Lawson for Congress

I’ve dissected the credit crisis in previous posts since last August, and outlined the bureaucratic overreach that we can expect as a result:

http://blog.lawsonforcongress.com/2008/02/24/mortgage-fun-and-games/

http://blog.lawsonforcongress.com/2007/12/19/a-review-of-the-mortgage-crisis/

http://blog.lawsonforcongress.com/2007/12/09/unintended-consequences/

http://blog.lawsonforcongress.com/2007/11/19/whered-the-money-go/

http://blog.lawsonforcongress.com/2007/08/30/obamas-gonna-fix-it/

Since then, we’ve witnessed the Bear Stearns debacle, where a bankrupt investment bank will have its trading losses covered by the Federal Reserve for up to $29 billion in taxpayer dollars. Clearly, these actions illustrate that the Federal Reserve puts the interest of Wall Street well ahead of Main Street. Even worse, these actions open a pandora’s box where further bailouts will be justified and expected.

So what is a bailout, anyway? Essentially, the government (through the Federal Reserve) is using its ability to create money out of thin air. This new money is given to those affected either directly or in the form of “loans” backed by questionable assets. That new money from the Federal Reserve enters into the banking system, and competes with your hard-earned dollars for goods and services. Did the Federal Reserve give you your Bailout Bucks today? If not, you suffer from the higher prices that result as your dollars purchase fewer goods and services.

Our financial system is broken. The inherent instabilities we’ve been experiencing are a symptom of a debt-based paper currency that’s managed by a money monopoly headed by our nation’s third central bank, the Federal Reserve. The Federal Reserve’s shareholders are its member banks, so it is owned by the banking industry. Furthermore, the Federal Reserve also regulates the banking industry. Talk about the fox guarding the henhouse.

The Federal Reserve has been widely implicated in the financial crises that have afflicted our economy since its founding in 1913, starting with the Great Depression. Here’s a recent apology for the Great Depression from our own Ben Bernanke:

Let me end my talk by abusing slightly my status as an official representative of the Federal Reserve. I would like to say to Milton and Anna: Regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again.

The “Anna” mentioned in Bernanke’s apology is revered economist Anna Schwartz. Dr. Schwartz doesn’t seem too impressed with the apology, as this past January she publicly blamed the Federal Reserve for its creation and mismanagement of the current credit crisis:

The high priestess of US monetarism - a revered figure at the Fed - says the central bank is itself the chief cause of the credit bubble, and now seems stunned as the consequences of its own actions engulf the financial system. “The new group at the Fed is not equal to the problem that faces it,” she says, daring to utter a thought that fellow critics mostly utter sotto voce.

	Anna Schwartz wrote a seminal text on the causes of the Great Depression

“They need to speak frankly to the market and acknowledge how bad the problems are, and acknowledge their own failures in letting this happen. This is what is needed to restore confidence,” she told The Sunday Telegraph. “There never would have been a sub-prime mortgage crisis if the Fed had been alert. This is something Alan Greenspan must answer for,” she says.

The Federal Reserve’s ability to create new money and allow the government to live beyond its means without raising taxes is the primary driver of inflation — you’ve noticed this recently if you’ve been watching your grocery and gas bills. Indeed, since the Federal Reserve was founded in 1913, its $1 Federal Reserve Note (a.k.a our dollar) now requires $21.38 to purchase the equivalent goods (by the government’s own optimistic estimates). So much for a stable currency.

Given this mess, one would think that we’d finally be ready to ask questions about how to arrange an alternative to the current system. Instead, Treasury Secretary Henry Paulson and the Bush administration propose to give us more of the same — more regulatory powers to the Federal Reserve, more bailouts for its friends on Wall Street, and higher prices for working American families.

Not surprisingly, the Wall Street crowd is singing its praises:

Wall Street’s main lobby group, the Securities Industry and Financial Markets Association, embraced Paulson’s proposals. “Our present regulatory framework was born of Depression-era events and is not well suited for today’s environment where billions of dollars race across the globe with the click of a mouse,” said Tim Ryan, chief executive of the association. “That fact, teamed with the current market conditions, result in an universal agreement that it is time to modernize and revitalize the current system.”

And our Chairman of the House Banking Committee is weighing in with his support:

Last week, Massachusetts Congressman Barney Frank said Congress should authorize the Fed to act as a risk regulator across the markets. “To the extent that anybody is creating credit, they ought to be subject to the same type of prudential supervision that now applies only to banks,” he said.

Instead of Frank’s gentle acquiescence, here’s the key question we need to ask: Can we continue allowing banks and other financial institutions to have a monopoly over creating money, through credit, in Federal Reserve Notes? The answer is no, we cannot. The current system is not sustainable, and we need to provide an option for the American people that includes the use of Constitutional money. Americans need to be free to save, invest, and transact business in gold and silver in addition to Federal Reserve Notes, without any sales or capital gains taxes.

While treating the symptoms of the credit crunch through “liquidity injections” and bailouts is a short term solution that may prevent the financial system from freezing up, it will cause accelerating inflation and further rob American workers of their purchasing power. The true solution to our current financial crisis is not giving more power to a broken system. That’s simply rearranging the deck chairs on the Titanic. We need the Honest Money Act, HR 2756. Allowing Americans to transact business with honest, Constitutional money instead of only paper created out of thin air by our central bank will provide a needed alternative during this period of turbulence.

Americans today are slowly being crushed by our currency’s decline. Oil is $110 per barrel, gold is over $1,000 per ounce, and foreign currencies across the board are hitting new record highs against the dollar.

These prices and events are not theoretical concerns. Americans across the board are facing rising prices for food, energy, and manufactured goods. Unfortunately, however, we’re not supposed to talk about the dollar here. In fact, we have such a provincial view of money in the United States that your average American consumer doesn’t even have the ability to save him or herself from a collapsing paper currency. In other countries, however, consumers are much more sophisticated:

In Bolivia, billboards feature George Washington’s image on a $1 bill alongside a bright pink 500 euro note, encouraging savers to turn to the euro to tuck away money earned abroad or sent home in remittances.

“If the dollar’s going down … save it in Euros!!!” say the signs popping up around La Paz for Bolivia’s Banco Bisa.

Just try going down to your local bank and switching your savings account to Euros. Not so much. (You can visit RBC Centura and gain access to Canadian dollars fairly easily, however.)

American consumers shouldn’t feel badly about their lack of knowledge regarding the dollar crisis, however. It turns out that even the White House isn’t allowed to talk about the dollar. Here’s a memorable quote from a recent press conference on March 7 by Dana Perino and Edward Lazear, Chairman of the Council of Economic Advisers:

Q I’d like to follow up on their refusal to talk about the dollar, if I could. I mean, we’re in a kind of a bad situation here, when OPEC says the reason for $105 or $106 a barrel of oil is the falling value of the dollar — and you won’t address that issue. Where do we go to find out who is right?

