Ted Schlater

Understanding the Gold Standard

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Can anyone direct me to material (online or otherwise) as to why Objectivists prefer going back to the Gold Standard? This particular issue in economics is one which I seem not able to fully understand. Something that could answer the following questions. Why Gold? What makes Gold the best commodity to back currency versus anything or everything else? Why is it both practically and morally more accepteble? And, how does it, if implemented, actually function in a free economy? What is it that we have now in place of the Gold Standard, and how does it function? And why is it worse?

Feel free to answer them yourself if you like, but if there are any definitive and instructive resources regarding this topic feel free to push me in there direction.

Thanks in advance,

Ted

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I recommend "Gold and Economic Freedom" By Alan Greenspan, which is found in Capitalism: The Unknown Ideal.

After that, if you would like to look into the subject in greater detail, try Gold and Liberty by THE FORUM's Economics Expert, Richard Salsman (Publisher: American Institute for Economic Research, 1995, ASIN: B0006PFFZO, 145 pages)

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What capitalists actually advocate is not gold per se, but free banking – as opposed to a coercive government monopoly of the currency. The best work on the topic I am aware of is Murray Rothbard’s What Has Government Done to Our Money?, available free here.

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What capitalists actually advocate is not gold per se, but free banking – as opposed to a coercive government monopoly of the currency.  The best work on the topic I am aware of is Murray Rothbard’s What Has Government Done to Our Money?, available free here.

Good point, because the phrase "gold-standard" by itself might be misunderstood to still mean a government monopoly of the money supply through central banking. After all, in the early 20th century the West had a gold-standard, but with central banks such as the Federal Reserve still in control.

So it is better said: capitalist advocate free banking in general, and free banking in gold in particular.

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What capitalists actually advocate is not gold per se, but free banking – as opposed to a coercive government monopoly of the currency.  The best work on the topic I am aware of is Murray Rothbard’s What Has Government Done to Our Money?, available free here.

Correct me if I'm wrong but, in addition to being an anarchist, didn't Rothbard want to forbid fractional reserve banking?

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Correct me if I'm wrong but, in addition to being an anarchist, didn't Rothbard want to forbid fractional reserve banking?

Rothbard thought that fractional reserve banking is immoral because it gives multiple people a claim on the same piece of gold, and tends to encourage business cycles. He didn’t think it should be banned, but rather argued against government bailouts of fractional systems.

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Rothbard's What Has Government Done to Our Money? is an excellent historical analysis of the gold standard and how the government gained a monopoly in the supply of money. I learned more from this book about this topic than I did in all of my high school classes combined. I would highly recommend this book to anyone interesting in learning why a gold standard is important economically, and what a lack of a gold standard does to an economy.

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Correct me if I'm wrong but, in addition to being an anarchist, didn't Rothbard want to forbid fractional reserve banking?

Rothbard thought that fractional reserve banking is immoral because it gives multiple people a claim on the same piece of gold, and tends to encourage business cycles. He didn’t think it should be banned, but rather argued against government bailouts of fractional systems.

"First, that a genuine free market must be based on an absence of fraud or theft, whereas issuing demand liabilities in excess of assets is equivalent to a warehouse issuing fraudulent receipts to non-existing assets, and is therefore a species of fraud or embezzlement.... On the first point, we contend that bank notes or deposits are bailments and not debt, and therefore an issue of fractional reserve liabilities can only be a violation of the bailment contract." (Aurophobia: or, Free banking on What Standard?, Murray N. Rothbard, The Review of Austrian Economics, Vol. 6, No. 1, pp. 97-98, 1992.)

What Betsy said about Rothbard was correct. He did not simply argue that it was immoral, but rather he argued that it should be considered illegal.

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He did not simply argue that it was immoral, but rather he argued that it should be considered illegal.

Stephen or Betsy: Would you disagree with this? If so, why?

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He did not simply argue that it was immoral, but rather he argued that it should be considered illegal.

