How Capitalism Will Save Us (53 page)

I
magine how chaotic life would be if the government was always changing the number of minutes in an hour: Say you agree to work eight hours per day at twenty-five dollars an hour. Suddenly, the government decrees that an hour is seventy instead of sixty minutes. Instead of making two hundred dollars for working eight sixty-minute hours, you’re working eight seventy-minute hours—eighty more minutes for the same money. Your work has been devalued by about 15 percent.

Think of the economic uncertainty this would cause. If you were a
piano teacher, for example, how could you commit to giving lessons for one hundred dollars an hour each week when you could not be certain how long an hour would be—and how much you’d really be making?

Fluctuating currency produces the same kind of confusion. How do you know whether you should invest, say, in U.S. Treasury bonds, if the dollar value of your holding may soon decrease? Economist Judith Shelton has described the confusion of today’s system:

We detailed earlier how the fluctuation of the dollar in today’s system of “fiat currency” is a key cause of today’s global recession. Alan Greenspan, who chaired the Fed for nearly twenty years, and his successor, Ben Bernanke, have allowed the dollar to be treated like a yo-yo. Compounding this destructive foolishness was the Bush administration’s belief that a weak dollar would help improve our trade balance.

While our trade deficit shrank, George W. Bush’s three Treasury chiefs all ignored the fact that volatile money damages business investment. Investing—in start-ups, existing businesses, securities, or anything else—is risky enough. Currency fluctuations are a deadly dampener on these necessary activities because they increase uncertainty, making investments even less attractive. Fear of the future decline of the dollar is one reason that China—despite the cajoling of Hillary Clinton and the Obama administration—has expressed fear of buying more Treasury bonds.

Today’s global system of government-managed currency also permits political manipulation of exchange rates—the kind of “currency protectionism” we’ve described in this chapter.

We would not have these problems if the value of the dollar remained stable. That’s why many free-market economists advocate constructing a new gold standard—setting the value of the dollar based on a fixed quantity of gold, or at least having it fall within a range of, say, $900 to $950 an ounce. Anchoring the dollar to gold would restore stability to global markets. It would sharply reduce the role of government and politics in determining currency values.

Today, for example, a country seeking to fund massive social spending will often do so by printing more money. What happens? The added money in circulation ends up lowering the value of its currency.

Gold is exceptionally well suited to anchoring currency values because its intrinsic value is constant. All the gold that has been mined is still in existence: gold cannot be destroyed. Even a major find wouldn’t be large enough to dramatically alter prices. Thus, you don’t get supply shocks and the kind of upheaval that, say, a drought might have on the price of wheat. In a report for the Cato Institute, University of Missouri economic historian Lawrence White writes that, while gold is not perfect, studies have shown it to be the best way to create an orderly global market.

Fiat currency encourages inflation because governments can capriciously print more money. The opposite is true of gold: in the years that the United States maintained a classical gold standard—from 1880 to 1914—inflation was virtually zero.

In the old days, Washington was obligated to convert to gold the dollars that were presented to it. This became a problem in the mid-sixties and early seventies, when the Federal Reserve, attempting to lubricate
economic growth, printed too many greenbacks. It became impossible to maintain the dollar’s value at thirty-five dollars an ounce.

The United States abandoned the gold standard, as Lawrence White has observed, not because of any flaw in the system, but because of politics. Richard Nixon, like George W. Bush, was under pressure to do something about American’s balance of payments and trade deficits.

For the gold standard to work today, Washington has to keep the value of the dollar pegged to gold at a value—as previously mentioned—of $900 to $950 per ounce. In today’s modern markets, Washington doesn’t need piles of gold to maintain a gold standard. Nor does the government need to promise to exchange gold at a fixed rate for dollars. All the Federal Reserve Bank has to do is look at the market price of gold: if it moves outside a certain narrow range, the monetary authorities should react by either tightening or loosening the money supply.

Today many economists ridicule the gold standard as “crazy.” However, for centuries gold was the touchstone of money. From the days of Alexander Hamilton until the 1960s (except briefly in 1933–34), it was an article of faith that, barring a major war, the dollar should be fixed to gold in order to remain strong and stable.

The biggest objection to gold is that the fixed nature of the system restrains economic growth. But this thinking is based on the illusion that a central bank can create prosperity by running off more dollars. Another objection is that a major discovery could so increase the outstanding supply as to cause inflation. But experience demonstrates that even major finds such as the 1849 gold rush or the mammoth amounts of gold that Spain took out of Latin America led only to a mild increase in prices, and then not for very long. The disruptions of such discoveries are minimal compared to the damage politicians routinely wreak when a currency isn’t anchored to gold.

An additional argument against gold is that it caused the Great Depression. This is also a myth. As we noted, the Great Depression was the product of bad policy—the Smoot-Hawley Tariff. Gold was a victim of the resulting global trade wars. Amidst an atmosphere of heightened economic and political uncertainty, people around the world exchanged their currencies for gold. With government supplies under pressure, nations led by Great Britain broke the link to gold. Its central role was
restored at the end of World War II with the creation of the gold-based Bretton Woods international monetary system.

President Richard Nixon blew up the system in 1971 because of concern over the nation’s increasing trade imbalance (remember, he and his advisers mistakenly thought an imbalance hurt the economy) and his declining poll numbers. So he succumbed to the temptation to try to “fix” the situation by devaluing the U.S. dollar. His unilateral abandonment of Bretton Woods and imposition of ninety-day wage and price controls were the “Nixon shocks.” They left the United States and the world economy reeling and set the stage for the stagflation of the 1970s. Sadly, George W. Bush and his administration did not learn from this Real World lesson. And Americans in 2008 paid the price.