MS. PERINO: Well, as he just said, the Treasury Secretary is where you go to talk about the dollar. It’s a longstanding policy that predates this administration, and I’m not going to change it today. But Treasury can talk about it.

Q I don’t expect you to change it, but I do expect you to be able to say whether OPEC is completely wrong about this, or whether there is at least something to their claim that the dollar is responsible for the high price of oil right now.

MS. PERINO: Wendell, I’m under strict instructions, and have been from the beginning, to not talk about the dollar, and I’m not going to get fired to satisfy your question. (Laughter.)

That’s funny, all right. It’s funny that the current crisis is cloaked in bureaucratic “secrecy”, and folks aren’t willing to be honest about a crisis of historic proportions.

Today, the Federal Reserve opened up the money spigots to bail out a broke investment bank. Not surprisingly, our currency continues its free-fall against commodities and other currencies. The American worker, saver, and retiree has never been so endangered as in today’s inflationary environment.

For folks who don’t understand why we’re in such danger, here’s the answer: un-Consitutional debt-backed paper money that can be created or destroyed at will by a private central bank. Right now, your salary and savings are being stolen by the rising cost of food, energy, and other necessities just so we can keep a corrupt system solvent.

It’s time for a change, and time for Americans to talk about the dollar again. My favorite quote from this recent post:

I urge all voters to apply this crucial test to their representatives before supporting them.

Make them commit squarely and unequivocally to these questions. Do you believe Congress should exercise its sovereign power as provided in the Constitution of the United States to create money and regulate the value thereof and control the circulating medium in the interest of the whole people? Or do you believe this sovereign power should be transferred to Banks of Issue?

Their answers will prove conclusively whether they are with the people or against them.

Or do you believe that Banking Corporations should issue a credit substitute and through it control the money and circulating medium of exchange of the people of the United States in their own interest?

Watch your presidential candidate carefully and see that he commits himself clearly on this vital question. It will be a true test of his honesty and fitness for office. Admitted ignorance on the monetary issue should not excuse him. The subject is as old as our government, and if he does not know enough about it now to answer these test questions, he is not qualified to fill the position he aspires to, and should not ask your votes.

These words were written in 1912. When’s the last time you considered the nature of money?

Lord Josiah Stemp, Director of the Bank of England, 1937:

“The modern banking process manufactures currency out of nothing. The process is perhaps the most astounding piece of sleight of hand that was ever invented. If you want to be slaves of the bankers, and pay the cost of your own slavery, then let the banks create currency.”

To paraphrase the title of Rothbard’s classic book, the past few weeks in the markets illustrate the consequences of irrational and frankly treasonous fiscal, monetary, and economic policies. Our groceries have not been getting more expensive, our dollars are worth less. Gasoline is not more valuable, our dollars are less valuable. Our cost of living has not gone up, our salary is worth less.

A friend of mine sent me the following summary, which uses some great analogies. If we’ve not previously considered the importance of a sound currency, we’re getting a lesson right now:

The measuring stick (US $) is 40% shorter than it was 3 years ago. If one is using a shorter measuring stick then everything looks longer and higher as in the case of the stock market. The US has been losing ground vis-à-vis the rest of the world for about 17 years now, which is just after the Berlin Wall came down and most of the super cheap labor, in the often well-educated rest of the world, began to be a factor in the world economy.

Initially it was really good for the US because the cheap imports really kept inflation down. Then more companies began to move production off shore and more “creative destruction” ensued, but inflation & interest rates continued to drop in the ‘90s which is good for just about everything in the economy, especially the stock market and home prices. As more and more dollars were exported for more and more goods, emerging countries began to realize that the wealth transfer would inflate their own currencies and thus make their goods more expensive for their best customer (US) unless they invested those exported dollars back into our capital markets.

Their markets were not very well developed and so those emerging countries, especially in the Pacific Rim, were only too glad put their money back into our capital markets, which meant that their own currency had to be converted back into dollars. That wasn’t a bad deal for them because both our bond and stock markets were in super bull markets in the 90s, especially between late 1994 & 2000.

Now it is a different story, and for the last 4 to 7 years the various economic elements that are relevant have been in a state of flux. First the dot com & tech bubble burst, then we had 9-11, then the S&P went into the worst bear market since the 1970s, then the Fed was afraid of deflation so they dropped Fed Funds to 1%, which was lower than the rate of inflation and represented a negative interest rate.

Along about this time the dollar really began to drop. The S&P 500 was down 50% at its low in 2002 (that is the trading rule that will make you rich, or richer, whatever. Buy when a market is down 50%, just make sure that it will go back up before you do that though. <grins>) but with the 2002 midterm elections coming up everyone was focused on “growing the hell out of government.”

That is a euphemism for fighting terrorism through expansionary, but mostly worthless fiscal policy. Soooo, “Greenspasm” cut Fed Funds to 1%, Bush browbeat Congress into a tax cut, and Congress browbeat Bush into providing full employment though Homeland Security. They were all in a race to see who could stimulate the economy the fastest and the dollar lost big time.

Everyone I talked to about markets (3 people) knew that the dollar would tank and it did. The dollar was sacrificed at the altar of big government and political expediency. The stock market was propped up and made to look higher & better with the shorter measuring stick.

All of that cheap money shot housing prices through the roof in 2005. That was also one of the most predicted things that I have ever seen. Most people don’t think about what happens when an asset class can be leveraged at ten to one or more, like housing, but that kind of leverage plus loose money was one of the main things that led to the stock market crash in 1929 and the housing bubble may do something similar to the economy before it is over.

Meanwhile the dollar is on the back burner politically because only a small percentage of Americans realize or care that the wealth transfer to the rest of the world is on full burner, and many of those who know how to hedge or benefit from the dollar weakness.

The stock market may bounce for a while because it was pretty washed out at the close of trading today but there is a good chance during this quarter it will roll over into a bear market. It has not been totally confirmed yet, which is why it will probably bounce for a little while but I don’t see much of a chance that that it can avoid a major swoon in the first half of 2008. They will find a way, some way, any way to get it up going into the election but it will probably be from a much lower level than it is now. 2009, the first year of the new administration is traditionally the year when all of the built up economic pain is recognized by the politicians and the treatment will really need to be radical and harsh this time.

2009 could be an exceptionally bad year in the stock market.

A final word from Alan Greenspan in 1968:

In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. Deficit spending is simply a scheme for the “hidden” confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights. If one grasps this, one has no difficulty in understanding the statists’ antagonism toward the gold standard.

No equivocation there. I wonder what happened?

