Thomas Paine, Champion of Sound Money The Foundation for Economic Education

Between writing his well-known revolutionary liberal tracts Common Sense (1776) and The Rights of Man(1791), Thomas Paine contributed knowledgeably to a 1785-6 debate over money and banking in Pennsylvania. Paine defended the Bank of North America’s charter and its operations in a number of lengthy letters to Philadelphia newspapers during 1786, followed by a December monograph that summarized his case, Dissertations on Government; The Affairs of the Bank; and Paper Money.[1]

“The natural effect of increasing and continuing to increase paper currencies is that of banishing the real money.” Paine argued that to repeal the bank’s charter violated both the rule of law and the maxims of sound economic policy. His writings show that he well understood the benefits of banking. Although proponents of the repeal accused Paine, publicly known to be in dire financial shape, of being paid by the BNA’s proprietors for defending it (one called him “an unprincipled author, who lets his pen out for hire”), Paine vociferously denied the charge, and historians (such as Philip S. Foner, who edited an anthology of Paine’s works), have found no evidence to support the accusation.

Prima facie evidence for Paine’s sincerity is found in his marshalling of serious arguments that were consistent with the classical liberal principles of his earlier writings.

Here’s the backstory: The Continental Congress chartered the Bank of North America, headquartered in Philadelphia and headed by Robert Morris and Thomas Willing in 1781. Considering a Commonwealth of Pennsylvania charter to be a sounder authorization, in 1782 the bank sought and received a charter from the Pennsylvania legislature. After the Revolutionary War’s end in 1783, as historian Janet Wilson noted, farmers in western Pennsylvania with large debts and tax arrears “set up a cry for paper money” to be issued by the Commonwealth.[2] These state-issued notes would not be presently redeemable, but would be receivable for future tax payments.

The clamor for irredeemable paper money, he wrote, derived from “delusion and bubble.” The inflationists understandably saw the BNA as a barrier to their plan. If the bank valued the state paper below its par value, while BNA banknotes and checks traded at par in terms of the silver dollars for which they could be immediately redeemed, real demand for the state paper currency would be low. Better for the sake of state paper to eliminate the superior alternative. Hence, with the legislature voting to authorize an issue of state notes in mid-1785, the inflationists demanded repeal of the bank’s charter.

They were further motivated by the bank proprietors’ public opposition to state paper. The legislature debated and then repealed the charter in September 1785. The BNA continued to do business, on a smaller scale, under its 1781 charter from the Continental Congress. (The 1st US Congress would not meet until March 1789.) Eighteen months after repeal, in March 1787, following a pitched public discussion and the election of pro-bank legislators in fall 1786, the charter was restored.

The clamor for irredeemable paper money, wrote Paine in 1786, derived from “delusion and bubble.”[3]Yes, the irredeemable paper currency issued during the war as a matter of necessity had provided revenue “while it lasted,” but not as a free lunch, but rather by taxing individual money-holders through price inflation and currency depreciation. Since its demise, “gold and silver are become the currency of the country.”[4] Those thinking that state paper will relieve a “shortage” of specie have it backwards: it is precisely the issue of irredeemable paper that drives out gold and silver. On this point Paine argued with impeccable Humean logic:

The pretense for paper money has been, that there was not a sufficiency of gold and silver. This, so far from being a reason for paper emissions, is a reason against them. As gold and silver are not the productions of North America, they are, therefore, articles of importation; and if we set up a paper manufactory of money it amounts, as far as it is able, to prevent the importation of hard money, or to send it out again as fast it comes in; and by following this practice we shall continually banish the specie, till we have none left, and be continually complaining of the grievance instead of remedying the cause. Considering gold and silver as articles of importation, there will in time, unless we prevent it by paper emissions, be as much in the country as the occasions of it require, for the same reasons there are as much of other imported articles.[5]

Critic of Monetary Stimulus

Paine understood that any stimulus from injecting money was only temporary, because issuing more paper money does not create any more wealth. He even offered the binge drinking / hangover analogy that has, in modern times, become commonplace:

Paper money is like dramdrinking, it relieves for a moment by deceitful sensation, but gradually diminishes the natural heat, and leaves the body worse than it found it. Were not this the case, and could money be made of paper at pleasure, every sovereign in Europe would be as rich as he pleased. But the truth is, that it is a bubble and the attempt vanity.[6]

State paper money became not just imprudent but unjust when it was combined with a legal tender law compelling the acceptance of depreciated paper dollars where a contract called for payment in silver or gold dollars:

