Recycling Monetary History Shows Need for Gold

More than two centuries ago Edmund Burke wrote, “Those who do don't know history are destined to repeat it.” Nearly 70 years ago the great economist Ludwig von Mises described the cycle of monetary debasement which could have been written for our own time. The new prime minister of Japan was elected largely by campaigning for debasing his own country's currency, thus recycling a previously failed policy still in vogue elsewhere. He said, “Countries around the world are printing more money to boost their export competitiveness. Japan must do so too.” Link   He called for more aggressive action along the lines of the Fed and the ECB.

And it is hard not to think of President Obama when Mises says, “It is a great comfort to every administra­tion to be able to make its citizens happy by spending. For public opinion will then attribute the resulting boom to its current rulers. The inevitable slump will occur later and burden their successors.... We are destined to spend decades paying for the easy money orgy of a few years.”

It is difficult, too, not to think of Obama's goal of redistributing wealth and increasing taxes on the rich when Mises writes that inflation creates winners and losers: “The creditors are the losers; it is their loss that is the profit of the debtors.”

The following is an abridged version of Chapter 11 of Mises' book Omnipotent Government, published in 1944:

The gold standard was an international standard. It safeguarded the stability of foreign exchange rates. It was a corollary of free trade and of the international division of labor. Therefore those who favored statism and radical protectionism disparaged it and advocated its abolition. Their campaign was successful.

The gold standard put a check on governmental plans for easy money. It was impossible to indulge in credit expansion and yet cling to the gold parity permanently fixed by law. Governments had to choose between the gold standard and their—in the long run disastrous—policy of credit expansion. The gold standard did not collapse. The governments destroyed it. It was as incompatible with statism as was free trade. The various governments went off the gold standard because they were eager to make domestic prices and wages rise above the world market level, and because they wanted to stimulate exports and to hinder imports. Stability of for­eign exchange rates was in their eyes a mischief, not a blessing.

All governments are firmly resolved not to relinquish inflation and credit expansion. They have all sold their souls to the devil of easy money. It is a great comfort to every administra­tion to be able to make its citizens happy by spending. For public opinion will then attribute the resulting boom to its current rulers. The inevitable slump will occur later and burden their successors. It is the typical policy of après nous le déluge. Lord Keynes, the champion of this policy, says: "In the long run we are all dead." But unfortunately nearly all of us outlive the short run. We are destined to spend decades paying for the easy money orgy of a few years.

The days are gone in which most persons in authority considered stability of foreign exchange rates to be an advantage. Devaluation of a country's currency has now become a regular means of restrict­ing imports and expropriating foreign capital. It is one of the methods of economic nationalism. Few people now wish stable foreign exchange rates for their own countries. Their own country, as they see it, is fighting the trade barriers of other nations and the progressive devaluation of other nations' currency systems. Why should they venture to demolish their own trade walls?

Some of the advocates of a new international currency believe that gold is not fit for this service precisely because it does put a check on credit expansion. Their idea is a universal paper money issued by an international world authority or an international bank of issue. The individual nations would be obliged to keep their local currencies at par with the world currency. The world authority alone would have the right to issue additional paper money or to authorize the expansion of credit by the world bank. Thus there would be stability of exchange rates between the vari­ous local currency systems, while the alleged blessings of inflation and credit expansion would be preserved.

These plans fail, however, to take account of the crucial point. In every instance of inflation or credit expansion there are two groups, that of the gainers and that of the losers. The creditors are the losers; it is their loss that is the profit of the debtors. But this is not all. The more fateful results of inflation derive from the fact that the rise in prices and wages which it causes occurs at different times and in different measure for various kinds of commodities and labor. Some classes of prices and wages rise more quickly and to a higher level than others. While inflation is under way, some people enjoy the benefit of higher prices on the goods and services they sell, while the prices of goods and services they buy have not yet risen at all or not to the same extent. These people profiteer by virtue of their fortunate position. For them inflation is good business. Their gains are derived from the losses of other sections of the population. The losers are those in the unhappy situation of selling services and commodities whose prices have not yet risen at all or not in the same degree as the prices of things they buy for their own consumption. Two of the world's greatest philosophers, David Hume and John Stuart Mill, took pains to construct a scheme of inflationary changes in which the rise of prices and wages occurs at the same time and to the same extent for all commodities and services. They both failed in the endeavor. Modern monetary theory has provided us with the irrefutable demonstration that this disproportion and nonsimultaneousness are inevitable features of every change in the quantity of money and credit.

