A GOLDEN RULE

To the ‘49ers who headed for California in the last century, the dream was not of precious metal, but of abundance and opportunity, fertility and freedom. In the same way, the pioneers who left the Old World for America a hundred years ago were told of "streets paved with gold," but the image was understood to mean freedom and opportunity. The Golden Calf, we have been taught, was a false god, a physical idol. It was rather the concept of the Golden Rule that infused the spirit of this New World. Do unto others as you would have them do unto you. It is this concept that has interested me in monetary issues this past quarter century -- a Golden Rule in our everyday business of living. How can men and women possibly live together in peace and harmony over any extended period of time without this Golden Rule? This central idea is at the heart of human civilization, the very essence of almost all religious and civil codes. It is, of course, the meaning of the Gold Standard in the monetary realm. It relates not to golden specie in bulk, to bars of gold bullion piled high in the hoard of King Midas, but to the trust that connects strangers to each other in the marketplace. In God We Trust represents the single Polaris of our Creator. Not "In gods we trust," for there is no pantheon of gods that can unite the human species in peace and harmony. Men would kill each other to the last in defense of their particular god, but an agreement on one Creator under different names holds promise of an eternal peace. There are not two or three or a dozen "North Stars" in the sky to guide the navigators. And there is only one golden rule. Paper monies of each nation can have differing names and appearances, but if each is defined in terms of one central physical specie, to connect concept to reality, they will all be linked across time and space to the same guiding standard.

Karl Marx, who agreed with the classical economists of the 19th century on monetary theory, put it well in the following passage of his Capital: "The weight of gold represented in imagination by the prices or money-names of commodities, must confront those commodities, within the circulation, in the shape of coins or pieces of gold of a given denomination. Coining, like the establishment of a standard or prices, is the business of the State. The different national uniforms worn at home by gold and silver as coins, and doffed again in the market of the world, indicate the separation between the internal or national spheres of the circulation of commodities, and their universal sphere." Note the word imagination.

Every trader knows, that he is far from having turned his goods into money, when he has expressed their value in a price or in imaginary money, and that it does not require the least bit of real gold, to estimate in that metal millions of pounds' worth of goods. When, therefore, money serves as a measure of value, it is employed only as imaginary or ideal money.5

It is literally impossible to imagine a colored piece of paper having a fixed value in terms of something concrete to the senses without some person or some government promising to exchange that something for it. A slip of paper that promises a kiss on Valentine's Day has redemptive value, but only in the future. It is not money, but a bond. An I.O.U. signed by me and given to you, promising to push a peanut up Fifth Avenue with my nose if and when the Chicago Cubs win the World Series, is a bond without maturity. It is not money. It is money if it can be redeemed on the spot, and it is money of fixed value if it can be redeemed on the spot or on St. Valentine's Day for the same something. Neither Karl Marx nor Alexander Hamilton nor David Ricardo would recognize a colored piece of paper, issued by the government without any redemptive value at all, as having fixed value. "The commerce and industry of the country," wrote Adam Smith, "cannot be altogether so secure when they are thus, as it were, suspended on the Daedalian wings of paper money as when they travel upon the solid ground of gold." The fact that the world can survive at all without a fixed unit of monetary value is testimony to the confidence of the world in the dollar and the people who manage its "floating promise." It is in this sense that Federal Reserve Chairman Alan Greenspan is the most important man in the world, as the slightest errors he makes in the management of the dollar are transmitted around the planet with lightning speed. Greenspan gets this enormous power first by virtue of being a citizen of the nation with the most important currency, the one which in recent centuries has been the most reliable in keeping its money as good as gold. Without a Gold Polaris, the dollar is the best port in the storm.

How did Greenspan get the job of managing a floating promise of a dollar? It is because he understands the importance of gold as his own best reference point in managing the floating dollar. As a younger man, Greenspan also connected the idea of gold's contribution to moral values and society's integrity. Younger Americans who have no recollection of life in this kind of world should be aware that it was not so long ago and was not so unusual. Greenspan's predecessor, Paul Volcker, also understood the importance of gold. Although a gold advocate, he was Treasury Undersecretary for Monetary Affairs in the Nixon administration when the dollar/gold link was broken on August 15, 1971. He was the protégé of Robert Roosa, who was Treasury Undersecretary for Monetary Affairs in the Kennedy Administration. Roosa in turn was a devoted advocate of the gold standard at the heart of the Bretton Woods system and the founder of the London gold pool. President John Kennedy was a gold advocate, as was his father Joseph Kennedy. It was in 1968 that President Johnson closed the London gold pool, which had been exchanging gold dollars for foreign exchange. And it was Roosa's statement in 1969 that U.S. gold stocks may not be sufficient to maintain the dollar's value that led Robert Mundell to make his prediction that the world would soon be in a floating regime. If Roosa, a friend, could not understand that the nation's gold reserves could easily be defended by draining surplus liquidity from the banking system, Mundell said it had to be clear that "the forces of history were determined to engage in one of their periodic experiments with a managed currency."