As to the assumed authority of any assembly in making paper money, or paper of any kind, a legal tender, or in other language, a compulsive payment, it is a most presumptuous attempt at arbitrary power. … [A]ll tender laws are tyrannical and unjust, and calculated to support fraud and oppression.[7]

For a legislator even to propose such a tyranny should be a capital crime [!]:

The laws of a country ought to be the standard of equity, and calculated to impress on the minds of the people the moral as well as the legal obligations of reciprocal justice. But tender laws, of any kind, operate to destroy morality, and to dissolve, by the pretense of law, what ought to be the principle of law to support, reciprocal justice between man and man: and the punishment of a member who should move for such a law ought to be death.[8]

Responding to an anti-BNA petition, which claimed that “the said bank has a direct tendency to banish a great part of the specie from the country, so as to produce a scarcity of money, and to collect into the hands of the stockholders of the said bank, almost the whole of the money which remains amongst us,” [387-8 n] Paine argued that the issue of immediately gold-redeemable banknotes gives a commercial bank like the BNA a strong reason to retain sufficient gold reserves:

Specie may be called the stock in trade of the bank, it is therefore its interest to prevent it from wandering out of the country, and to keep a constant standing supply to be ready for all domestic occasions and demands. … While the bank is the general depository of cash, no great sums can be obtained without getting it from thence, and as it is evidently prejudicial to its interest to advance money to be sent abroad, because in this case the money cannot by circulation return again, the bank, therefore, is interested in preventing what the committee would have it suspected of promoting. It is to prevent the exportation of cash, and to retain it in the country, that the bank has, on several occasions, stopped the discounting notes till the danger had been passed.[9]

Here Paine failed to add that the public’s voluntary substitution of banknotes for specie, although it does not banish any specie that is still wanted, does allow the payment system to conduct a given volume of payments more economically, with less specie. The ability to export the share of specie thus rendered redundant, in exchange for productive machines and material inputs, was a growth-enhancing benefit of banking that Adam Smith had emphasized in The Wealth of Nations published ten years earlier.

In response to the claim that the bank “will collect into the hands of the stockholders” the specie remaining in the country, Paine explained that a bank’s specie reserves are not the net worth owned by its shareholders. Rather the reserves are held to redeem its liabilities, and thus are “the property of every man who holds a bank note, or deposits cash there,” or otherwise has a claim on the bank.

The Bank of North America at the time held the first and as yet only bank charter granted by the legislature of Pennsylvania. Critics damned the BNA as a privileged monopoly. Legislator John Smiley asserted that the charter repeal “secured the natural rights of the people from invasion by monopolies.” This view – later echoed by the Jeffersonians and Jacksonians in their opposition to the First and Second Bank of the United States – is of course paradoxical.

The Cure for Monopoly Power

The cure for monopoly power created by exclusive charter (incorporation) is to grant charters freely, to go from one to a multiplicity of charters. It is not to go from one to zero charters. If more banks were free to enter but simply hadn’t yet, then the BNA was a monopolist only in the benign sense that the entrepreneur who creates a new market (thus expanding and not restricting trade) is the single seller until others arrive. Eventually additional chartered banks did enter the Pennsylvania market: the (First) Bank of the United States (chartered by the US Congress) in 1791, and the Bank of Pennsylvania (state-chartered) in 1793.

In a later work criticizing the Bank of England (which did have an exclusive charter to issue banknotes as a corporation), Paine unfortunately seemed to blur the distinction between banknotes and irredeemable paper money. He made the valid point that banknotes held, unlike gold held, are not net national wealth (because they are liabilities of the issuer). Then he declared:

the rage that overran America, for paper money or paper currency, has reached to England under another name. There it was called continental money, and here it is called bank notes. But it signifies not what name it bears, if the capital is not equal to the redemption. … The natural effect of increasing and continuing to increase paper currencies is that of banishing the real money. The shadow takes place of the substance till the country is left with only shadows in its hands.[10]

To reconcile this passage with his previous writings, we must suppose that Paine is not criticizing banknotes in general, but the Bank of England in particular for holding inadequate reserves relative to its growing note-issue.

