Antal Fekete Responds To Ben Bernanke On The Gold Standard
http://www.zerohedge.com/sites/defau.../picture-5.jpg
Submitted by Tyler Durden on 03/21/2012 12:04 -0400
Yesterday, Ben Bernanke dedicated his entire first propaganda lecture to college student to the bashing of the gold standard. Of course, he has his prerogatives: he has to validate a crumbling monetary system and the legitimacy of the Fed, first to schoolchildrden and then to soon to be college grads encumbered in massive amounts of non-dischargeable student loans. While it is decidedly arguable that the gold standard may or may not have led to the first Great Depression, there is no debate at all that it was sheer modern monetary insanity and bubble blowing (by the very same professor!) that brought us to the verge of collapse in the Second Great Depression in 2008, which had nothing to do with the gold standard. And as usual there is always an other side to the story.
Presenting that here today, is Antal Fekete with "The Gold Problem Revisited."
THE GOLD PROBLEM REVISITED (pdf)
Antal E. Fekete
The article The Gold Problem of Ludwig von Mises, published 47 years ago in 1965, just six years before he died (the gold standard died with him in the same year) has some breath-taking thoughts, for example, “the gold standard alone can make the determination of money’s purchasing power independent of the ambitions and machinations of governments, of dictators, of political parties, and of pressure groups”, or: “the gold standard did not fail: governments deliberately sabotaged it, and still go on sabotaging it.” But for all our admiration we would be amiss if we did not point out certain errors in his article. These are all errors of omission, and correcting them would hopefully make the Mises article even more helpful to the discriminating reader.
Mises fails to answer his own question why gold is the best choice to serve as money. Indeed, why not another commodity, or a basket of commodities? The reason is that the marginal utility of gold is unique in that it declines at a rate slower than that of any other substance on Earth. Various assets have various marginal utilities which determine their value. All of them decline, albeit at various rates. In other words, economic actors accumulate assets increasingly reluctantly, up to their satiation point that will be reached sooner or later. For gold, this point is removed farther, so far indeed that for all practical purposes it is beyond reach.
Therefore if you substituted another commodity, or basket of commodities for gold, then you would end up with a unit of value the marginal utility of which was inferior. It would decline at a rate faster than that of gold. It would be akin to substituting a yardstick made of rubber for one made of metal.
1. The futility of inflationary policies
Mises ignores the fact that newly created money can be spent not only on goods and services, but also on financial assets. This is the proverbial fly in the ointment of the inflationary argument. It is also a subtle one, so much so that the government as the would-be perpetrator of inflation often falls victim to it. It may think that it is promoting inflation while, in fact, it acts as quartermaster for deflation.
By restricting the circulation of gold money or by other means, the government can make financial speculation more attractive. In doing so it wants to reduce the amount of money available for buying goods and services. This strategy of the government and its pseudo-economists consists precisely in channeling enough of the newly created money into speculative ventures so that the untoward consequences of price and wage rises will not occur, or they will occur later, so that the causality relation is obscured.
The paramount example is bond speculation. Of course, under the gold standard there is no bond speculation because the variation in the bond price (or, equivalently, in the rate of interest) is minuscule making the opportunity to earn speculative profits negligible. Unless… unless… the central bank makes profits risk free as a bait to speculators by inappropriate monetary and fiscal measures. This is exactly what happened in the early 1920’s when the policy of open market operations, so called, of the Fed were first introduced quite illegally, we might add (the policy was legalized retroactively in 1935).
As the Fed was originally constituted, it was only enabled to be a passive partner in business. Limited by its charter the Federal Reserve Act of 1913, it could enter (or decline to enter) business initiated by others, but it could not initiate business on its own. It could post its rediscount rate, but member banks had step forward to request rediscounting real bills from their portfolio. In and of itself rediscounting was not inflationary as a way to create new money. The new purchasing power so created was backed, dollar for dollar, by salable merchandise arising in production, and it was to be extinguished when the merchandise was sold to the ultimate consumer at the time the bill matured.
