The following is a transcript of an interview requested by a gold-friendly hedge fund.
Q.: Professor Fekete, you are known as a staunch advocate of a return to the gold standard. But mainstream economists are saying a gold standard is not practicable and they are fighting the idea with everything they have. How do you answer their criticism?
A.: To say that the gold standard is not practicable is the same to say that honesty is not practicable, and Constitutions are made to be blithely ignored when convenient. The American Constitution, for example, mandates a metallic monetary standard for the United States in the clearest possible language. Opponents of the gold standard have never been able to muster up the moral fortitude to amend the Constitution so as to formalize the abolishing of the gold standard. Yet in 1933 president Roosevelt confiscated the gold of the citizens, gave them irredeemable paper in exchange, and proceeded to write up the value of gold in terms of the paper by 75 per cent. Might makes right: if you cannot do it fairly and legally, then you can use the strong arm of the government to do it through chicanery, backed by the constabulary and the jail cell.
More recently, in our own century, Switzerland changed her Constitution in which the gold standard was also enshrined, through a referendum. Citizens were given a week-end to debate and decide the merits or demerits of the proposed constitutional changes. The indecent haste with which they were railroaded through the constitutional process betrayed the bad conscience of the authors.
One of the key principles supporting a gold standard is that jurisprudence cannot tolerate a double standard of justice. The government, its departments and agencies ought to be subject to the same contract law as are citizens. There are no valid grounds to allow the Treasury and the Central Bank to issue obligations which they have neither the means nor the intention to honor — while everybody else doing it will be dealt with according to the Criminal Code. To say that the gold standard is not practicable is the same as saying that the government should be exempted from the provisions of the Criminal Code in its dealings with its subjects.
Q.: What would be the basic steps involved in reintroducing a gold standard? How to proceed?
A.: Three indispensable steps are involved.
First, the government should open the Mint to gold. This means that everybody who wants to convert his gold of the right quantity and quality into gold coins of the realm should be able to do so at the Mint, free of seigniorage charges, and with no limit imposed on the amount. In other words, they would get gold back, ounce for ounce, in coined form, and the cost of minting would be absorbed by the government, the same way as it absorbs the cost of maintaining highways in good repair. Conversely, owners of the gold coins of the realm must have the right to hoard, melt down, or export them as they see fit. This is designed to vest the right to regulate the money supply in the people, rather than in unelected bureaucrats.
Second, "legal tender protection" of paper money must for once and all be declared unconstitutional. This is designed to remove coercion whereby labor can be forced to accept irredeemable currency for services rendered.
Such coercion was first legalized in France and Germany in the year 1909, just five years before the outbreak of World War I. These countries wanted to make sure that civil servants and military personnel could be paid in chits, thus putting the entire labor force at the disposal of the government — regardless of the state of budget and collection of taxes — in case of war. The motivation behind the second provision is that governments should not be able to wage undeclared and unpopular wars, as could kings of old, but must raise taxes. World War I would have come to an early end but for the legal tender laws. As soon as treasuries had run out of gold, the belligerents would have been forced to make peace, unless the electorate agreed to pay for the continuing bloodshed and destruction of property. And the world would have been the better for it.
Third, the principle known as the "Real Bills Doctrine" of Adam Smith should be observed. Bills of exchange drawn on fast-moving merchandise in most urgent demand by the consumers, which mature into gold coins within 91 days (the length of the seasons of the year), must be allowed to enter into spontaneous monetary circulation. This would guarantee the flexibility of the monetary system not through government coercion, but through the voluntary cooperation of producers and consumers in satisfying human wants.
It can be seen that the market for real bills is the clearing house of the gold standard. In 1918, at the end of World War I, the victorious allies decided not to allow the world to go back to multilateral international trade. To be sure, they wanted to go back on the gold standard, witness Great Britain's decision to make the pound sterling once more convertible into gold at the pre-war exchange rate in 1925, but with only bilateral trade allowed. This meant nothing less than the castration of the gold standard: once its clearing house was amputated, it could not perform.
The allied powers did this out of spite and vengeance: they wanted to cripple Germany over and above the provisions of the Versailles peace treaty. Forcing bilateral trade upon Germany was equivalent to peacetime blockade whereby the allied powers could monitor and control Germany's imports and exports. The measure backfired. The Great Depression and the 1931-1936 collapse of the international gold standard was due to the forcible elimination of the multilateral financing of world trade with real bills.
