[Originally published in American Affairs, April 1948.]
“Public money is like holy water. Every man helps himself.”
~ Italian proverb
As the hungry dollar devours its own purchasing power we may think we are going to find out what happened to the fabulous snake that swallowed itself. But we won’t; and if we did, it would add perhaps nothing to the sum of human wisdom.
There is a long history of monetary experience. It tells us that government is at heart a counterfeiter and therefore cannot be trusted to control money, and that this is true of both autocratic and popular government. The record has been cumulative since the invention of money. Nevertheless it is not believed.
There is also a history of sound money, and if its lessons are likewise disregarded, what shall one conclude but that monetary delusions are, by some strange law of folly, recurring and incurable?
There was a century of sound money. During one hundred years preceding World War I, government touched money hardly more than to establish standards of weight and measure, to lay down the laws of liability and to license bankers.
In that century the wealth of the world increased more than in all preceding time of economic man.
In that century it was business that controlled money, banking and credit by laws of its own; and by that fact the scope of government was limited.
In that century government was confined and enterprise was released, with the result, beyond the prodigious increase of wealth, that never before had political man been so free.
In all that era of free exchange, free price, and sound money there were two things responsible governments did not do.
The first thing was that they did not create money — or if they did, it was called fiat money and fiat money went bad so fast that no government having any regard for its credit could afford to do it again. It went bad because, in the first place, it represented nothing of value and because, in the second place, it had to circulate in competition with sound money. The result of that competition was that for everything there were two prices — a fiat-money price and a sound-money price — and the credit of the government was humiliated. By experience, therefore, in that century government learned the better way, which was when it needed money beyond its revenue to borrow it from the bank like an individual, or to borrow it directly from the people at the prevailing rate of interest and afterward pay it back.
The second thing was that governments in that century did not manipulate money and credit. Such terms as planned money or managed currency were unknown. This needs to be somewhat explained.
Since the amount of money needful to be in circulation to effect the rhythmic exchange of goods is not a fixed quantity — and this for the reason that there are tides in the volume of business — it follows that the supply of money, even gold-standard money, must be in some degree managed. Somebody must see to it that the quantity in circulation shall expand and contract as the need fluctuates. During that century of sound money it was the private banker who performed that office. You may think of him sitting with his fingers on the pulse of business, saying no to the borrower when the pulse was too high, thereby curtailing the supply of credit money, or, when the pulse was low, releasing credit freely, thereby increasing the supply of money as a stimulus to business. Such was the classic psychotherapy in a free economic system privately conducted.
But as people came more and more to do business with credit money, that is, checks drawn against credit at the bank, they were never pleased at the way bankers managed money.
They said, “Look what these bankers do. By a stroke of the pen on their books when it suits them to do so they create money. Again, when it suits them, by another stroke of the pen they write the money away. Thus at will they cause money to be either plentiful and cheap or to be scarce and dear, with alternating consequences that touch all economic affairs for both good and evil. That is more power than may be reasonably trusted to private persons. Control of money is properly a government function, to be exercised for the people’s welfare. Moreover, these private bankers, as the record proves, do the thing badly. They lead us from boom to bust; and after all it is not their money to do with as they will.”
In these sayings there was much seeming plausibility. It was true that the bankers often did it badly. Boom and bust were alternating phenomena. But whereas bankers were seldom if ever blamed for the ecstasy of boom, they were bitterly denounced for the miseries of bust. What people complained of therefore was not what they exactly said. What they quarreled with really was what may be called the pain function of money. If that function be suspended, or if there is nowhere an authority willing and able to exercise it, then a money economy is doomed to explode. Why? Because the imagination in pursuit of gain is boundless. Expectations are infinitely expansible. If then there are no limits to the supply of money, inflation will be uncontrollable to the point of disaster. Everyone knows this to be true; and yet never was there a borrower defending his own bubble who did not believe that if only he had been able to borrow more he could have saved it. That is why deflation is always painful. One of the uses of sound money is to produce that pain in the economic body; the ache tells it that by excess and wrong living it is doing its health a damage.
Now the first difference between the management of money by bankers and the management of it by government is that the banker is not as free as he seems. He is bound by the necessity to keep his bank solvent; he must stand always ready to meet the demands of his depositors, whose money he has accepted in trust with the understanding that while they are not using it he will lend it. It is true that by a stroke of the pen he can create credit money, but he cannot pay off his depositors with that.
