Gold and Honey
Open letter to Thomas Hoenig, President, Federal Reserve Bank of Kansas City
Dear President Hoenig,
On January 5, 2011, you were quoted on ABC NEWS as saying that "the gold standard is a very legitimate monetary system". The quotation went on: "We are not going to have fewer crises necessarily. You will have a longer period of price stability or price level stability, but I don't know that you will have lower unemployment, and I don't know that you will have fewer bank failures."
As a student of the gold standard for the past 50 years I welcome your statement. I would be happy to open my files and archives if the Research Department of the Federal Reserve Bank of Kansas City (that, as far as one can tell, has so far not been interested in gold standard research) invited me. My files may have the answer to some of your queries.
(1) You are right, the gold standard is a necessary but not a sufficient condition for achieving lower unemployment. A necessary and sufficient condition would assume that Adam Smith's Real Bills doctrine is also rehabilitated along with the gold standard. The bill market is the clearing house, without which the gold standard cannot survive. The explanation why it collapsed in the years 1931-35 is that, when the victorious Entente powers decided to restore the gold standard after World War I, they also decided not to restore real bill financing of world trade or world-wide real bill circulation. Thus the gold standard which Britain reestablished in 1925 lacked a vital organ: a clearing house. The Entente wanted bilateral (to the exclusion of multilateral) trade for fear of German supremacy in exports. This decision was a great setback for world trade. In effect, it meant a return to barter. The consequence was: beggaring-thy-neighbor, trade war, the destruction of the wage fund, and massive unemployment world-wide.
(2) As pointed out by the German economist Heinrich Rittershausen in his 1930 book Arbeitslosigkeit und Kapitalbildung (Unemployment and capital accumulation), before World War I ‘structural unemployment' was unknown. Part of the ‘float' of maturing real bills was earmarked for payment of wages to workers producing consumer goods. This float was what Rittershausen called the "wage fund", out of which wages could be paid up to three months in advance, well before the underlying consumer goods were paid for by the ultimate, gold-paying consumer. This wage fund was destroyed by the "Guns of August" in 1914 at the start of hostilities. The destruction of the wage fund went unnoticed because the production of war materiel absorbed all slack labor. After the war, a great inflation inflicted on the world by the Fed created not only the T-bond bubble (that burst in 1921), the Florida real estate bubble (that burst in 1925), and the stock market bubble (that burst in 1929), but it also financed a hugely bloated production of consumer goods.
* The German word ‘Honig' means ‘honey' in English.
Only after the stock market bubble burst did it become clear that there was no wage fund out of which the workers producing consumer goods could be paid. The workers had to be laid off and the factories had to be closed. Thus did the prohibition on real bills circulation cause the collapse of the gold standard and the Great Depression.
My research suggests that if after World War II both the gold standard and real bill circulation had been rehabilitated, there would have been no serial currency turmoils and no Great Financial Crisis. The gold standard and real bills go together like hand and glove.
(3) The purpose of the gold standard is not to stabilize prices or the price level, which is neither possible nor desirable. Its purpose is to stabilize the interest-rate structure, which it can do very efficiently, as history shows. There was no bond speculation under the gold standard. Speculation was confined to agricultural commodities, the supply of which is governed by nature rather than bureaucrats in the Treasury and the Central Bank. Changes in commodity prices or in the price level under the gold standard were mild. They reflected changes in marginal productivity, not speculative fever. Virtually all crises after the collapse of the gold standard in the 1930's were caused by volatile changes in interest rates due to bond speculation.
(4) Gold is the ultimate extinguisher of debt. The reason is that gold enters the asset column in the balance sheet of banks but, unlike every other asset, it has no corresponding entry in the liability column of the balance sheet of someone else. Gold survives any consolidation of balance sheets. Other assets are wiped out when the balance sheets of debtor and creditor are consolidated, as in default and repossession.
(5) No runaway debt or derivatives tower can develop under a gold standard. Such cancerous growths have occurred in the 21st century because, in the absence of a gold standard, the economy is lacking an ultimate extinguisher of debt. Total debt can only grow. It can never contract through normal debt retirement.
