Mr. Moderate

On September 10, 2002, Congressman Ron Paul introduced legislation to abolish the Federal Reserve and re-establish a gold-backed dollar as the money of the United States. This would mean a return to fixed exchange rates between the dollar and an ounce of gold. I believe that is a very-bad idea, and the purpose of this page is to explain why.

Ron Paul is a medical doctor and a long-time Libertarian. He was the Libertarian Party candidate for President in 1988, and I would not be surprised to see the Libertarian Party nominate him again this cycle, regardless of what happens in the Republican race (where Ron Paul does not have any chance at all). Dr. Paul’s more recent statement deplores “dollar hegemony” and focuses less on the idea of a gold standard, referring more generally to a commodity-based money system.

The business about the gold standard is typical Ron Paul: he doesn’t really understand economics so he adopts the positions of his cult. I think most libertarians (small-l) have inadequate understanding of economics or they would not be libertarians. They would seem to believe that the modern market is just a larger version of the barter economy of the Middle Ages. In fact, modern technology has made the barter economy obsolete as most “value” today is in services rather than in goods, and in this case there is rarely any real opportunity for a contemporaneous exchange of like value.

Gold is a commodity like any other. There is a certain amount of gold produced every year and a certain amount is consumed. There is a vast storage in the middle as many people prefer to rely on gold as a storehouse of value. This idea of gold as a storehouse of value is psychological. In fact, there is nothing inherent about gold that makes it a good form of money. Down through the ages, many different items were used as money, including beads and large stone wheels. Gold is just the favored commodity of our particular cultural heritage.

But never in history has there ever been enough gold around to run a robust national economy. The Roman sesterce was based on silver. In the 19th century, William Jennings Bryan (who was later famous for the Scopes “monkey” trial) ran for President in 1896 and gave his famous “cross of gold” speech advocating bimetallism. Part of the rationale for bimetallism is the need for more “money” than you can reasonably obtain through the use of gold.

But even those who advocate bimetallism (Gold and Silver having a fixed exchange rate) miss the point entirely in a modern economy. Ancient economies were largely goods-based. Little money was required because people sold their goods in a market and used the profits to buy what they needed themselves. So, little actual money was required to run the economy over the long haul.

The modern banking system, however, is credit based. It creates new money with the stroke of a pen using credit. You sign loan documents and the bank creates the money needed to fund the loan using its own credit resources, which trace back to the Federal Reserve. The Federal Reserve has no limit at all on the amount of money it is allowed to create. The only limits are those imposed by policy discipline (i.e., the focus for the past several decades has always been to limit credit to keep inflation down). And this leads to the rather simplistic complaint Dr. Paul used when he introduced his legislation:

From the Great Depression, to the stagflation of the seventies, to the burst of the dotcom bubble last year, every economic downturn suffered by the country over the last 80 years can be traced to Federal Reserve policy. The Fed has followed a consistent policy of flooding the economy with easy money, leading to a misallocation of resources and an artificial “boom” followed by a recession or depression when the Fed-created bubble bursts.

There may well be some truth in that allegation: the height or depth of natural economic cycles can be traced in part to the actions of the Federal Reserve. But the cycles themselves are natural happenings based on the psychology of the population and not so much on any governmental policies. The psychological influences can be issues of war or peace or other great happenings on the world stage. The economy of the United States is not isolated from the world economy by any means, so the US suffered during the “Asian meltdown” of almost a decade ago. And finally, any student of history would easily point out that economic cycles existed back when gold and/or silver was the only conceivable form of money. Ron Paul’s suggested solution will clearly not remedy his observed “disease.”

The problem with any gold (or silver or bimetallism or any other commodity) standard is that it creates an entirely artificial exchange rate between the favored commodity and cash money. The Law of Supply and Demand will always recognize differences between reality and any such money exchange rate established artificially. If the money is worth less than its equivalent value in the commodity, then people will rush to exchange money for the commodity or for some equivalent commodity or value. If the money is worth more than its equivalent value in the commodity, then people will rush to exchange the commodity for money. When you have a dual standard (such as gold, silver, and paper money), there is a three-way exchange rate as one of the three pillars will always be perceived to be the “best value for the long term.” Bimetallism simply creates more opportunity for arbitrage profits.

The national commodity markets do a pretty good job of setting the price (exchange rate) between money and any number of regular commodities. Gold and silver should not be any exception, and for the past several decades, gold and silver futures have been traded right along with wheat, soybeans, pork bellies, and other commodities.

The proper view of having a gold standard for money is that in such cases the government is required to interfere in the free market so as to maintain a particular set exchange rate between the favored commodity and money. The irony of this is that THIS IS ANTI-LIBERTARIAN! The whole point of libertarian philosophy is that the government has no business messing around in a free market. (This is where libertarian philosophy matches up well with the traditional conservative philosophy.)

So, if Ron Paul could be made to understand that advocating a gold standard is an anti-libertarian position because it has the government interfering with the free market to maintain a fixed exchange rate, I would bet he would drop the idea. But perhaps libertarians have some idea that prevents them from recognizing the truth; much like many ideologues do.