Gold Will Destroy Keynesian Fallasies

 

Leaders of the Western democracies are unprepared to deal with forces that will end the fiat dollar’s dominance as the preferred medium of international trade settlement, in place since the end of the Bretton Woods Agreement in 1971.

 

The BRICS summit, currently taking place in Johannesburg, South Africa, is expected to include an agreement on a first step toward establishing an alternative international trade settlement system based on commodities, which would certainly include gold. Dozens of non-Western and even some Western affiliated nations are attending with great interest. Six new members have been invited to join Brazil, Russia, India, China, and South Africa—Argentina, Egypt, Ethiopia, Iran, Saudi Arabia, and the United Arab Emirates.

 

Although the coming change may be characterized as one between the Western democracies and the BRICS nations, the real battle is one of ideas between Keynesian economic theory and gold. The winner will be gold.

 

As Murray N. Rothbard explained in What Has Government Done to Our Money?, gold was never proven to be inferior to fiat money. The gold standard was not replaced by a better monetary system. It was suppressed in stages to satisfy the state’s insatiable need for money--first to make war and then to corrupt the people via welfare. The result, of course, has been never-ending wars, creeping expansion of the welfare state, unsustainable public deficits, and accelerating debasement of the currency.

 

The challenge to the fiat dollar began with its debasement, which lowered its purchasing power to gold by 98% since 1971, and accelerated with introduction of the so-called “Russian Sanctions” of freezing Russian owned assets in the West and denying Russia access to the international dollar trade settlement messaging system known as SWIFT. Russian monetary expert Sergey Glazyev has led the movement toward an alternative system.

 

Putting “Paid” to Keynesian Fallacies

 

Introducing gold into the trading system will expose the main fallacy of Keynesian economics; i.e., the elevation of aggregate demand to prominence in a nation’s economy rather than production. Keynes shunned Say’s Law of Markets in his General Theory of Employment, Interest and Money in order to hide his theory’s internal contradictions. As put succinctly by Emile Woolf, “Keynes endows the concept of ‘aggregate demand’ with god-like status while disregarding ‘production’-the only means of satisfying it.” Jean-Baptiste Say shows that production is required in order to enjoy the benefits of consumption.

 

On the face of it, it is hard to believe that anyone would believe that production either isn’t required for consumption or that it magically appears. Yet, this rather upside down theory appealed to politicians for obvious reasons; i.e., it gave them carte blanche to spend, all with money created out of thin air by the central bank. Rather than economize and prioritize spending that was absolutely necessary for the benefit of the entire nation, politicians were told by Keynes that it was their duty to spend if only to pay people to dig holes and others to fill them up.

 

Basics of a Gold Settlement System

 

The new international trade settlement system will require settlement in gold. A possible mechanism has been outlined by Alasdair Macleod of Goldmoney.com, which I have included at the end of this article. The benefits of the new system will become obvious to every nation, not just the current BRICS members. The political benefits are that no one nation can control or manipulate the system for its unearned benefit. The economic benefits are that government spending will be minimized so that resources can be allocated to production rather than state aggrandizement. A member can expand imports only by expanding exports. This puts market pressure on member governments to reform their internal economies in order to increase production.

 

To artificially increasing demand, per Keynesian orthodoxy, would be counterproductive, because gold would drain from the nation’s gold settlement account and imports would be suspended. Therefore, the system encourages sound economic practices within its members’ individual economies. Printing money, excessive and unnecessary regulations, excessive taxation, and excessive government spending do nothing to aid a member’s ability to engage in trade. Nations like the US who have huge welfare obligations and who have politically connected industries that do not add to the nation’s capital base will struggle. Having lots of nuclear weapons will be irrelevant and having bases around the world will be liabilities rather than assets.

 

An important point made by Macleod is that over time the gold settlement system for international trade will expand into members’ internal monetary systems. In other words fiat currencies, which can be inflated/debased by governments, will be thrown on the ash heap of history. They will become “barbarous relics” instead of gold, as Keynes predicted in 1924.

 

 

Possible Gold Settlement System by Alasdair Macleod

 

Credit must take its value from something else. We assume that commercial bank credit takes it value from bank notes, which is a central bank’s credit. Equally, if you and I agree an exchange for future settlement, we will value the settlement in credit, either in cash notes or bank credit. Each form or pool of credit is quite distinct, with all credit taking its value from another pool of credit.This is why gold almost never circulates in settlement of transactions. But for the whole system of credit to be stable in its value it must be attached to legal money, which for all currencies is gold, despite governments not permitting central bank credit to be redeemable in gold today.