Under a system of world inflation or world credit expansion every nation will be eager to belong to the class of gainers and not to that of the losers. It will ask for as much as possible of the ad­ditional quantity of paper money or credit for its own country. As no method could eliminate the inequalities mentioned above, and as no just principle for the distribution could be found, antago­nisms would originate for which there would be no satisfactory solution. The populous poor nations of Asia would, for instance, advocate a per capita allotment, a procedure which would result in raising the prices of the raw materials they produce more quickly than those of the manufactured goods they buy. The richer nations would ask for a distribution according to national incomes or ac­cording to the total amount of business turnover or other similar standards. There is no hope that an agreement could be reached.

Central Banks Buy Gold, Print Money

Central banks bought 534.6 tons of gold during 2012, the largest amount in 48 years. Interest is clearly growing in gold as an international monetary asset as more countries have participated.  Many have specifically stated their intent is to diversify away from U.S. dollars.

China is the world's largest gold producer, by far. It produces 40 percent more than second-place Australia. But since 2009, China's central bank has not reported gold purchases even though it is known to be buying gold directly from its own mines—including from foreign companies mining gold in China—and also from international gold markets.  Though China's doesn't report its central bank purchases, the World Gold Council reports investment demand for gold in China was up 24 percent in the fourth quarter 2012, compared to the previous quarter, and jewelry consumption was steady at 137.0 tons.  China is second only to India in consumption of gold for jewelry.  (Every year India buys four times as much gold as all of North America.)

Countries are shifting away from the dollar because the massive increase in U.S. government spending has undermined confidence in its future.  In his first term of office President Obama added more to the national debt than all prior presidents from George Washington through George W. Bush combined.  Everyone knows Social Security, Medicare, and Medicaid are going broke, but Obama has made no effort to address those problems.  Instead, he tries to further increase spending.  The Fed has been accommodative by “quantitative easing”—printing money.  Now in the fourth round, QE4, the Fed creates $85 billion every month by simply writing checks for that amount to buy treasury bonds and mortgages.  Over a year, that's another $1 trillion.

The monetary expansion is being done in the name of stimulating the economy, but the results are very unsatisfactory.  The recovery from the recession has been far slower than from previous recessions which had no such stimulus measures.  The Obama administration claimed its original stimulus program (over $800 billion) would keep unemployment below 8 percent. Instead, it not only rose above 8 percent but remained there for more than 40 months.  It rose even higher than the administration predicted would occur without the stimulus!  The effect was the exact opposite of what the administration intended, despite adding QE2, QE3, and more than a year of QE4.

The recession triggered by the housing/banking bubble in the U.S. led to economic contractions in Europe compounded by revelations of financial weaknesses in certain euro-zone countries.  The result was a series of bailouts and a flood of new money in the form of massive expansion of credit by the European Central Bank to hundreds of banks in the various countries.   This was to prevent an immediate liquidity crisis, but it was also intended to stimulate economic growth, which it failed to do.  The euro-zone's economy shrank last quarter at the fastest rate since the worst of the recession in 2009.  It has now contracted for three straight quarters, and the European Commission expects it to worsen in 2013. Euro-zone unemployment at11.7 percent is now the highest in its history, and the rate is 26 percent in Greece and Spain.  The European Commission expects Portugal's unemployment rate to reach 17.3 percent in 2013. Countries are failing to meet their targets for deficit reduction; Spain has obtained a two-year extension, and Portugal says it, too, will need an extension.  France lost its triple-A credit rating in November, and Moody's stripped the United Kingdom of that prized rating in February.  A Moody's spokesman said, “We expect the country's debt will continue to grow in coming years ...[and not] stabilize until 2016.” Link
 

Printing more money lowers the value of a currency in relation to others.  Therefore, a weak currency is seen as a way to improve the economy by increasing exports to other countries, who find them less expensive.   Of course, other countries may then retaliate and devalue their currencies in order to remain competitive in international markets.   If that happens, no country has an advantage; all the currencies will simply have gotten cheaper.  That is what happened in the 1930s in a series of destructive devaluations that came to be known as “beggar thy neighbor” policies.  It is happening again today as an expedient to evade unpopular but necessary reforms on fiscal and budgetary matters.  At the same time, the uncertain and depreciating paper currencies have led to distrust of their value as monetary reserves, making gold look better and better as a monetary asset.

