Tuesday, November 11, 2008

Bring Back the Gold Standard

Does the financial crisis make clear that capitalism, the free market and the classical liberal ideology are failing? Of course not, whatever social democrat ideological veterans might proclaim. Socialism and its derivatives have been morally discredited since the fall of the Berlin wall and there is no chance for them of getting back. People get a grasp that there is something wrong with the way the system works for now, but not with the system itself, as a recent poll by FT/Harris suggests.

What has been the ultimate source of the financial crisis hurting the world economy? To understand this, one has to consider on what the world economy is founded and that is still the U.S. Dollar. This rock of confidence has been originating from Western-European civilisation, deriving from mediaeval Bruges, the first financial center of its time, dubbed as “the cradle of capitalism”, where the Flemish van den Beurze family has borrowed its name for the “bourse” institutions emerging in the world’s later financial centers Antwerp, Amsterdam, London and New York. A protestant classical liberal culture has culminated in the founding of the new world, where nothing less than the absolute individual freedom was deemed sufficient for humanity and where without any doubt the highest level of civilisation has been reached, to the regret and envy of the less developed cultures outside the new world still suffering from oppression and jealousy. The American money has outcompeted all rivals in becoming the sure rock for the tired, the poor and the huddled masses, also those outside the new world, to rely on.

Unfortunately the inherent tendencies of the old world have not been completely disappearing in the new world, and the fall of the Dutch republic is being repeated by America. As the history of the Dutch republic (1581 – 1795) goes according to the world’s encyclopaedia:

“Long term rivalry between the two main factions in Dutch society, the Staatsgezinden (Republicans) and the Prinsgezinden (Royalists or Orangists) sapped the strength and unity of the country. Johan de Witt and the Republicans did reign supreme for a time at the middle of the Seventeenth century (the First Stadtholderless Period) until his overthrow and murder in 1672. Subsequently, William III of Orange became stadtholder, after a stadtholderless era of 22 years, and the Orangists regained power; his first problem was to survive the Franco-Dutch War (which was related to the Third Anglo-Dutch war), when France, England, Münster and Cologne united against his country.

Wars to contain the expansionist policies of France in various coalitions, after the Glorious Revolution mostly including England, burdened the Republic with huge debts, although little of the fighting after 1673 took place on its own territory. After William III's death in 1702 the Second Stadtholderless Period was inaugurated. The end of the War of Spanish Succession in 1713 marked the end of the Republic as a major military power.

Fierce competition for trade and colonies, especially from England, furthered the economic downturn of the country. The three Anglo-Dutch Wars and the rise of Mercantilism hurt Dutch shipping and commerce.

The establishment of the Bank of England, at a time when the Dutch were fighting against the French on Dutch soil, meant that money could be borrowed from London at lower interest rates and at greater reliability and protection. Gradually, London displaced Amsterdam as the leading European financial centre.”

Sounds familiar? Let’s proceed on the rocky path of historical comparison: one could compare the U.S. to the Dutch republic. Current classical liberals to the Dutch republicans, big government conservatives to the royalists achieving victory over the former. Mediaeval France causing the republic to overspend on defence would be what Nazi-Germany and the U.S.S.R. were for the U.S. China as the creditor for the U.S. would be as England served as a creditor for Holland. And would New York thus be replaced by Shenzen or Shanghai as London replaced Amsterdam? Luckily we shouldn’t believe in historical determination, as the great Ludwig Von Mises has taught, but we might however try to learn from it.

A standing army, a central bank and ongoing wars have led the U.S. Dollar to suffer from a turbulent history, weakening the currency. The ongoing collapse of the Dollar is the true drama in the current crisis.