Often when I talk to people, questions come up about the current subprime/mortgage crisis and just how serious its impact is on our banking and financial system. This recent CNN/Money article does a good job of summarizing the “writedowns” announced and projected by major commercial and investment banks, and the impact that those writedowns will have on the broader credit markets.

So what’s going on here? Why does the system seem so fragile, and how can some bad mortgage loans amplify into a “$2 trillion lending crunch”?

Quite simply, when you create money out of thin air, it can (and does) just as easily disappear back into thin air. It’s all about leverage — $100 deposited at the bank allows the bank to create $90 in new loans (assuming a typical 10% “reserve ratio”). Those new $90 then go into circulation through  the bank’s customers, and most of those $90 are put on deposit again, which creates more reserves, and results in still more loans. Lather, rinse, repeat… and you end up with a tremendous pile of money on top of a tremendous pile of debt.

So that’s how a fiat currency and “fractional reserve” banking work in building up the money supply. What should also be clear, however, is how such a system will work equally aggressively in reverse. When a loan is made that is determined to be “bad”, or an asset listed on the books of the bank is found to be suddenly much less valuable then previously believed, then the bank has a problem. If its reserves decrease, then it needs to replace those reserves, or reduce its lending proportionately. That may mean restructuring, seeking additional investment, shutting off lines of credit to businesses, calling in loans, or begging for help from the Federal Reserve.

When a bank suddenly stops lending, businesses that need credit suffer. When a bank calls in loans, businesses really suffer. Suddenly reserves are being pulled out of the system, and the contraction ripples through the system in reverse. None of those things are good for sustained economic growth, or the health of the economy.

So what about the Fed? Ultimately, in a fractional reserve banking system, we need a central bank. The Federal Reserve’s ability to be the “lender of last resort” and be the ultimate source for creating fiat money out of thin air ensures that we won’t have obvious bank failures… but unfortunately the new money created to keep the inherently unstable system solvent causes inflation and the destruction of your dollars’ purchasing power.

Over the past 20 years, your dollar has lost 46% of its purchasing power, or equivalently, prices have run away from your dollar by 84%: $1.84 in 2007 is required to buy $1.00 in 1987, according to the Bureau of Labor Statistics’ Inflation Calculator. It’s not a mystery why this occurs, it’s a fundamental consequence of a system in need of help. There is a better way, however. Sound money, and sound banking, result in price stability and sustained, long-term, stable economic growth. Our nation doesn’t remember what that looks like, however, so it’s going to take some education to get there.

Addendum: When you’re ready to laugh about these events, check out this video:

Amendment IV

The right of the people to be secure in their persons, houses, papers, and effects, against unreasonable searches and seizures, shall not be violated, and no warrants shall issue, but upon probable cause, supported by oath or affirmation, and particularly describing the place to be searched, and the persons or things to be seized.

This morning the government seized my property. You may have heard about it, or read about it, although probably not in the Old Media. Here’s an article that describes the raid on the Liberty Dollar headquarters in Evansville, IL.

You see, just over a week ago I placed an order for some Liberty Dollar “rounds”, or 1 ounce silver thingys. (I’m not going to call them “coins”, since they’re not “legal tender” and I wasn’t intending on using them as “money”.) They’re just attractive, and heavy, mementos of what money used to be — something with intrinsic value. Here’s a picture:

I gave them a check, and was awaiting receipt of my silver pieces, when I read the news today. What’s a guy to think? Is it now illegal to purchase silver in the United States of America? What has the government done with the silver that I purchased? Most importantly, when will the FBI show up at my house with an apology to give me my property?

It’s ironic, though, to consider all the stuff that IS being sold today. I just discovered Facebook a few weeks ago, and was amused to discover that people are apparently willing to exchange Federal Reserve Notes for “gifts” on Facebook that are entirely virtual. Check this out:

Oh, wow! A Jibble! I’ve always wanted one of those! And my friends would think I’m SO COOL if I sent them a few! Mom, can I have some money to send my friends some Jibbles??? (Better hurry, though… they’re only creating 100,000 of them! Will they finance???)

Question: What do you call a country with a $9.1 trillion national debt, and an $800 billion current account deficit, that seizes its citizens’ silver but has a profitable market exchanging its paper currency for Jibbles?

Answer: Bankrupt.

Maybe I’m asking too much of our government, and maybe the Fourth Amendment is still intact — perhaps I just need to change my expectations for the word “unreasonable”. But would it be unreasonable search and seizure if the government took away my Jibbles?

Addendum: Video just in.

The North Carolina State Fair opened this weekend, and the family enjoyed a fantastic day checking out prizewinning vegetables and livestock, an 1,187 pound pumpkin (unbelievable!), and meeting some new Ron Paul supporters. But the most educational conversations came when the kids and I were sitting down at lunch discussing the corn dogs.

Three corn dogs, nine dollars. That’s three dollars per corn dog. Each “game” on the midway? Two dollars. Each ride? Generally three dollars unless you had discount ride tickets. The kids brought their own money, just to feel grown up, but as they counted their change at the table, it gradually dawned on them that they couldn’t actually afford to buy anything.

My oldest realized it first: “Dad, that’s crazy.”

Then I explained that when I was her age, the games at my school carnival were fifty cents. She replied, “But that’s just two quarters. These games are eight quarters! And the prizes aren’t even that good! That doesn’t make any sense!”

So then we had to talk about inflation.

“Honey, imagine that you had the ONLY diamond in the whole world. Do you think it would be valuable? Do you think other people would want it?”

“Yes!”

“OK, now imagine that instead of there being only one diamond in the world, that diamonds were just like sand on the beach — and that you could pick up endless handfuls of diamonds whenever you wanted. Do you think diamonds would still be valuable?

“Well… no.”

“Well, money is kind of like diamonds on the beach. The more money there is, the less valuable it is. When I was your age, there was less money. So it only cost two quarters to play a game at the carnival.”

We chose not to get into the question of where all that money comes from. Understanding the time decay inherent in paper money is enough of a shock for one day.

I highly recommend the fair, although I consider the midway a pretty poor value for our declining dollars. Perhaps they’re targeting Europeans and Canadians instead of the state’s taxpaying citizens.

There has been a flurry of recent activity in a series of threads over at the Republican blog Redstate.com. I’ve linked the threads below, and then summarized the final thread’s conversations.

Ron Paul’s Currency Plan and Merovingian France
Answer to Ron Paul’s supporters: the Federal Reserve is the Lender of Last Resort
Attention, Ron Paulites: Please help me understand how alternative currencies will work.

blackhedd begins:

I’m posting this as yet another diary because the other ones have gotten too big to keep track of.

And we are now graced with the presence of some new Paulites here at RedState, so I’m hopeful they’ll be able to enlighten us economic illiterates.

