Fix It Again, Treasury

August 15, 2011

An interesting piece in the Wall Street Journal, suggesting that the sun is setting on fiat money:

Forty years of persistent monetary interventionism have left the economy addicted to cheap credit and continuous asset inflation. Forty years of monetary expansionism have led to distorted prices, misdirected economic activity and unsustainable debt levels. Since Lehman Brothers we know that the accumulated imbalances have become so momentous that a market-driven liquidation of them is deemed politically unacceptable. Credit correction, debt deflation and liquidation—as much as the market is craving them to cleanse the economy of its dislocations—will not be allowed under any circumstances.

The central banks are now boxed in. There is no exit strategy. Low interest rates and further credit growth must be sustained at all cost, and as the private sector becomes reluctant to participate, the state is increasingly the “borrower of last resort” to the central bank’s “lender of last resort.” The Fed will engage in QE3, then in QE4. After mortgage-backed securities and Treasuries, it will be corporate bonds, auto loans and credit card debt that will also end up on the central bank’s balance sheet—and, of course, more Treasurys. The ECB will continue to accumulate the ever-growing debt of European sovereigns. But when the public realizes that the mirage of solvency is only being maintained by ever-faster money creation, the confidence in the state’s paper money will evaporate quickly.[1]

The United States began its monetary history under bimetallism, a monetary policy recognizing both silver and gold as money.  Indeed, gold was the advent, as silver was considered the “ancient money.”[2]  Gold- rarer and more valuable- ultimately came to prominence. But all this changed under President Roosevelt:

In 1933, the U.S. Congress passed the Joint Resolution of June 5, 1933 that abolished all gold clauses in all public and private contracts. This meant that contracts could not require payment in gold. The Gold Reserve Act of 1934 went further, withdrawing all gold coin from circulation to be formed into gold bars. Even the Treasury could not hold gold coin unless it was in the form of gold bullion.  The Gold Reserve Act was intended to “abolish[] gold coin as a component of our monetary system.” Gold was thereafter not money, but rather a commodity. The public could not get gold in the United States. Coin collectors were able to hold gold coins but only those of numismatic value.

Gold remained in circulation for international transactions involving the federal government until 1971 when the U.S. government ceased supplying gold to foreign central banks. In short, hard currency no longer exists in the U.S. monetary system except in the form of coinage. The U.S. government systematically, from 1933 to 1971, obliterated any notion of a value standard by refusing to permit the conversion of its paper money into gold and forcing the acceptance of its inferior paper currency. By putting an end to redeemability, policymakers eliminated an effective means for imposing discipline on government-issued money. The way was opened to abuse on a grand scale.[3]

The merits of returning to a commodity-backed currency has been discussed for decades:

[U]sing present-day terminology, gold was the principal international reserve asset, although after the Great War the increasing use of foreign exchange as reserves led the variant of the gold standard in operation from 1925 to 1933 to be called a “gold exchange” standard. However, the essential element in the international gold standard — and this is a crucial point in contemporary discussions of a return to the gold standard — was that there was a close link between the domestic money supply in each country and its gold holdings. It was an “essential element of the classical gold standard… that the money supply must be limited by the gold reserves and a change in the gold reserves should be followed by a change in monetary policy.”  In part this link was reflected in “gold cover requirements,” such as the provision of United States law specifying the value of gold that had to “back” issuances of currency. More fundamental were the institutional arrangements in each country causing increased or decreased public gold holdings to lead respectively to a larger or smaller money supply.[4]


[1] Detlev S. Schlichter, Forty Years of Paper Money: Fiat currencies always end in hyperinflation and economic collapse. http://online.wsj.com/article/SB10001424053111903918104576500811399421094.html?mod=googlenews_wsj (August 15, 2011).

[2] For a fascinating discussion on this topic, see: Ali Khan, The Evolution of Money: A Story of Constitutional Nullifcation, 67 U. Cin. L. Rev. 393 at 402-403 (1993).

[3] Lewis D. Solomon, Local Currency: A Legal and Policy Analysis, 5 Kan. J.L. & Pub. Pol’y 59 at 64 (1996) [citations omitted].

[4] Kenneth W. Dam, From the Gold Clause Cases to the Gold Commission: A Half Century of American Monetary Law, 50 U. Chi. L. Rev. 504 at 508 (1983) [citations omitted].

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