(6) Bank failures are a consequence of unbridled escalation of debt. The gold standard acts as a restraining force on banks with a propensity to expand credit even after further expansion becomes detrimental to their capital. Widespread bank failures that presently hit the economy are an indication of destruction of bank capital. Banks were happy to put their capital in jeopardy during the boom as their cash flow from fees was plentiful. However, cash flow is no substitute for capital. When the boom was over, cash flow stopped, but bank capital was gone.
Under the gold standard banks know better. They cannot expand credit with impunity beyond safe capital ratios. If a bank does, it deserves to fail and should not be bailed out.
We can indeed return to a gold standard by going back to Constitutional money. This means opening the U.S. Mint to unlimited free coinage of gold and silver. We can return to financing production and trade in goods demanded most urgently by the consumer through real bills, if the Federal Reserve Banks go back to the legal provisions of the F.R. Act of 1913. That Act confined F.R. credit to real bills arising out of the production and distribution of consumer goods, to the exclusion of anticipation and accommodation bills as well as government debt. The solution to the present crisis will be found in the strict observance of the monetary provisions of the Constitution, and enforcement of the law governing Federal Reserve credit.
Posted by PAGAU on 01/17/11 01:01 PM
Like I said, there is no monopoly in this arrangement. It is quite the opposite. But if you insist there is a monopoly in there somewhere, then I would have to agree with you. We don't need a monopoly.
Since you have confirmed my suspicion that you have zero tolerance for government involvement in money, perhaps you are an anarchist of some sort. No?
Posted by Intuitive Reason on 01/17/11 02:04 AM
As a follow on, what do you mean by inflation?
A fixed monetary supply doesn't mean that prices will be stable. It means that prices will add up, which is not at all the same thing.
What Real Bills add is price stability – the flexibility to cope with periods of increased / decreased demand without change in prices being exacerbated due to a shortage or surfeit of money.
Even in today's fiat regime this is provided for. A quick look at monetary supply charts will show (at least it does in Australia, so I assume others elsewhere have the same degree of clue) pulses in monetary supply that are introduced to deal with periods of increased demand – here Christmas and to a less extent Easter.
If you have a fixed monetary base, as you do with a Gold Standard and no Real Bills, every change in demand or supply will be exacerbated.
Posted by Intuitive Reason on 01/17/11 01:20 AM
Wait.. you have some base disagreement with 'fiduciary media'? In that case stop arguing about whether Real Bills are inflationary, and just say you don't like fiduciary media.
If you are trying to make the case that Real Bills are inflationary because they are not funded from an existing account then you probably need to sort out the definitions you are using.
What do you mean by savings? Fekete is obviously using it to mean the increase in value of consumer monetary accounts – i.e saving as the alternate act to consuming. I think you are using it more generally (when you say 'the only non inflationary source of credit is savings') to mean the value of any account. As a result, you're getting your knickers in a knot about something that is actually pretty simple.
The statements aren't inconsistent – just the use of terminology.
Posted by Bionic Mosquito on 01/17/11 12:34 AM
BM: "Is there only the government mint, or will others be allowed to compete freely, unhindered by legal tender laws or other tax and legislated disadvantages?"
PAGAU: "You seem to have zero tolerance for government involvement in money."
Yes. Tell me why some people who happen to work for a particular employer should be allowed a monopoly, backed by force, over this process? The market is supremely capable of sorting this out.
"I am in favor of reining in the out of control government....But I consider a government operating within the limits of the constitution to be a good thing."
How do you propose reining in a group of people to whom you gladly grant a monopoly of legalized force over you? By what means will you be able to keep them in "control"?
What would you propose to do if a group of individuals decided that they willingly and voluntarily wanted to transact in coin other than that minted by the government? By what moral basis would you stop them? Your answer will either cause you to refute your faith in granting the government such a monopoly, or it will condemn you as a willing cheerleader for a government agent compelling that group via a gun to the belly.
Posted by PAGAU on 01/17/11 12:02 AM
"this is too much. Is there only the government mint, or will others be allowed to compete freely, unhindered by legal tender laws or other tax and legislated disadvantages?"
You seem to have zero tolerance for government involvement in money. You have to grant government its rightful place. I am in favor of reining in the out of control government. I am in favor of reducing the size and scope of government. But I consider a government operating within the limits of the constitution to be a good thing.