But this raises the question: Why would the BOE want to hold inadequate reserves when the BNA (as he had argued) did not? Paine might have explained this (but unfortunately did not) by Parliament’s implicit guarantee that it would not penalize the BOE for a suspension of payments, giving the Bank a moral-hazard incentive to skimp on reserves. When the Bank of England did suspend payments in 1797, forced by a run on the bank prompted by the threat of an invasion by Napoleon’s troops, Parliament did in fact immunize the Bank against note-holder lawsuits. Paine ten years ahead warned that the BOE might suspend in 1796, which was only one year off if we consider it a prediction:

A stoppage of payment at the bank is not a new thing. Smith in his “Wealth of Nations,” book ii. chap. 2, says, that in the year 1696, exchequer bills fell forty, fifty and sixty per cent; bank notes twenty per cent; and the bank stopped payment. That which happened in 1696 may happen again in 1796.[11]

To be clear, Paine anticipated trouble from the growing British public debt, not from threat of invasion. But the two were not unrelated.

The Nonexistent “Social Costs” of a Gold Standard System

Nathan Lewis via Forbes

One of the odd notions that has come down through the years is that a gold standard system has “social costs.” It does not. It creates a profit.

Of course, it does take effort to dig gold out of the ground. However, gold production never ceased after the end of the world gold standard in 1971. Roughly half of all the gold ever mined, in all of history, has been mined after 1971. Annual production today is the highest in history, and about double what it was in 1970. People seem happy to continue paying those “costs.”

If one is to use gold coins, then someone needs to pay for this gold. Who pays? Is it “everyone”? The government? Taxpayers? Who?

Let’s say an economy uses gold coins only. There is no paper money. (For simplicity, we will also assume no banks.) Someone works all week and gets a one-ounce gold coin in payment on Friday. The person has “paid” for this coin with a week’s worth of work.

Now, let’s have an economy with no gold coins, just paper banknotes linked to gold. Let’s say there’s a banknote worth one ounce of gold. (The U.S. $20 banknote, before 1933, was worth about 0.97 of an ounce of gold.) Someone works all week, and gets a banknote worth one ounce of gold in payment on Friday.

The “cost“ to the person of the gold coin and the banknote are the same. One week of work.

The government is in much the same situation. Whether its taxes are paid in coinage or in banknotes, the outcome is about the same.

The difference is at the currency issuer – the producer of the banknotes, which would be a central bank today. Let’s say that the currency issuer has a “100% reserve” system. For every banknote, there is an equivalent amount of gold in a vault.

This situation is not much different than where gold coinage was used exclusively. The amount of gold is the same.

Now, let’s say that the currency issuer has a 20% reserve, which was a typical level among private currency issuers in the U.S. during the 19th century. The other 80% of reserves consists of interest-bearing debt. Today, that would most likely be government bonds.

The amount of gold used by the monetary system has now fallen by 80%, replaced by interest-bearing bonds. The interest income from the bonds produces a profit for the currency issuer.

If you had a floating fiat paper currency, with no gold at all, the “cost” of the money would still be the same – a week’s worth of work. However, the assets of the currency issuer could be 100% interest-bearing debt.

Thus, we see that the “cost” of the money is the same in all cases – a week’s worth of work. The question is the “profit.” In a 100% bullion reserve system, there is no profit. However, with a 20% reserve system, there is quite a bit of profit. This profit accrues entirely to the currency issuer – today, a central bank.

We can also see that the profit enjoyed by the currency issuer doesn’t really change much, from a 20% bullion reserve/80% debt gold standard system and a 100%-debt system. The difference is only the 20% portion. The other 80% is identical. (In practice, today’s central banks still hold gold bullion reserves.) So, the gold standard system’s profitability is actually much the same as the floating fiat system’s profitability.

Some economists – including David Ricardo, in 1817 – have suggested ways of operating a gold standard system with no gold bullion reserves at all. The “gold exchange standards”, or currency-board systems, common in the 20th century, were one example of this. They are “100% debt” systems.

I suggest that you shouldn’t be too concerned about maximizing the profitability of central banks. They can look after it well enough themselves.

Concern yourself with the quality of the currency. For nearly two centuries, 1789 to 1971, the U.S. embraced the principle of gold-based money, and became the world’s economic superpower. Money was simple, stable, reliable and predictable. Despite short-term setbacks, the middle class grew steadily wealthier, generation after generation.

Today’s economists talk a big talk, but in the past forty-five years of floating currencies, have they ever been able to produce that kind of result? Mostly, they just bounce from one crisis to another, blowing bubbles along the way and leaving a train of wreckage in their wake. Have they learned anything? They seem to have gotten pretty good at “kicking the can”, avoiding a minor crisis with further distortions that lead to a bigger crisis later.

