagflation in the 1970s and beyond, when we had crises in the 1980s, when we had financial crises, what do people do when they're confronted with rapid inflation or fear of bank collapses and financial collapses? Well, they rush out and they buy gold, don't they?

In fact, in the late 1970s, the price of gold shot up to around $800 an ounce. What did that do to the amount of resources in gold mining? It pushed more resources into gold mining, okay? Why?

Because people wanted to use gold as a hedge. So governments haven't gotten rid of their gold. All governments hold big stocks of gold. They haven't, I don't see governments selling that gold off, allowing the market to use that gold to produce more, you know, products for dentistry, more electronics, and so on, okay?

In fact, the stocks of gold held now out of production may be greater than they were under the gold standard. Resources devoted to gold mining might be greater, you don't know what would happen under the gold standard. So first of all, so we can respond is, first of all, even if it is high, that is resource costs, it's a form of insurance against government inflation. Two, government fiat money inflation has caused repetition of the business cycle, repeated again and again, and that has resource costs, and no one tries to add that up, okay, and compare that to the resource costs of gold.

Though they have figures, and Friedman has and others have, of what the resource costs of gold are, but you want to compare it to something, to the alternative institution. And finally, paper money doesn't save on the resource costs of gold because people use gold as a hedge. It's the first hedge against inflation or against prices. Lastly, the gold standard results in high interest rates that discourage investment and retard economic growth.

Basically, this is the Keynesian criticism. Again, if you have a gold standard, especially a genuine pure gold standard, it's impossible for the Fed to increase bank reserves and push down interest rates, bringing it out of a business cycle. And we know in the short run of the business cycle, you do seem to get a boom in output. And that's what they're talking about, that Alan Greenspan would not be able to manipulate interest rates.

Well, I think that's a good thing. I think it's a good thing not to have overinvestment, right? So basically, the response to that is that we don't want low interest rates if low interest rates are a result of manipulation by central banks because low interest rates result in misallocation of resources and eventual recession. So those are my critiques of the objections to the gold standard.

Let's talk about returning to the gold standard. I think this is an interesting and important and unresolved area of the theory of the gold standard. The thing that we do not want to do is return to what you might call a pseudo-gold standard or a phony gold standard. Because when that breaks down, like when Bretton Woods broke down, they will blame, that is the Keynesians and monetarists and others, will blame the gold standard for the breakdown.

So if we return to the gold standard, we want to go back to a genuine gold standard. So let's look at some of these plans to return to pseudo-gold standards. When Alan Greenspan first took office as chairman of the Fed, he and others on the board of governors of the Fed, Wayne Angel being someone else, began to talk about using the price of gold as one of a number of indicators of inflation or deflation, along with some other commodity prices. So if the price of gold was suddenly rising, that would indicate to Greenspan and the others on the federal open market commission, federal open market committee, excuse me, that there was inflation that is imminent in the U.S.

economy. So that would indicate to them, ideally, that they should drain reserves from the banking system and slow down the rate of growth in the money supply. Well, it's not a real gold standard, just looking at gold as one price among many. It's certainly not a real gold standard.

And so we can criticize it as it really does, still leaves the monopoly of money squarely in the hands of the Fed. It's just another indicator to them. They're using it as an indicator. Also, it makes central bank policy gold-plated, meaning that it's not a true gold standard.

It's not a gold standard under there, but it opens the gold standard for criticism. And so gold can be blamed for the inevitable failure of this. Now, we came a little bit closer in the early 1980s to a gold standard. President Reagan's advisors, the supply-siders, most prominently Arthur Laffer, Robert Mundell, and Jack Kemp, and other writers at the Wall Street Journal, were pushing for what they called a new Bretton Woods, which was a distorted form of the gold standard in which only the U.S.

dollar was, as I said, convertible into gold, and then only for foreign governments and official institutions, not for American citizens. And plus, of course, there would be no gold coin in circulation and so on. So they were pushing Reagan to institute a new Bretton Woods. And, in fact, Reagan did convene a commission to study this question.

And they held hearings minus 40% plus or minus 10%. What would happen if the amount of gold suddenly fell, meaning that there was inflation, below 30%, okay? Well then at that point, the Fed could not, its liabilities would be frozen. It could not create any more reserves.