I’ve been trying really hard to understand what you want to do. Here’s where I am so far.

Let’s leave the global financial system alone for a moment. This world deals with everything, including currencies, on a risk-adjusted basis. They can and do respond almost instantaneously to changes in the risk profiles of various assets. They’re also big boys and they can take care of themselves.

However, they’re totally in cahoots with both the US Treasury and the Federal Reserve. (And the ECB, and the Bank of England, Japan, the People’s Bank of China, and so on.)

That badly taints the US dollar as both a store of value and a medium of exchange, because we know the dollar is fictitious, and will be created and destroyed willy-nilly by non-market actors (viz., the Fed) in order to serve the interests of the big financial players.

Ok, so far, that should be non-controversial.

We also know that the Fed is fully capable of preventing disruptions in the financial world from messing up the real world, where people go to work and make goods and services. Not only have they proved it several times, but Ben Bernanke also has spent a lifetime studying how that happened in the Depression, and one supposes he’s learned a few tricks.

Ok, so far, still non-controversial.

Now we come to the interesting part. We the people are getting the shaft, because we’re forced to hold funny money that can have all of its value taken away at the whim of non-market actors that we can’t control.

That’s the problem we’d like to solve here.

Now it’s true that the American people have responded to this situation by holding assets other than cash (most notably, residential real estate). In fact, the national saving rate as a percentage of income is now roughly zero. So one could argue that the whole issue is a non-problem. But leave that aside.

Ok, so the proposal is to give legal status to private “money,” to be 100% backed by gold and/or silver.

How exactly is this expected to work? We know that we want everything to be as unregulated and free-market-based as possible.

We also know (because the Paulites have said it again and again) that there will be no fixed dollar-gold exchange rate, as in past gold-standard periods. Rather, the dollar-value of gold-backed money will be fixed by the already-functioning free market in gold.

Did I get that right? Ok, good.

Now that means there will be depositary institutions (Citigroup for example) that will hold publicly-auditable gold reserves, and offer (presumably) certificates. Now there is no requirement that these depositaries be regulated or chartered. Therefore, as with the Federal government during gold standard periods, gold certificates MUST be fully-convertible on demand. Otherwise there will be no public confidence in them.

Are you all still with me?

Now just as with all forms of private currency (e-gold, Second Life, even the US Government), the depositaries need to make a living. Banks normally make a living by lending money at interest. Now comes the first difficult question for the Paulites:

Do you permit fractional reserve lending?

Uniformly, the Paulites have said no. Presumably you wouldn’t allow anything like the 10% fraction that we have today. But during the late 19th century when we had full gold convertibility, banks were allowed to lend against fractional reserves (they didn’t usually hold gold reserves directly but were required to deposit government bonds with Federal authorities). But of course we won’t do that now, since we’re requiring depositaries to hold their own gold.

In the late 19th Century, what happened is that the specific reserve fraction fluctuated over time, as the public found its own preferred balance between deposits and currency.

The problem with all of this, which the Paulites must address, is bank runs. It’s inevitable that banks will close during panics if they use any kind of fractional reserve. Remember, under full gold-backing by private institutions, there is no credible deposit insurance.

So here’s the most likely outcome:

Depositaries will make their livings as SecondLife and e-gold do now: they will take a small percentage of all gold transactions. In order to keep all the money from ending up owned by bankers, we will then depend on the “natural” inflation of the gold supply that takes place through yearly mining.

Among the things we’ll have to forego: the practice of writing paper checks on bank deposits. All transactions will be done in paper gold certificates. (Of course, these can still be done electronically.)

Also, there will be no more risk capital, since there is no real way to earn a rate of return by lending money. But that’s ok, because the real point is to make sure that the money stays sound.

Now I’m stuck. Paulites, please answer this for me: how can I buy a house or a car? Who’s going to lend me the money to do it? Or do I stick to dollars for any kind of transaction involving finance?

Responses:

Not that hard by Whitfox

Easy enough. As mentioned, there is no fractional-reserve lending. Therefore, during a bank run, all assets are available for distribution. Heck, there’s no other place for assets to be, since banks can’t make loans - they must mantain 100% reserves. Naturally, they’ll be charging a fee for that, not giving interest.

So how do you finance a boat? The rent-to-own model still works without creating currency. After your final payment, the boat is yours. Until then, you’re just renting it, with the option to continue renting until ownership is obtained.

Financing a business is more interesting. Sales of equity are fine. Sales of bonds aren’t, since that again creates money from nothing more than a promise. The closest you can come to the latter is selling assets to the bondholder and getting a rent-to-own agreement in return.

As said, this much is easy. What’s much, much harder is:

* Is the removal of debt from financing actually worth the market restriction you’re getting? You can argue that Treasury bonds are a net loss to the United States, since we taxpayers have to keep paying interest on them. But we’re not talking about Treasury bonds here, but Ron Paul’s new currency.

* Is there any point in making this alternate currency, and then restricting it from current finance opportunities? It’s not clear the markets will be leaping for joy about money that can’t be invested in traditional ways. Also consider any advantage in having precious metals evaporates the instant you invest it into something.

* What’s the cost of the transition? All government mandates have their costs, and reorganizing financial institutions to deal with new restrictions won’t be cheap.

As mentioned on the other thread, I can’t support Ron Paul in this, much as I appreciate the idea of finance reform.

There’s no problem with bond sales by bhday

A company can sell a bond, and put the money to work to pay you a rate of return. If you buy the bond with your hard currency, no “new” money has been created. The company has just assumed an obligation to pay you back.

In fact, this mechanism (selling bonds) is used by the People’s Bank of China specifically for the purpose of “sterilizing reserves”. When new USD come in to pay for exports, the PBC gives the exporter RMB in exchange for their USD. The PBC then sells a bond to Chinese banks and insurance companies to “soak up” an equivalent amount of RMB so no new net RMB are created.

That’s just a temporizing measure, though, since those bonds then become reserve assets in China’s fractional reserve banking system… and the banks will inflate by loaning against those assets…

Although the PBC regulates reserve ratios etc. to try and minimize inflation, they can’t hold it off forever. That’s the reason why EVENTUALLY China’s currency will float.

Amazing how all this stuff is related…

Doesn’t quite work by Whitfox

Say I start up a newspaper, and I get a money from selling a bond. That money buys a printing press and the services of some copywriters. Where’s the money going to come from if I get a payment demand? I may not make enough money to pay it back, even if I sell my used printing press.

This is creating money, not in the form of dollars, but in the form of that bond. It may or may not ever be repaid. If that risk gets included in the contract, we’re really trading partial ownership in the venture for money.

Our finance law giving sales of debt (bonds) so much privledge over sales of equity is one of the places there’s room for improvement, IMO.