 

My plan draws on the fact that in a gold-backed currency, gold is almost never used in settlement, settlement being in bank notes or more commonly commercial bank credit, both of which derive their value from gold. The objective, therefore, must be to devise a system of credit firmly tied to gold, without gold actually having to change hands. The result is a plan drawing upon elements of the Bretton Woods system, whereby exchanges of the gold currency for physical gold can only happen between central banks withdrawing or adding bullion from or to the New Issuer.

 

Accordingly, I suggest the following:

 

1. A New Issuer is established for the sole purpose of taking in gold, which is earmarked in designated vaults, against which it issues credit denominated in gold by weight (i.e. a gold gram) in the ratio of 1 unit to 2.5 units of currency (credit). This is designed to ensure Sir Isaac Newton’s ratio of gold to currency is maintained at 40% backing, while boosting the reserves of a participating central bank reallocating some or all of its gold reserves to the New Issuer. These gold currency reserves are recorded as an asset on the balance sheets of participating central banks, enabling them to issue credit denominated in the gold currency to commercial banks which have an account with them, and for the purpose of extending credit into the settlement system. This credit extension is recorded as a liability on the central bank’s balance sheet, and an asset on that of the commercial bank. It ties in the pool of central bank credit initially created by the New Issuer, into the pool of commercial bank credit used to finance cross-border trade, including the acquisition and sale of commodities.

 

2. A central bank can only submit gold currency units for redemption to the New Issuer to the extent that it has previously deposited bullion with it in the 1:2.5 ratio.

 

3. The credit denominated in gold is not initially intended for general circulation. Commercial bank credit denominated in the new currency will be created in the normal way for trade finance and cross-border sales and purchases of commodities. In any event, the whole system of credit linked to gold depends on genuine demand for it, unlike fiat currency which is debased by governments.

 

4. Commercial banks issuing this credit must be members of a clearing facility, which will also include central banks as members. Note that the New Issuer is not involved in any clearing activity: it simply runs a ledger recording the initial credit created in favour of a depositing central bank, and of any subsequent amendments based on additions and withdrawals of bullion by individual central banks.

 

5. Importers and exporters obtain trade finance denominated in the trade settlement currency from commercial bank members of the clearing facility, created in the normal way.

 

6. Since commercial bank credit ends up circulating locally, a government will have to decide whether to introduce exchange controls limiting its circulation to importers and exporters to “protect” its own fiat currency. Practicalities suggest that fiat currencies will be eventually displaced by the new gold currency units because of the stability of its value.

 

7. Only central banks registered with the New Issuer have the right to demand gold in exchange for the gold currency from the New Issuer. This ensures that the value of the new gold currency remains firmly tied to gold and is the sound basis for the value of credit issued by commercial banks for the purpose of trade finance.”

 

Of course, Glazyev may have other ideas.

 

 

Dollar Hegemony Ending Due to Geopolitical Change

 

Since the Bretton Woods Agreement in 1944 the dollar has been the world’s preferred reserve currency; i.e., the major trading nations of the world were willing to hold dollars in vast amounts to satisfy their need for a readily accepted worldwide payment medium. Even when in 1971 the US had violated its solemn promise to redeem its dollars for gold at thirty-five dollars per ounce, nations still were willing to hold dollars.

 

Germany Shies Away from Monetary Leadership

 

In the mid-2010’s I was certain that Germany would abandon the Euro and reinstate the Deutsche Mark. It was clear, especially to some German central bankers, that Germany was being cheated by the European Central Bank (ECB). Germany’s TARGET2 surplus represented a vast excess of German exports to other European Union members who were pledging near worthless government and corporate bonds in exchange for newly printed Euros from the ECB. These bonds would never be redeemed for anything of real value; therefore, it was simple rational self-interest for Germany to quit the charade. I predicted that such an action would cause the Euro zone to collapse and make Germany’s DM the preferred unit of trade in Europe and possibly threaten the dollar for worldwide reserve dominance. Obviously, this never happened. Why?

 

Germany knew and feared that alarm bells would sound all over the world that, once again, Germany was rising and would dominate Europe. The French, especially, would panic for at least two reasons. One, the collapse of the Euro would force France to make a stark choice. Either adopt the DM, as I expected most northern tier European countries to do, or try to revert to the French Franc, knowing that almost no other nation would be willing to hold Francs. France would be cut off from international trade unless it reformed its unsustainable welfare system. But every time in the past when France tried to institute any modicum of welfare reform, the population rioted. Two, France benefited immensely from internal EU transfer payments, most importantly farm subsidies. French farmers would be forced to reform or go bankrupt, ending a cushy lifestyle that seemed to be synonymous with France itself. The stark fact was that France had nuclear weapons and Germany did not. It was unthinkable that either Germany or Japan, along with Italy the losing Axis powers of WWII, would ever get nuclear weapons. Independent control of one’s own nuclear arsenal was the minimum stake for playing the reserve currency game. Thereafter, the game belonged only to nations with large economies that produced a variety of export goods and services desired throughout the world. That left only America in the game.

