Gold and the Wicked Magicians

Why is there such hostility toward a return to a gold standard? After all, the U.S. prospered mightily by tying the dollar to gold from 1791 to 1971. (The exception was during the Civil War, but the link was resumed in the 1870s.) Other factors were at work, of course, but the sound dollar was critical to our phenomenal success.

Amsterdam became a capital powerhouse in the 1600s and tiny Holland, a global empire. This was, in no small part, because its currency was firmly tied to gold. Ditto Britain in the 18th and 19th centuries with the pound. Germany and Japan quickly and miraculously rose from the rubble of World War II when they firmly fixed their currencies to the gold-backed dollar.

So what gives?

There are two powerful forces opposed to this sensible step: the inherent rapaciousness of Big Government and the conceit of economists who believe that economies can be guided, like steering an automobile. Both forces share a visceral dislike of the gold standard.

Linking the value of money to gold removes a huge source of Big Government’s power. No longer can government confiscate wealth by stealth by devaluing your money. Economists hate the gold standard because they think they’re being deprived of one of their magic wands to shape the economy.

Big Government looks after its own interests. Left to its own devices it will relentlessly expand, crushing the private sector. That’s what’s happening in Europe today. Despite all the talk of austerity, the public sector has hardly been touched, while businesses and individuals have been hit with more and more taxes.

C. Northcote Parkinson, a British historian, noted this phenomenon when writing his history of the British Navy. After World War I Britain’s fleet was drastically downsized, with ships mothballed, sailors mustered out and dockworkers laid off. Yet the agency running the Navy increased in size. As Parkinson noted, “[There is] little or no relationship between the work to be done and the size of the staff to which it may be assigned. Politicians and taxpayers have assumed (with occasional phases of doubt) that a rising total in the number of civil servants must reflect a growing volume of work to be done. … The fact is that the number of the officials and the quantity of the work are not related to each other at all.”

During the 19th century’s industrialization era, governments came to believe that their spending had to be restrained and taxes kept in check lest inflation be created and economic progress halted. But WWI, like the serpent’s apple, demonstrated that governments could nationalize liquid capital via taxation and borrowing. Money manipulation came to be seen as a way to add steroids to the economy. Politicians could spend prodigiously. During the Great Depression Britain went off the gold standard, devaluing the pound. Numerous other countries followed suit. In 1933-34 the U.S. devalued the dollar, but its tie to gold was maintained.

After WWII countries linked their currencies to the gold-backed dollar. But the U.S. was constantly tempted by the lure of cheap money to goose economic growth. In 1971 we went off gold.

Since then we and the world have faced an unprecedented series of currency and banking crises. The disastrous housing bubble would never have happened if the Fed hadn’t been cheapening the dollar.

Despite thousands of years of experience to the contrary, central bankers and countless policymakers and economists believe that money manipulation can stimulate and wisely guide an economy.

It’s a destructive delusion. The world today would be an immensely richer place were it not for these hu bristic notions that a handful of people can keep an economy rolling smoothly with minimal unemployment.

John Maynard Keynes was the chief promoter of the illusion that economists could wave a magic wand via monetary and fiscal policies and all would be well. This fantasy is at the center of our economic woes today, which will be taking a turn for the worse later this year and in early 2013.

Ben Bernanke is engaged in Soviet-style credit allocation. By keeping interest rates low, he makes it easy for the federal government to massively expand its power through gigantic increases in spending. The Federal Reserve buys most of the government debt, and the interest Uncle Sam pays on it is de minimis . Call it “deficits without tears.”

The resources government devours mean fewer resources for the private sector. Ominously, the U.S. is now in the process of destroying wealth instead of creating it, as small and medium-size businesses have major difficultly in securing a reliable flow of credit.

What the Fed is doing is a form of Big Government coercion. In an open market two parties may voluntarily agree to a transaction at a certain price. But when government manipulates the value of currency, it arbitrarily changes the real value of your agreement.

The Great Depression was seen as proof that free markets are inherently unstable and need the guiding hand of government to keep them from going off the rails, that when government lightens its hand we get the kind of excesses that brought on our current economic troubles. But the truth is that government error has brought on every major economic crisis. Yet the belief in our magician economists persists.

The idea that the economy is similar to a piece of machinery is preposterous–it is simply the aggregation of literally billions of transactions between individuals and between businesses. And, as never before, national economies are not islands unto themselves. Each country has its own economic policies, but the conditions in each country will be impacted by what happens elsewhere.

Global supply chains are becoming ever more intricate. Take the iPhone 4. It has $171 worth of parts, which are assembled in China. Of those parts a little more than $6 worth are actually manufactured in China. The rest are brought in from other countries, such as Germany, Japan and the U.S.–we export $10 worth of those iPhone parts to China.

Another thing that should make us leery of this Keynesian idea of guidance is the disruption that routinely comes from innovation. The rise of fiber optics dramatically reduced the value of all the copper wire owned by incumbent telephone companies. The iPod made countless traditional music stores obsolete. Netflix shattered Blockbuster’s once happy existence. Wal-Mart’s legendary efficiency led to numerous small-store closings, and its supermarket business forced traditional chains to undergo major, painful restructurings, if not occasional bankruptcies. I’m old enough to remember once ubiquitous things like typewriters and pay phones.


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