Stephen or Betsy: Would you disagree with this? If so, why?

I disagree with Rothbard. There is nothing immoral or illegal about fractional-reserve banking. In a laissez-faire capitalistic system it is simply a contractual arrangement that occurs with full knowledge of the parties involved. And, it has been argued, by Harry Binswanger and others, that fractional-reserve banking is a great accelerator of production by making use of otherwise idle goods.

But, I do not feel confident in fully defending the practical value of the system, since I have no expertise here. However, in regard to the practice being both moral and legal, of that I have no doubt at all.

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What Betsy said about Rothbard was correct. He did not simply argue that it was immoral, but rather he argued that it should be considered illegal.

When I have critiqued Rothbard for this apparent inconsistency with free banking, the usual response offered by Austrian economists is that Rothbard’s statements must be understood in the proper context.

Rothbard was attacking the traditional policy of accepting funds with the promise of unconditional withdrawal to it, and then lending out 9/10ths of those funds. Such a policy is fraudulent because the bank cannot guarantee payment since they are perpetually insolvent. Historically, this policy not only made bank runs common, but created business cycles and led to growing interventionism as banks begged the government to stop bank runs. The economists I talked to said that Rothbard thought that the policy of granting ownership to non-existent property constituted fraud. However, as long as banks explicitly identify the nature of their operation, fractional banking is legit, even if it would not be competitive with 100% reserve banks and is more gambling than investing – or so the Rothbardians argue.

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What Betsy said about Rothbard was correct. He did not simply argue that it was immoral, but rather he argued that it should be considered illegal.

When I have critiqued Rothbard for this apparent inconsistency with free banking, the usual response offered by Austrian economists is that Rothbard’s statements must be understood in the proper context.

Have you read the Rothbard paper I referenced? The context seems pretty clear to me, with no wiggle room for interpretation.

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Have you read the Rothbard paper I referenced? The context seems pretty clear to me, with no wiggle room for interpretation.

I just did. The context is clear indeed – he is arguing against the Federal Reserve and the fiat system it supports. I don’t think that the interpretation I provided contradicts anything he states. In particular, he uses the term “demand liability” with a specific meaning – a guarantee for immediate access to one’s funds. Fractional banks, by their very nature, are incapable of making such a promise.

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Fractional banks, by their very nature, are incapable of making such a promise.

I do not know how to respond other than to repeat what I already said, so I will leave it at that.

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I do not know how to respond other than to repeat what I already said, so I will leave it at that.

I disagree with Stephen on this point. Fractional Banking is immoral when you promise your depositors access to their money any time. The bank is counting on the chance that ALL the depositors will not withdraw their 'gold' at the same time (or enough to deplete its reserves). They have no control over when depositors will withdraw their property.

Practical advantages of the fractional banking system, which are evident, as long as depositors do not withdraw 'gold' all at once, must not take precedence over the principle involved. Treating the 'gold' like bank property would justify the thinking that fractional banking is moral. When the context is kept, remembering that it is the depositors 'gold', and the bank is a trustee. It becomes clear to me that fractional banking is immoral.

Our long chain of constitutional usurpations in America began with putting the practical above principle. This leads to the same place every time. More government controls and a subsequent decline of personal freedom.

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Practical advantages of the fractional banking system, which are evident, as long as depositors do not withdraw 'gold' all at once, must not take precedence over the principle involved.  Treating the 'gold' like bank property would justify the thinking that fractional banking is moral.  When the context is kept, remembering that it is the depositors 'gold', and the bank is a trustee.  It becomes clear to me that fractional banking is immoral.

Our long chain of constitutional usurpations in America began with putting the practical above principle....

So let me see if I understand your view. Proponents of fractional-reserve banking say that although they cannot of course honor all their bank notes immediately, they still can pay the statistical average of claims, and thus be very successful. This, I presume, is what you would call "putting the practical above principle."