I think that there will eventually be a big enough crisis that people say: “Enough is enough. You’ve had your chance. Now it is time for you to go.” But before then, we will have to know what we will replace them with.

Janet Yellen And The Federal Reserve Are Losing Credibility

Peter Schiff, By Jason Shubnell

U.S. central bankers decided to maintain the FFR range at 0.25 to 0.50 basis points, keeping the discount rate at 1.00 percent.

While the Federal Reserve did see indicators of a strengthening labor market (along with projections of 4.5 percent unemployment by 2018), not all may be well. The central bank cut its 2016 GDP forecast to 2.2 percent from 2.4 percent previously, and also said global economic and financial developments pose risk for markets.

Fed Chair Janet Yellen spoke for about an hour to discuss the Fed’s outlook. However, is the Fed is losing credibility? Peter Schiff thinks so.

“The public knows that the economy is weak (that’s why Trump and Sanders are doing well),” Schiff told Benzinga in an email. “But the Fed can’t admit it and they are looking stupid as a result.”

Peter Schiff expects increasingly dovish movement as the year goes on, pushing down the dollar.

“Most economists are saying that the current pickup in Inflation must mean that the economy is improving,” Schiff said. “To reach this conclusion one must not only ignore the basics of economics but also the very many signs that the economy is currently weakening drastically… The optimistic conclusion is that wages will rise to match price increases. But that is not happening (the last payroll report showed a huge drop in weekly earnings). So what we have is rising prices and flat wages…a terrible mix for consumers.” 

Schiff said if the Fed were to raise rates in this environment, it would risk igniting a serious recession that would have huge political implications. Instead of risking this, he said, the Fed will continue to say that they want to raise, while hoping the economy will reverse course and strengthen.

“But the more likely scenario is that the Fed does nothing while promising to do something,” Schiff‘s email said. “But if the economy weakens further, they will have to officially call of future hikes, and perhaps go back to zero. They will of course have to ignore any additional signs of inflation to do so. When the market realizes that, the dollar will plunge, and non-dollar markets and gold will outperform.”

Schiff then highlighted the current decline in U.S. manufacturing would be the first time since 1952 that Industrial Production has declined for four straight months without the U.S. economy not being in recession. A worse-then-expected 0.5 percent month-over-month plunge (near the worst since 2009) led to a 1.0 percent year-over-year drop, the fourth monthly decline.

The market responded positively following the 2 p.m. ET release. The Dow closed at its highest level of 2016 at 17,325.76. The SPDR S&P 500 ETF Trust SPY spiked sharply following the announcement, closing up about 0.6 percent at $203.39.

Schiff concluded by saying Yellen’s biggest loss of credibility today was when she said “April remains a live meeting.”

“There is literally no one in the world that expects a hike in April,” Schiff said.


BONUS TRACK: World’s Second Largest Reinsurer Buys Gold, Hoards Cash To Counter Negative Interest Rates


The world’s second-largest reinsurer, German Munich Re which is roughly twice the size of Berkshire Hathaway Re, is boosting its gold reserves and buying gold in the face of the punishing negative interest rates from the European Central Bank, it announced today.

As caught by Mark O’Byrne at GoldCore and reported by Thomson Reuters this afternoon, the world’s largest reinsurer is far from alone in seeking alternative investment strategies to counter the near-zero or negative interest rates that reduce the income insurers require to pay out on policies.

Munich Re has held gold in its coffers for some time and recently added a cash sum in the two-digit million euros, Chief Executive Nikolaus von Bomhard told a news conference.

 “We are just trying it out, but you can see how serious the situation is,” von Bomhard said.

The ECB last week cut its main interest rate to zero and dropped the rate on its deposit facility to -0.4 percent from -0.3 percent, increasing the amount banks are charged to deposit funds with the central bank.

Munich Re is one of the largest reinsurance companies in the world – It oversees €231 billion in investments. A small 3% allocation to gold would equate to buying gold worth €8.19 billion. At the current spot price of €1,130 per ounce that would equate to 7.2 million ounces or 225.4 tonnes of gold bullion

The news is interesting and we believe that other institutions will follow in their footsteps and diversify into gold in order to protect themselves from negative yields. We have not heard of any other non central bank institutions diversifying into gold but it stands to reason that a small percentage will follow in Munich Res footsteps.