This was not the case, however, when the Fed assumed an active role and started purchasing government bonds in the open market at its own initiative in contravention of the Federal Reserve Act of 1913. The monetary base was enlarged. This provided a direct incentive for member banks to make loans regardless whether or not new merchandise was simultaneously emerging in production. Using standard Quantity Theory of Money (QTM) reasoning the Fed and everybody else assumed that the effect would be inflationary. Hooray, a subtle and potent new way of inflating the money supply has been invented! The economy can now be micromanaged at will! There was jubilation in the inflationist camp.
The jubilation was premature. The policy of open market operation as an instrument of inflation was an enormous blunder. QTM was inoperative: bond speculators overrode it. They knew when the Fed had to go to the open market to relieve ‘natures urge’ (to purchase its next quota of government bonds). Speculators could make risk-free profits by pre-empting the Fed in buying the bonds first. The ‘tool’ of baiting speculators with risk free profits backfired badly, if only for the reason that speculators were a much smarter lot than central bank agents facing them in the bond pit. They risked their own capital while losses made by central bank agents were covered from public funds. The game plan was upset. What was supposed to be inflation ended up as deflation. Here are the details.
In an unhampered market risk-free profits that may occur from time to time are ephemeral and therefore inconsequential. Hawk-eyed speculators immediately take advantage of them with the result that any further opportunity to make risk-free profits is eliminated on the spot. This is no longer true if the opportunity to make risk-free profit is not an infrequent aberration but the consequence of deliberate and well-advertised official policy as it is in the case of the policy of open market operations. When the central bank relies on open market purchases of government bonds in order to augment the monetary base on a regular, ongoing basis, then speculators can anticipate and pre-empt it. This policy, whole-heartedly supported by Keynesian/Friedmanite economics, is the most ill-conceived monetary policy ever concocted for the purpose of increasing the stock of money. The Federal Reserve Act of 1913, for excellent reasons, disallowed such a policy and imposed stiff and progressive penalties for non-compliance on the Federal Reserve banks if their balance sheet showed that government bonds had been used to cover Federal Reserve note or deposit liabilities. At first the Fed used open market operations illegally. It could get away with it because of the connivance of the Treasury in ‘forgetting’ to collect the penalty. The conspiracy created a fait accompli and, in the end, Congress was forced to legalize the corrosive practice retroactively in 1935 when it amended the Federal Reserve Act.
The newly invented monetary policy of open market operations is responsible for much of the deflationary damage inflicted on the world economy during the Great Depression of the 1930’s. It started an avalanche of falling interest rates that soon went out of control. Falling interest rates destroy capital as they increase the burden of debt contracted earlier at higher rates. Perfectly sound businesses fail if their debt burden, through no fault of theirs, exceeds the profitability of deployed capital. The whole process was most insidious. Entrepreneurs did not know what hit them. From one day to the next they found themselves uncompetitive as competitors financed their business at lower rates. They had to lay off their employees. They went bankrupt in droves. Wanton destruction of capital was the main cause of deflation and the Great Depression in the 1930’s.
Herein lies the incredible failure of the policy of open market operations, missed by Mises. The policy is counterproductive from the point of view of central bank and pseudo-economists acting as its cheer-leaders. It released the genie of risk-free bond speculation from the bottle in the hope that it could always be put back. But it could not. Falling interest rates would run their devastating course.
The same thing repeats itself today. Interest rates have been falling for over thirty years. The Fed is no longer in control. It is lunacy to believe that it can stop the avalanche that it started so easily in the early 1980’s. Today the speculators are the only buyers after China and other exporters to the US bailed out of the US T-bond market. Speculators will keep buying the bonds as long as they can reap risk free profits. It is true that ‘quantitative easing’ cuts into that business, as the Fed is buying bonds directly from the Treasury, bypassing the open market (another illegal practice). Watch for the day when the speculators will start dumping bonds and selling them short. When they transfer their buying from the bond market to the commodity market, the game is up.
Open market operations is a charade that can go on only so long as speculators are allowed to reap risk-free profits at the expense of the producers and the savers. When the latter have been squeezed dry, it’s “après nous le deluge”. That is the true scenario of Great Depression II.
more of this fantastic tome at: http://www.zerohedge.com/news/antal-...-gold-standard