Sure it does… by bhday

Bond == Securitized Loan

If you’re starting up a new newspaper, you’d typically get a collateralized loan, or pursue equity investment. If you’re an established media company with a good track record looking to expand, you can likely sell a bond which is just a loan that’s packaged for purchase by investors.

So you want to start up your newspaper, and blackhedd (with a few of his friends) take a hard look at your business plan. They think you’re going to be able to reverse the decline in the print media business with your plan for a new Republican newspaper called the “Daily Red State”.

Because they believe in YOU, and the business plan you’ve proposed for the DRS, they take THEIR EXISTING MONEY and give it to you in exchange for a promise to be repaid over time, with suitable interest to compensate them for the risk. Additionally, because they are debt (instead of equity) investors, they have first claim on the assets of the DRS in the event you can’t pay them back as expected (ie, default).

Again, in the context of “This is creating money, not in the form of dollars, but in the form of that bond. It may or may not ever be repaid. If that risk gets included in the contract, we’re really trading partial ownership in the venture for money.” –> The bond BETTER be repaid, or blackhedd is going to take over your business. The risk of default will ALWAYS be included in the contract. The key difference between debt and equity investors is that debt investors have first claim on the business’ assets in default. Equity investors (people who buy stock) are co-owners of the assets with you so you all succeed (or lose) together.

Regardless, NO NEW MONEY HAS BEEN CREATED. The dollars that Blackhedd Syndicate, LLC loan you were earned by them, and not created out of thin air by a fractional reserve banking system.

Regarding, “Where’s the money going to come from if I get a payment demand? I may not make enough money to pay it back, even if I sell my used printing press.” –> Your creditors expect you to get the money to pay the interest and principal back over time from your customers, and successful execution of your business plan. If they call in the loan and take over your business because you’re not successful and default on the loan, then they (and you) are likely to take a loss. But that’s the free market at work, and perhaps everyone overestimated the popularity of a daily newspaper comprised of insightful blog postings from redstate.com.

But again, no new money is created when an owner of capital (Blackhedd Syndicate, LLC) lends its existing money to someone else. It’s just when banks create new capital out of thin air by lending 10x as much money as they have in the vault that things get, well, inflationary.

Fiat currency + Fractional reserve banking –> Rewards debt and speculation, benefits banks at the expense of the capital owners

Sound currency + “Honest” (not fractional reserve) banking –> Rewards saving and investment, puts banks and their customers (who are the owners of capital) on equal footing

The problem with this picture is deflation by blackhedd

You’re pretty astute about how I and my partners would go about evaluating a new media venture, and how we would expect to be rewarded for making the investment. You’re even perceptive about what would make me take an interest in the venture in the first place.

But the net result of successful business activity is always the production of goods and services that improve people’s lives in ways that are tangible enough to attach a price to.

In a strict sound-money world, as both production levels and productivity levels increase (the latter as a direct cumulative result of the increase in physical capital), the price that ordinary people pay for goods and services must fall.

And so does the price they receive for their labor. Remember, I’m not going to fund the newspaper unless I get my coupon payments every six months, plus return of the principal when the bonds run off. Multiply me by all the other investors, and over time we become a class of fat cats with most of the gold, while no one else has very much to speak of.

Over a hundred years ago in Chicago, a Presidential candidate with a huge voice said what I just said, but in a much more concise and compelling way:

“You shall not press down upon the brow of labor this crown of thorns, you shall not crucify mankind upon a cross of gold!”

We’re getting closer… by bhday

blackhedd, this is great. We’re getting there.

Regarding “But the net result of successful business activity is always the production of goods and services that improve people’s lives in ways that are tangible enough to attach a price to…. In a strict sound-money world, as both production levels and productivity levels increase (the latter as a direct cumulative result of the increase in physical capital), the price that ordinary people pay for goods and services must fall… And so does the price they receive for their labor.”

You’ve illustrated a potential cause of price deflation for whatever goods/services are subject to increased production and increased productivity levels. But the subsequent argument about wage deflation does not follow from that. Just because a particular item is cheaper now due to greater production or productivity does NOT imply that anyone’s time or labor is less valuable.

The bottom line is that in a free monetary system, where gold or silver or platinum (or whatever) is transferred among buyers and sellers as a medium of exchange, the purchasing power of any individual unit of money WILL NOT REMAIN CONSTANT over time. It will fluctuate, appropriately, based upon the supply and demand for money itself.

I repeat, we “sound money” folks are not against inflation or deflation per se. Inflation is a loss of purchasing power of an individual monetary unit — and in an “honest” system, that simply reflects a decreased demand for money. Deflation is a gain of purchasing power of an individual monetary unit, and simply reflects an increased demand for money.

Perhaps this example will help. Most people get stuck on sound money because they are obsessed with the “quantity” of money. Will we have enough money to create growth? What if there isn’t enough “circulating” because people are hoarding it? (You said earlier that you’re real concern is ECONOMIC ACTIVITY, not MONEY… and I agree 100%. Let’s just see how this plays out.)

Let’s take the case of folks irrationally hoarding gold coins, taking them out of circulation. What happens? The purchasing power of the remaining gold coins go up, and prices go down. Voila, deflation. The money you have now buys more stuff. How is that a problem? Does that hurt economic activity? If you were saving to make an investment, or start a new business, your now-increased purchasing power might be the impetus for pulling the trigger on your latest entrepreneurial venture. Your investors likewise feel that their dollars will now provide enough working capital to fund the business plan, and you start creating value and true wealth in the market. All because prices of goods had fallen (or the purchasing power of your money had increased).

Now let’s look at the flip side. All of sudden these irrational hoarders start dying off, and their relatives find these massive supplies of coins in walls, mattresses, and closets. Assuming the relatives choose to spend or invest the coins, they will then re-enter the economy. Just as the hoarding drove demand for money up (and price levels down), this “dishoarding” drives demand for money down (and price levels up). So more money available means higher prices, or inflation. Is that a bad thing? No… as I’m sure you’d agree, this money is now available for spending or investing… it may be spent on goods and services, or invested still your NEXT entrepreneurial venture. So while low prices may have been the impetus for investment in the deflationary environment, access to this newly-freed capital will be the impetus for investment (and subsequent growth) in the inflationary environment.

Get it? The quantity of money ultimately DOESN’T matter. Prices will adjust to their appropriate monetary ratio based upon the availability of the “moneystuff”, whatever it is.

So we sound-money types don’t fear inflation or deflation *in a free market*. But we should ALL fear inflation AND deflation in a “managed” system with a fiat currency and fractional reserve banking… because the boom/bust cycles that result disrupt what we all want, which is real economic growth.

***

Regarding ” Remember, I’m not going to fund the newspaper unless I get my coupon payments every six months, plus return of the principal when the bonds run off. Multiply me by all the other investors, and over time we become a class of fat cats with most of the gold, while no one else has very much to speak of.”