A critical point in this evolution was without any doubt the final abandoning of the Gold Standard in 1971. Under the Gold Standard system, a banknote is a property title that one is entitled to borrow for real value, namely gold. Gold has been deemed the least imperfect material in history to represent “real value”, and supposedly to be the only material we have that meets all five essential characteristics of money, described as portability, durability, homogeneity, divisibility and value. If Joe gives his money to the bank and receives a banknote as a receipt for that, he probably won’t appreciate it if also Paul, a good friend of the banker, receives a similar receipt, without bringing in any gold then. As a consequence, the banknote of Joe loses some of its value and Paul receives value for free from Joe, as he is effectively stealing from him. All too often Paul is of course the government, who thereby manages to suck money out of Joe which it hasn’t already obtained through taxation.

As a consequence of the massive military state spending in world war I the Gold Standard had come under severe pressure, urging to abandon it. Apart from a short period in the interbellum and during the Bretton woods system after world war II, a weakened form of Gold Standard was in place. In 1971, as a consequence of amongst others high US spending for the Vietnam war and France and the U.K. wanting to redeem their U.S. dollar for gold, the system was abandoned for good, fully establishing a system whereby one doesn’t have the right to exchange money for gold, but one has to trust the government’s promise not to print money.

A similar system could work, if the government was indeed keeping its promise. The American government has been able to parasite on the strong tradition of the Dollar and the fact that under Bretton Woods all currencies were valued in terms of Dollars, leading to a situation whereby the Dollar was still good for 63.9% of all reserves in 2007, while the Euro as the successor of the D-Mark only counts for 26.5 % and thus no real competitor for the Dollar currently exists. The fact that the European Central Bank has joined moves to push interest rates artificially lower, breaking with the tradition of the solid D-Mark isn’t going to improve the prospects for an alternative to the Dollar. However the Dollar is degenerating fast with the United States of America imitating the fall of the Dutch republic. “A republic, if you can keep it”, as Benjamin Franklin answered to the question whether in 1787 a republic or a monarchy had been established.

The legacy of the D-Mark has made that the European Central Bank hasn’t fully gone the way of becoming totally dependent of politics, as French president Sarkozy desires, mirroring the French Franc. Looking back to the history of the French Franc, we can see this was a weak currency all too often misused by politicians having to devaluate it after years of overspending. In a bid to export the negative effects of lax French budgetary policies, French president François Mittérand managed to blackmail Germany that it had to give up its D-Mark in order to obtain German unification, by telling to the former Germany president Helmut Kohl in March 1990: "You get all of Deutschland, if I get half of the Deutsche Mark"

France obtained the Euro: a system whereby it could export its flawed budgetary policies to more sound budgetary nations, as Gemany or the Netherlands. Resistance by the latter countries to model the Euro to the French Franc is still strong, amongst others against a recent proposal by Sarkozy to form an economic government of the euro-area, which would enable even more transfer of the consequences of irresponsible economic governance. However in the U.S., the Clinton and Bush administrations have fully accomplished to model the Dollar to the French Franc, so the monetary powers of the U.S. government have become a tool to finance the government’s welfare and warfare programs.

Back in 1992, former U.S. president Bush senior had to cut the budget in order to pay off the debts of the Reagan administration, and his calls to Federal Reserve chairman Alan Greenspan to lower interest rates were falling in deaf ears. As a result, the economy experienced the necessary downturn, making Bill Clinton winning the election as the Americans choose to follow his creed “it’s the economy, stupid.”

Greenspan had to change his position under severe pressure by accepting a “pact” with Clinton that the government would balance the budget in turn for the Fed lowering interest rates, thereby distorting real economic growth brought about by globalisation with bubbles as the IT bubble bursting in 2000 or the current credit bubble burst.

George Bush junior has only stepped into the footprints of Clinton by pushing Greenspan to lower interest rates, but without respecting Clinton’s promise to balance the budget. Irrespective of the Greenspan-Clinton pact it is however clear that it was the 1990-ies political climate which has pressed Clinton to balance the budget and the post 9-11 trauma which has allowed the Bush administration to break all spending limits. Alan Greenspan, a libertarian opposing the existence of a central bank and once writing the preface for books of libertarian author Ayn Rand, had become the puppet of politicians eager to spend like never before.