* * *

It isn”t just gold: the German company confirms that when rates turn negative enough, physical cash will be increasingly more valuable.

As Bloomberg reports, the German company will store at least 10 million euros ($11 million) in two currencies so it won’t have to pay for the right to access the money at short notice, von Bomhard said at a press conference in Munich on Wednesday. “We will also observe what others are doing to avoid paying negative interest rates,” he said.

Institutional investors including insurers, savings banks and pension funds are debating whether it may be worth bearing the insurance and logistics costs of holding physical cash as overnight deposit rates fall deeper below zero and negative yields dent investment returns. The ECB last week cut the rate on its deposit facility, which banks use to park excess funds, to minus 0.4 percent.

“This may well become a mass phenomenon once interest rates are low enough — the only question will be where that exact point is,” said Christoph Kaserer, a professor of finance at the Technische Universitaet in Munich. “For large institutions, that may be the case sooner rather than later. The ECB will react with countermeasures, such as limiting cash.”

As Bloomberg adds, Munich Re’s strategy, if followed by others, could undermine the ECB’s policy of imposing a sub-zero deposit rate to push down market credit costs and spur lending. Cash hoarding threatens to disrupt the transmission of that policy to the real economy.

Munich Re, which oversees a total of 231 billion euros in investments, wants to test how practical it would be to store banknotes, having already kept some of its gold in vaults, von Bomhard said. This comes at a time when consumers are increasingly using credit cards and electronic banking to pay for transactions. Deutsche Bank AG Chief Executive Officer John Cryan has predicted the disappearance of physical cash within a decade.

“This shows the difficulties that the ECB is facing in its efforts to stimulate the real economy,” said Andreas Oehler, a professor of finance at Bamberg University in Bavaria. “Charging negative rates on overnight liquidity doesn’t stimulate longer-term lending. All it does is make companies’ and institutions’ payment transactions more expensive.”

Incidentally, once the Fed’s infatuation with playing central planning doctor fizzles as the economy relapses into an accelerating downward spiral, negative rates are coming to the US next, as such the real-time experiments of how to evade a repressive monetary regime such as those conducted by the Munich Re CEO will be particularly useful to those who want to protect their assets once NIRP crosses the Atlantic.


Gold is the spectre haunting our monetary system

Via TELEGRAPH By James Rickards

For a century, elites have worked to eliminate monetary gold, both physically and ideologically.

This began in 1914, with the UK’s entry into the First World War. The Bank of England wanted to suspend convertibility of bank notes into gold. Keynes counselled wisely that the bank should not do so. Gold was finite, but credit elastic.

By staying on gold, the UK could maintain its credit, and finance the war effort. This transpired. The House of Morgan organised massive credits for the UK, and none for Germany. This finance was crucial, and sustained the UK until the US abandoned neutrality and tipped the military balance against Germany. 

Despite formal convertibility of sterling to gold, the Bank of England successfully discouraged actual conversion.

Gold sovereigns were withdrawn from circulation and turned into 400-ounce bars. This form of bullion limited gold ownership to the wealthy, and confined gold’s presence to vaults. A similar disappearance of gold as a circulating currency occurred in the US.


Gold graph

The price of gold has jumped in recent years CREDIT: LONDON METAL EXCHANGE

In 1933, US President Franklin Roosevelt issued an executive order making ownership of gold a crime. FDR relied on the Trading with the Enemy Act of 1917 as statutory authority for this edict. Since the US was not at war in 1933, the enemy was presumably the American people. 

In 1971, US President Richard Nixon ended convertibility of US dollars into gold by trading partners of the US. Closing the gold window was said by Nixon to be temporary. Forty-five years later the window is still closed. 

In 1973, the G7 nations, and the IMF demonetised gold. IMF members were no longer required to hold gold reserves. Gold was now just another commodity. The view of the monetary elites was that gold was dead. 

Yet, like Banquo’s ghost, gold insists on its seat at the monetary table. The US holds 8,133 tonnes of gold. The members of the eurozone and ECB hold 10,788 tonnes.  China reports holdings of 1,788 tonnes, but actual holdings are closer to 4,000 tonnes, based on reliable data from Hong Kong exports and Chinese mining.

Russia has 1,447 tonnes, and has been acquiring over 200 tonnes per year. Mexico, Kazakhstan, and Vietnam, among other nations, have added to their gold reserves recently. (Pity the UK, which sold more than half its gold at rock- bottom prices between 1999 and 2002). 