I don't believe a government mint or legal tender laws to be so abhorrent so long as they stay within the limits of the constitution. What is abhorrent is for 1) the money supply to be controlled by banks (or as DB might prefer to say, central banks) as is done today *or* 2) the money supply to be controlled by government as Ellen Brown proposes.
What Dr. Fekete proposes with the open mint restores to the people the control of the money supply. The government does not supply the silver or gold used at the mint, the supply comes from those who labor to produce it. The government's role in minting the coins is consistent with its constitutional role to regulate the value of money. It is also consistent with the constitutional requirement that legal tender be silver and gold only.
BTW, Fekete did not dream up this idea. Fekete has pointed out the historical and traditional use of the mint:
Please read Fekete's "OPENING THE MINT TO GOLD AND SILVER"
Click to view link
An excerpt follows:
"I should start by stating that the Mint is a monetary institution far more important than the Central Bank. It is an ancient and venerable institution. The Central Bank is a relatively new invention, hardly venerable. It was conceived to make ordinary people absorb the unpaid and unpayable debt of kings. The importance of the Mint is not to be found in its altogether negligible role of coining small change, the so-called subsidiary coinage which people use to make small purchases. The Mint is all-important because it is designed to produce real money. The origin of the Mint is intertwined with religion. From the point of view of political economy, the Mint is a reminder of the fact that, ultimately, real money is created (and extinguished) by the people and not by the government, or banks approved by the government. For example, the U.S. Constitution reserves the power to create money directly to the people themselves who convert gold and silver at the Mint into the coin of the realm (and extinguish money by melting it down). This is a power like habeas corpus that cannot be delegated, still less usurped. If the government grabs it, then, in the admirable phrase of Malcolm Muggeridge, it becomes the power of habeas cadaver. The Mint is the symbol of Constitutional Money, the only kind not subject to manipulation."
So, when Fekete said at the end of his original post "We can indeed return to a gold standard by going back to Constitutional money. This means opening the U.S. Mint to unlimited free coinage of gold and silver. We can return to financing production and trade in goods demanded most urgently by the consumer through real bills..." he has said that both the open mint and the real bills represent a return to constitutional money. Now we have a split in Austrian thinking. I'm with Fekete.
Posted by Bionic Mosquito on 01/16/11 09:22 PM
Saying the same thing in a different way doesn't change the fact that you are saying the same contradictory thing.
It isn't only the transfer of gold from the consumer to the retailer that is involved. That covers one day of the ninety days. What of the other eighty-nine days, and all the intermediate producers involved? For eighty-nine days there is no transfer of gold, just transfers of man-made paper. Fiduciary media, by any other name, smells as (un)sweet.
"At the same time, what these funds are between receipt and maturity is savings. And as you said, savings are a non-inflationary when used as credit."
But Dr. Fekete says the source IS NOT SAVINGS. Why do you say it is (except when you say it isn't)?
The beauty of Austrian economics (besides its truth) is in its simplicity. It is simple because it captures very well human behavior and human action.
Besides the inflationary, fiduciary media, non-asset backed currency aspects of real bills, something as convoluted as RBD, whatever the merits, cannot be called Austrian. My objections still stand.
Posted by Intuitive Reason on 01/16/11 05:50 PM
The statements are not at all contradictory. It's just a matter of perspective.
Consumption – transfers gold to retailers, ahead of its being due for the payment of maturing bills. It is the 'source' of the credit.
At the same time, what these funds are between receipt and maturity is savings. And as you said, savings are a non-inflationary when used as credit.
Don't confuse storage and flow.
In full: The different between the rate of consumption and the rate of bill maturation is the source of the savings that are used to provide non-inflationary, time limited credit for the real bill market.
And further: The change in the above determines the change in the discount rate.
Posted by Bionic Mosquito on 01/16/11 01:36 PM
Intuitive Reason: "These accounts are used in the purchase of bills, and are the 'savings' that form the source of credit. As the source of credit is a pool of savings, the credit is non inflationary."
Dr. Fekete: "I made the central point that the source of commercial credit is not saving but consumption."
Your statement and Dr. Fekete's statement are not only contradictory, you have made the argument fully circular: The source of credit is a pool of savings which is not the source of credit.
Reply from The Daily Bell
Hopefully Ingo Bischoff will weigh in at some point.