He creates credit money by writing in his book a credit to your account; and when you draw upon that credit by writing checks to pay your bills the checks you sign serve the purpose of money. We say that what the banker does in this case is to monetize credit. The amount of credit money so created runs into billions, but against it at all times the banker must keep in his till a certain reserve of real money. If he carries the monetization of credit too far, a day comes when somebody appears at his window and wants a dollar of real money, and if he cannot pay it out on demand his bank will have to close. The amount of credit money the banker can create is therefore definitely limited by the amount of real money he has in reserve. As he finds himself passing that limit he must not only stop lending but must call upon borrowers at the same time to pay off their loans. This is deflation. The pain function of money is then acting.
But when the power to create money at will is in the hands of government the pain function will be suspended. The reasons are obvious. Firstly, it is not politically feasible for government to force deflation and so puncture the people’s bubbles. After World War I the Federal Reserve System did it to reduce the cost of living, and the people whose bubbles were destroyed at that time have never forgiven it. Secondly, why should the government force deflation? It has no solvency to keep. It is not in the case of the banker who must never forget that somebody may come to his window asking for a dollar of hard cash and that if he hasn’t got it he is bankrupt. The government is never in that difficulty. If people come to its windows wanting dollars, it can print them. Whether it is real money or not the government can say it is legal tender, and people must take it as if it were real.
There is yet another difference and this is crucial in a political sense.
So long as government, like any other borrower, must go to the bank for funds, pay the ruling rate of interest and give sureties for the repayment of what it borrows, its projects are limited in both peace and war. But once it gets control of the monetary mechanism so that it can control the rate of interest and create money it is entirely free. Parliamentary control of government by control of the purse makes sense only so long as the quantity of money is limited; it ceases to have any meaning when the government itself controls the supply of money and may fill its own purse.
When World War I started there were bankers who thought the duration of it might be counted in weeks because, as they could foresee, the cost of it was going to be frightful. They could not imagine how the money could be found to carry it on for long. This thinking belonged to the old days of war chests, when a government at war, needing more money than it had saved for that purpose, had to go to the private money market for funds, borrow there, give security and pay interest.
But it was not for want of money that World War I stopped. It was then that government, having overtaken the mysteries of credit banking, made a profound discovery. That was how to monetize public debt. That means simply to turn public debt into money. To understand what happens in that case it is not necessary to comprehend the techniques of banking procedure. Mark first that when a government sells bonds to the people it is, in a strict sense, a borrower; it borrows money from them on its promise to pay it back, and since it cannot borrow more than the people are able to lend, the amount it can borrow on its bonds is limited. But there is no limit to the amount of public debt that may be monetized. In that process the government does not sell its bonds to the people. Instead, with one hand it “sells” its bonds to the banks and then with the other hand it creates and provides the money the bonds call for.
The difference between this kind of money and pure fiat money is a matter of split perception. There are two pieces of paper instead of one. In pure fiat money you have only one piece of paper engraved with the promise of the government to redeem it, and, since it represents nothing of value nor any increase of purchasable goods, the history of it will be that its value is destroyed by a rise of prices and that in the end it will be either partially or wholly repudiated. In the case of money created by monetization of public debt you have two pieces of paper. One is the bond engraved with the government’s promise to pay and the second is the paper money that passes from hand to hand, secured by the bond.
Insofar as this new currency represents nothing of value nor any increase in the supply of purchasable goods it produces the like effect as fiat money — that is, it will cause prices to rise and as prices rise its buying power falls. But now mark the difference that makes the monetization of public debt the wonderful device it turns out to be. The scandal of repudiation, which is the historic sequel of fiat money, is beautifully avoided. How? By this means: The government’s promise to pay according to the engraving on the bond is a promise to pay in what? It is a promise to pay in nothing other than the money that is put forth on the security of the bond. Thus, one piece of paper is security for another. The bond secures the money and the money secures the bond. So you may secure a dog by tying him to his own tail. But so long as it works, no government any more needs to worry about money.
This is the discovery that made it so easy to finance World War I. However, the superstitions of solvency were too strong to be destroyed all at once.