After decades as net sellers of gold, central banks became net buyers in 2010. A scramble for gold has begun. 

What drives gold’s new allure? In some cases, central banks are constructing a hedge against US dollar inflation.

China has $3.2 trillion in reserves, over half of which is denominated in US dollars, mostly US Treasury notes. The dollar has no greater friend than China because its wealth is held in dollars. Still, inflation looms. China cannot dump its Treasury notes; the Treasury market is deep, but not that deep.

If Chinese selling of Treasuries became a threat to US interests, a US president could freeze Chinese accounts with a phone call. 

The Chinese know this. They are stuck with their dollars. They fear, rightly, that the US will inflate its way out of its $19 trillion mountain of debt.

China’s solution is to buy gold. If dollar inflation emerges, China’s Treasury holdings will devalue, but the dollar price of its gold will soar. A large gold reserve is a prudent diversification.  Russia’s motives are geopolitical. Gold is the model 21st century weapon for financial wars.

The US controls dollar payments systems and, with help from European allies, can eject adversaries from the international payments system called Swift. Gold is immune to such assaults. Physical gold in your custody cannot be hacked, erased, or frozen. Moving gold is a simple way for Russia to settle accounts without US interference.

Countries are also acquiring gold in advance of a collapse of the international monetary system. The system has collapsed three times in the past century. Each time, major financial powers came together to write new rules.

This happened at Genoa in 1922, Bretton Woods in 1944, and the Smithsonian Institution in 1971.  The international monetary system has a shelf life of about 30 years.

It has been 30 years since the Louvre Accord (an upgrade to the Smithsonian Agreement). This does not mean the system will collapse tomorrow, but no one should be surprised if it does. When the financial powers next convene to reform the system, there will be no appetite for the dollar’s exorbitant privilege.

The Chinese yuan and Russia ruble are not true reserve currencies. The only feasible benchmarks for a new system are the IMF’s world money, called special drawing rights, and gold. 

Critics claim there is not enough gold to support the financial system. That’s nonsense. There is always enough gold, it’s just a matter of price.

Based on the M1 money supplies of China, the eurozone, and the US, and with 40pc gold backing, the implied non-deflationary price of gold is $10,000 per ounce.

At that price, a stable gold-backed monetary system could be sustained.  When it comes to monetary elites, watch what they do, not what they say.

While elites disparage gold at every opportunity, they are buying it, hoarding it, and preparing for the day when one’s gold determines one’s seat at the table of systemic reform.

It’s past time to claim your seat with an asset allocation to physical gold.


Lenin and Marx: Sound Money Advocates? by Louis Rouanet (Mises Institute)

Most modern socialists are in favor of inflation, because it is supposed, in Keynes’s words, to “euthanize the rentiers.” It doesn’t mean however, that the “founding fathers” of socialism were in favor of inflation. In fact, the opposite is true. Karl Marx had a wide knowledge of the economic literature and even though he’s usually wrong, he was correct in his preference for a gold standard.

As for Lenin, he was in his writings opposed to inflation and saw paper money as a means used by the bourgeois capitalists to enrich themselves. Even though Marx and Lenin were not supporters of inflation, they supported sound money for the wrong reasons. But, at least, we can say that concerning money they did not succumb to naïve inflationist views.

Karl Marx, Inflation, and the Gold Standard

Marx applied the labor value theory to money. According to Marx, the use of a particular commodity like gold or silver for money rests on the fact that — like all other commodities — there is an amount of “socially necessary labor” required to produce it. If, for example, one ounce of gold requires ten hours’ labor, its value is equal to another product requiring ten hours’ labor. Marx’s labor theory led him to say that “Although gold and silver are not by nature money, money is by nature gold and silver …”

What Marx put forward was that the total value of needed currency represented a total amount of labor value, and therefore a total weight of gold. According to Marx, if the total of gold is replaced by inconvertible paper money and the paper money is then issued in excess, prices will go up:

If the paper money is in excess, if there is more of it than represents the amount of gold coins of like denomination which could actually be current, it will (apart from the danger of falling into general disrepute) represent only that quantity of gold, which, in accordance with the laws of circulation of commodities, is really required and is alone capable of being represented by paper. If the quantity of paper money issued is, for instance, double what it ought to be, then in actual fact one pound has become the money name of about one-eighth of an ounce of gold instead of about one-quarter of an ounce. The effect is the same as if an alteration had taken place in the function of gold as a standard of prices. The values previously expressed by the price £1 will now be expressed by the price £2.