Posted by Intuitive Reason on 01/16/11 07:23 AM
It took me a while to understand the argument that consumption provides for both credit and in doing so the discount rate.
Consumption is the movement of gold from the consumer to the retailer. When consumption occurs at a greater rate than the maturing of bills issued in exchange for the goods being sold, the accounts of the retailers build up. These accounts are used in the purchase of bills, and are the 'savings' that form the source of credit. As the source of credit is a pool of savings, the credit is non inflationary.
Posted by Bionic Mosquito on 01/13/11 01:54 PM
@DB, I will clarify one statement in my last post, I did not mean to suggest that I include Ingo as one who "fawns" over Dr. Fekete, as many others do. I have found his statements on many subjects quite well reasoned, even though I don't always come to the same conclusion as he does.
@PAGAU, this is too much. Is there only the government mint, or will others be allowed to compete freely, unhindered by legal tender laws or other tax and legislated disadvantages?
@Philip Mccormack, "Social Circulating capital." This adds nothing to clarification. This term is nonsensical to anyone who understands free markets and Austrian economics. Words have meaning. If these words are yours, please consider the interpretation. If they are Dr. Fekete's, I would suggest the same to him. Is the "New Austrian School" inventing an entirely new dictionary with new meanings to old terms?
In any case, Dr. Fekete is quite clear, and I am not misquoting him. "I made the central point that the source of commercial credit is not saving but consumption." Perhaps these terms also have meanings not previously understood in the study of economics and finance.
With apologies, I will sign off for the next day or two, other responsibilities. If there is any clarification offered in the meantime, I shall reply when I come up for air.
Posted by Philip Mccormack on 01/13/11 01:21 PM
@ Bionic mosquito.
His school of economics is called the New Austrian School, no patent on the name. Social Circulating capital is savings. Philip
Posted by PAGAU on 01/13/11 01:16 PM
"Trusting a monopoly, with the power to legislate, interpret, and enforce its own dictates (backed by a gun), is the most certain way to ensure that which you most fear. Virtually every time the government held this monopoly, it cheated. Why would you expect otherwise now?"
No monopoly here. The act of opening the mint breaks monopoly control. that is the point.
To quote Fekete:
Opening the Mint to gold has a technical meaning, namely, opening it to the free and unlimited coinage of gold on private account.
Please read Fekete's article
Open The Mint To Gold!
Click to view link
Posted by Avidlearner on 01/13/11 11:55 AM
great article, i followed it quite easily....
Posted by Bionic Mosquito on 01/13/11 10:14 AM
Fekete: "I made the central point that the source of commercial credit is not saving but consumption."
DB: "What is your point regarding this statement? Can you clarify?"
My point is reflected in the first two statements of my first post on this topic.
1) The only source of non-inflationary credit is savings.
2) If credit is provided absent savings, it is inflation by definition
There can be no credit without savings. Credit comes from savings. Absent savings there is no credit. How many ways can I say it? EXCEPT if the credit is NOT backed by savings. Then it is no different than funny money, and it is inflation.
This point was discussed ad nauseum the last time Dr. Fekete wrote for DB, and never clarified or refuted. It was defended that the source of commercial credit is something other than savings...the source is consumption.
Credit comes from consumption? If there is some theory that explains how two people can eat the same meal, I am all ears. Seriously...enough people fawn all over Dr. Fekete (including Ingo Bischoff, whom I have grown to respect) that I want to believe there is meat there. Let's start by explaining this seeming impossibility.
And keep it simple, as Austrian economics doesn't require convoluted explanations.
Reply from The Daily Bell
"How many ways can I say it? EXCEPT if the credit is NOT backed by savings. Then it is no different than funny money, and it is inflation."
This seems a strong point. Let Mr. Bischoff respond simply and directly if he wishes to.
Posted by Mel Lindley on 01/13/11 09:28 AM
During my National Service " served with the B.A.O.R. (British Army on the Rhine)- we were paid in BAFS (British Armed Forces currency) ' a Monopoly-like money but which on camp was, to all intents and purposes, real money accepted for all your requirements ' cigarettes, beer, cinema tickets, coffee, jam doughnuts, toiletries, repaying debts to comrades etc etc. Were you planning to leave camp for a night on the town then you had to pre-order the necessary Deutsche Marks, which were duly received at the next pay-parade.