Huh? That doesn’t make any sense to me at all. First of all, you’re a CREDITOR, not an investor. You loaned me the money to start a paper. I pay you back out of my earnings as expected and you receive your desired rate of return. No more, no less. But I participate in the upside of my equity position, and when Rupert Murdoch decides he wants to buy the DRS, I (and my equity partners) have a huge payday. But on the balance, we all do well — we should, we created real value in the market.

***

Regarding ” Over a hundred years ago in Chicago, a Presidential candidate with a huge voice said what I just said, but in a much more concise and compelling way:
“You shall not press down upon the brow of labor this crown of thorns, you shall not crucify mankind upon a cross of gold!” –> Ironically, we’re kind of on the same page here. There’s no reason that ONLY gold should be coined into money. Silver will also work fine, as well. There’s no need to fix a ratio between the two, however, as that will also take care of itself.

Alright, hang on… by bhday

This shouldn’t hurt a bit

First, I also disagree with the assertion, “Fed is fully capable of preventing disruptions in the financial world from messing up the real world.” –> As previously stated, eons of history suggest otherwise. Which is why we’re having this discussion.

Regarding the question, “Ok, so the proposal is to give legal status to private “money,” to be 100% backed by gold and/or silver. How exactly is this expected to work?” –> Easy. Just repeal the legal tender laws. The only institution that will be *required* to accept Federal Reserve Notes for settlement of debts is the federal (and perhaps state and local?) government (i.e., you could always pay taxes in Federal Reserve Notes). Anyone else can take ‘em or leave ‘em. Most folks would continue to take ‘em, but they would be instantly subject to open market competition.

Regarding the question, “The problem with all of this, which the Paulites must address, is bank runs. It’s inevitable that banks will close during panics if they use any kind of fractional reserve. Remember, under full gold-backing by private institutions, there is no credible deposit insurance.” –> “Honest” banks that support hard currency would (again) distinguish between time deposits and demand deposits (that’s where we’ve again lost our way). A time deposit (i.e., a CD) pays interest, but CANNOT be withdrawn until it matures — because the money literally isn’t in the vault, it’s out working and earning you interest. A demand deposit (i.e., a checking account) is something that YOU pay for, for the convenience of drawing against it via Web banking, checks, ATMs, or whatever. (You could still write checks, though… we WOULDN’T need to eliminate “the practice of writing paper checks on bank deposits”.)

Your demand deposits would sit in the vault until you needed them, no loans would be written against them. Your time deposits would be put to work following the risk/reward profile YOU choose (or maybe you’d continue to invest in stocks, real estate, or whatever). Complete confidence in demand deposits == No runs on banks. The previously-cited financial instabilities during the “gold standard” eras resulted from fractional reserve banking gone awry, not the currency itself.

In this world, you wouldn’t NEED deposit insurance. But you’d probably look for an independent “Consumer’s Reports” seal of approval on your bank of choice to ensure it had the appropriate audits and internal controls in place.

Regarding “In order to keep all the money from ending up owned by bankers, we will then depend on the “natural” inflation of the gold supply that takes place through yearly mining.” –> I’d question this assertion, as there’s no one forcing you to use one bank or another to intermediate transactions. And banks have expenses, too. It’s not like they will be earning “abnoral profits” if there’s truly a free market for their services. They’ll pay employees who will spend money, etc.

Regarding, “Also, there will be no more risk capital, since there is no real way to earn a rate of return by lending money.” –> This part is emphatically NOT true. The key difference is that YOU will be lending YOUR money, and not allowing the bank to create new money out of thin air based on your deposit. If YOU have the money, you can choose to buy a bond, or a CD, or any other instrument that then allows YOU to lend your money to someone else. You can use a bank as an intermediary, or perhaps even you could create an “S&L” with your friends and loan to people YOU trust. The heart of the current system’s immorality is that it CREATES NEW MONEY in loans, and takes value from YOU, who put the deposits there in the first place.

Regarding, “Now I’m stuck. Paulites, please answer this for me: how can I buy a house or a car? Who’s going to lend me the money to do it? Or do I stick to dollars for any kind of transaction involving finance?” –> Again, lots of options. You can borrow for things that make sense. Does it make sense to borrow money for a depreciating, non-revenue generating asset? Uhhh… not really. So you really *should* save for a car. Should you borrow to start or expand a business? Sure. But you can also look for investors. Should you borrow for a house? If the the real estate market isn’t inflated beyond belief due to loads of cheap money, that’s not the worst thing in the world to do.

If none of this makes any sense, I’d highly recommend that you read Dave Ramsey’s book, “Total Money Makeover”. We have a belief system regarding consume debt that is (as you’ve noted) both highly rational (due to our inflationary currency) but ultimately self-destructive.

I should also note that you *could*, if you wanted, by bhday

purchase private deposit insurance. The insurer would be incented to watch the bank closely, and it would be cheapest to buy insurance for deposits in the best banks.

The free market would be an amazing thing…

How do I get compensated for taking risk? by blackhedd

In what follows, I’m assuming that your new commodity-money system operates alongside of the existing financial-money system, and only supplants it to the degree that free markets determine.

If I may assume that (and nothing any of the Paulites have said contradicts it), that simplifies the analysis because I don’t have to throw away the whole existing infrastructure that is based on capital-asset pricing models.

That allows us to concentrate strictly on personal business that would now be transacted in commodity money.

You disposed of the problem of bank runs as I expected you would: by strictly ruling out fractional reserves. Strictly speaking, this rules out commercial banking as well.

Insofar as demand deposits are concerned, we’re in agreement. The reason to continue having them is that gold is cumbersome and inconvenient to hold compared to paper or electronic gold-certificates, so someone has to be the custodian of the physical metal. And since that someone (I call it a depositary, you call it a bank) needs to be paid to provide the service, you and I agree that they should take a small fee either for every transaction or a yearly fee for deposits.

As you say, the services provided to demand-depositors are something they have to pay for. We’re agreed on this point. Now my point about this that you brushed past is that since the total amount of gold is fixed, if the depositary/bank takes, let’s say, 50 basis points per year from your deposits (about the load of the most efficient mutual funds), then after a couple hundred years, the bank owns everything and the depositors own nothing. Of course, the “natural” inflation of the gold supply through mining takes care of this little problem.

On to time deposits. What you’re proposing amounts to this: I give my money to a bank, which gives me in return a piece of paper that is no different from a traditional coupon-bearing fixed-income security.

The bank, in turn, uses its resources (of wisdom, judgment of character, personal contacts, and knowledge of current business conditions) to invest my money in ways that will bring them a high enough return to make coupon payments to me, and still have a profit for themselves.

