The Bear’s Lair: Back to the Gold Standard!

As gold finally broke through its 2011 all-time high the mainstream media played the story down as much as possible. No surprise there. However, gold’s surge in 2020, which shows no sign of ending, strongly suggests that the era of dozy Keynesians monetary policies is finally reaching its inevitable Götterdämmerung. The Fed having proved over the last 25 years that all lesser restraints are useless, there is only one resource left to save our more or less free market economy: a full return to the Gold Standard, with all the blissfully corrective discipline that would impose.

Several years ago, I responded to the excessive monetary laxity by suggesting that steps should be taken to “Volckerize” the Fed, in other words, to force it into adopting the tight monetary policy pursued by the late Paul Volcker. Were there a way to achieve such thing, a Gold Standard might not be necessary; Volcker’s success in conquering inflation in the early 1980s was very impressive, although it should be noted he had to push interest rates up to nosebleed levels, briefly touching 20% on short-term paper, to achieve his goals.

Still, Volcker did manage to achieve one perennial goal: he made gold an unattractive investment, since it fell from a peak of $850 per ounce in January 1980 to around $250 per ounce at the end of the 1990s. So far am I from being an irrational “gold-bug” that I can truthfully claim I never looked at a gold- or silver- based investment from 1982 until the middle of 2000. Since then, it has naturally been a different story, for better or, occasionally (2011-15) for worse.

The experience of the last ten years has however shown us that no legal restraint imposed by Congress, however carefully drafted, could restrain the crazed Keynesians at the Fed. There already is a mandate for “stable prices” from the Federal Reserve Act of 1977, yet the Fed has completely ignored this mandate, so far as to set an inflation target of 2% per annum (which doubles prices every 35 years, and is certainly not stability) and now seeks to push inflation UP to the 2% per annum from its current level of somewhat below that. Add to the Fed’s ability to ignore clear Congressional mandates the Bureau of Labor Statistics’ ability to fiddle the figures, reducing prices by an arbitrary amount because of supposed “hedonic” improvements, and you have a recipe for a system with inadequate restraints. Until last year, we could have solved this problem by recalling Paul Volcker himself (1927-2019) to lead the Fed; alas this is now impossible.

There is thus no way to get the Fed to set an appropriate course in monetary policy. Appointing Judy Shelton, a known friend of the Gold Standard, to the Fed Board of Governors may make one tiny step towards solving the problem (she would be only one voice among 12 at Federal Open Market Committee meetings) but alas even this overwhelmingly sensible mini-step may be blocked by quislings (Sen. Mitt Romney, R.-UT) and limp noodles (Sen. Susan Collins R.-ME) on the left of the Republican party.

To remove most of the Fed’s power, and prevent it setting interest rates at economy-destroying levels far from their natural equilibrium, there is thus no alternative but to make the dollar directly convertible into gold. Not theoretically convertible into gold by government insiders, as it was under the truly dreadful Keynes-White Bretton Woods system of 1944-71 (which collapsed in inflation) but directly convertible into gold by any ordinary individual walking into his bank and demanding gold coins or bullion. Only then would the money-creators at the Fed be thwarted; if they printed too much money, or the Treasury ran an excessive budget deficit, the public would demand gold, thereby causing a salutary period of correctively high interest rates.

The last leader to return successfully to a Gold Standard from a period of fiat money was Robert, Lord Liverpool, who as Britain’s prime minister shepherded through the necessary legislation in 1819 and returned to a full Gold Standard in 1821 (golly, how time flies!) Britain had been on a fiat money standard for 24 years by that stage, had suffered price rises of around 100% at the peak in 1813-14, and had a public debt in 1819 of 250% of GDP, far higher than any rich country except Japan today. Nevertheless, the transition to a full Gold Standard was accomplished in under 3 years, at the cost of a deep but brief recession that lasted less than a year. This was accomplished even though the decision to return to gold at the pre-1797 parity involved severe price deflation, with prices falling some 40% between 1815 and 1824.