It was an attempt to force the Fed to restrict its inflation, okay? If it fell, if its liabilities fell below, or I'm sorry, if the gold backing fell below 20% of the liabilities, then it had to reduce the monetary base by 1% per year. In other words, they had to begin to reduce, actually reduce the money supply. And finally, if the target reserve quantity fell below 10% of the Fed's liabilities, well, what would happen?

Nothing. What would happen would be, well, you have to raise the price of gold now, okay? So there was no punishment for inflating to the point where they began to lose their gold stock. So this was not a real gold standard.

This was a phony gold standard. It was a price-fixing scheme. In fact, some of the supply-siders later on said, you know what? We don't even have to buy and sell gold to keep gold.

All we have to do is look at the price of gold. So if the price of gold went towards $410, we'll simply take off in securities, sell them on the market, absorb some of the dollars, and bring the price of gold back to $400, okay? And if we had deflation, we would do the opposite. We'd go out, and we'd print money, and we'd buy securities.

So gold didn't need to be what they called the intervention asset, okay? They're talking in bureaucratic, technocratic terms. They had no intention of allowing gold to be the real medium of exchange, okay? Well, it could be the intervention asset, the asset that you buy and sell to keep the price of gold fixed, or you could use government securities.

It didn't matter, okay? And one of these supply-siders who happened to be my professor at Rutgers when I was getting my PhD was named, his name was Mark Miles. He wrote a book on this, and he basically came out and said, look, we don't need gold in this scheme, okay? We just need to use government securities to fix the price of gold.

So that, Friedman would be right, and the monetarists would be right to call that a price-fixing scheme. In fact, later on, I named it price-rule monetarism. It's simply monetarism, okay? Regular monetarism is the brand that Milton Friedman promotes.

It's quantity-rule monetarism. Under Friedman's scheme, you would simply increase the money supply at about 3% per year to try to keep the price level stable. Under price-rule monetarism, you'd keep the price of gold fixed to try to keep the price level stable, okay? So it's basically monetarism, which took into account the fact that the demand for money may change, which quantity-rule monetarism doesn't take into account.

And if the demand for money changes, well, then you're going to have a change in the price of gold. So, in fact, in Mark Miles' book on this, he said, we're a better brand of monetarism, okay? The monetarists want to increase the money supply at the same rate as the quantity of goods are increasing. But what if the velocity of circulation is changing?

There's no way to adjust the quantity rule. But with the price rule, that would affect the price of gold, and we could react to it, okay? So it came down to basically coming up with a rule to kind of, like monetarism, to restrain a government monopoly, okay? And any rule that you try to come up with to restrain a government monopoly is simply a pious wish.

It's basically saying, please don't increase the money supply too fast, if you're a monetarist, or please don't let the price of gold rise too high. There's nothing to stop the Fed from doing that, okay? People aren't there ready to turn in their dollars for gold like in the old days, causing the Fed to fear and the banks and the Fed, that they're going to lose their gold reserves, okay? So those are the fake gold standards.

Now, there was an interesting plan, I think Mosquito Housman supports, well, I think it was maybe introduced by Henry Hazlitt, it was later picked up by Hans Senholz, and by Professor Timberlake, who I did criticize this morning. He actually, at one time, promoted this plan. I thought, you know, it's a step in the right direction, away from monetarism. It's called parallel private gold standards, okay, or a parallel private gold standard.

Basically, you don't get rid of the monopoly fiat money. What you do is you allow individuals, and you give them the means, to make exchanges and contracts in gold. How would that work? And Hazlitt and Senholz, I think, I believe Guido, once you get rid of the legal tender laws and you get gold into people's hands, then you could have two monies.

Then people could take the gold if they wish, and they could begin to deposit it in banks or have it minted privately and begin to use it. Now, I have an objection to this. I think it's a pretty strong objection. And Murray Rothbard has voiced an objection to this kind of a scheme.

First of all, you get rid of the Fed. All right? The government can still, at some point, I mean, people are still tied to these notes. These Fed notes are dollars, okay, in their minds.

So, if there is some sort of national emergency, quote, unquote, okay, if we expand the war on terrorism and they want to finance a greater deficit, or if there's a recession for some reason and they want to push down interest rates, they can, this is paper. They can have Congress pass an emergency exception to the rule that you have to have, that these liabilities have to be frozen, and the Treasury can print them up and finance the deficit with them, okay? So you don't get rid of the dollar, but more importantly, you don't get rid of the paper dollar. But more importantly, if it actually begins to work and these things are frozen for a time, why would people use gold?