Now in a low or no-inflation world, interest rates are generally very low, because (obviously) investors don’t need to be compensated for the (nonexistent) risk of inflation.

But investors still need to be compensated for taking credit risk and market risk. What if the bank invests the money from my CD in a business that fails?

So the rate of interest can never be zero. But in a strictly non-inflationary world, a non-zero interest rate is socially unsustainable because, given enough time, the investors own everything and the people own nothing.

So what rate of interest is low enough to forestall this outcome, yet high enough to make investments worth making? That’s why I said that there is no risk capital in your world, and we still need my world of finance and capital assets backed by (somewhat) inflationary money.

My conclusion at the end of the day is that your system is useful primarily as a hedge against total catastrophe, which can result from market failures, government malfeasance, incompetence, or all three.

Since Paulites consider total catastrophe to be a foregone conclusion with only the timing in doubt, this is a very reasonable hedge for them to buy.

Since I’m a financially-oriented guy, I take a risk-adjusted view of everything. Since you’re willing to buy a hedge against total catastrophe, I’m willing to sell it to you. Let’s meet in New York next chance you get and discuss deal terms.

 

 

 

Wow, maybe this WILL take a while… by bhday

Ok, deep breath… Here we go:

Regarding “That allows us to concentrate strictly on personal business that would now be transacted in commodity money.” –>

What? I’m starting a business here, a real entrepreneurial venture called the Daily Red State, with your commodity money that you earned through great effort. There’s no distinction between “personal” and “commercial”.

***

Regarding “You disposed of the problem of bank runs as I expected you would: by strictly ruling out fractional reserves. Strictly speaking, this rules out commercial banking as well.” –>

Hmmm… Why does this rule out commercial banking? A bank simply holds deposits (demand deposits for a fee, and time deposits that earn interest). An HONEST bank just doesn’t confuse the two, and never lends out more than its depositors have allowed it to. Commercial or retail, there’s no difference. This free market system would encourage and reward honest banks.

***

Regarding “As you say, the services provided to demand-depositors are something they have to pay for. We’re agreed on this point. Now my point about this that you brushed past is that since the total amount of gold is fixed, if the depositary/bank takes, let’s say, 50 basis points per year from your deposits (about the load of the most efficient mutual funds), then after a couple hundred years, the bank owns everything and the depositors own nothing. Of course, the “natural” inflation of the gold supply through mining takes care of this little problem.” –>

What? All we’re talking about is a network of warehouses that store physical assets. Those warehouses will compete in a free market for their services, which are not highly technical. That competition will make the storage service available as cheaply as possible — because if anyone starts earning “abnormal” profits, you are free to open a competing warehouse next door. In the absurd case you postulate, if a bank could truly own EVERYTHING just by guarding the gold at 50bp per year, then EVERYONE (myself included) would open a bank to do just that. That

Economically, here’s what happens: The person paying the storage fee is the person holding the “demand” on the gold. After you loan me your sound money at 8% to start the DRS, I have claim on that gold. My carrying cost for this capital is 8.5% (8% interest, plus 0.5% storage fee). But I am going to deploy this capital into printing presses and other investments that I expect to grow at 20%. (You believe it too, which is why you gave me the loan.) So not only am I going to earn a better rate of return than the interest plus the storage fee, that storage fee will go down as I start spending the money.

The point you make is actually a strong argument for the *pro-growth* nature of free-market money in an honest (non-fractional-reserve) banking system. There IS a cost to just leaving gold idle in the vault. You could take it out of the vault and hide it in your mattress, but that doesn’t scale too well. What you’ve illustrated is that in this environment capital does NOT benefit from being lazy — it will always seek to be invested in a way that maximizes its return, and certainly will cover the (very small) storage fee.

***

Regarding “On to time deposits. What you’re proposing amounts to this: I give my money to a bank, which gives me in return a piece of paper that is no different from a traditional coupon-bearing fixed-income security… The bank, in turn, uses its resources (of wisdom, judgment of character, personal contacts, and knowledge of current business conditions) to invest my money in ways that will bring them a high enough return to make coupon payments to me, and still have a profit for themselves… Now in a low or no-inflation world, interest rates are generally very low, because (obviously) investors don’t need to be compensated for the (nonexistent) risk of inflation… But investors still need to be compensated for taking credit risk and market risk. What if the bank invests the money from my CD in a business that fails?” –>

Well, the bank better not make too many bad investments, or else they will lose their depositors’ money. But they will ONLY lose the money that was put at risk. And that risk could be minimized by (again) private insurance. So let’s say that the bank (or ANY institution — doesn’t need to be a “bank”) offered an interest-bearing deposit that gave you 5% interest over 6 months. The prospectus said that the deposit funded short-term working capital needs for your local gas and electric utility company. Would you invest in that? Sounds pretty safe to me. But it’s your choice. Say you could also buy principal protection insurance for another 50bp. Thus, your RISK-FREE return was 4.5%. Does that sound better to you? You’re still covering the storage cost, and you’ve preserved your buying power over time since interest rates reflect the supply and demand for money discussed in my prior post.

The free market can provide all that, and more. It slices, it dices… it’s the invisible hand! (Meanwhile, the bank has been forced through competition to get quite lean, and charges the utility 6% to borrow the funds. It can be profitable on a spread of 1% due to the lack of government regulations and compliance requirements. It just needs to satisfy its private insurers demands for transparency and internal controls).

***

Regarding “So the rate of interest can never be zero. But in a strictly non-inflationary world, a non-zero interest rate is socially unsustainable because, given enough time, the investors own everything and the people own nothing… So what rate of interest is low enough to forestall this outcome, yet high enough to make investments worth making? That’s why I said that there is no risk capital in your world, and we still need my world of finance and capital assets backed by (somewhat) inflationary money.” –>

I’m not following the assertion that nonzero interest rates imply all wealth flows to investors over time, and “people own nothing”. The reality is that in a free-market monetary system, ALL the people (and institutions) are investors. There is no difference between saving and investing. Say you (as a corporation or individual) keep two months’ worth of money in a demand deposit account. You pay your bills out of that account, live within your means, and structure the rest of your assets in equity investments, real estate, fixed income, and short-term certificates of deposit for ready access to emergency capital. YOU are the investor. I am the investor. We all are investors. As we invest, we are by definition taking risk. All our investments are risk capital in different types of assets. We DO NOT want all our assets just sitting in a demand account, withering away. That would be irrational. So we manage our demand deposit balance accordingly.