The system worked perfectly, which begs the question as to whether a similar setup would work on a larger scale, that is for national currencies to be used within a country's borders with gold reserved for international trade. Clearly the price of gold would have to be the free-floating market price, not one dictated by bureaucrats and probably used (for added liquidity) in conjunction with Bills of Exchange (redeemable in gold), as espoused by Professor Antal E. Fekete
Reply from The Daily Bell
Why is it good to inflict paper on a domestic population while trading in gold outside the borders? And why turn a country into a military barracks?
Posted by Bionic Mosquito on 01/13/11 02:14 AM
"...eventually some low-life crook (read moneychangers) will seek to control or corrupt the standard. In such a case it is the government's rightful place to step in and regulate it."
Trusting a monopoly, with the power to legislate, interpret, and enforce its own dictates (backed by a gun), is the most certain way to ensure that which you most fear. Virtually every time the government held this monopoly, it cheated. Why would you expect otherwise now?
There is no need for a government mint. We do not have a government "mint" for cars, yet the production of cars is infinitely more complex that the production of turning bullion into a recognizable coin.
Posted by Bionic Mosquito on 01/13/11 02:01 AM
"Austrian economists have the same problem with RBD." Yes, it appears many do. The entire doctrine would bother me less if Fekete did not refer to himself or his economics as Austrian " just as I am not so bothered with Friedman as he didn't refer to himself as an Austrian. The theories can be wrong, but at least not associated with the Austrian school.
"Strictly speaking a bill of exchange...is not a credit instrument. It is a clearing instrument."
Perhaps I take his words out of context, but this is how Dr. Fekete has described at least one aspect of real bills in a previous article: "I made the central point that the source of commercial credit is not saving but consumption."
As this was discussed exhaustively the last time Dr. Fekete posted here, without correction or clarification from any advocates as to my interpretation, I assume I do not misunderstand him.
As a source of credit without savings, it must be inflationary. As a clearing instrument, it is not necessary. Gold (or silver, or whatever the market chooses) can clear.
I accept that real bills may naturally spring up in a free market, and in fact can provide certain benefits. But, just like drug use in a free society, it does not require me to be a proponent or to ignore the fallacies, the main ones listed above.
Reply from The Daily Bell
"I made the central point that the source of commercial credit is not saving but consumption."
What is your point regarding this statement? Can you clarify?
Posted by Philip Mccormack on 01/13/11 12:08 AM
Hi DB Certainly give my email to JOHN BLENKINS or his to me if that.s ok with you Thank you.
." But I do not see a connection of RBD to Austrian economics." Austrian economists have the same problem with RBD.
Fekete-Credit versus clearing
Strictly speaking a bill of exchange, pejoratively called "real bill" by Milton Friedman following his mentor Lloyd Mints, is not a credit instrument. It is a clearing instrument.
It enables the market to clear goods in most urgent demand without needlessly invading the pool of circulating gold coins that would cause monetary contraction whenever division of labor is further refined and production processes are made more "roundabout" (to use the phrase of Boehm-Bawerk) by the most progressive elements in the ranks of entrepreneurs and inventors. Lending and borrowing are not involved.
The real bill circulates on its own wings and under its own steam by virtue of the urgent demand for the underlying consumer good. This also explains why 100% gold advocated by Austrian economics is unnecessary thus social circulating capital is not robbed by interest as there is none, only discount.
The final payment however must be in gold with the RBD. Professor Fekete worked with Senator Dannemeyer for a number of years whilst the first Bush was President and Paul Volker one of his advisers who to this day completely avoids debating with Fekete.
Volcker is a fiat money fiend and was at the Fed creating interest rates as high 20% destroying the wealth of many in the productive class. Finally no one I have read explains the RBD as well as Professor Fekete, and he explains it in monetary terms in one of his articles which I can't find at the moment-Sorry
Posted by PAGAU on 01/12/11 11:52 PM
This particular "Open letter" from Dr. Fekete is not so much over my head. Perhaps I have read so much of him that I am beginning to catch on to what he is saying--or perhaps his writing style is improving and is more comprehensible. Perhaps it is a little of both.
