How Governments Distort the Value of Money With or Without a Gold Standard

By Joel Bowman


05/27/11 Buenos Aires, Argentina – Speculation is not the same as gambling. As our good friend Doug Casey, a perennial favorite at the Agora Financial Investment Symposium, likes to say, speculation is the act (some might say “art”) of “capitalizing on politically caused distortions in the marketplace.”

Consider, for example, the recent housing bubble…and its subsequent bust. We touched on this in Wednesday’s issue, “Debunking the Myth of a Free Market Run Wild“.

Superficially, the mortgage meltdown looked like, and was so labeled, a “crisis of confidence,” leading to a convenient excuse for greater intervention by the Feds. Of course, and as usual, the exact opposite was true: the bubble was in fact a crisis of overconfidence, nurtured by the very same pinheads who pumped, via the Federal Reserve, more credit into the system during the 1990s and early ’00s than the free market would ever have reasonably tolerated.

As far as the perpetrators of the whole mess were concerned, the state-sponsored manipulation of the mortgage market, “worked”…which is to say, home prices went up…and up and up and up. But that was only half of the equation. The other half – the down and down and down part – is at present working its way through the bowels of the market. At last count, home prices – already 33% off their peak – were falling at a rate of about 1% per month. Ouch!

Needless to say, such a grotesque distortion had both its winners and losers. The winners, for their part, were to be found closely huddled around the DC-to-Wall Street profit pipeline, suckling on bailout funds and pulling ripcords on their golden parachutes. Losers, meanwhile, tended to resemble ordinary folks who were left to foot the bill, ordinary folks without the means to employ the gun-for-hire that is the state along with its various and multitudinous law “makers” and inner-beltway lobbyists.

Similar market distortions – from the tech bust in 2000-01 all the way back to Tulipmania during the Dutch Golden Age of the early 1600s – all find their origin in monetary meddling of one form or another. The asset class affected may vary, in other words, but the culprit – namely, governments who manipulate the money supply – is always the same.

The biggest distortion of the modern era, therefore, is not flower bulbs or dot-coms or even housing prices. These are effects, not causes. There is a much greater distortion underway, one that underlies all of these booms and busts, peaks and troughs. It’s the distortion of the value of money itself.

Explain Morris and Linda Tannehill in their book, The Market for Liberty:

Governments commonly sap the strength of their currencies by engaging in inflationary practices. (They do this because inflation is a sort of sneaky tax which allows the government to spend more money than it takes in, by putting extra currency into the economy, thus stealing a little of the real or supposed value of every unit of currency already there.) As tax burdens become more oppressive, few governments can resist the temptation to circumvent citizen protest by resorting to inflation. They then protect their shaky currencies from devaluation, as long as possible, by international agreements which fix the relative value of currencies and obligate nations to come to each other’s aid in financial crises. In a sense, the main protection which an inflated currency has is the fact that all the other major currencies of the world are inflated, too.

The history of centrally controlled monies is a history of theft, inflation and, eventually and invariably, defaults. From coin clippings during the Roman Empire through to debasement of German marks under the Weimar Republic…to hyperinflationary corruption of, in no particular order, Hungarian pengős…Zimbabwean dollars…Greek drachmai…Brazilian cruzeiros…Polish zlotych…Chinese yuan…Nicaraguan córdobas…US continentals…Peruvian soles…Angolan kwanzas…Russian rubles…Argentine pesos…

…and the list goes on (and on…and on…).

And it’s happening today, sometimes covertly, other times right out in the open. Belarus, for example, this week devalued its ruble by 36%…overnight!

For some, the solution lies in returning to a “gold standard,” to be maintained and safeguarded under the vigilant eye of the benevolent, “night watchmen” state. Fringy politicians and newsletter writers often advocate some form of metal-backed currency, whereby the state would be able to mint coins and print notes only so far as it had gold and/or silver in reserve to “back it up.”

This line of thinking seems, to us at least, to miss the point entirely. Have governments not gone out of their way to demonstrate their utter incapability of keeping a promise? The United States HAD a gold standard…more than once. (It also had a constitution. Remember that?) And what good did it do? Nixon may have severed the last thread of the dollar/gold peg back in 1971, but he was certainly not the first to devalue the greenback against the Midas metal. Remember, before FDR confiscated all the gold in the land back in 1933, an ounce of gold was only “worth” $20. (More correctly, a dollar was worth 1/20th an ounce of gold.) Then, in one fell swoop, the original New Dealer “revalued” the metal to $35 an ounce, thereby devaluing the dollar to 1/35th an ounce of gold. Some “standard.”

Men and women, kings and tyrants, prime ministers and presidents, both black and white and from the east and the west, have made a career out of cheating the citizens they affect to serve out of the value of their currency. Why give them another chance?

No. The solution is not vesting more trust in the state and the do-good meddlers who infest it. The solution is not tying them to a gold standard (again) only to watch them wriggle out from under it (again). The counterfeiters-in-chief of the world’s central banks have done enough already to prove they can’t be trusted, with or without a gold standard.

The solution, rather, is competing, free market currencies operating outside the reach of the easily, demonstrably corruptible influence of those in positions of power who would seek, as they always and forever do, to devalue it for their own ends.

Mired, as we are, in the archaic realms of state-backed currency monopolies, it is sometimes hard for us to imagine just what a truly free market currency might look like. Would it be backed by gold? Silver? Both? Or would the market, driven by the competitive need to provide a safer, more reliable store of value, create an alternative, superior guarantee of trust?

Advocates of a small but fast-growing digital currency network called bitcoin think they’ve found the answer (or, at the very least, an answer). If it is successful, claim its adherents, this totally-decentralized, peer-to-peer (P2P) currency could supplant the world’s central bank-issued fiat money, potentially providing savvy speculators with an opportunity to cash in on the greatest politically motivated market distortion of our time. But even if this particular currency does not fulfill the hopes and aspirations of its enthusiasts and participants, it has at the very least shown that the free market is ready for the challenge.

Joel Bowman
for The Daily Reckoning

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