The Mises Institute monthly, free with membership
Volume 15, Number 2
Gold or the Fed?
If members of the congressional classes of 1994 and 1996 are serious about curbing
they should rally around Ron Paul, the newly elected congressman from Texas's 14th district.
For Ron, a longtime friend of the Mises Institute, is the outstanding political opponent of the
main engine of statism in American life: the Federal Reserve.
In his prior terms in the House, Ron was an indefatigable advocate of the free-market
system--the pure gold standard--and the bane of Fed officials. In those days, the power of his
rested on how the gold standard could eliminate business cycles and inflation, important points
that still apply.
But today, a renewed effort to abolish the Fed and establish gold as money has a new source
strength. A recent partial audit of the Fed showed the central bank as a corrupt and wasteful
bureaucratic empire, with cost overruns large enough to dethrone the head of any other agency.
And if this isn't enough to invite attention, the Fed has again reelected an incumbent president,
which should alarm any Republican worth his campaign contribution.
Yet the biggest obstacle to a gold standard, as always, is intellectual. What these
need is a good monetary education. Four objections invariably crop up when the subject of gold
is raised. Here they are, with some short answers.
1. The gold standard is too costly. This claim overlooks
the efficiency of the market itself.
Entrepreneurs produce the right amount of each good because they must pay market prices to
successfully bid for factors of production.
If they could avoid these market-imposed production costs, it would be profitable for them to
vastly over-produce. Fiat money can be produced at a low cost, which is one reason the
government can produce so much, and cause so much inflation.
Moreover, to re-monetize gold would require no expense of mining and refining. Vast hoards
gold sit idly in government vaults. There would be only the one-time cost of minting bullion into
coins, followed by a declaration by the Treasury that it will redeem Federal Reserve notes in gold
coin at a fixed rate.
The Fed could then be liquidated and the profits used to cover the Treasury's minting costs.
Government could then revoke legal tender laws that prohibit private mints and banks from
producing the gold coins and fully-redeemable paper money demanded by the public.
2. The gold standard is too inflexible. Even if the
money stock were fixed, it is enough to buy
any amount of goods. If there are a lot of goods, prices will be low; if goods are few, prices will
be high. With the money stock fixed, economic growth results in a consistently falling price for
goods and a rising value of savings.
If prices fall, production does not become less profitable. Entrepreneurial demand adjusts
prices to the prices of consumer goods, and profit margins are left intact. If falling prices did
indeed lower profits, rising prices would consistently increase profits. In fact, inflation has long
coincided with lower, long-run rates of economic growth and profitability.
Moreover, the money stock under a pure gold standard is not fixed. A rise in the demand for
money increases its market value, which makes it profitable to produce more gold coins.
Entrepreneurs increase the stock of money by production, which mitigates the rise in its market
value and bids up factor prices.
In a period of economic growth, money demand increases and brings forth neither too much
too little additional money, but precisely the amount warranted. The Fed, in contrast, has no
market test to guide its policies. It is left to vacillate between over-issue and under-issue, with
consequent price inflations and recessions.
3. A gold standard is too unstable. In fact, under a gold
standard, the variability of changes in
money's purchasing power are strictly limited by the market costs of changing the stock of
money. At its extreme, a gold standard results in falling prices at a rate that corresponds to the
rate that economic production expands. Prices rise only in proportion to the reduced costs of gold
In contrast, the variability of price inflation under fiat money is unlimited. The Fed can
the money stock overnight or cut it in half. Just the prospect invites the Fed chairman to exercise
unwarranted market power. Traders on Wall Street hang on to his every utterance.
A gold standard, in contrast, produces a relatively constant purchasing power of money. This
not the same as a constant "price level," which is a chimera. It cannot be defined or measured, as
the debate about the accuracy of the CPI reveals. No matter how prescient, the Fed cannot attain
a monetary-policy goal it cannot define.
4. A gold standard has failed in the past. The U.S. has
never been on a pure gold standard. The
closer we've come to one, the better off we've been. As we've moved further and further from
one, the worse off our economy has been, and the more the government has grown.
The problems of the gold standard resulted from a system that was not pure enough. It was
compromised in one respect or another: paper-money inflation, banking regulation, legally
protected fractional reserves, bimetallism, the presence of a central bank, etc. By learning from
the past, we can eliminate each of these problems and allow a free-market system to flourish in
money as it does in other sectors.
The Republican revolutionaries should take up their anti-government cause again, and this
time--led by Ron Paul--attack the fundamental source of today's economic problems. It's not
public opinion, an imperfect Constitution, nor the lack of this or that regulation. It's big
governments best friend, the Federal Reserve itself.
Jeffrey Herbener teaches economics at Grove City College