After the bursting of the Federal Reserve bubbles a period of necessary spending cuts and economic downturn is awaiting the U.S. Protectionism has postponed and worsened painful industrial restructuring. Moreover in the wake of 9-11 laws have been passed infringing on fundamental rights and economic freedoms, as for example the Sarbanes-Oxley Act.

Looking at the existing mass of financial regulation will learn the left’s ideological veterans that the financial sector is probably one of the most regulated of all economic sectors, to the extent that banks are forming legally protected cartels as only the existing players on the market and not newcomers are able to comply with the set of regulations financial actors have to endure.

It cannot be emphasized too strongly that it was the government who should bear the guilt for the crisis, in the first place the U.S. government, who has been cracking down on the Dollar by the influence it has to push the Federal Reserve to artificially lower interest rates. Apart from that, regulatory causes as the Community Reinvestment Act or supposedly the mark-to-market acounting rule have played a major role. Last but not least is the fact that overregulation of all known financial products has forced investments into fewer known, more complicated but also more risky products, leading now to calls for regulation of for example hedge funds or credit rating agencies, which will without any doubt push investments into even more risky areas. Can the world’s mafia now expect a surge in investments?

Today there is one big difference with the other financial crisises occurring since the abandoning of the Gold Standard in 1971. It’s not about a region (Asia in 1997), an economic sector (IT in 2000) or an unexpected event (11 September 2001). This time there is a structural failure of a worldwide system. Until now all the answers have been even more regulation, spending and printing of money. Maybe these measures can be defended in some cases in the short term: shouldn’t a government that has taken all the instruments to cope with a crisis cope with it, before it hands back these instruments back to where they belong: to private actors? Possibly, although it seems hard to say which measures will work and which will worsen the crisis.

What is for sure, however, is that fire fighting will not be enough and that the root causes of the crisis need to be tackled as well. To restore trust is the central part of the solution, and how else could this be made possible without restoring the only system an economy has always been able to thrive on, which is on a Gold Standard?

The re-installment of a Gold Standard has been under scrutinity by countless opinion articles. However, as the crisis deepens further, claims for actually implementing it are getting more serious and possible technical objections are being dealt with, for example with the claim that not enough gold would be available. This rests on the assumption that a gold-based system cannot contain leverage, a claim easy to dismiss as governments cannot be trusted to apply leverage responsibly, but private entities could.

Some sort of Bretton woods II negotiations are now under way. Politicians will probably the last ones to be convinced to go back to the Gold Standard as a Gold Standard would drastically reduce their spending capacities, but maybe American politicians might want to consider it, keeping in mind the words written in April 2008, by Judy Shelton, a monetary economist and author of "The Coming Soviet Crash" in 1989.

The dollar won't be strengthened by further interest-rate cuts or more fiscal stimulation leading to inflationary consumer spending.If the U.S. is to reclaim its position as provider of the world's most trusted currency, we must think more boldly. It's time to confront currency disorder. Our goal should be to put forward a new proposal for international monetary relations on the scale of the 1944 Bretton Woods agreement, invoking the same sentiments that inspired architects John Maynard Keynes and Harry Dexter White to provide a foundation of hope for a world all too prone to violence. A global system based on a universally-accepted monetary asset -- the U.S. has the world's highest level of official gold reserves, followed by Germany and France -- would not only counter Russia's offensive. It would convert a national security threat into a golden opportunity. (Source)

Will she prove to have been predictive again?

1 comment:

Jeroen said...

Pieter, interesting article.

IMO, a return to a 'gold standard' as we knew it before, is not the solution. But you're close...

I suggest you read 'http://www.fofoa.blogspot.com/' e.g. topic on 'Freegold' and other articles ... .

Best regards,
Jeroen