CONSEQUENCES OF CHAOS

On the trek back to gold that Mundell prognosticated in 1969, the costs to the U.S. and world economy have been painfully high indeed. His study of economic history told him that the gains to be had from a common currency are so great that the world will always find a way back to one. The most serious damage in the United States occurred as the unit of account marched up the progressive tax system. Originally designed during World War I, when the dollar was defined as a twentieth of a gold ounce, the income-tax progression then exempted all but the highest income Americans -- essentially professionals and the business class. Even then, the steep progression so inhibited capital formation that in 1922 a capital-gains differential was enacted. This was to encourage the flow of surplus capital from the business and professional class to ordinary Americans who aspired to the American dream. For the remainder of the 1920s, the WWI marginal income tax rates were reduced in a series of steps during the Harding and Coolidge administrations. The progression steepened again in the Hoover years, contributing to the depression triggered by the 1930 Smoot-Hawley Tariff Act. The progression steepened even more sharply in the New Deal years of Franklin Roosevelt, not only because nominal income-tax rates were increased at the top to 94% from 63%, but also because the dollar was devalued 70% against gold in 1934 in a failed attempt to spur the economy.

The impact of the 70% devaluation was cushioned by the long history of the dollar's preceding integrity.6 The average maturity of contractual debts, public and private, easily exceeded 10 years, and there were a great many contracts fixed at more than 20 years. The devaluation would be spread over this period as the contracts unwound, with some of the observed inflation occurring after World War II. In other words, the monetary standard declined by 70% in 1934 as the gold Polaris shifted, but it would take another 20 years for its full effects to ripple through the dollar price structure. The population experienced a "price inflation" after the war that Keynesian economists incorrectly attributed to a release of "pent-up demand." Actually, wartime price controls had held back the ripple from the 1934 devaluation and when the controls were lifted, prices surged.

It should be noted that the dollar did not decline by 70% in 1934 because of "market forces." President Roosevelt personally decided to made the gold price $35 instead of $20.67. This was in response to the monetarists of the day, who argued that the lower gold price had caused the economic depression -- when in fact it was the Hoover tax and tariff increases. When two ships collide in a storm, we would not blame the constancy of the North Star. There is no record that FDR's Treasury Secretary, Henry Morgenthau, advised him that his action constituted a repudiation of a large portion of the national debt. Nor was the President told that the devaluation would over time be followed by a 70% rise in the general price level. He was simply trying all variety of things, hoping one or another would work.

Roosevelt, at least, did not abandon the gold Polaris, only shifting it in the commercial firmament. There is also no record that President Nixon's economists advised him that by completely closing the gold window on August 15, 1971, he would invite the worst global inflation in recorded history. Rep. Henry Reuss [D-WI], chairman of the Joint Economic Committee, helped force this decision by announcing ten days earlier that it had to be done, an action that set off a wild selloff of dollars and dollar bonds in Europe. Reuss predicted that when the dollar no longer propped up the price of gold, it would fall to no more than $7 an ounce. The dollar now "floated" in value relative to gold and in two years hovered around $140 an ounce. The economists who advised the President to do this preferred to think of the dollar as being fixed while gold floated. Gold, said Milton Friedman, was now a commodity to be traded no differently than pork bellies. The general inflation that ensued rippled though the price galaxy much more quickly than it had following the 1934 devaluation. In 1971, of course, the dollar did not have a century of historical integrity behind it. The world was now getting used to a declining monetary standard in the United States.

By the time the Roosevelt devaluation ran through the price galaxy, its impact on the progressivity of the income-tax caused Internal Revenue's net to cast beyond the professional and business class, catching craftsmen and factory journeymen. The devalued Nixon greenback cast much further, bringing shop girls and apprentices into the net. Worse, the conservative Keynesians who advised Nixon in 1969 had persuaded him to sharply increase the capital gains tax to 48%. As a result, when the price inflation rippled through the system following the 1971 devaluation, it caused the real rate of capital taxation to soar. The economy slowed further, its decline masked by nominal increases in wages, prices and Gross National Product. When President Jimmy Carter arrived in 1977, gold was still at roughly $140, four times its Bretton Woods price. As Robert Mundell had predicted, by now the world price of oil had quadrupled as well, "black gold" adjusting to the gold Polaris.

In the four Carter years, the gold price quadrupled again, spending much of 1980 above $600 as interest rates climbed to their highest levels in U.S. history. It made not the slightest difference that Carter presented a "balanced budget" in January 1980. By the time Paul Volcker had arrived as Chairman of the Federal Reserve Board in July 1979, the price of gold was being totally disregarded as a monetary signal and was already up to $237. Without the Polaris, Volcker and the Carter Treasury began pushing buttons and pulling levers, hoping something would work. They tried credit controls, a switch of monetary targets, "jawboning" or "moral suasion," and raising the federal funds rate which the Fed controls. It did everything but drain surplus liquidity from the market -- the one thing that would have worked. Indeed, in the fall of 1979, Volcker advised Congress that because the economy would grow faster in 1980 than had earlier been anticipated, it would need more liquidity! The price of gold jumped to $850 at its peak on February 1, 1980.

The rampant inflation underway was blamed on everything else but the central bank's dismissal of gold as a signal of surplus liquidity. The Arab nations were blamed the most for raising the price of oil. The Organization of Petroleum Exporting Countries (OPEC), though, specifically blamed the quadrupling of the gold price as their reason for wanting four times as many paper dollars for a barrel of oil. American economists also blamed American companies for raising prices, blamed management of American companies for raising executive compensation, and blamed American workers for excessive rising expectations. In the absence of a federal budget deficit to blame in early 1980, they blamed the U.S. trade deficit with Japan. When soaring interest rates then drove up the cost of debt service, and with it the federal budget deficit, the economists who had pushed Nixon into the devaluation blamed the "twin deficits," budget and trade.