Former U.S. Congressman and Reagan administration budget director David Stockman delivered this talk at the New York Historical Society on May 5, 2011.
It took 200 years to build and perfect the classic gold standard system; then it was destroyed in about seven weeks when the Guns of August 1914 thundered across Europe; and now I am allotted seven minutes to resurrect it.
Fortunately, Churchill’s defense of democracy also applies to the daunting task at hand: To wit, the classic gold standard is the worst possible monetary system—except for all of the alternative, inflation-generating, savings-destroying, debt-breeding, bubble-emitting, and boom-and-bust-prone systems which have been tried in the 100 years since its demise. Hence, we offer six present-day monetary vices which are curable by gold.
First, the gold standard wouldn’t have allowed the US to incur nearly 40 straight years of massive current account deficits and to live high on the hog for decades by running a $7 trillion tab against its neighbors. Indeed, before Richard Nixon and Milton Friedman instituted their floating rate fiat money contraption in August 1971, nations were compelled to live within their means. Chronic profligacy and current account deficits resulted in a drain of gold abroad, causing a domestic contraction including tighter credit, higher interest rates and deflation of prices, wages, and demand—pressures which encouraged a speedy return to virtuous living and payments balance.
The gold standard tamed the demon of debt by delegating the pricing of money to the marketplace of savers and borrowers, not to an administrative board of interest rate riggers and manipulators. Consequently, a national leveraged buyout wasn’t possible under gold: the sky high interest rates needed to induce extra savings tended to harshly discourage binges of cheap money borrowing. Thus, the national leverage ratio—the sum of public and private debt divided by GDP—was 1.6 times in 1870, and was still 1.6 times a century later.
Since 1971, however, the Fed has found repeated excuses to drive real interest rates toward zero or negative—a maneuver which has generated explosive debt growth the easy way; that is, not by coaxing it from savers but by manufacturing bank credit out of thin air. Consequently, America had a full-fledged LBO and now its leverage ratio is off the charts at 3.6 times GDP. This means that our $15 trillion national economy is being crushed under $52 trillion of debt—a figure $30 trillion larger than would have obtained under the golden constant.
The gold standard was an honest regulator of Wall Street greed. Under gold, we did not seek Bernanke-style faux prosperity by levitating the Russell 2000; nor did we crucify Main Street on a cross of obscurantist theory like the Taylor Rule whereby the Fed naively gifts Wall Street with limitless zero-cost funding for leveraged speculations in commodities, currencies, derivatives, and equities; nor did we punish people who invest in savings accounts out of an abundance of caution while placing a central bank “put” under those who speculate with reckless abandon.
Moreover, unlike the Fed’s money bubbles and crashes, which heavily punish Main Street, the so-called “panics” of the gold standard era—those of 1873, 1884, 1893, and 1907—had the opposite aspect. They were largely sequestered on Wall Street and were rooted not in gold but in the glaring defects of the Civil War era National Banking System. The latter drained nationwide banking reserves to the Wall Street call money market where it periodically fueled stock buying manias—but these episodes were quickly ended when deposits reflowed back to the country banks at harvest time, causing call money rates to soar and panic to supplant euphoria on the stock exchanges.
The gold standard made the world safe for fractional reserve banking. To be sure, banking—which is to say, scalping a profit from the interest spread between loans and deposits—is the world’s second-oldest profession. While arguably doers of God’s work, bankers become positively dangerous when backed by a sugar daddy central bank—like the Fed or the People’s Printing Press of China—willing to supply all the reserves needed for the endless inflation of bank credit and the destructive asset bubbles which follow.
Under the gold standard, by contrast, commercial bank deposits and currency notes were convertible into gold on demand, and central bank reserve injections into the banking system were firmly checked by requirements to cover such liabilities with gold at a 35-50 percent ratio. Indeed, the folly of the Fed’s recent manic reserve creation was even foreseen by the father of fiat money, Milton Friedman of Chicago, and by its grandfather, too, Irving Fisher of Yale. Both supported 100% reserve banking in lieu of the monetary discipline of gold. So give us gold or give us 100% reserve banking—but not fractional reserve gambling halls superintended by a Princeton math professor with a printing press.
The gold standard made the world safe for fiscal democracy because chronic budget deficits generated immediate pain. If financed from savings, deficits caused higher interest rates and squeezed out private investment; and if financed by central bank credit, they caused a deflationary drain on gold. Nowadays, however, central banks have become monetary roach motels—places where treasury bonds go in but never come out. Consequently, sovereign debt has been drastically underpriced, causing Washington lawmakers to borrow lavishly and without fear.
Finally, the gold standard protected Main Street from the boom and bust of credit cycles. Such disturbances never issue from the people’s work, saving, investment, and enterprise, but always and everywhere they originate in the banking system and the speculative precincts of Wall Street. So the central bankers’ “Great Moderation” is a myth—refuted by the compelling evidence that these gosplanners of fiat money do not tame the business cycle but intensify and exacerbate it is.
Their printing presses fueled the stagflationary 1970s, the real estate bust of the late 1980s, the dot-com frenzy which followed, history’s greatest housing bubble which came next, and the “risk-on” mania of recent months. Among all the arguments against gold, the claim that it would worsen the business cycle is, on the evidence of 40 years now, surely the most specious.
David Stockman is the founding partner of Heartland Industrial Partners and a member of the board of directors of The Committee for a Responsible Federal Budget, a bipartisan, nonprofit organization committed to educating the public about issues with significant fiscal policy impact. He served as director of the Office of Management and Budget in the Reagan administration. From 1976 to 1981 he represented Michigan in the U.S. House of Representatives. Used with permission of the author.
The Committee for a Responsible Federal Budget: http://crfb.org/