Therefore, Marx opposed the use of inflation as a means for increasing production. However, Marx’s monetary theory is very confusing. Concerning money, Karl Marx owes nothing to Ricardo. He was influenced by Tooke and the Banking school while he was very critical of the Currency school. Furthermore, Marx was fiercely opposed to Peel’s Act of 1844 which forbade notes unbacked by metallic money. Oddly enough however, Marx was criticizing fiduciary credit as being “fictitious capital” which seems to be in contradiction with his opposition to Peel’s Act.

We must keep in mind, however, that the main difference between Marx and other economists is that Marx was simply trying to describe how capitalism operates, with or without inflation. He was not saying that inflation will improve or destroy capitalism. In Marx’s view, capitalism is inevitably unstable and doomed. For him, workers must abolish capitalism and replace it with socialism, in which there are no problems of prices, inflation, crises, and unemployment.

Lenin, the Bolsheviks, and Inflation

The following quote is often attributed to Lenin: “The best way to destroy the Capitalist System is to debauch the currency.” This supposed statement has circulated widely among economists and the public. Hellwig remarked that: “It is almost a ritual, on the occasion of the required tributes to a stable monetary standard, to quote Lenin as a bogeyman.”[1] The problem is that this quote has never been found in Lenin’s works. The first attribution of this statement was made by J.M. Keynes in his book The Economic Consequences of the Peace (1919). No one at the time challenged what Keynes was attributing to Lenin, and even today, this quote is still used by some sound-money advocates. However, Lenin’s few remarks on monetary matters give the opposite impression from the remark attributed to him by Keynes. In September 1917, before the Bolsheviks overthrew the government in power, Lenin wrote an article on “The Threatening Catastrophe” where he speaks about money and banking. Of inflation he said:

Everybody recognizes that the issue of paper money is the worst kind of a compulsory loan, that it worsens the conditions principally of the workers, of the poorest section of the population, that it is the chief evil in the financial confusion. … The unlimited issue of paper money encourages speculation, allows the capitalists to make millions, and places tremendous obstacles in the path of the much-needed expansion of production; for the dearth of materials, machines, etc., grows and progresses by leaps and bounds. How can matters be improved when the riches acquired by the rich are being concealed?

This paragraph could have been written by an Austrian economist, and it is known that the Marxist tradition is sometimes close to the Austrian analysis concerning business cycles (see Huerta de Soto’s Money, Bank Credit and Economic Cycles). Like Lenin, we believe that inflation can foster income inequality, hamper economic growth, impoverish the poor, and cause asset inflation.

However, once they were in power, the Bolsheviks were responsible for hyperinflation. In Socialism, Ludwig von Mises wrote:

The Bolshevists, with their inimitable gift for rationalizing their resentments and interpreting defeats as victories, have represented their financial policy as an effort to abolish Capitalism by destroying the institution of money.

Mises is right, but he forgot to say that political opportunism and not ideology was the reason why communists used inflation. Basically, for the communists, inflation is wrong when communists are not running things, but it is all right when they are in control. Professor E.H. Carr wrote:

None of the Bolsheviks wanted, or planned, inflation. But, when that happened (since the printing press was their main source of revenue) they rationalized it ex post facto by describing it as (a) death to the capitalists and (b) a foretaste of the moneyless Communist Society. Talk of this kind was widely current in Moscow in 1919 and 1920. … Keynes in 1919 had no special knowledge of Lenin; everything that came out of Moscow was automatically attributed to Lenin or Trotsky, or both.

Hayek wrote once that as long as it remains theoretical, socialism is internationalist, but when it is put into practice, it becomes violently nationalist. We should also say: as long as it remains theoretical, Marxism is anti-inflationist, but when it is put into practice, it becomes violently inflationist.

8 Reasons to Take a New Shine to Gold (K. Tan, Barrons)

The formerly precious metal is in a slump, but could top $2000 over the next decade with Asia’s boom.

Gold should be ashamed of calling itself a precious metal these days. Since it peaked near $1,889 a troy ounce in August 2011, the price of gold has fallen almost 40% into a perennial bear market. This year alone, gold has underperformed stocks in China, Japan, Hong Kong, Taiwan, Korea, Australia, the U.S., Russia, Switzerland, Italy, Portugal, Ireland, Germany, Poland and Israel; government bonds of countries from China to Russia; the dollar, Swiss Francs, Picassos, Warhols, Rothkos, Manhattan real estate, cocoa, eggs, cotton, silver and – gasp – even lead! Like frankincense and myrrh, gold has been relegated to the heap of has-beens, overlooked by fast money chasing momentarily hotter assets.

