In last week’s essay I explained that the failure of the U.S. to uphold its commitments under the Bretton Woods Agreement to redeem the dollar for gold at $35 per ounce was the primary cause of the great inflation in all the world’s currencies. Just to recap events: In 1944 the allied powers agreed that the dollar would serve the same role as gold for the purposes of international currency settlements after World War II. At that time the U.S. owned (or safe kept for allied governments who were at war and whose territories were threatened by invasion) most of the gold reserves of the allied central banks. As long as the U.S. would keep its dollar to gold ratio at the agreed-upon $35 per ounce ratio, central banks around the world could settle their trading accounts in dollars. These central banks would maintain an agreed-upon ratio of dollars to their local currencies just for this purpose. The world would be on a "gold exchange standard". If one country inflated its currency, its trading partners would demand dollars in exchange far in excess of the profligate country’s ability to pay. It would be forced to deflate. Just as the case under a true international gold standard, that country’s prices would fall, its exports would increase, thus generating dollar reserves and all would be back to equilibrium. The key to this whole program was the promise of the United States itself not to inflate. But, of course, this is exactly what it did.
Theoretically, the U.S. should have been placed in the same position as any other country that inflated its currency--instead of running out of dollars, the U.S. would run out of gold. Its gold reserves did dwindle, which should have set off alarms at the International Monetary Fund, which was charged with the job of auditing the gold supplies of the U.S. and ensuring that it honored its obligations. But the IMF did not do its job. Why? This enters the arena of psychology, but I imagine that the Cold War had something to do with it. The U.S. alone was capable of protecting the Allies from the growing Soviet threat. Perhaps the Allies and the IMF felt an obligation not to criticize their protector. Who knows? But once France got the atomic bomb and a president—Charles de Gaulle—who felt comfortable acting as an equal on the international stage, it no longer felt that it needed to cow tow to the U.S. So in 1963 France demanded to be repaid in gold for its ever-increasing stockpile of dollars. This should have instilled much needed fiscal and monetary discipline in the U.S., but it did no such thing. President Johnson committed the U.S. to fighting a foreign war AND instituting new welfare entitlements—his "guns and butter" policy. In 1969 President Nixon could have reversed this policy, but he feared that the inevitable recession would mean the loss of a second term, so he simply reneged on Bretton Woods and "closed the gold window" in 1971. So much for U.S. honor and prestige!
The world kept spinning ‘round, though, and the dollar continued to be used as a reserve currency--there simply was no other. In the 1980s President Reagan and Federal Reserve Chairman Paul Volcker put America’s economy on a two decade long, inflation-free growth path. It appeared that the world could indeed operate with a fiat reserve currency; that is, one not tied to gold. But administrations change and now it is apparent to our trading partners that our continued inflation means that the dollars they hold will become increasingly less valuable. We are cheating our trading partners.
China was so concerned that it floated the idea of creating an IMF-issued "super reserve" currency to replace the dollar. Although the Chinese government later claimed that it wasn’t really serious, no one believes them. But China has pegged its yuan to the dollar at too low a (yuan) rate. Many state-owned industries in its export-oriented economy would go bankrupt if China revised its exchange ratio with the dollar. This would mean lower spending in China and probably would trigger a recession. So China demurs…at least for awhile.
But the answer to the problem--that has been brewing for more than six decades now--is NOT to cobble together some new Frankenstein monster than no one will be able to control. The answer is right before our eyes—return to gold. Each country should set its own ratio of local currency to gold and settle all trades in the actual commodity. Then no country—not the U.S., not the European Community, not China, nor Japan—will be able to inflate its currency without destroying its ability to import goods. It will run out of gold for settlement purposes and be forced to deflate. No special governmental agreements are needed. Gold would settle just as checks settle today—by debiting and crediting each nation’s gold accounts wherever they may be. Just as no business can operate with zero money—it is forced to economize—no nation would be able to import continuously by papering the world with its currency, as the U.S. does today. As the profligate nation’s gold reserves dwindled, its ability to import would dry up; prices would drop, making its goods a bargain for export; its gold reserves would start to climb and all would be well. Just as explained by Jean Baptiste Say, all trade tends toward equilibrium.
IMF bureaucrats managing a super currency will be no more reliable than were U.S. bureaucrats managing the dollar. They, too, will succumb to political pressure to over-issue an IMF reserve currency, and the entire world will be off and running in an inflationary binge that will destroy world trade. As Professor Thorsten Polleit of the Frankfurt School of Finance and Management says, we all must make our peace with gold. It is in the best interest of the common man, because no one can manipulate it. Gold is money and money is gold. Gold is inflation and deflation proof, because it is not built upon debt, as is the current case with all the world’s fiat currencies. So it cannot be inflated when banks lend against a small reserve and it cannot suffer deflation when those loans are not repaid. This is the cycle through which we have just passed—money supplies inflated by profligate lending and now money supplies deflated when those loans go sour. This cannot happen with gold as long as governments strictly enforce currency convertibility and shut down banks that engage in fractional reserve banking.
So why doesn’t the world return to gold? Because governments benefit the most. The fiat money that we all use may be manufactured in infinite amounts by governments. Would we expect a counterfeiter, who was protected by law in his ability to print money, to deny himself its benefits? Of course not. Governments are no different. They are the primary beneficiaries of their fiat money monopoly. They may spend as they please. They are not obliged to tax the people or borrow honestly from them. It is a heady and corruptive power that appeals to the tyrants among us. No, reform must come from the people. Either that or reform will come only after a total collapse of our monetary system, which would cause untold hardships and possibly even massive death around the world as the ability of the people to engage in indirect exchange was destroyed. So monetary reform is no academic issue. It is a life and death issue.
A good start to reform would be for the citizens to become informed of monetary matters. Demand that real economics be taught in our schools. Demand that our politicians stop lying to us about the causes of our problems. End the demagoguery that seeks out enemies in the business class and attempts to place guilt upon the public, calling us "addicted to spending" and/or too "consumer oriented". This is nonsense. The people are perfectly capable of determining and guiding their own financial futures as long as the medium of exchange allows them to plan and understand the reality of their situation. Our government is the problem. We should demand that it confine its actions to those enumerated in the Constitution. Our founding document, the highest law of the land, does NOT give the government the power to print money. It assigns government the RESPONSIBILITY of protecting us from counterfeiters; it does not give government the power to BECOME A COUNTERFEITER. Enforce the Constitution. End the Fed. Return to gold. Restore our freedoms and our rights. Is this really such a radical demand?