The gold standard did not collapse because of its "contractionist nature" – as alleged by Keynes. It collapsed because of its clearing system, the bill market was blocked. Falling prices in 1930 were not the cause of the Great Depression: they were the effect. The cause was falling interest rates. Incidentally, falling interest rates were in turn caused by the illegal introduction of "open market operations" by the Federal Reserve of the United States in 1921, whereby the central bank pays bribe money, in the form of risk-free profits, to bond speculators for bidding bond prices sky-high.
Q.: To what extent should money be "covered" by gold?
A.: The Real Bills Doctrine provides the answer to that question. There are on average 75 business days in a quarter. Therefore on each business day, on average, one-seventy-fifth, that is, 11/3 percent of the outstanding real bills mature into gold. Sufficient gold must be available at all times to pay the bills at maturity; more if the discount rate is rising, less if it is falling. In normal times the commercial banks should have that much gold flowing to them in the ordinary course of business, with which they can pay the maturing bills. If times are abnormal, banks go to the bill market and sell at a discount a sufficient amount of bills from their portfolios to raise the gold. This should be no problem: a maturing real bill is the best earning asset a commercial bank can have. At any given time there are commercial banks somewhere in the world overflowing with gold. They scramble to acquire earning assets. The value of real bills increases every single day through maturity. They represent "self-liquidating credit". Sale of the underlying merchandise to the ultimate consumer provides the wherewithal for their liquidation.
Q.: What happens if a country has no gold in its coffers?
A.: Such a country will experience a rise in the discount rate. The appearance of a positive spread between the discount rates prevailing in two countries improves the terms of trade in favor of the one with the higher rate. It can offer lower cash prices on its exports, while paying lower prices (91 days net) for its imports. This means that the country gets the gold for its exports 91 days before its bills payable in gold for its imports fall due. In addition, the higher discount rate will induce an inflow of short term capital that will help finance both exports and imports. We have to remember that imports are financed by exports, not by gold. Gold is there to tie the country over through temporary imbalances.
Should this help not be sufficient to meet the shortage of gold, then consumers, if they want to eat, to keep themselves clad, shod and, in winter, warm, will have to dig into their pockets and come up with the gold coin to pay the bills for their imports upon maturity.
The point is that a shortage of gold need not cause privation: thanks to the discount-rate mechanism it is a self-correcting condition.
Q.: You have announced that in August you will start a school, and call it the New Austrian School of Economics, in Budapest, Hungary. Why new? Why Austrian? Why in Hungary?
A.: The Austrian School of Economics was started by Carl Menger (1840-1921) of Austria-Hungary who deserves the epitaph, along with Isaac Newton, humanis generis decus (pride of the human race). The first members of the school, like Menger himself, were all great monetary scientists who abhorred the idea of irredeemable currency. Keynes introduced the notion that the gold standard is a "barbarous relic" and should be discarded. Through bribe and blackmail academia was enlisted to rally to the new doctrine, while the Austrian School withered.
When the intellectual bankruptcy of Keynesianism — which turned things upside down in castigating the virtue of thrift and lionizing the vice of prodigality — has become obvious, the Austrian School has gone through a renaissance, especially in the United States, calling for sanity and return to the gold standard. However, the "American Austrians" are vehemently against the Real Bills Doctrine of Adam Smith for doctrinaire reasons, as it contradicts their holy of holies, the Quantity Theory of Money. They do not understand that real bill circulation is spontaneous and its suppression is nothing less than unwarranted interfering in the operation of the free market. They do not see the difference between the discount rate (yield on real bills) and the rate of interest (yield in the gold bond).
This prompted me to start my school in Hungary where I live. It would be a disaster if the American Austrians succeeded in making their "100 percent gold standard" a reality. It would not survive the first Christmas shopping season. Markets would seize up, and the gold standard would be given a bad name for the second time.
Austria and Hungary used to be a dual monarchy during the days of Carl Menger, sharing not only the monarch, but also their scientific and cultural heritage.
Q.: Why a gold standard? Why not pick a basket of precious metals, or of some other marketable commodities to serve as the standard unit of value?
A.: American money doctors are in the habit of ridiculing gold in comparing it to frozen pork bellies that, horribile dictu, have been trading in the same pit since gold was expelled from the Monetary Paradise. This reflects a mindset suggesting that gold, at best, is just one of several marketable commodities, and a basket of wider selection could provide a better monetary reserve than gold.