After World War I the old order, though somewhat damaged, was restored. England went back to the gold standard. In this country there was a purposeful deflation. Gold and paper money became freely interchangeable again and the public debt began to be paid off by taxation. Even Germany, after she had repudiated her paper money, was provided by her former enemies with gold on which to base a new gold-standard money, and this was in order that other countries would be able to trade with her again.
It was certain, however, that government would never forget what it meant to be free from the frustrations of sound money. It was certain also that when the next occasion should appear the new economic intelligence of government would be ready with a complete and plausible doctrine of control derived from the experience of World War I.
First, however, it would be necessary to get rid of the gold standard. So long as money and credit were, by law and custom, definitely related to a gold reserve a government could not manipulate the money supply with perfect freedom, nor infinitely increase it, and the great discovery of how to monetize public debt was of limited use. Every government, therefore, was an enemy to the gold standard.
In the second year of the Great Depression, England abandoned it on the ground that to support it had already cost her too much deflation. Shortly thereafter the American government, under no necessity whatever, having in fact more gold than it needed, repudiated the gold obligations engraved upon its bonds and upon its money and at the same time seized control of money, credit, and banking, which means that it seized definitely two powers, namely:
the power to manipulate money as an instrument of social policy, andthe power to create money by monetization of the public debt in peacetime as in war.
Merely to overthrow the gold standard was not enough. One thing more was necessary, and that was to make sound money illegal. The government’s planned money had to be the only legal money, for if it were not it would find itself in competition with gold or gold-standard money. And so private property in gold was destroyed. Private possession of gold was made a crime, and a law was passed saying that any contract stipulating payment in any kind of money other than the government’s planned money was unlawful.
This was the supreme monetary achievement of the New Deal — to make sound money illegal. Gresham’s axiom was thereby cheated — the axiom that when two kinds of money, one better and one worse, are in circulation together the better money tends to disappear because people will hoard it. The New Deal made that kind of competition impossible. There was to be only one kind of money, and that was money as the government planned it. All that could happen after that was a black market in gold.
It must be noted that what the New Deal did was popular. The government and the people struck hands. So it was also in Great Britain, when in a similar manner planned money was substituted for sound money. What government gained was a vast extension of power in the economic dimension, and what people gained — or thought they had gained — was immunity forever from the pain function of money. Never again should people suffer for want of money — that is to say, for want of purchasing power. The government could always provide enough of it. Never again would banker be permitted to sacrifice social welfare on the altar of solvency. Never again would a banker be able to say, “Borrowers must pay off their loans, and everybody must sell more and buy less, because we are running out of money.”
For a while it works. Indeed for a while and for many it works so well that one may wonder whether there is not a kind of immediate logic in what we call monetary delusions. A never-failing abundance of cheap planned money offers immunity from liquidation. It holds forth also the delusory idea of stability. The alternation of boom and bust shall be abolished. For of course if nobody has ever again to suffer deflation for want of money there is no reason why there should ever be a bust at all.
What this turns out to be, however, is a fantasy of perpetual boom. The corrective principle of sound money, which we have called the pain principle, is to induce selling and liquidation under certain circumstances. When that function of money is suspended, the positive function, which is to induce buying, works alone, so that everybody would sooner buy than sell and the monetary mechanism acts as a clock without a pendulum, ticking up prices faster and faster. And this will go on until the spring is spent. What will happen then nobody knows. It is a calamity to be postponed as long as possible.
Meanwhile, the time comes when the government itself is helpless, even if it should want to stop inflation. The theory of planned money is that the pendulum can be put back when necessary. This is the doctrine of controlled inflation. But when the time comes to act, the government faces not a theory but a political reality. It does not dare to deflate the economy by restoring the pain function of money. Was it not for that the banker was damned? Now shall the government do it in his stead? If so, what becomes of the delusion that once the government controls and plans the money people will be delivered forever from that experience?
One source of confusion is the idea that the frightful cost of war was the primary cause of this inflation. War provided the volcanic spectacle. But the fire was already burning. It began in the ’30s when governments overthrew the gold standard on the pretext that it frustrated the social aspirations of people and took control of money. Long before the war, governments had freed themselves from the limitations of sound money. They had found a way to socialize money, and one consequence was that the cost of the war was enormously dated.
