January 21, 2011 – Freeread

This entry is part 15 of 50 in the series 2011A

Those who want to return to the 100% gold standard often point back to those halcyon days before 1913 when the money of the United States was based on gold.

This thinking needs some adjustment. Up until 1873 the nation was on a bimetallic system. That is both gold and silver were used as a basis or backing for our money. Technically this was not a gold standard period, but was a gold/silver combination standard. If we were to hone it down to one metal we would have to say the standard relied more heavily on silver than gold because the value of gold was established by the value of the Spanish silver dollar.

In 1873-4 silver was demonetized in an attempt to create a gold standard. This was done through two pieces of lengthy legislation passed under the radar with few people outside of Congress approving of it or knowing what was in the bill. It was a little like the Healthcare Bill of 2010 where we were told that they had to pass it to find out what was in it. Even President Grant didn’t know that silver had been demonetized for some time after it was passed.

However the people soon woke up and smelled the coffee and discovered that they could no longer use silver to pay bills. This sent the nation into shock as a large portion of the nation’s money was suddenly not money any more.

Meanwhile those behind the legislation who knew what was coming converted their assets into gold and made out like bandits while many common people lost everything.

Many were not happy with a gold only standard and pushed Congress to act. On Feb 16, 1878 Congress passed the Bland Bill re-monetizing silver. The fact that it passed 205 to 72 gives strong evidence that people were not that happy with a gold only standard. Also the fact that a depression occurred a few months after the gold standard was implemented just added fuel to public dissatisfaction.

The nation thus went back to the gold/silver standard until the passage of the Gold Standard Act of 1900. From 1900 to 1918 we were on the single monetary gold standard. Because of the war we threw the gold standard out the window (from 1918-1919) and the value of the dollar rested only on faith and the value of goods and services produced. This occurred with the other warring nations, but for longer periods. After the war we then went back on the gold standard until 1933 when it was dramatically changed by FDR who made the consumer use of gold illegal. Gold could be exchanged between nations, but not individuals and the dollar could no longer be redeemed for gold.

So we had the closest thing to a pure gold standard from 1873-1878, 1900-1918 and 1919-1933. Before that, for most of our history, we had a bimetallic standard, which used the competing metals of gold and silver.

But… have we ever had a pure full-reserve banking system backed by either gold or silver? Actually, we haven’t. There has always been some type of fiat money in circulation since the beginning of the Republic so one could say that a full-reserve gold-backed system really only exists in theory and has never been tested – that is unless you want to go back to the 16th century and earlier to the Dark Ages.

The closest thing to a pure metallic standard in our history has been a partial gold standard consisting of fractional banking that allows for a mix of fiat money with gold and silver. During this period citizens have been promised that they could redeem their money for gold, but that money has always been at risk due to runs on banks caused by unforeseen circumstances and the frailties of human nature.

Still many full reserve gold standard advocates point to our history of the good ole days when citizens could redeem dollars for gold as the financial Camelot of our history.

One of the main arguments for its restitution is to cite the progress we made with inventions and overall improvement of the standard of living while it existed.

As of this writing it has been 78 years since we have gone off the redeemable gold standard in 1933. If we subtract 78 from 1933 we arrive at the year 1855. If we look at the two periods 1855-1933 which used a metallic standard compared to 1933 to the present we see that great progress has been made in both times. Does the progress since 1933 create an argument to the case that we should not have a redeemable gold standard? If one says no then he can’t use a corresponding argument that the gold standard was a prime reason for progress before 1933, or 1913 or whatever date is selected.

If the gold or gold/silver standard of the past worked so much better than fiat money then the economic times should have been a lot better while it existed. So, were there any downturns while we had metallic based money?

Quite a few actually. There was either a depression, financial crises or severe recession that started in the following years – 1792, 1796, 1819, 1825, 1737, 1807, 1847, 1857, 1873, 1884, 1890, 1893, 1901, 1907, 1910, 1920 and of course the Great Depression beginning in 1929.

Some of these were as bad as the great Depression except they didn’t last as long. Several were particularly severe. The depression of 1837-1843 was devastating as was the one from 1873-1879 with even longer effects in Europe. There they called it the Great Depression. The depression of 1893-1897 is sometimes called the worst economic downturn except for the Great Depression. Unemployment hit over 18%.

A little known or understood depression began in 1920. Wholesale prices dropped a whopping 36.8%, and the retail value close to 50%, the largest in history. Unemployment began to soar and the GDP lost 24%. This could have easily been worse than the Great Depression. Consider that in the devastating year of 2009 the GDP only lost 2.4%.

Calvin Coolidge, an unsung hero, solved the problem by cutting spending in half and by 1923 cut taxes from 73% to 25% on the top rate. The stock market tripled and wages increased 20%. By 1926 the unemployment rate went down to from 11.9% to 1.8%.

After the Great Depression and going mostly off the Gold Standard we have had recessions in 1973, 1980, 1990 and 2008. Only the 2008 downturn compares in any degree to earlier depressions.

Looking at history then one cannot say that one of the advantages of the gold standard is that it keeps the economy stable. There have been major calamities with and without the help of gold, but the greatest ones so far have occurred during the days when gold and silver was the foundation of our money system.

How do Gold Standard advocates explain this? Here is a quote from “Gold: The Once and Future Money,” a popular book advocating a return to the Gold Standard.

“The gold standard cannot be blamed for crises caused by leaving the gold standard or for those that took place while the gold standard was not operating…Liquidity-shortage crises are not inherent to the gold standard, and the problem of the liquidity-shortage crisis was eventually solved within the gold standard framework.” ¹

Another explanation I have heard is that the problem was that we just did not adhere closely enough to the gold standard. If we had done this then no major problems would have occurred.

I find these explanations very flimsy on logic for problems occurred in times of closest adherence and not so close. This argument reminds me of the one produced by the socialists and communists who always claim that problems occurred because the people did not follow the model closely enough. They rarely consider that something could be flawed in the system itself.

Likewise, are there flaws in the gold standard itself that are ignored by advocates? One would think that all the depressions that occurred during its practice is evidence that the money system of the past is far from perfect, just as is the one in the present.

One strong evidence of this is what happens when a great crises occurs, especially war. In such times the gold standard is almost immediately thrown out the window.

During the Revolutionary War the colonists had little gold and if they had stayed on the gold standard independence could not have been won. They immediately dropped the gold standard and printed fiat money. This was imperfect but worked better than gold which was in very limited supply.

During the Civil War both the North and the South abandoned the gold standard and printed their own money.

In World War I the United States and other major nations involved all abandoned the gold standard in favor of fiat money.

Deep into the crises of the Great Depression FDR abandoned gold redemption for all citizens.

During World War II many billions of fiat dollars not backed by gold were used to win the war.

During the Vietnam War Johnson removed all silver from our coinage and then in 1972 Nixon completely removed us from the gold standard between nations.

Obviously, there is a big problem with the gold standard when it comes to dealing with a threat to the survival of a nation. Not only the United States but all nations throw it out the window if their survival is on the line.

Do we really want to go back to a monetary system that is so rigid that it is abandoned at the sight of any major crises? Is there not a better system that can be created that we do not have to throw out the window every few decades?

There is an answer and solution to every problem and we will discover that solution as we proceed.

1. Gold, the Once and Future Money, Nathan Lewis; John Wiley & Sons, 2007, Page 174

2. Most of the other data cited is readily available at Wikipeadia and many other sources.

Read This entire series. Here are the links.