This position is false. Gold is not frozen pork bellies — wishful thinking of the American money doctors notwithstanding. The reason is that the marginal utility of the former declines more slowly than that of the latter. In fact, the marginal utility of gold declines more slowly than that of any commodity (or a basket of any commodities) known to man. That's what makes gold what it is: the monetary metal par excellence. That's what makes gold the only monetary asset that has no counterpart as a liability in the balance sheet of someone else.
Incidentally, there are only two monetary metals: gold and silver. Other precious metals such as platinum and palladium are not monetary metals. What sets monetary metals apart from other precious metals is their stocks-to-flows ratio. They are a high multiple for the monetary metals, but a small fraction for other precious metals.
Q.: Critics say that historically, under the gold standard, the world economy languished, trade was sluggish, technological and therapeutic innovation was unexciting, in a word: the gold standard has never worked well. How do you answer that?
A.: This allegation is just the opposite of the truth. The heyday of the gold standard was during the 100 years' period between 1815 (the end of the Napoleonic wars) and 1914 (the start of World War I). This was the age of transcontinental railways, intercontinental shipping, when all the key inventions were made that ushered in the age of electricity, of the internal combustion engine, of aviation, of wireless telecommunication, of the X-ray, etc. Financing these discoveries and their applications in transportation, telecommunication, and therapeutics would have not been possible without the gold standard and the accumulation of capital that it facilitated.
Q.: Introducing a gold standard hardly seems possible today, in view of the gigantic injections of new currency into the economy world-wide. How could the gold standard handle that?
A.: It wouldn't. The new gold standard would let the regime of irredeemable currency run itself aground and boil in its own juices of excess fiat money. When it can no longer handle the task of delivering food and other necessities to the people, when it can no longer provide employment to the majority of the population, the gold standard will spring back to life spontaneously. People have to eat, and they also have other necessities. They must have work to be able to earn a living. It will dawn on the world, maybe unexpectedly for the majority, that gold has a place underneath the Sun. Gold is that hard core of capital that can be destroyed neither by inflation nor by deflation, that will survive any consolidation of balance sheets. Gold is at the heart of the healing process of the world economy that makes survival possible.
Q.: Is a gold standard the ultima ratio to cure the human weakness, the belief that you can multiply wealth by printing money without limits? Is it not true that no central bank could ever stand up to do-gooder politicians?
A.: Friedrich Hayek, the Nobel-laureate Austrian economist thought so. He said that there would be no need for a gold standard but for the propensity of governments to spend beyond their means.
I don't believe that. I see gold everywhere, independently of the government's spending propensities. Even without a gold standard, gold has a role to play in forming prices, wages, rents, the rate of interest. It helps to find the balance between short- and long-term satisfaction; it determines the marginal productivity of capital and labor. It is like air, we don't see it yet it's there and, without it, there is no life.
You need a yardstick to measure value. Gold is the raw material of which that yardstick is made.
Q.: In the past states also went bankrupt, some repeatedly, e.g., ancient Athens, Rome, or France in the 17th and 18th centuries. This shows not only that such occurrences are possible under a gold standard, but also that the powers-that-be could always circumvent limitations put on coining money and restrictions on banking whenever the idea of scarcity of gold takes hold. What makes you think that a future gold standard may be more successful, and could endure for a long period of time?
A.: There is no hard-and-fast limit on the amount of self-liquidating credit that can be safely built on the unit weight of gold. Improvements in clearing techniques, such as those in telecommunication, freight-forwarding and warehousing will increase the amount of credit outstanding while there is no corresponding increase in gold bearing that credit. It is this property that makes gold the ultimate extinguisher of debt. It is simply not true that restrictions put on the economy by the gold standard are "contractionist", and that the "powers-that-be" are justified in breaking those fetters.
Gold is not scarce: in terms of its stocks-to-flows ratio gold is the most abundant substance on earth. But for the gold standard to endure man has to have confidence in the promises of government to pay gold. If this confidence is impaired, gold tends to go into hiding and then the system may break down. The answer to the problem is that the government must keep faith with its subjects without fail.
Q.: What is your opinion of the governments' handling the great financial crisis, the Greek crisis, the crisis of the Euro, and the other currency crises brewing? How long can they contain the "debt-firestorms"? Will they be able to extinguish it with a shower of new debts?