We can learn from Liverpool’s experience. We should not impose violent deflation on the U.S. or the world, so the gold price parity should be close to the present level, say $2,000 per ounce. If the U.S. had been experiencing substantial inflation, or if the gold price was not already well above its equilibrium, a higher price parity would have been justified. Then the legislation, if along the lines of Liverpool’s 1819 Act and passed today, should include three provisions:

  • Gold “Reagans” containing ¼ ounce of gold, so therefore weighing somewhat more to allow for the normal 22 carat fineness, should be offered for sale by the Fed through banks immediately, at $500, with a maximum purchase of 10 coins
  • From January 1, 2021, gold bullion should be sold by the Fed to all buyers in exchange for dollars (i.e. dollar deposits redeemed for gold) at a minimum price of $2,200 per ounce, for a minimum sale of 1,000 ounces. The sale price would be reduced to $2,100 per ounce on January 1, 2022
  • From January 1, 2023, bullion or Reagan coins will be freely bought and sold by the Fed through banks for dollars at $2,000 per ounce of gold content.

Thus, with a 29- month lead-in period, the United States would be fully on the Gold Standard from January 2023. Dollar bills would be used for small denominations, as now, and most payments would continue to be made by wire transfer, but payments in multiples of $500 could from that date be made in gold coins, which would be legal tender. The problem with large denomination bills, that they might be counterfeited, would not exist with gold coins, which could be weighed or melted down if there was any question as to their authenticity.

A Gold Standard world would have a remarkable effect on the economy in which we all live. Many of the “financialization” excesses of the last three decades would disappear. For example, you cannot make much money on a private equity fund if you have to borrow at positive real interest rates to fund your positions, unless you make genuine value-creating reforms in the companies you are managing, which most private equity funds are incapable of doing. As for hedge funds, they would probably disappear altogether, since the greater stability of the financial economy would eliminate almost all the profits from short-term speculation, which relies heavily on the Fed creating money to fund it.

Speculative asset prices would collapse. The excesses of New York City and San Francisco real estate would disappear for three reasons. First, there would no longer be an endless supply of excessively rewarded speculative tycoons to buy top-end real estate. Second, the finance would no longer be available to create or buy new top-end real estate – money would be much scarcer and much tighter. Third, and most important, in a gold standard world there is no longer the expectation that real estate prices will forever increase. As a consequence, real estate prices will revert towards the real equivalent of their level in the nineteenth century, when a house would be built to last 50 years, and would depreciate gradually in value over its expected lifespan, with the return from owning it being achieved by the opportunity of renting it out. In such a world, real estate would become affordable for Millennials, and many of the troubles of today’s younger generation would be eliminated.

The most important change achieved by the return to a Gold Standard economy would be the return to historically normal rates of U.S. productivity growth. Since it would no longer be possible to borrow at negative real interest rates to invest in speculative rubbish, speculative rubbish and deal froth would no longer exist. This would finally alleviate the productivity blight that has affected the U.S. economy in recent decades, lifting only briefly with the more sensible interest rate policies of 2018-19. Provided that a generally de-regulatory President occupied the White House, the U.S. people would, for the first time since the 1980s, enjoy an economy in which Wall Street was not siphoning off resources to its own nefarious ends, and the regulators were not quelling innovation with their absurd leftist fantasies. Small business formation would finally return to its 1970s levels, double the present anemic trickle, and decently paid jobs for people with decent skills would proliferate.

There would be a downside as well, of course. Much of the speculative debt of the last 25 years would be liquidated, and speculative deals would be forcibly undone – this would be very painful, but quick, provided politicians did not attempt to alleviate it. Excessive salaries paid to private equity fund managers and Wall Street would disappear, and CEO salaries would be forced down to their proper multiple of shop-floor pay (companies that paid too much would be uncompetitive and over time would go out of business). The grotesque “non-profit” sector, so full of scams, would drastically shrink, as would colleges turning out useless degrees. Billionaires would become mere millionaires, and over time, the current excessive inequality would fade away.

As $2,000 gold indicates, we have come to the end of the road; the current financial structure is no longer viable. It is time to replace it with the only financial system that is proof against inept government meddling. Economic understanding among the ruling class has been in steady decline over the last 200 years; we must therefore revert to the principles that worked to give us the Industrial Revolution.

(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)