If I Were Dictator (Part 19)

Posted on Tue 07/12/2011 by


By Marlin6

On 02/05/2008, I authored a post “Benevolent Dictators Make Good Government”. Examples are King David – Israel – (1010 BC –970 B.C.) in ancient times and General Douglas McArthur – Japan – (1945 –1947) in modern times. I started musing about what I would do if I were absolute dictator of the United States to fast track our country back to a position of greatness and prosperity. Therefore I am submitting a series of posts to PA Pundits (many controversial) about how I would provide solutions to the major issues facing our nation.


I would issue an order that would return the United States to the Gold Standard as quickly as practicable. This will help keep the federal government from out-of-control spending policies and stop the Federal Reserve from printing more money. This would be academic, as I would eliminate the Federal Reserve.

The growing disillusionment with politically controlled monetary policies has produced an increasing number of advocates for a return to the Gold Standard – including at times President Reagan. In years past a desire to return to a monetary system based on gold was perceived as nostalgia for an era when times were simpler, problems less complex and the world not threatened with nuclear annihilation. But after a decade of destabilizing inflation and economic stagnation, the restoration of a Gold Standard has become an issue that is clearly rising on the economic policy agenda. A commission to study the issue, with strong support from President Reagan, was in place. The increasingly numerous proponents of a Gold Standard persuasively argue that budget deficits and large federal borrowings would be difficult to finance under such a standard. If we don’t go on the Gold Standard, it is predicted that fold will reach $20,000 an ounce by 2016.

Heavy claims against paper dollars cause few technical problems, for the Treasury can legally borrow as many dollars as Congress authorizes. But with unlimited dollar conversion into gold, the ability to issue dollar claims would be severely limited. Obviously if you cannot finance federal deficits, you cannot create them. Either taxes would then have to be raised or expenditures lowered. The restrictions of gold convertibility would therefore profoundly alter the politics of fiscal policy that have prevailed for half a century. Disturbed by alternatives, even some of those who conclude a return to gold is infeasible remain deeply disturbed by the current situation. For example, William Fellner of the American Enterprise Institute in a forthcoming publication remarks:

“I find it difficult not to be greatly distressed by the very large damage done to the economies of the industrialized world by the monetary management that has followed the era of (gold) convertibility… It has placed the Western economies in acute danger.”

Yet even those of us who are attracted to the prospect of gold convertibility are confronted with a seemingly impossible obstacle, the latest claims to gold represented by the huge world overhang of fiat currency; many dollars. The immediate problem of restoring a Gold Standard is fixing a gold price that is consistent with market forces. Obviously if the offering price by the Treasury is too low, or subsequently proves to be too low, heavy demand at the offering price could quickly deplete the total U.S. government stock of gold, as well as any gold borrowed to thwart the assault. At that point, with no additional gold available, the U.S. would be off the Gold Standard and likely to remain off for decades. Alternatively, if the gold price is initially set too high, or subsequently becomes too high, the Treasury would be inundated with gold offerings. The payments the gold drawn on the Treasury’s account at the Federal Reserve would add substantially to commercial bank reserves and probably act, at least temporarily, to expand the money supply with all the inflationary implications.

Monetary offsets to neutralize or “earmark” gold are, of course, possible in the short run. But as the West Germany authorities soon learned from their past endeavors to support the dollar, there are limits to monetary countermeasures. The only seeming solution is for the U.S. to create a fiscal and monetary environment which in effect makes the dollar as good as gold, i.e., stabilizes the general price level and by inference the dollar price of gold bullion itself. Then a modest reserve of bullion could reduce the narrow gold price fluctuations effectively to zero, allowing any changes in gold supply and demand to be absorbed in fluctuations in the Treasury’s inventory. What the above suggests is that a necessary condition of returning to a Gold Standard is the financial environment that the Gold Standard itself is presumed to create. But, if we restored financial stability, what purpose is then served by return to a Gold Standard?

Certainly a gold-based monetary system will necessarily prevent fiscal imprudence, as 20th Century history clearly demonstrates. Nonetheless, once achieved, the discipline of the Gold Standard would surely reinforce anti-inflation policies, and make it far more difficult to resume financial profligacy. The redemption of dollars for gold in response to excess federal government-induced credit creation would be a strong political signal. Even after inflation is brought under control the extraordinary political sensitivity to inflation will remain. There are certain preparatory policy actions that could test the eventual feasibility of returning to a Gold Standard, that would have positive short-term anti-inflation benefits and little cost if they fail. The major roadblock to restoring the Gold Standard is the problem of re-entry. With the vast quantity of dollars worldwide laying claims to the U.S. Treasury’s 264 million ounces of gold, an overnight transition to gold convertibility would create a major discontinuity for the U.S. financial system. But there is no need for the whole block of current dollar obligations to become an immediate claim. Convertibility can be instituted gradually by, in effect, creating a dual currency with a limited issue of dollars convertible into gold. Initially they could be deferred claims to gold.