The U.S. Federal Reserve and the European Central Bank have led the way in printing money.   Fed chairman Ben Bernanke has stated he will continue to pursue easy money policies until the economy improves.  ECB president Mario Draghji has said he will supply any amount of money that is necessary to save the euro.  Like the Fed and the ECB, the Bank of England has also been pursuing quantitative easing as a remedy for past spending excesses and to stimulate the British economy.  Lack of results has led to larger doses of the same failed medicine.  Now Japan, the world's third largest economy, has joined in with larger doses of the same prescription for its stagnant economy.  In the recent election, Shinzo Abe was elected prime minister in large measure because of campaigning for monetary easing through “unlimited” or “open ended” purchases of government debt by the Bank of Japan.   He said, “Countries around the world are printing more money to boost their export competitiveness. Japan must do so too.” Link   He called for more aggressive action along the lines of the Fed and the ECB.

The idea that government spending would stimulate the economy can be traced to John Maynard Keynes.   He claimed government spending produced a multiplier effect, a chain reaction of additional spending in the economy.   But in my new book, The Impending Monetary Revolution, the Dollar and Gold, I point out that the Keynesian multiplier is always less than 1.0.  That means the money that is spent over and over again in the private sector from the government spending is always less than the cost of the programs.  If it weren't, the U.S., Greece, and other spendthrift countries wouldn't be going broke—they'd be getting richer the more they spent!  My book supports this conclusion by citing impressive academic research as well as actual historical examples, including Japan's own experience.
 

No nation has more completely and energetically put Keynesian policy into practice for longer than Japan, and the results have been disastrous.  Two decades of economic stagnation.  Japan had ten stimulus programs between 1992 and 2000.  It spent massively on infrastructure, building bridges, roads, ports,airfields—even sidewalks—as well as supplying huge subsidies to the biotech and telecommunications industries.  Yet the 1990s are known as Japan's “lost decade,” when it had the lowest productivity rate of any industrialized nation.  Instead of boosting economic growth, government spending ballooned the nation's debt-to-GDP ratio to 235 percent, the highest in the world, compared to 65 percent in 1990.  Japan now has an even worse national debt problem than the U.S. Oblivious to his nation's last two decades of experience, Prime Minister Abe is embarking on a more aggressive application of the same policies that have brought trouble to both nations.

The Federal Reserve Bank of New York has long stored monetary gold for foreign central banks, not only for security but, in times past, as a convenience for some international operations.  Following World War II and the onset of the Cold War, Germany stored a large quantity of its gold in the U.S. against the possibility of a Soviet invasion.

Now Germany says it will repatriate 300 metric tons of its gold from the New York Fed and all of the 374 tons stored at the Banque de France.  Disappearance of a threat from the Soviet Union was given as the reason for the transfers, but many view them as defensive moves against collapse of the euro.  While minimizing the issue, officials at the Bundesbank acknowledged that the moves are “preemptive” in case a “currency crisis” hits the European Monetary Union. Link Germany several years ago repatriated 940 tons of its gold from the Bank of England. It now has possession of 31 percent of it gold and wants to raise that to at least 50%.

Venezuela, Libya, and Iran have repatriated their gold holdings.   The question now is who will be next? It might be Switzerland. In March 2012 four members of the Swiss Parliament began an initiative to bring Switzerland physical possession of all of its 1,040 tons of gold. The measure now has 90,000 supporters.  If 100,000 is reached, parliament must take up a referendum on the issue.

There is talk of the Netherlands repatriating its gold, and Azerbaijan is already doing so.  The Netherlands has only about 10 percent of its 612.5 tons of gold at home.  Azerbaijan began its repatriation of gold in January 2013 with one ton transferred from London to the new storage facility of the central bank in Baku.  In the future all gold will be transferred there.  The country expects to double its gold holding this year to 30 tons because of oil revenue.  The State Oil Fund (SOFAZ) has been buying 10,000 ounces of gold every week since February 2012.

The repatriation movement is gaining momentum, along with the trend of increased gold buying by central banks. An increasing number of private institutions and individuals are thinking like the banks, especially in the East, where gold is soaring in popularity. Brinks tripled its precious metal storage capacity in Singapore in 2012 and is building a warehouse in Shanghai for precious metals and other high-value goods.  Malca-Amit has gold storage sites in New York, Zurich, Hong Kong and Singapore.  It's facility in Singapore has a capacity of 600 tons of gold and is almost full.   Its recently opened vault in Hong Kong can hold 1,000 tons of gold. Joshua Rotbart, executive director of the company, said some Asian investors storing gold in the U.S. and Europe are keen to move it closer to home as more storage space becomes available.