 

The great question is why Germany, even though it eschewed nuclear weapons under its own control, would ascent to giving up the DM and adopt the Euro in the first place. There are two answers. One, Germany wanted to reunite East and West Germany. The French, who legally held veto power over such a move, made adopting the Euro a condition for reunification. But why couldn’t Germany just ignore this now irrelevant agreement? Answer number two is just a theory but probably pertains to some extent, large or small to all major European nations. Germany had suffered between six and seven million military losses during the two great wars. (World War I losses) (World War II losses) Germany’s best and brightest, its future leadership, was lost for all time. These were wars in which the elite of all belligerents fought. Such leadership can never be replaced. The loss of future leadership was equally harsh on the other major European combatants. In the two world wars Russia/USSR suffered between nine and thirteen million military dead. France suffered a million and a half dead, the vast majority in the 1914 Great War. The United Kingdom suffered slightly over one million (this number excludes India, Canada, Australia, New Zealand, and South Africa.) As former member of the European Parliament Godfrey Bloom has stated:

 

“The 1914-18 war killed the best of the British Empire. The 1939-45 war killed what remained. Then the welfare state danced on their graves.”

 

The Event that Changed Everything

 

Then a great geopolitical event occurred--Deng Xiaoping rose to power in China following the death of Mao Zedong. Deng instituted sweeping, capitalistic economic reforms, and China rose to become a rival to America in terms of economic power. China had obtained nuclear weapons under Mao. Despite the fact that China was and remains a one-party dictatorship, it now had the two ingredients to challenge the US dollar—a large economy and nuclear weapons. China was blackmail proof. Like China, Russia had thrown off the worst of its Soviet economic policies under Yeltsin and Putin, but its small population and relatively backward economy was not in the same league with America and China. Nevertheless, after the US, NATO, and the European Union spurned Russia’s attempt to rejoin the old Concert of Europe (after all, Russia had been a great ally in WWII and had every reason to believe that, now that it had thrown off communism, it could become a vital part of Europe once again), it gradually saw its future as aligned with China.

 

So, what does all this have to do with the end of dollar hegemony? The answer is that the new Asian nexus saw a way to break the US use of dollar hegemony as a political tool. The Achilles Heel of the dollar is that it is a fiat currency. This suits the US political establishment very well, since it allows the US to inflate the dollar at will to pay for welfare and warfare. It also allows the US to impose sanctions on its perceived enemies, such as Russia and Iran, by cutting them out of the SWIFT international trade messaging system. It is similar to what happened to Brexit advocate Nigel Farage in the UK. For strictly political reasons his bank closed his accounts, and Farage was unable to find another that would accept his money for deposit. No bank account, no way to exist in a modern economy. Farage feared that he might be forced to leave his own country. The US-imposed Russian sanctions froze billions of Russian owned assets. But rather than cause Russia to back down in Ukraine, it seems to have sped up the process, started by Russia, to develop a new world reserve currency backed in some measure by gold. The “BRICS” nations—Brazil, Russia, India, China, and South Africa—have been joined by dozens of others who are determined to break away from the fiat dollar hegemony and use an honest, gold-backed trading settlement system. This new BRICS+ group claims that it will announce a first step in pursuing this goal at its meeting in Johannesburg at the end of August.

 

The US Will Be Forced to Embrace Gold…or Become Isolated

 

There are many who dismiss this development. After all, the US and the US dollar have been supreme worldwide for eighty years. These critics fail to understand real economics, real monetary theory, and real international statesmanship. The US has been enthralled by three destructive concepts. The first is Lord Keynes’ economics, which ignores Say’s Law of Markets, effectively endowing the Keynesian concept of ‘aggregate demand’ with god-like status while disregarding ‘production’-the only means of satisfying it. The second is the so-called Modern Monetary Theory, which posits that sovereign states can never go bankrupt due to their ability to print all the money they need. And the third is out-and-out arrogance since the end of WWII, which deigns to cancel entire nations. All this will come to an end when gold returns as the focal point of the BRICS’ monetary reform project. At that point the US will start losing friends until it, too, reluctantly regains its senses and returns to gold and honest dealing and honest, respectful statesmanship. America will need new leaders for this task. They are there, waiting to be called by the people. The US and the world will be a much better place as a result.