For example, five-year Treasury Notes could be issued with interest and principal payable in grams or ounces of gold. With the passage of time and several issues of these notes we would have a series of “new monies” in terms of gold and eventually, demand claims on gold. The degree of success of restoring long-term fiscal confidence will show up clearly in the yield spreads between gold and fiat dollar obligations of the same maturities. Full convertibility would require that the yield spread for all maturities virtually disappear. Presumably five-year note issues would reflect a similar relationship. The exchange risk of the Treasury gold notes, of course, is the same as that associated with our foreign currency The U.S. Treasury has, over the years, sold significant quantities of both German mark – and Swiss franc denominated issues, and both made and lost money in terms of dollars as exchange rates have fluctuated. There is a risk of exchange rate loss with gold notes. However, unless the price of gold doubles over a five-year period (16% compounded annually), interest payments on the gold notes in terms of dollars will be less than conventional financing requires. If gold prices remain stable or rise moderately, the savings could be large: Each $10 billion in equivalent gold notes outstanding would, under stable gold prices, save $1.5 billion per year in interest outlays. A possible further side benefit of the existence of gold notes is that they could set a standard in terms of prices and interest rates that could put additional political pressure on the administration and Congress to move expeditiously toward non-inflationary policies. Gold notes could be a case of reversing Gresham’s Law. Good money would drive out bad. Those who advocate a return to a Gold Standard should be aware that returning our monetary system to gold convertibility is no mere technical, financial restructuring. It is a basic change in our economic processes. However, considering where the policies of the last 50 years have led us, perhaps there are lessons to be learned from our more distant Gold Standard past.

The United States will likely go back on the gold standard within five years in order to correct fiscal and monetary imbalances, says former GOP presidential candidate and Forbes Magazine Publisher Steve Forbes. The gold standard, under which the dollar is pegged to gold instead of other currencies as it is today was abandoned by President Richard Nixon in 1971. “What seems astonishing today could become conventional wisdom in a short period of time,” says Forbes. A return to the gold standard would stabilize the dollar by discouraging hefty fiscal spending as well as preventing the Federal Reserve from printing excess money. “People know that something is wrong with the dollar,” he says, adding “you cannot trash your money without repercussions.” The dollar would not only be stronger today if the gold standard were in place, it would be less volatile. Currency volatility has helped open the doors for speculators to invest in commodities as a hedge against swinging currency values, which has helped stoke inflationary concerns.

Under a gold standard, it is “much harder” for governments to borrow excessively like they are doing today. The housing bubble, partly the product of loose monetary policy, would never have been so severe under a gold standard. “When it comes to exchange rates and monetary policy, people often don’t grasp” what is at stake for the economy, he said. By restoring the gold standard, the country would move away from “less responsible policies” and toward a stronger dollar and a stronger America. “If the dollar was as good as gold, other countries would want to buy it.” Talk of returning the country to the gold standard has risen in recent months. Sean Fieler and Jeffrey Bell, respectively the chairman and policy director of the American Principles Project, say resurrecting the gold standard can tame the Federal Reserve’s money printing campaign.

“Members of Congress seeking to restrict the Fed’s power need to consider what oppositional force is truly capable of hemming it in,” the two write in recent The Wall Street Journal editorial.
“One answer is a revived gold standard, which would once again obligate the Fed to redeem dollars for gold at a fixed rate.” With the dollar weakening and with the Fed in no hurry to change its policies, gold has been soaring. Precious metals often do when paper currencies soften. Gold recently hit a record $1,577.57 an ounce, which is six times higher than the precious metal’s low in August 1999, according to Bloomberg. Gold’s rally did take a breather recently, falling 1.6 percent after the Wall Street Journal reported that Soros Fund Management sold precious-metal assets. Still, others say the metal has a ways to go before truly peaking. “I’m bullish on gold despite its current levels,” says Hal Lehr, Deutsche Bank’s managing director for cross-commodity trading, according to Bloomberg. “It could reach $2,000 an ounce
in the next eight months.

Credits – Alan Greenspan – Steve Forbes