You and I and businessmen and everyone in the economy think, calculate, compare in terms of dollars. So if you go back to the regression theorem, okay, you somehow, if you want to get gold back in the circulation as money and not just give it back to people, if you want to get it back in the circulation as money, what you need to do is to make them think of gold as dollars again. How do you do that? You have to establish a link between the dollar and the gold.

Under the parallel standard, all you do is you have gold over here and you still have these dollars that people have been using all along. All right? So this is a potential problem with this. Now I'm not as, you know, I'm still willing to entertain this as one way of going back because no one has come up, I think, with a perfect way of going back to gold.

This would work if we had a horrendous inflation. If we had a very, very bad, you know, hyperinflation, then people would have the gold in their hands and they would be able to begin to use it in exchange. But the whole point is to freeze the Fed notes and not allow inflation any longer. So I don't see how you would get gold back into circulation.

Now very interestingly, some of the free bankers have said, you know, initially they said, well, we want free banking. The Austrian free bankers like George Selgin, Larry White, Steve Horwitz. They initially said, we want gold at the base of our free banking system. But then George Selgin said, you know what?

And I don't think the others have said this. We don't really need gold. If we get rid of the Fed and freeze the amount of paper dollars we have in the economy now, then they can serve as the base of the free banking system. Okay?

So we just have this paper. And if they wear out, then the government would replace only the ones that wear out and so on. Okay. So the problem is that it ignores the regression theorem.

It ignores the fact that people love the dollar, are used to the dollar, and compute and calculate in exchange in terms of dollars. And secondly, it still leaves the Fed notes in existence, which allows government at some point, because people believe it's money, to increase the money supply, okay, by having the Treasury print up new Fed notes. Let's take a look at von Mises' plan. Ludwig von Mises liked the currency school, but he just believed that they didn't go far enough.

Remember the currency school, what they wanted to do was, even though there were unbacked notes in circulation, they wanted any new note that came into circulation to be 100% backed by gold, okay? But what they forgot was that checking account money is also part of the money supply. And banks would increase checking account money and cause business cycles that way. So von Mises recognized that and he said he wanted a strict currency school gold standard, okay?

He put forth a plan in 1953 for the United States, okay, in an epilogue to his book, Theory of Money and Credit. And in it, he said, we should impose a 100% reserve on banks for all future checking account deposits and currency. If banks were allowed to issue banknotes, that also would have to be 100% backed, okay? All new notes and all new checking deposits, okay?

Whatever was unback to be able to buy any more government bonds or securities. In other words, you could not print up money to perform open market operations with. For some reason, he didn't say that we should get rid of the Fed. He said that the Fed could not interfere with the operations of the conversion agency.

He would also have withdrawn all small denomination bills from circulation. I guess he meant $1 bills and $5 bills, maybe $10 bills. And they could no longer be in circulation, so that people would have to use gold for small purchases. So gold coins would be in people's pockets.

Now, of course, at the price of gold as it is today, that would really be impossible. You couldn't use gold for small purchases if an ounce is equal to $400. Well, there's a couple of... Again, this is a good plan.

This does not ignore the regression theorem. Now, there's a link. The dollar is one four hundredth of an ounce of gold. So there's a link between the dollar and gold.

People can still think in dollars, but now their dollar is defined legally as a weight of gold. So I think it's better than the parallel gold standard I talked about. But it does leave the old Fed notes in existence, and again, the government can increase them. Now, Rothbard...

There's Rothbard 1 and there's Rothbard 2. There's two different plans that Rothbard puts forth. His newer plan is the following. This came out in his book, The Case Against the Fed.

What he says is that we should liquidate the Fed. We have to get rid of the Fed. We have to cancel all its assets except the gold that it owns. And then we're going to reprice the gold.

And the way we're going to determine the price of gold, according to Rothbard, would be to take the total amount of currency in the economy. And I just checked online today. At the end of... on May 30th, okay, we had $707 billion of currency in the U.S.

economy held by the public. Divide into that the ounces of gold owned by the Treasury, which is $260 million, and that would give you a price of $2,272 per ounce, enormously higher than the market price. I'll get to that point. So then what Rothbard would do is he would abolish the Fed.

