Monday, August 15, 2011

Death of the Gold Standard

Forty years ago today, the world left the last vestiges of the international gold standard with Nixon's order to suspend gold payments to foreign central banks in 1971. When the British abandoned the gold standard decades earlier, it was foolishly celebrated by John Maynard Keynes.

As David Stockman has carefully explained, however, leaving the monetary discipline of the international gold standard ushered in four decades of inflation via artificial credit expansion.The graphs below tell the tale.

Gross Federal Debt began its almost exponential growth shortly after 1971.

The trajectory of the money stock also noticeably shirted upward after closing the gold window.

The increased money stock help fuel massive increases in government spending.

Not surprisingly, consumer prices began to rise faster than ever before after 1971 as well.

A gold standard is not perfect. It will not usher in the Kingdom of God on earth. No mere human institution will do that. What a commodity standard does, however, is to constrain the acts of politicians eager to impoverish the rest of us in order to enrich their friends and themselves. As Mises says in his excellent 1965 essay "The Gold Problem," "The gold standard alone makes the determination of mon­ey’s purchasing power independent of the ambitions and machinations of dictators, political parties, and pressure groups."

As Mises has also pointed out to anyone interested in listening,
The gold standard did not collapse. Governments abolished it in order to pave the way for inflation. The whole grim apparatus of oppression and coercion, policemen, customs guards, penal courts, prisons, in some countries even executioners, had to be put into action in order to destroy the gold standard.
The reason Nixon felt compelled to officially abandon the gold standard forty years ago today, was that the U.S. government had been quietly abandoning the gold standard during the sixties. It was doing so by expanding the money supply at a rate much higher that the increase in our gold stock.

As Paul Kasriel documents, from the first quarter of 1952 through June 1971, "the total financial assets of the Federal Reserve, in effect, the amount of credit created out of “thin air” by the Fed, grew at a compound annual rate of 2.81%. But starting around 1964, the golden anchor on monetary policy started to “drag.” That is, growth in total Fed assets accelerated." Between the first quarter of 1952 and December1963, total assets held by the Fed increased at an annual rate of 1.00%. From the beginning of 1964 through June 1971, however, total assets held by the Fed increased 6.09% per year. Too many foreign central bankers began to read the inflationary writing on the wall and began redeeming their U.S. Federal Reserve notes for gold, until it became clear that we would run out if something was not done.

That something was Nixon's closing the gold window. That act moved us to a full fiat paper currency. After the gold window was closed by Nixon, July 1971 through 2003, the annual rate of increase in Fed assets was 7.02%.

Note that there is nothing special, per se, about gold as the monetary standard. I generally us the term 'gold standard' as verbal shorthand meaning any free-market commodity standard. It is possible that if we transitioned into a free market for money production and use, the commodity used as money would be something besides gold; silver for instance. The point is that adopting a free market commodity-based monetary system would help restrain the inflating ways of modern politicians.

No comments:

Post a Comment