So now the incomparable delusion comes to a sequel. Planned money has run its course so well and true that there is today nowhere in the world an intelligible price for anything nor anywhere a piece of legal money for which people are willing, in the normal way, to exchange their goods; wherefore hoarding of things as a universal evil, black markets, a disrhythm of exchange, a disorder of production, and international trade more and more inclined to the principles of barter.
The evils of inflation assume now the proportions of a universal scourge. Yet in the mind of government the only thought is to deal with these evils as effects — by edicts forbidding them or by new mechanisms of control and capital levies — instead of acting upon the cause. How to act upon the cause, how to restore in the world the principle of solvency, how to get back to a kind of money that people will trust, that will stop hoarding, that will destroy black markets and release the forces of free enterprise — this is a problem for which there is no painless solution.
Since the rise of modern economy it has never happened before that money everywhere in the world was all at one time inflated. Never before was it impossible to test the value of inflated money by the simple method of pricing it in gold. Even in our own greenback days — that was in the Civil War period — fiat greenback currency could be valued in gold. The government’s financial prestige suffered as the greenback dollar declined. At the lowest point it was worth 35 cents. Ultimately it was made redeemable in gold at full face value.
But now gold as money has been outlawed by government. The free market in gold has been suppressed. Where now will you test the value of the American dollar or the British pound by offering it in exchange for gold? The International Monetary Fund fixes the value of the dollar in terms of the pound sterling and the value of the pound sterling in terms of the dollar.
If this were all, you would be dealing with a monetary problem. But there is much more. Deeply the problem is moral. Of all the principal monetary nations of the world there is not one that has not recently abased its money or repudiated the promises engraved upon its obligations. Distrust of money, therefore, is distrust of the word of government.
France now is struggling with that moral disability. She is the one country that ought to have known better. Her experience with inflation is historically classic. Nevertheless she carried the monetization of public debt to a point at which the franc was a demented currency, expressing values in a kind of gibberish. So at last she resolved to devaluate it by edict and at the same time to permit what she would call a free market in gold and dollars.
The International Monetary Fund pleaded with her not to do it. The fear was that she would wreck its cobweb of artificial parities and expose the true value of somebody’s money, especially the British pound sterling, which was heady selling in the black market at about one half what the International Monetary Fund said it was worth.
Nevertheless, in selfish desperation, France did it, with the result that instead of solving any problem of her own she made the general confusion worse. The French people knew perfectly well that the new value of the franc was arbitrary and provisional; it could be changed again. Therefore they distrusted it still. Moreover, the new monetary law was properly read to mean that the French government reserved the right to do anything it liked with money, even to confiscate it.
As for the free market in dollars and gold, it was free not in its own right but by permission as an experiment, just to see what would happen. The French government was so naive as to believe that if free trading in gold were permitted for a few hours each day the premium on it would tempt the French peasants to bring in their famous hoards; but the French peasants were not in the least persuaded to exchange their gold for any kind of paper money, not even paper dollars.
The moral debacle now is such that when and if governments do decide to deflate their currencies, confidence in money will not be reinstated. That is so for the reason that no government’s word about money is good. Who can be sure that new promises are better than the ones that were broken? Only time can tell that. And there is no time. The necessity to restore the rhythm of exchange in the world is extremely urgent. It cannot be restored until people hear again the ring of sound money.
Gold would make that sound; but although there is more gold than ever before in the world the use of it as money is forbidden. It does pass between governments, mostly in the form of bullion, and all governments are jealous to possess it, since it is now the only measure of value that even governments can trust; but both gold coin and paper money convertible into gold on demand have disappeared from circulation in the whole world. An individual wanting gold to hoard must first find it in the black markets of Bombay, Cairo, or China, and then smuggle it away, for it is subject to confiscation, and the individual found in possession of it is penalized.
The curious fact is that at the same time governments themselves are hoarding it, and they do this for the reason that they can no longer trust their own planned money.
Under the New Deal, the American government passed a law making it a crime for an American citizen to possess gold. Then, having confiscated the people’s gold, it buried it in the ground at Fort Knox. From time to time this hoard bas been added to, until now it represents more than one half of all the monetary gold in the world. Yet the existence of this gold is not the true reason why the American dollar is the least distrusted kind of planned money. It is the productive power of America that supports the dollar, not the gold hoard at Fort Knox.