Then he would call it all Fed notes. At least he'd get rid of the Fed notes. And people would bring the Fed notes in and exchange it for gold at that rate. For every $2,272, you would get an ounce of gold.

So you and I would be able to do that, as well as the banks. The banks that have reserve deposits at the Fed would also be able to turn them in for gold. Well, not melting down, but just people from all over the world would be coming to the U.S. Basically what would happen is that all this gold would flow into the U.S.

and automobiles and everything else would flow out of the U.S. until there was an equilibrium reached. And the price of the U.S. would rise rapidly to adjust to this very high price of gold.

That's one of the problems with this plan. But it would be a once and for all inflation, and it wouldn't create a business cycle because it wouldn't be going on through the banking system. So that's one of the problems with that. And that would leave fractional reserve banking.

So all the gold would either be held by people in their hands or would be deposited in the banks, and they could go on with fractional reserve banking, whatever fractional reserves they wished to hold, they could hold. It would be a fractional reserve system still. Demand deposits would not be 100% backed by gold. Only the currency notes would be transformed into gold itself.

So you get rid of the Fed notes. So once you got your gold and you deposited in the bank, the bank wouldn't have to hold 100% reserves against your deposit. They could create checking accounts that were let's say 10% backed by gold dollars. There would no longer be a law limiting them to 10%.

Whatever they thought would be prudent would be what they would decide as the back reserves. Rothbard's earlier plan would be to go back to a 100% gold standard. And what he would have to do there is he would have to take the total amount of checking account money as well as currency. And that would determine what the price of gold was.

And I looked again online at the single Fed. Right now, M1 stands at, let me put it up here, that M1, which is basically currency plus demand deposits, which are checking accounts, that's equal to $1,354 billion. So basically $1.3 trillion. If you divided that, I think it's going to be 0.583, divide that by the amount of the 260 million ounces of gold, you would come out with an enormously high price of $5,209 per ounce.

But now, all Fed notes would be redeemed at that rate and Federal Reserve deposits, as well as the checking account money. So everything would be backed. Now, what would you do about savings accounts? Savings accounts could be turned into what they actually are.

Really, they're a claim on the bank's assets, on the bank's loans. So you could turn them into a form of mutual fund. You could separate the bank into a 100% warehouse in which any notes they issue must be 100% backed by gold and any checking accounts they issue have to be 100% backed by gold. That would be, let's say, the deposit part of the bank.

And on the other hand, you would have the loan part of the bank. And there, all the bank's loans would be there and people would own, their savings accounts would be turned into rights to pro-rata shares or pro-rated shares of the bank's loans. OK? And the same thing with their certificates of deposit.

So they would become more like mutual funds. So the banks could take in money and loan it out, but they would only do that through their loan department. OK? That's what the currency school did.

They separated the Bank of England into a deposit department, sorry, into a deposit, they called it the issuing department, and a loan department. OK? So you'd have 100% backed money and you would still have banks able to accept investments or savings from clients and then loan them out at interest and pay the clients interest in the same way that mutual funds do that. And many mutual funds are not part of the money supply and neither would be the loan banking operations.

It wouldn't cause any inflation at all. OK? Also, you then could abolish the FDIC because the banks are, all the deposits are 100% backed. There's 100% reserve banking.

You could abolish the mint. OK? And have private mints minting coins. And you could then transform the savings deposit either into mutual funds or you could tell people, we're going to turn them into certificates of deposit.

So, for example, if the average maturity of the bank's loans are nine months, then you would tell people, well, you can't get your money out for nine months. OK? And then they would know from then on that anything that they put in that interest into the loan part of the bank would be a certificate of deposit that would be a true investment. OK?

So you wouldn't have any inflation. OK. Let me mention a plan that I recently came up with. In the old days, OK, for example, in the U.S., after the Civil War in 1879, Great Britain in 1821, after the Napoleonic Wars, Great Britain again in 1925, they would go back to the gold standard by simply deflating the money supply and going back at some past price of gold, at some lower price of gold, OK, than was existing during the period of non-convertibility.

Now, there was a problem because of unions in 1925. OK? There was no problem going back after the Civil War in 1879 or 1821. There was a little bit of a problem with deflation, but it was nothing like it was in Britain in 1925.