So why is now the time to take a new shine to the old metal? Let us count the ways:

1) Once a hedge against market turmoil and inflation, gold has lost its calling in a world where stocks keep rising and inflation stays maddeningly meek. But Asia’s surging stock markets represent the last big reflation trade – where money managers snap up risky assets in anticipation of central bank easing, and which had paid off in markets including the U.S., Europe, Japan and China. But this popular playbook is now running out of pages, and if the volatility that has lately plagued currencies and bonds starts spilling over into stocks, then watch out.

2) Stocks have been a big – and logical – beneficiary of the trillions printed by global central banks, but valuations cannot climb indefinitely. How many indexes across the planet are already pushing record highs, even while economic growth remains middling? The MSCI World Index, for instance, already commands a price nearly 18.6 times what its components earned, while the Russell 2000 index of small U.S. stocks fetched 44 times.

3) While gold has gone nowhere over the past four years, the formerly precious metal seems to have found a floor near $1,200, with buyers stepping in each time prices slide below this threshold.

In addition, gold is a famously expensive metal to mine, and producers are unlikely to increase new supply until gold prices rally well above $1,200. All this helps limits the downside risk of adding gold at current levels, near $1,174.

4) Rising wages and purchasing power across Asia will improve the demand for gold, especially in tightly-regulated economies with under-developed financial systems where gold is still a store of wealth.

ANZ chief economist Warren Hogan and commodity strategist Victor Thianpiriya reckon that average gold demand amounts to just 0.70 grams per person among Asia’s emerging economies – half the per capita consumption of more developed countries. “Per capita gold demand in emerging economies of the Asia 10 has the potential to double as these countries become richer and more industrialized,” wrote Hogan and Thianpiriya, who expect gold demand among individuals and institutions to reach 5,000 tonnes per year by 2030, up from 2,500 tonnes recently. They see gold prices rising gradually and breaking through the $2,000 level within the next decade.


5) Central banks, especially those in emerging economies, will need to stockpile more gold to shore up confidence in their liberalized exchange rates. “If all central banks in the world were to hold at least 5% of their foreign exchange reserves as gold, this would require the purchase of almost 8,000 tonnes of gold,” argued Hogan and Thianpiriya. Emerging market central banks should remain net buyers of gold to bring their allocations more in line with developed countries’ – to the tune of about 75 tonnes a year, they added.

China, in particular, not only wants to establish the yuan as a global reserve currency, it wants to build Shanghai into a global hub for gold trading. Having supplanted South Africa as the biggest gold-producing nation, China is also the biggest importer of gold. Yet its share of global gold trading is still modest. Don’t be surprised if China’s central bank is buying up the country’s own domestic production, while also amassing gold from abroad.

6) Already, sentiment toward gold couldn’t get much worse. Once upon a time, gold bugs were as loud and as legion as Benedict Cumberbatch’s teenage fans. But Barron’s latest “Big Money Poll” showed a whopping 71% of money managers who said they’ve become bearish about gold, while the huddle of bulls shrank to just 29%.

Meanwhile, Newmont Mining ( NEM ), which mines the unloved and allegedly precious metal, quietly became the fourth best performing stock in the Standard & Poor’s 500, and has shimmied up 41% this year.

7) Of course, rising U.S. interest rates threatens to siphon money from assets including gold. But the prospect of rising real rates has become one of the longest drum rolls heard in the financial markets, and may already be amply factored into current prices.

Nearly 83% of the planet’s stock market cap recently is supported by zero interest rate policies, and more than half of all global government bonds still yield less than 1%, according to BofA Merrill Lynch. Even if U.S. rates were to climb spiritedly – a big “if” given the fragile state of global growth – rates from Europe to Japan won’t necessarily join the party.

8) Central bank largesse, quite arguably, has become the biggest driver of asset prices in recent years, but the bill for all this wanton money-printing will one day come due. Either central banks will eventually succeed in inflating prices, or the surplus liquidity and leverage will suck money from the economy’s productive sectors into its more speculative fads, and central banks will then have to wean us from the lavish stimuli. In either scenarios, gold benefits. And when that happens, some of what glitters just might be gold.