Now granted, this system is NOT for everyone at first. The only people who will participate are those who understand that true wealth comes from creation of value in the marketplace (like you said earlier), and not from some misguided effort to finance conspicuous consumption. Folks with credit card debt, subprime mortgages, car loans, and so forth will probably feel more comfortable in the inflationary world, where they can try to get ahead on the hamster wheel of paying down their debt with a depreciating paper currency. While prior discussions have characterized that behavior as “rational” and “smart”, in the long run it’s a form of slavery to the banking industry. But the banking industry isn’t complaining.

But that’s at the micro level. At the macro level, the real problem comes when a nation of debtors with a national debt can no longer sell bonds to China because they no longer need, or want, to support their fixed RMB exchange rate. Then we’ll all be competing with a billion Chinese to buy food and energy in the global market with an even weaker paper currency:
http://www.redstate.com/stories/economy/sino_american_economic_relations…
http://blog.lawsonforcongress.com/2007/08/12/the-china-conundrum/

***

Regarding “My conclusion at the end of the day is that your system is useful primarily as a hedge against total catastrophe, which can result from market failures, government malfeasance, incompetence, or all three. Since Paulites consider total catastrophe to be a foregone conclusion with only the timing in doubt, this is a very reasonable hedge for them to buy. Since I’m a financially-oriented guy, I take a risk-adjusted view of everything. Since you’re willing to buy a hedge against total catastrophe, I’m willing to sell it to you. Let’s meet in New York next chance you get and discuss deal terms.” –>

The problem is that when that hedge pays off, your paper money, contracts, and promises will be worthless. Seriously, all we RonPaul™ supporters are asking for here is free choice. The dynamics have changed — this time, the cross is not of gold, it’s of paper. WJB did not want to be limited to gold, we don’t want to be limited to paper.

I would caution you not to be too comfortable with our current position, and more importantly our trajectory, as a nation and an economy. We have a number of challenges facing us, and the stability of our currency within the international monetary system is a significant one. The governmental assault on domestic job creation and the entrepreneurial environment is also critical. It’s not too late to make a difference, but folks need to get educated on these topics, and quickly.

Reply To This — User Info — #44

To re-emphasize… by bhday

First, I hope these posts have illustrated how a free-market commodity currency in a non-fractional-reserve banking system is the *most* pro-growth monetary system imaginable. Since there is a small but real cost for holding commodity money in a demand deposit account, all monetary assets will immediately, and efficiently, be assigned through investment to their highest-yielding (and thus most valuable) use. That’s the key to responsible growth. It doesn’t require subsidies, “adding liquidity”, or social engineering. Just let the market do its job separating the good ideas from the bad.

Second, while I welcome the discussion, at some point I need to suggest that you read the following books:
What Has the Government Done to Our Money? (Murray Rothbard, available from www.mises.org)
Economics in One Lesson (Henry Hazlitt)
Economics for Real People (Gene Callahan)

They’re straightforward easy reads and debunk a lot of myths and misunderstandings that permeate our current dialog.

 

 

It’s painful to hear people dismiss Ron Paul and say, “Oh, he’s that guy who wants to go back on the gold standard” while rolling their eyes. And before I really understood the history of our monetary system in the U.S., and indeed the world, I was one of them. Clearly, the gold standard failed, the 70s and early 80s were extremely painful, and who would want to go back to that mess?

But based upon his interviews (Ron Paul @ Google) and writings, such critics and Ron Paul are not talking about the same “gold standard”.

People equate the words “gold standard” with the currency system we’ve had since the Federal Reserve was established in the early 1900s, and more recently the Bretton Woods currency system that lasted from the post-WWII era until Nixon closed the “gold window” and ended foreign central banks’ convertibility of dollars into gold in 1971.

But the U.S. monetary systems that we’ve labeled “gold standards” in this country have all been destined for failure. Why? Because all the government did was fix the price of gold in dollars, without necessarily restraining the printing press that churns out Federal Reserve Notes. Essentially, we had a mechanism that allowed the government to “cheat” all along — while our Treasury publicly declared that the price of gold was *fixed* at a specific value in dollars, there was no absolute restraint to the Federal Reserve System printing paper money when we needed it (initially to finance wars, eventually both guns and butter). There are books about this topic, but this article does a pretty good job of hitting the historical high points (or low points — can you imagine the government confiscating all your gold today?)

The bottom line is that Ron Paul is not looking to return us to the “gold standard” as those words are widely interpreted. He is, as he says in the Google interview, “against the idea that government can print as much money as it wants” (to paraphrase).

Ultimately, money is trust. The prices of gold, gas, milk, butter, and even the price of US dollars against other (equally intrinsically useless) fiat currencies show that trust in our government and its monetary system is declining at an concerning rate. We can hide our heads in the sand, or we can ask if it’s possible to change the direction that we’re going.

Every central banker understands and professes that “sound money” is critical to economic growth. Like Ron Paul says, if money is one-half of every economic transaction, it’s your measuring stick for value. How effective would an architect be with a ruler that was always changing in length? But what central bankers don’t say is that the presence of a central bank that has a complete monopoly on a fiat currency driving a nation’s economy inherently undermines sound money as people accept the dogma that inflation is something that you “manage”, and deflation is something that you fear.

Inflation hurts savers, but benefits debtors. Savings lose their purchasing power, but debtors can pay back their loans in cheaper currency. But guess what — do banks make more money from savers, or debtors? And why must we fear deflation? Is it a bad thing that a computer today is cheaper than it was a decade ago?

What Ron Paul *does* want to do is legalize competition in the domestic money supply. That’s a first step towards providing sound money that rewards production, savings, and investment, as opposed to artificially stimulating debt, consumption, and speculation.

So what is a “real” gold standard? It’s simply where the government (or any institution) provides a currency that is convertible into a specified quantity of gold (or silver, or whatever commodity you like) without artificially fixing the commodity’s price. In other words, the government can’t just “talk the talk”, it must “walk the walk”. Because if the government provides convertibility between paper money (or zeros in your checking/savings account) and a commodity WITHOUT fixing the price of the commodity, the purchasing power of that money in terms of that commodity will be preserved forever.

In other words, in the Roman empire, the price of a nicely-tailored suit was an ounce of gold. Give or take a bit, that same ounce of gold today will still buy you a nice suit (in Hong Kong, even a custom tailored one!)

But I can still hear someone asking now… “But wait, why would we want our currency tied to the value of a commodity as volatile as gold?” Of course, gold would not be nearly as volatile if it was priced in gold :). Extreme volatility exists because gold is priced in our fiat currency that is subject to credit expansion, credit contraction, liquidity booms, busts, and all sorts of speculative excesses.

Indeed, while gold today is close to its peak in non-inflation-adjusted dollars, in inflation-adjusted terms, the price of gold is still MUCH lower than its peak since the dollar’s purchasing power is so much less today. As mentioned in the article above, the 1980 peak gold price in 2006 inflation adjusted dollars was over $2,000. So much for a sound currency.