So all economists today look back at 1925 and say it's wrong to go back to the gold standard, even if you're a gold standard economist, by deflating, trying to deflate the money supply. Even Rothbard and Mises believed that. OK? And let me just read you a little, some comments by Rothbard and Mises.

Also, Hayek has the same view. Mises opposed the deflationist policy and went on to argue that it was erroneous, even in the case in which a country was attempting to revalue its depreciated currency in order to return to the gold standard at the previous mint par. To avoid monetary contraction, Mises favored a restoration of gold parity at or near the currently prevailing price of gold. And so that was his plan.

OK? Figure out what the price of gold is right now and then let's go back. Even Murray Rothbard, although an enthusiastic proponent of bank credit deflation, that is he likes when banks fail and you get bank credit deflation, that is a disappearance of these unbacked bank deposits. However, he generally refrained from advocating a deliberate contraction of the money supply by the Fed.

OK? Under an existing fiat money regime. So, for example, he referred to, quote, the crucial British error and, quote, fateful decision of returning to the gold standard in the 1920s at the pre-war parity. For Rothbard, the, quote, sensible thing to do would have been to recognize the facts of reality, the fact of the depreciated pound, franc, mark, and to return to the gold standard at a redefined rate, a rate that would recognize the existing supply of money Again, I have thoughts, it's not completely thought through.

I think a lot more has to be done on this. So I wouldn't stand by as a plan that I would want to implement. So what I say is in order to analyze the case within the context of contemporary institutions, it is necessary to provide some technical details of the relationship between the Fed and the Treasury. Basically, the Treasury maintains two types of deposits.

It has deposits at commercial banks, okay? When you pay your taxes, those taxes go to the commercial banks. And it has deposits at the Fed. When they want to spend, they use their deposits at the Fed.

They write a check on the Fed to buy the things the government needs, right? Now, in between, when they take the money, the deposits out of the commercial banks, and they put them in the Fed, guess what happens to the money supply? Well, because the banks lose reserves, those reserves go back to the Fed, the money supply shrinks. Now, to prevent a deflation, what the Treasury does is to make sure that funds are flowing, that as it's taking funds out of the commercial banks to spend them through the Fed, the same amount of funds are flowing into the commercial banks, okay?

So that the commercial banks' reserves don't fall, so they prevent a deflation. So my plan involves around the Treasury allowing, when they're spending money, allowing the reserves to decline and the money supply to shrink. So I want to give you an example of what I mean by that. Let's say that you have $1,000 of fiat money in the economy.

It's all held in commercial bank demand deposits. And that the required reserve ratio is 10%. So in this economy, we have $1,000 of checking account money, that's the money supply, and $100 backing that up in the banks. So it's 10% reserves.

If all banks were fully loaned out, they were holding $100 in required reserves in the reserve deposits at the Fed. When the Treasury shifts a surplus of, say, $20 to its general account at the Fed, it will leave the commercial banks with only $80. In other words, they have to pay the Treasury in their reserves. The reserves fall out, $20 of reserves fall out.

So now they only have $80 of reserves, and they have to reduce the money supply by the same 20%. Reserves fall from $100 to $80, so the money supply has to fall from $1,000 to $800. They call in loans, okay? If you've had money in banking, you know how this works.

So what I advocate is that as this money supply shrinks, the Fed will then mandate an increase in the required reserve ratio to 12.5%, okay? And simultaneously, the Treasury will spend its surplus funds by transferring them to the reserve deposits of the commercial banks, permitting them to meet the new reserve requirements with total bank reserves once again equal to $100. In other words, what would happen is that this would shrink, this is the money supply, okay? It would shrink from $1,000 to, that's time T0, in time T1, it would be $800, okay?

If this is the reserves, the reserves would shrink initially from $100 to $80, but then the money would be spent and it would get back into the commercial banks. But we don't want them to use that extra $20 in the multiple deposit expansion to increase the money supply back to $1,000. So the Fed would increase the reserve requirements up to 12.5%, meaning that now $80, or rather $100, would be necessary as that money gets back, after it's spent, it gets back into the commercial banks. Okay, so this could be, I'll just take it a few more rounds.

This could continue to happen. The Fed will then mandate, in the following year, so you give this each year, in the following year, the Treasury again runs a surplus of $20. This is a fiscal deflation. What it's doing is it's deflating, okay?