If this is the case, I am curious how you would evaluate insurance companies. Surely they cannot in fact cover all of their claims if everyone had a car accident simultaneously, or everyone required emergency medicine immediately. Of course their actuarial tables are very accurate and they are able to pay the statistical average of claims, but isn't this still putting the practical above principle? After all, if they calculate some group is 5% likely to need a payout (say, due to death) each year, they don't promise "we will only pay for the first 5% of you that die this year."

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Can anyone direct me to material (online or otherwise) as to why Objectivists prefer going back to the Gold Standard?

Though he is not an Objectivist, I would recommend Carl Menger's Principles of economics, part 8 + the appendice. Not only do one get a powerful defence of gold-money, but also an explaining of the history of money.

By the way, I think Stephen Speicher has answered quite good on Rothbard.

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For a good description of the gold standard and its advantages, I recommend George Reisman's treatise Capitalsim. Some of the latter chapters, in

particular chapter 19, "Gold versus Inflation" provide a very detailed defense of the gold standard. It's a big book, but one I think any Objectivist or student of Objectivism would appreciate owning.

If you want to explore the issue of fractional reserve banking further, the book Free Banking in Britain, by Lawrence White, while not explicitly about fractional reserve banking, describes a system of free banking that existed and in which banks used fractional reserves.

Specifically, the subject of this book is mostly the banking system in Scotland before 1845. This banking system was characterized by banks that issued their own notes, backed fractionally by gold reserves. Significantly, there were no legal tender laws: that is, nobody was forced to accept a bank's paper notes as payment of a debt that was denominated in the money unit, pounds sterling.

As I remember it, the fractional reserve banks' notes had clauses such that, if a customer presented a note for payment and the bank could not meet the demand, the note holder was entitled to a rate of interest which was high for the time, until the bank could pay him in gold.

This system did not lead to inflation; the banks were very sound; and the banking system was able to finance the great growth of commerce that was occurring at the time.

(Interestingly, the notes of many of these banks were backed, not only by the bank, but by the personal fortunes of the owners. This wasn't legally required, but many bank owners made such promises, presumably to attract depositors.)

.......

There is nothing inherently fraudulent or unprincipled about fractional reserve banking. As long as the bank is truthful about the fact that it will in general be lending out the gold that a customer has on deposit, the depositor would understand that there is always a chance he would not be able to get his gold on demand right away.

Fractional reserve banking is well regulated by the free market forces, because there is no law that forces any creditor to accept any bank's notes in payment of debt. This forces a banker to keep adequate reserves, but he must be the judge of their adequacy. Too few reserves and he will not be able to meet the demands of depositors. (It is mostly other banks that would probably notice this problem first, since banks would be presenting each others' notes for payment through some kind of clearinghouse.) Too many reserves and he is tying up too much of his capital unproductively.

In a free market, some banks might also provide accounts that were explicitly backed 100% by gold, none of which could be lent out - in other words, the bank itself explicitly says it's not using fractional reserves. In this case, the bank's notes would truly be "warehouse receipts" for the gold. If such a bank then surreptitiously lent the gold out, then of course that would be fraud.

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If this is the case, I am curious how you would evaluate insurance companies.  Surely they cannot in fact cover all of their claims if everyone had a car accident simultaneously, or everyone required emergency medicine immediately.  Of course  their actuarial tables are very accurate and they are able to pay the statistical average of claims, but isn't this still putting the practical above principle?  After all, if they calculate some group is 5% likely to need a payout (say, due to death) each year, they don't promise "we will only pay for the first 5% of you that die this year."

You are paying for a service with insurance companies, you trade your money for a valuable service. Protection in the future against the losses caused by a car accident, to use the above example. With the service comes a contract, and if there is a claim, you expect to be paid via the terms of the contract.