A.: The governments of the industrialized countries bear full responsibility for bringing the world to the brink of this crisis — the greatest financial and economic crisis ever. They should have resigned in admission of their guilt, and let new governments armed with a better economic theory take over and work out the remedy. Instead, they doggedly cling to power. Their analyses of the causes of the malady are faulty; the remedial measures they have recommended are the old nostrums, incredibly inept, nay, counter-productive.
Take the example of the runaway growth of the debt tower. The great financial crisis, the Greek crisis, and all the currency crises still at the brewing stage, are part of the same problem, namely, the debt problem. It goes back to the year 1971. On August 15 of that fateful year the U.S. government defaulted on its international gold obligations. By now the debt tower threatens with toppling, and burying the world economy under the debris.
The reason for the exponential growth of debt in the world is that the international monetary system has been lacking an ultimate extinguisher since 1971. Total debt in the world can only grow, never contract. We should do well to remember that, since time immemorial, gold has successfully acted as the ultimate extinguisher of debt — until it was forcibly removed from the international monetary system in 1971. Paying debt in gold extinguished the debt, period. Since 1971 governments have pretended that paying debt in U.S. dollars extinguished it, too. But in fact it did not. Debt was merely transferred from the debtor to the U.S. government and kept accumulating. Transferring debt is not the same as extinguishing it. Debt accumulation has a natural limit. This limit has now been reached.
Your description of the debt-tower as a firestorm is apt. Governments of the leading industrialized countries will not be able to contain the firestorm they have started. They are just pouring oil on the fire.
Q.: How will the current situation unfold? Do you think resolution will come in the form of hyper-inflation or deflation?
A.: One has to be careful with these terms. Both inflation and deflation mean destruction of wealth through destroying the value of obligations; the former through depreciation, the latter through default. It is also possible to have a mixture of both simultaneously.
But if you insist on my answering your question, chalk me up in the deflation column. Signs of deflation are all around us. Rivers of new money are unable to turn receding prices and interest rates around. Confidence in promises to pay is evaporating. Banks do not trust one another with overnight money. Paper gold is being pushed down the throat of those wanting physical gold. Worse still, vanishing confidence has reached the stage of contagion. Paper wealth is disintegrating before our very eyes. The domino-effect is spreading: the collapse of one firm brings down two other. Most frightening is the shrinking of employment. It is leading to a break-down in law-and-order. Governments are completely unprepared and think that it is just a matter of printing more money, for which they are superbly equipped, to prevent further contraction.
Q.: Your answer to my next question would certainly interest our readers very much. Are you invested in gold, silver, and other precious metals? Would you still buy them at these elevated prices?
A.: I take exception to your use of the word "investing". To my way of thinking holding monetary metals is not investing but more like taking out an insurance policy. I don't think the other precious metals (or stones, for that matter) make good investments. As far as the monetary metals, gold and silver, are concerned, you would be well-advised to buy some more every month routinely, regardless of the price. You should look at your holdings as you look at your fire insurance policy. If you never need to collect, well, so much the better.
At the optimum, you would track the value of your assets not at their dollar price but at their gold equivalent. In other words, you would carry your balance sheet, both on the asset and the liability side, not in dollar or euro units, but in gold units (ounces or grams). It takes self-discipline to do that, but this is the only way to avoid the pitfall of always looking at your own face in a curved mirror. The torsion of the image may easily translate into torsion of the mind.
Q.: I come to my final question, if I may. What do you think the gold price will be in terms of U.S. dollars or euros in 3 to 5 years' time?
A.: I am sorry, but I am not a practitioner of clairvoyance. I think I would compromise my reputation as a scientist if I ventured to answer this question. Besides, I don't think I am very much interested in knowing. Guesses at the future price of gold are dime a dozen.
A more appropriate — and interesting — question may be whether the dollar and the euro will still be around in 3 to 5 years. I am not sure about the euro, but I think the dollar will definitely be around 3 years from now. 5 years — maybe not, but I wouldn't be surprised if the staying power of the dollar extended beyond 5 years.
It is dangerous to underestimate the strength of the poison you have to live and work with.
Interviewer: Thank you for your time to talk to us.
Professor Fekete: Thank you for the opportunity to express my views.
May 6, 2010.
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