by Steve Forbes
Even the massive influx of gold and silver from Spain’s New World colonies resulted in price increases averaging only 1.7% a year. Giant finds such as the California and Australian gold rushes of the late 1840s, as well as the enormous South African discoveries of the 1890s, resulted in relatively mild supply spikes that never exceeded 5%—and the growth rate quickly returned to normal.
Beautiful to behold, gold has been treasured by all nations and cultures since human beings first walked the earth. It has intrinsic value. Other commodities have intrinsic value—oil, for example, is referred to occasionally as “black gold.” The petroleum supply, however, fluctuates far too much to be of use as a monetary anchor, not to mention the disadvantages of bulk, storage, and perishability.
What about silver? For centuries, silver had a close ratio to gold; 15 to 16 ounces of silver were equivalent to an ounce of gold. The currencies of China and India were once fixed to silver. But in the latter part of the nineteenth century demand for silver declined with the increasing use of paper money. Improvements in mining technology also enabled supplies to increase. The value of silver to gold began to fall. By the mid-1890s, the ratio was about 30 to1. Today it is in excess of 60 to 1.
Every alternative to a gold standard has been tried, including no standard at all. If something were superior—another commodity or a basket of commodities—we would have found it. And so the answer to the question Why gold? becomes self-evident: in 4,000 years of human experience human beings have found nothing better. History shows that a gold-based monetary system is frequently abandoned, but it always reemerges. Always.
No Better Stimulus than Gold
Janet Yellen, Ben Bernanke, and other Keynesians have forgotten the global economic expansion that took place from the 1870s until 1914, during the era of the worldwide gold standard. In a unique interlude of monetary harmony, European nations, Japan, and the United States linked their currencies to gold.
The move toward the worldwide gold standard era began in the late 1600s in Britain with the Great Recoinage debate of 1696. Britain’s currency had been debased by wear and tear, as well as by the age-old practice of coin clipping favored by governments as well as counterfeiters. They would slice precious metal off the edges of coins, and the shavings could then be melted down into bars or currency.
Almost 50% of the precious metal was missing from British coins by the end of the seventeenth century. It was decided that, to avert a monetary crisis, Britain would melt down and remint the damaged money. Traditionally such an occasion was an opportunity for a devaluation. British treasury secretary William Lowndes wanted the coins reissued at a far lower value. John Locke, the esteemed political philosopher, argued that such a devaluation was a violation of natural law, equivalent to an arbitrary seizure of property. The eminent Isaac Newton also opposed debasement, considering it an affront to science, a moral transgression no different from counterfeiting.
Parliament’s eventual decision not to devalue was a victory for advocates of sound money. Newton, as Master of the Mint, formally fixed the pound to gold in 1717 at the once-famous rate of three pounds, seventeen shillings, and ten-and-one-half pence to an ounce (£3.89), a ratio that stood unchanged until 1931.
When it tied the pound to gold, Britain was a second-tier nation. Soon all of that would change.
Great Britain Leads the World into a Golden Era
By the end of the Napoleonic wars in 1815, Great Britain emerged indisputably as the world’s major power and global center of innovation. The industrial revolution, gaining momentum since the early 1700s, reached full speed. Great Britain gave us such innovations as steam engines, steam-powered trains, and mass-produced cotton fabrics, to name a few. The city of Manchester became to manufacturing what Silicon Valley is today to high technology.
The United States underwent a similar metamorphosis after adopting sound money. Reckless money printing during colonial days and the War for Independence had left the finances of the young republic a shambles. Alexander Hamilton, the first secretary of the treasury, realized that the only hope for recovery lay in a system based on sound money. Among other initiatives, Hamilton established a mint with a dollar fixed by law to a specific weight in gold. The value was fixed at $19.39 per ounce. (In 1834 it was slightly devalued to $20.67.)
Overnight the economy sprang to life. Capital poured in from the Dutch and also America’s former enemies, the British. Barely a century after Hamilton’s reforms, the United States was the premier industrial power in the world, surpassing even Great Britain. This growth took place despite a chaotic banking system bogged down by politics and burdened with government restrictions.
Inspired by the success of Great Britain and to a lesser extent the United States, other nations began to follow their example. By the end of the nineteenth century, Germany, Italy, Spain, France, Russia, Japan, and even Greece all adopted gold-based money.
The Era of the Classical Gold Standard
The era of the classical gold standard was a unique interlude in history. It saw an explosion of trade and innovation that, in many respects, has yet to be equaled even today. Rarely in human history has there been such an increase in population and living standards—or such a free flow of people and capital. Money was not the only factor in the global boom; by discrediting mercantilism, Adam Smith and his fellow free-market thinkers had helped still the heavy hand of government in the economy. The nineteenth century was an era of economic freedom, with no restrictions on the flow of capital.
London became the world’s center of finance. British investments played a significant role in the development of the United States and numerous other countries. Railroads, factories, and agricultural enterprises proliferated throughout the world, including India, Argentina, China, Malaya, and Africa.