Using the insurance example, I am curious what would happen if an insurance company was unable to pay a claim and what lawful recourse you would have. What would you tell these statistically unlikely individuals? Would it be unintentional 'fraud', if such a concept exists (all fraud is intentional) or would it be simply breach of contract. Either way, the company cannot pay the claim, and you paid for a service you never received. At the very least this is immoral and at the worst illegal.

If there were a contract between you and the bank stating that they would hold 50% gold reserve (or no reserve as it is today), and that there may be an indefinite delay in receiving any gold payment, and all the terms were fully explained and agreed to then I would agree that this version of fractional banking is moral. In this case, you would be 'rolling the dice', but it is of your choosing to do so.

American fractional banking of the 1920s and 1930s did not make such a promise. At that time, they were to keep a certain amount of gold in reserve, payable to the bearer on demand, period. No exceptions. When citizens realized the promise was invalid, they rightfully went to the banks and traded their gold certificates for gold currency (taken in the context of the early Depression, they wanted something more stable than paper currency). This led to bank runs, subsequent government legislation, and the eventual abolishment of the gold standard. The courts even upheld the constitutionality of the 'bank run' legislation.

I should clarify. I object to the fractional banking system of America in the early 20th century. I still maintain that this system was immoral. It did not respect the property rights of the individual depositors, and sacrificed them for the sake of efficiency.

A proper alternative to fractional banking is to charge a fee for storing gold. It is then this fee that is loaned, not any fraction of the depositors gold. To loan or invest any portion of the depositors gold without their express permission is theft, even if little or no harm (or only good) comes from it.

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David, based on your argument, just about all business activities are inherently fraudulent. Companies have payables and receivables that all assume contingent events happening (e.g. that inventories get sold, generating cash and thus allowing the payables to be repaid). Must all business be run as if a worst-case scenario should be assumed?

Your analysis blaming banks as the cause of the end of the gold standard is quite faulty, given the government's role in the matter, but that is a side issue.

Your suggested alternative to fractional reserve banking is not banking, it's running a warehouse - a non-financial service that would provide no channel between borrowers and lenders, which is what banking is about.

This and another discussion of fractional reserve banking on another forum has convinced me that Rothbardians are fundamentally anti-capitalist, because in my view they seem to see banking and financial markets generally as irrational, destructive, and in the case of normal banking, inherently fraudulent. They do not appear to understand the role a financial system plays in directing resources and capital to the economy. Many that I've encountered seem to be praying for collapse, so that they can finally pull their gold coins, dehydrated vegetables, and beef jerkey out of the vault to show everyone else how stupid they were to try to deploy their savings in the productive economy through financial channels.

The idea of gold storage vaults being economically attractive to savers is laughable. It has failed the free market test through history. Rational savers for the most part want to move up the risk/reward spectrum by deploying their capital in productive efforts. Fractional reserve banking in a free market would be one of the lower risk ways to deploy one's capital.

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David, based on your argument, just about all business activities are inherently fraudulent. Companies have payables and receivables that all assume contingent events happening (e.g. that inventories get sold, generating cash and thus allowing the payables to be repaid)

All of this is understood by the persons involved. It is agreed upon and therefore a proper way to conduct business.

Your analysis blaming banks as the cause of the end of the gold standard is quite faulty, given the government's role in the matter, but that is a side issue.

I was not blaming the banks, I was blaming government regulation. I was not as clear on this point as I could have been.

"This led to bank runs, subsequent government legislation, and the eventual abolishment of the gold standard. "

Was meant to show that bank runs initiated regulation and this regulation was partly what led to the eventual abolishment of the gold standard.

Your suggested alternative to fractional reserve banking is not banking, it's running a warehouse - a non-financial service that would provide no channel between borrowers and lenders, which is what banking is about.

I disagree, the fee could be used for capital as easily as the depositors gold could. Granted, it is not as efficient or as plentiful as using the depositors gold, nor does it produce as great or disasterous results if bad investments/loans are made.