Which at the new higher purchasing power of money exceeds the real terms of the prior year's surplus, okay? So in the prior year, the surplus was $20. But now, since prices are lower, since you have a lower money supply, you have a greater real surplus. Following the same procedure of disposing of the fiscal surplus, the money supply shrinks by another 20%.

So now it's down to $640, okay? The Fed then raises the required reserve ratio to about 15%, so that $100 now supports $640. And so on. So you can continue to reduce the money supply at some, maybe slow rate, year after year, okay?

And that would mean that there are less dollars to back my gold. So when you go back to the gold standard, that would imply that you're going to go back at a lower gold price. Now what's the problem? This is the problem, too.

The problem is, can we depend on the Fed to continue to engage in this policy of slowly contracting the money supply, especially when we know that it's going to bring about a temporary recession, okay? Initially, it'll bring about a recession. But if people get used to the, and businesses get used to the slowly falling prices that will result, the depression will be recovery in the economy. So my worry is that the Fed's, well, we have a recession, you know, we've got to stop this program.

And so it's the length of the program that's a problem, right? There's another possible solution here, and I'll just mention it and then end. And that is in Argentina. When Argentina had problems with its currency board, okay, back in the late 1990s, early 2000s, what happened was Argentina had approximately $70 billion worth of pesos and dollars, okay?

Now, remember, Argentina backed their peso with American dollars. So whether you had a dollar checking account, which you could have in Argentina, or a peso checking account, the Argentine central or the Argentine currency board had to pay off in dollars. But there was only $5 billion because of the massive inflation that had gone on. There was only $5 billion backing up the $70 billion of deposits, okay?

So you have your much greater deposits. Well, my recommendation, which I had written up for an Indian journal, was this. Give people back, okay, now what did the Argentine government, in this case dollar standard, right, and at the same time, you have a situation where banks, when that money is put back into the banks, have to back it up by 100%. Okay, if they put the back in the checking accounts.

And as I said, the savings components of the investment component of the bank portfolio, whatever it does have in reserves, turn that over to the people in the sense that make it into a mutual fund. The bank is bankrupt. The shareholders should have nothing. They should have no assets.

All those assets should go to the people, okay? All right, so I'll stop there and take about one or two questions. Yes. On your first, about the policy of the gold standard, I would add number seven.

A friend of mine said that the problem with the gold standard, gold fluctuates too much in value. So I tried to explain to him, no, it wasn't gold. It's the paper money. It's because gold isn't money, that the paper money is changing in value and people are using gold as a hedge, and the price of gold is going up and down.

Once you link the dollar to gold, then gold is the money. And simply the supply and demand for money that determines the value of gold at that point. And it doesn't fluctuate wildly at all because the supply of gold doesn't change very rapidly, as we know, and people's demand for gold, if they trust the money, that doesn't change very rapidly. It changes every year as the economy grows.

It changes slowly and prices slowly fall, but the value of gold doesn't change under gold standard. It changes under paper standard. Yes. The people, it seems to me, in the European Union countries who have gone from their local currencies to the euro pretty readily, I'm not sure of that.

Yes. You seem to be concerned about people's ability to change from dollars to assets in the gold. Well, that's a very good question. The reason why they did it is because it didn't contradict the regression theorem.

The euro, there was an exchange rate between the euro and each individual currency. So, in other words, the euro was based on the various national currencies. And there were fixed exchange rates, so you easily passed from, let's say, the franc to the euro. But if you just put euros into circulation, print them up, and there was no exchange rate, transitional exchange rate to the existing currencies, no one would accept the euro.

Now, with gold, it's a little bit better because gold is bought and sold in terms of dollars. But my concern is that people are not going to calculate and analyze the gold. They don't look on it as money. Anyone who remembers gold as actual circulation, if there is anyone, is a very small proportion of the population.

So, not having had recent experience with gold as money, people will still look on paper dollars as money. And I don't think they're going to take this gold that they're given or sold and put it in banks and start gold banks and so on. I think they're going to continue to operate in dollars. That's why I think the parallel gold standard will not come into operation.

It's a good start. You should get rid of the Fed. You freeze the amount of dollars and so on. You get gold back in the hands of people.

But it's better than what we have, but I think we might be able to do better. Yes. It's the Fed goes as one institution. It goes.

But they don't run