This explosion of capital helped trade flourish despite a flurry of protectionist tariffs in the latter part of the nineteenth century. Enormous strides in shipping and the technological advances of the industrial revolution were raising living standards, bringing new products and services at lower prices to people around the world. The invention of refrigeration, for instance, meant a country such as Argentina could grow immensely rich by exporting beef in greater volumes and more cheaply than ever before. International trade as a proportion of global economic activity wouldn’t reach the levels of 1914 again until almost a century later in 1996; capital flows, not until 1999.
Advances in the United States were particularly impressive. Between 1870 and 1914, real wages more than doubled even though the country had millions of immigrants. Agricultural output tripled. Industrial production, led by Andrew Carnegie’s application of new steel technologies, surged a jaw-dropping 682%. Tens of thousands of miles of new railroad tracks crisscrossed the continental nation.
The United States was hardly alone in experiencing such spectacular growth. Russia saw increases in oil and steel output after adopting a gold standard in 1897. The country became a magnet for foreign investment, especially from its ally, France. Russian bonds became a staple of the French bourgeoisie. The country also became the world’s biggest exporter of grain, with the highest economic growth rate in Europe on the eve of World War I.
Contrary to the myth long perpetuated by the communists, Russia was moving in the right direction economically and was on the way to industrialization without communism, which retarded development and killed tens of millions of people.
No longer was military power the way to riches. Thanks to trade and the free flow of capital, smaller countries like Norway, Switzerland, and Holland with lesser armies—and lower military budgets—enjoyed higher standards of living than Germany or France.
By providing a shared standard of value and facilitating global trade, the worldwide gold standard also helped break down longstanding barriers between nations that had been adversaries. For example, France got a significant portion of its coal, the chief source of energy at the time and a critical component of explosives, from its arc
henemy Germany.
The era’s focus on commerce also helped calm tensions between the warring nations of Latin America. Capital poured into the region, mostly from Great Britain. New opportunities attracted millions of immigrants who were more interested in bettering their lives than in battling their neighbors. The incidence of warfare in South America declined so that by 1914 peace, not war, was the rule. The British author and Parliamentarian Norman Angell remarked in 1913:
Just note at what is taking place in South America. . . . These countries, like Brazil and Argentine, have been drawn into the circle of international trade, exchange and finance. . . . It is not because the armies in those states have grown that the public credit has improved. Their armies were greater a generation ago than they are now. It is because they know that trade and finance are built upon credit.
Other examples of interdependence abounded. The naval rivalry between Great Britain and Germany did not prevent the owners of Germany’s growing merchant marine from insuring their ships with British companies in London.
The pre–World War I era was no utopia (working conditions in factories were harsh by today’s standards) and saw plenty of political agitation, but it was in retrospect a remarkably positive time, unrivaled in history. Unfortunately age-old forces of nationalism and political antagonisms eventually won out over the advances of commerce. Tensions between Austria-Hungary and Serbia set off the chain of events leading to World War I. Germany and Austria-Hungary, among others, had long military traditions. The military castes of both countries, particularly Germany, failed to grasp the fact that trade, not military muscle, is the true source of power. Few leaders at that time could have ever imagined that just a century later a commercially successful Germany with a significantly smaller army would be the dominant power in Europe, while Russia with a far larger military would lag behind.
Lower Interest Rates, Cheaper Capital, Gangbuster Growth
In today’s command-and-control system of fiat money, lowering interest rates requires an act of largesse from a central bank. Under a gold standard system of sound money, interest rates naturally fall. That’s because lenders can expect to be repaid in money that has not declined in value.
The cost of capital dropped dramatically in Great Britain after Newton tied the pound to gold in 1717. The Crown had previously rued the fact that it had been unable to borrow money at the low rates obtained by the fiscally prudent Dutch. In 1694 the newly created Bank of England lent the government of William III 1.2 million pounds at 8%. That was considered a concession to the new king, but it was far higher than the 4% rates the Dutch were paying.
After Great Britain adopted gold-based money, however, the government could issue bonds (called stock in those days) with no maturity at a rate as low as 3%. By the late 1800s that rate went down to 2V/2%. Between 1821 and 1914 the average yield of British government bonds—called Consols—that had no maturity was 3.15%.
The peg to gold also meant that Great Britain was now a better investment. Before the pound was linked to gold, fiat money had enabled a free-spending monarchy. A gold-based pound, however, signaled that Parliament—specifically, the taxpayers who made up the House of Commons—was firmly controlling the purse strings. (Unlike today’s Keynesians, they knew that money didn’t come from the tooth fairy.)
Nathan Lewis writes that lender confidence soared in the nineteenth-century gold standard era: “Interest rates worldwide converged to low levels. British debt was perceived to have the lowest risk of either credit default or currency devaluation. Other governments’ debt traded with a small risk premium.”
The story was much the same in France and the United States: yields on French government debt started out at about 15% when the Bank of France was established in 1800. They slid to 3% by 1902. As for the United States, Lewis writes:
The market recognized that gold indeed served as a superlative standard of stable value—that it was money par excellence, as Karl Marx wrote in 1867. Currency stability in turn engendered economic stability and provided the reliable foundation for all financial and economic activity.