It is said that this country has an “international gold bullion monetary standard,” if you know what that means. It is said that the American dollar is “tied” to gold. It is said that against the planned paper money you have in your pocket there is a “gold reserve.” These are monetary constructions only. What good does it do you to know that behind your paper money there is a gold reserve when it is illegal for you to touch gold, and when even the banker who keeps what is called a gold reserve has not got the gold?
No bank has gold. No bank is permitted to own gold. What the bank has is a gold certificate issued by the government. This certificate cannot be converted into gold, except by the permission of the government, and then only provided the gold is wanted for the purpose of making an international payment. And this gold certificate, which constitutes what we call the gold reserve against our money, is neither legally nor morally any better than the beautiful yellow gold certificate you had in your pocket a few years ago engraved as follows:
“This is to certify that an equal amount of gold coin has been deposited in the United States Treasury and is payable to the bearer on demand.”
That was the gold certificate the government obliged you to surrender on pain of fine or imprisonment. In doing this it not only disregarded the words engraved on the money; it repudiated a legal receipt for gold that bad been deposited by individuals in the United States Treasury. That is simply to say, it confiscated the gold it held in trust for the people.
So a gold certificate is not gold. If it was not gold in the hands of the individual neither can it be gold in the hands of a bank. No solemn word engraved on the paper by a government that has once broken its word can make it gold. Only gold is gold. It follows that against all the planned paper dollars now in circulation, the money in our pockets, there is actually in the whole banking system not one dollar of gold reserve.
In all this confusion of fact and fiction the one thing that glitters is gold. To some its glitter is the evil eye of the basilisk, luring people back to 19th-century capitalism; to others it is the wee light of day in the mouth of the cavern in which we are lost.
Thus now the economists divide. And if you mark the line of their separation, which is like the line of a religious schism, with the modernists on one side and the fundamentalists on the other, you will see that a point comes at which we cease to be talking about money. The argument turns not on monetary principles, which may be either proved or disproved, but upon political convictions, which are generally beyond argument.
Economists who believe in a planned economy believe also in planned money, and logically so, for when government undertakes to plan the economic life for social ends it must be able also to plan money. Otherwise its social intentions will be frustrated.
On the other hand, economists who believe in a free economy and limited government believe also in sound money, because sound money is, of all instruments, the one that has most successfully defeated the totalitarian instinct of government.
These are the fundamentalists. With a rising voice they now demand a return to the gold standard, and this not for monetary reasons alone but on the higher ground that there is no other way to save a free economy and a free society from total ingestion by government. Gold-standard money is the one thing that government cannot swallow.
But the road back to sound money is hard. It was hard enough when there was but one natural obstacle, namely, the power of fallacy, which is always on the side of public money because there will be plenty of it and every man, according to the proverb, may help himself.
But beyond this first obstacle are two more.
The second is the resistance of government, with its entrenched control of the money supply. That is a power it will not give up without a struggle.
The third obstacle is the Keynesian economist, who stands for the planned economy partly upon grounds of social conviction and partly, one may suspect, upon grounds of advantage, for in a planned economy he is raised to the honors of priestcraft. The influence of this Keynesian economist is great, both upon government and upon economic thought, and in his field of vision there is scarce another image so hateful in every way as the gold standard.
In Congress, the idea of returning to the gold standard is led by Howard Buffett of Nebraska, who has introduced a bill proposing “To restore the right of American citizens to freely own gold and gold coins; to return control over the public purse to the people,” and “to restrain further deterioration of our currency.” The essential paragraphs are two, as follows:
The standard monetary unit of the United States of America shall be the gold dollar of fifteen and five twenty-one one-hundredths grains nine-tenths fine. Gold coins of not less than $10 denomination and such larger denominations as the Secretary of the Treasury finds desirable shall be minted and issued on demand.
All other money of the United States shall be maintained on a parity with the standard gold dollar by freedom of exchanges at par with standard gold.
Speaking of his bill, Mr. Buffett said:
Somewhere along the line these thrifty and frugal people will decide that depriving themselves of immediate enjoyment by saving dollars is unwise. Like the populations of many European lands, these workers no longer put their trust in an irredeemable paper currency.
If Congress does not soon effectively deal with the problem, this peril may not be too far away. A mass abandonment of dollar-saving habits would be a major calamity, especially as a mass flight from the dollar would almost surely follow.