When I first started reading Fekete on the now defunct "Gold Is Freedom" site where his writings were once posted, I understood very little of what I read. It was difficult for me but I pushed through because I sensed something, or recognized something--a certain mode of thinking that I relate to.
I am not an economist or a monetary scientist as he calls himself. I am technical as he is but in a different field. I'm the guy that took his toys apart as a kid to see how they worked. Today, I am the guy you can go to find out how something works. (at least regarding anything I have taken a personal interest in) I am wired that way and I can tell when someone really understands that which he is teaching.
When I read Fekete--even when I am not comprehending everything--I get a sense that... Wow! this guy really understands this stuff. He is doing the same thing that I do. He has all the pieces fitting together and can explain it. And so, thanks in large part to Fekete, I am learning a new thing--money.
Now that I have learned a few things about money, I find the same analytical skills I have honed in the technical fields apply to the study of money as well. So as I said, When Dr. Fekete speaks, I listen. I have been persuaded by his position on opening the mint to gold [and silver]. I have been persuaded by his position on real bills. This is [at least part of] what is missing in the gold standard of the purists in the Mises camp.
Another thing that is missing is a recognition of the real standard--namely silver--and a recognition of what exactly constitutes a standard. Silver is the standard--not gold. The [original, pre fiat] dollar is defined in a measurable quantity of silver--not a measurable quantity of gold.
When a disparity arose between the value of silver and the value of gold, it was the quantity of gold that was adjusted--not the quantity of silver. This is the essence of a standard. I have a clear understanding of what constitutes a standard. It has little to do with economics and everything to do with weights and measures. You can have a pound of coffee, you can have a gallon of water and you can have a dollar of silver. These are defined by standards of weights and measures. In the case of gold, you can have a dollars' worth of gold, but you can't have a dollar of gold.
DB and Gunter advocates letting the free-market decide what is money and what is not. I agree in principle. But in practice, Fekete's answer is more technically sound--opening the mint to gold [and silver].
I might prefer it stated "open the mint to silver [and gold], but that does not diminish the validity of his position. Fekete's answer is free-market, but its mechanism is not widely understood.
It is best understood in the historical context of how the dollar came to be the standard for colonial America. The people [operating in a free market] did what Gunter and DB suggested, they let the free-market decide what is money. Their overwhelming favorite was the Spanish milled silver dollar already in circulation. And so the people's choice was adopted as the standard.
Although the law that created the standard has been ignored, it has not been properly superseded. Like so many other buried laws protecting the interest of the people, this law is still there. In terms the number of grains of silver, the Spanish milled dollar remains the standard.
Perhaps Gunter and DB's position is that we don't need a government controlled standard for a free market to operate. I would agree with that from an absolute purist perspective. But I would not agree that government has no place in a free market.
On the contrary, I would argue that people operating in a free market would naturally seek a standard in trade. When the people find their chosen standard, eventually some low-life crook (read moneychangers) will seek to control or corrupt the standard. In such a case it is the government's rightful place to step in and regulate it. Not to control the money itself, but to protect the mechanism of control.
With the open mint, as Fekete proposes, the control of money is in the hands of the people. But it is the function of the government controlled open mint to protect the form of money chosen by the people. The constitution places limits on the government, but it also gives government control over the value of money. When properly understood in its historical context, the government does have a legitimate protective role to play in the free market. The constitution grants it this role.
Fekete is right regarding real bills. He is also right regarding opening the mint to gold. I just think he has the role of silver and gold backwards. Silver is the natural choice of the people.
Today I read a quote on Jim Sinclair's blog which says it much better than I ever could:
"Gold is the money of kings, silver is the money of gentlemen, barter is the money of peasants, but debt is the money of slaves."
--Norm Franz, Money and Wealth in the New Millennium
Posted by Bionic Mosquito on 01/12/11 10:14 PM
@Philip Mccormack, Jeff Albertson
My intent with the Blumen article was not to suggest it was the last word, or that I agree fully with each comment. As Jeff mentioned "...because I had never seen him mentioned by the Von Mises-linked scholars..." I thought I would get the ball rolling regarding this comment.
As does Philip, I also suggest you read all you desire on this subject. I have done so and am not satisfied regarding my four critiques above.
So, I guess instead of looking "upon it as a gift", I see a void. I guess my eyes weren't "opened!" :-)