Investors were so confident during the gold standard era that in 1896 Northern Pacific Railroad issued a 150-year bond at an interest rate of 3%!
The explosion of wealth creation that took place during the worldwide gold standard era was no anomaly. From 1946 to 1970, under the gold-based Bretton Woods system, U.S. industrial output surged 209%, an average of 4.8% a year. In the post–gold standard era this growth dropped dramatically: industrial production increased 159% between 1970 and 2012, a little more than 2% a year; in the period of 2000 to 2012, it rose a total of 7%.
No Credit Rationing
Under a gold standard the cost of money will be somewhat higher than it is today—after all, you can’t get much lower than zero interest rates. But the Fed would no longer be artificially suppressing interest rates with its price controls. The result: credit and capital would be more widely available. Smaller businesses will get loans at an affordable cost instead of getting no credit at supposedly near-zero interest rates. For most job-creating small businesses, credit in recent years has been a lot like government-rationed healthcare—supposedly free, but much of the time you can’t get it.
A Return to Government Accountability
Gold makes governments accountable. Having to maintain a stable monetary value makes it harder to turn on the printing press to pay for political promises or to buy votes. Governments have to turn instead to borrowing and higher taxation, actions that require popular support. In other words, gold discourages the profligacy possible with fiat money by assuring that spending has consequences. Gold standard advocate Daniel Ryan explains:
Government can still borrow, but they can’t use the central bank to sidestep the consequences of excessive borrowing that every other borrower has to face: higher interest rates. A gold standard would forbid quantitative easing. Thus, a gold standard puts a lid on the shenanigans politicians like to use for political gain. We’ve all seen the effects of leaving monetary and fiscal discretion in the hands of politicians and their appointees: chronic inflation and chronic government debt. Had there been a gold standard, government debt would have never gotten out of hand like it has.
Government finance was never as self-restrained as it was during the classical gold standard era. With European nations becoming increasingly democratic and dependent on consensus, budget expenditures therefore had to be of a more careful nature. Germany, for example, badly wanted to boost spending for its military to compete with rivals France and Russia, which were improving their armies. It also wanted a navy to rival Great Britain’s. But the German government was constrained by the fiscal discipline imposed by the gold standard.
Germany spent only around 2 to 3% of its GDP on its military—a far lower percentage compared with the size of its economy than what was spent by nations like France (3 to 4%). The numbers, in other words, suggest that it could have easily spent more. In a sense, the prewar gold standard saved the Allies. Germany came within a whisker of winning the war in its early weeks. Without a gold standard, it is very likely that Germany’s military outlays, and its military strength, would have been far greater.
Even without a gold standard, stable money fosters fiscal discipline, though to a lesser degree. We saw this during the Clinton administration, which generally maintained a steady dollar. In his book The Agenda, Bob Woodward quotes the president’s incredulous reply when told by his advisors that, before spending to stimulate the economy, he first needed to cut a record-high national deficit. To do otherwise would imperil demand for the government’s bonds and its ability to borrow. According to the book, the president exclaimed, “You mean to tell me that the success of the program and my re-election hinges on the Federal Reserve and a bunch of f****** bond traders?”
Top Clinton advisor James Carville told the Wall Street Journal: “I used to think if there was reincarnation, I wanted to come back as the president or the pope o
r a .400 baseball hitter. But now I want to come back as the bond market. You can intimidate everybody.”
Because it would mean a return by government to fiscal accountability, the idea of gold-based money has traditionally struck fear into the hearts of many proponents of big government who wrongly equate stable money with austerity. As we’ve pointed out, this is not true: Otto von Bismarck began the modern welfare state in Germany during the era of the classical gold standard. Great Britain likewise enacted a series of social welfare programs before World War I.
At the same time, Europe’s great powers also were able to afford large military establishments. It was amazing to see how small military budgets as a proportion of countries’ gross domestic product were before World War I. Great Britain, for example, was famous for its navy, yet its naval outlays were relatively small at less than 2% of GDP.
Gold allows governments to do more with fewer taxpayer dollars. It would lower the cost of capital for government as it would for the broader economy. Washington could more easily service its debt. There would be the added benefit of more tax revenue because the economy would flourish under a gold standard, especially when combined with a sensible tax and regulatory system.
A gold standard would allow government to deploy money more efficiently. It doesn’t necessarily mean lower spending, because in a vibrant gold standard economy the tax base would be bigger.
Real Money Means Real Prices
Sound money via a gold standard would mean that median incomes would once again rise in real terms. When you have fiat money, as we’ve discussed, prices go up and real salaries go down. You’re getting paid in money that is worth less and less.
A gold standard would obliterate inflation. From 1821 to 1914 the cost of living in Great Britain went up 0.1% a year. Compare that to the double-digit rate of inflation in the United States between 1971, when the link to gold was severed, until 1983, when that bout of inflation was conquered. Since then the average rate has been above 3%, based on the highly imperfect CPI calculations. In the real world it’s higher; for example, a gallon of gas in the United States in 1971 could be bought for as little as 30 cents a gallon. Today it is around $3.50 and has been far higher.