Referencing my post above:

If there were a contract between you and the bank stating that they would hold 50% gold reserve (or no reserve as it is today), and that there may be an indefinite delay in receiving any gold payment, and all the terms were fully explained and agreed to then I would agree that this version of fractional banking is moral. In this case, you would be 'rolling the dice', but it is of your choosing to do so.

This is moral.

And

...At that time, they were to keep a certain amount of gold in reserve, payable to the bearer on demand, period. No exceptions...

This cannot be practiced or upheld, as history will testify (Government regulation gave the bankers wiggle room to withhold gold, but what would have happened without the regulation, we're back to my question in the previous post about an insurance company failing to pay and your lawful recourse). Therefore it is immoral. Stated again, but in a different way: Fractional banking is not necessarily immoral, but certain forms of it are. Namely, the American early 20th century version of it.

I question America's central banking today, with no gold backed currency (all fiat), despite its practical advantages for deploying capital.

I see I am in the minority and I'll cut to the chase, maybe an explanation of why fractional banking (my 'immoral version' of it) does not violate the property rights of the depositors would be helpful, and an objection to the statement below...

To loan or invest any portion of the depositors gold without their express permission is theft, even if little or no harm (or only good) comes from it.

...would be helpful also. Without answers to these, my position will remain unchanged.

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David, you say about business payables and receivables that "All of this is understood by the persons involved. It is agreed upon and therefore a proper way to conduct business." Well, "fractional reserve banking" is also just a business of payables and receivables. And one of their key skills is managing the maturities of their assets and liabilities to maintain liquidity. In a free market, and even in a semi-free market of the 1920s, bank depositors knew that banks were in the business of making loans with their money, and only children and mentally disabled were unfamiliar with the concept of bank runs. What both banks and depositors didn't expect was massively incompetent government policy, and the increasing distortions that government policy caused to bank liability management.

Banks guarantee to pay deposits just as K-Mart guarantees to pay its payables. When they screw up, and can't do so, they get wiped out, or taken over, and better managed institutions take over. Why should banks be singled out and regulated by the governement such that they cannot operate with even the remotest chance of liquidity problems?

If banks were forbidden to make loans (i.e. forbidden to act on a fractional reserve), the market would develop business arrangements parallel to what banks do, (e.g. business payables and receivables) and companies and people would be just as vulnerable to government interference created crises through these channels.

So under this scenario, so-called "free market" Rothbardians would have to create some sort of secret police searching for underground fractional-reserve-banking-like activity, as if it were a pyramid scheme, which apparently, they think that it is.

It's not "fractional reserve banking" that's the problem - it's government controlled central banking that's the problem. If you really want to stand the relevant issues, I recommend that you read Richard Salsman's "Breaking the Banks" and "Gold and Liberty"

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I'll add your recommendation to my reading list. It looks interesting.

I agree, when you say the problem is government regulation and not the free market.

Regarding my questions:

"...An explanation of why fractional banking (my 'immoral version' of it) does not violate the property rights of the depositors would be helpful..."

for clarification, my immoral version:

[#1]

...At that time, they [banks] were to keep a certain amount of gold in reserve, payable to the bearer on demand, period. No exceptions...

Let me preface this by saying that I have never seen a bank-depositor agreement from this time period, but to the best of my knowledge, the banking position on withdraws was similar to what is outlined above. Is this in dispute?

If so, I'd be interested in viewing your evidence/reasoning so the conversation can proceed this direction. If not, I am left with the conclusion that fractional banking is immoral because:

"...[for the bank] To loan or invest any portion of the depositors gold [property]without their express permission is theft, even if little or no harm (or only good) comes from it."

I'm seeing this as a property rights issue. That is, the right to loan/invest another's property without their consent, and if this is moral or not.

On a side note, if two consenting, legally qualified (proper age, sound minds, etc.), persons commit to an agreement, does this automatically grant the agreement moral status, regardless of the content of the agreement?

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