08 June 2012

In Defense of Gambling with Borrowed Chips, Part V



My book, Gambling with Borrowed Chips, calls for the abolition of legal tender laws.
For a sense of what that means, dear (American) reader, please take a dollar out of your wallet. Above and to the left of George Washington’s head, you’ll see in small print the words, “The Note is legal tender for all debts, public and private.”

Once upon a time, not too long ago, the words in that spot offered the prospect of redemption of the dollar bill in specie, gold or silver.
Between the one sort of engraved bill and the other, the notion of a “legal tender” stipulated by law has replaced the idea of redemption by a backed currency. The system of fiat money, then, is one in which legal tender laws require people to accept unbacked paper that they might not otherwise take, arbitrarily forcing a medium of exchange upon the populace. For those who like the particulars of codification: the “legal tender” status of these bits of paper is secured at 31 USC §5103.

Those of us who speak of repealing legal tender laws, are, then, in effect proposing a return to commodity backed money. We speak this way not for the delight of talking in codes, but simply as a way of focusing on the difficulty: not so much what the government isn’t doing, but what it is doing (installing its paper by fiat as the Ur-money).    
I don’t really feel like a “gold bug.” I do believe there are lots of ways of hardening a money supply, as I mentioned in yesterday’s entry. Still, for the remainder of our discussion (and we near its end), I will accept the shorthand account of what I am proposing here. I am advocating a gold standard as a geology-backed medium of exchange.

When Gravelle writes: “In fact, most economics textbooks, for good reason, devote no more than a page or two to explaining the gold standard and how the U.S. and other countries’ economies moved away from commodity money to fiat money….” she merely confirms my own pessimistic assessment of the textbook publishing industry.
She then adds her own definition of “fiat money” in a parenthetical comment. She calls it “money backed by the promises of the government.” Sorry but, no. This is not what it is! The promise of the government to do …? Fiat money is backed only by the demands of the government, as expressed 31 USC §5103. There is no “promise” involved. That word suggests the long-discontinued redemptions.
But then say: for purposes of discussion, let us make this about gold.

Gravelle writes: “Faille seems to believe that the gold standard was restored after World War II, but that standard only applied to international transactions and even then only in a limited fashion.”

She suggests here that I am confused about the nature of the Bretton Woods monetary system. In fact, I explain explicitly that “U.S. citizens were not allowed to convert their dollars into gold” during the Bretton Woods period. I also say, though, that through the Bretton Woods accords the U.S. “committed itself to tying the value of its dollar to the price of gold.” Both assertions are true. Yes, the tie in question was not what it had been before 1933, or before the creation of the Federal Reserve twenty years before that, but all that establishes is that there is more than one way to harden the money supply, even more than one way to alloy it with gold.   

Indeed, in December 2011 (too late, alas, for mention in Gambling with Borrowed Chips) the Bank of England issued a white paper, its “Financial Stability Paper No. 13,” that reviews the global financial crisis from a monetary perspective and that confirms many of my book’s points.

The authors of this paper – Oliver Bush, Katie Farrant, and Michelle Wright –list three objectives for an international monetary and financial system: internal balance, allocative efficiency, and financial stability. They conclude that the system now in place “has performed poorly against each of its three objectives, at least compared with the Bretton Woods System.”

The key fact about gold is that its supply is limited by the nature of the planet we’re on, and that adding new gold supplies to the world system will always require investment, risk, and expenditure. Such additions cannot be accomplished by fiat. This is why Robert Zoellick, former president of the World Bank, said recently, “The system should … consider employing gold as an international reference point of market expectations about inflation, deflation, and future currency values.”  Indeed it should.

The problem, finally, is that the "business cycle" is not really a circle. The turns don't leave us where they found us. The business cycle is in many respects a downward spiral. So long as we grease up the money making machinery each timne around to save us from each bust, we preserve old inefficiencies and create new ones. In the best of times they are hidden, in the worst of times they are obvious. We should take advantage of that obviousness to address them head on.

That is my point, and I am happy -- or at least content -- to have gone outside of the mainstream to make it.

There is just one final point I need to make, and this arises from Gravelle's casual observation in her review that the only worrisome symptom of "easy money" would be "accelerating inflation while at full employment." I passed that remark by rather lightly in an earlier entry in this series. Tomorrow I hope to come back to it. It gives us a bang-up close.

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