By
Christopher M. Quigley B.Sc., M.A., QFA
This article is a summary of work by Professor Antal. E Fekete, Professor Heinrich Rittershausen and Ferdinand Lips.
Summary
The World's developing financial crisis is totally inter-connected with a crisis of monetary theory and until we change how money works we will change nothing. What is required is a return to a solid monetary standard that is also a return to a more moral standard, which protects real work and long-term monetary value.
Most students of economics today do not realise the true implications of our current money system being based on "paper" i.e."legal tender". These students know nothing of the inherently inflationary nature of this system and do not realise there is an alternative such as the gold standard with a real bills clearing and exchange mechanism.
The existing legal tender arrangement is a compulsory paper system. It replaced the old gold standard that had developed internationally over thousands of years. Under this framework gold coins were value money and gold backed paper was accessory. All this changed around 1909 that fateful year when France and Germany, in preparation for the coming war, decided to concentrate monetary gold in their own coffers. They stopped paying civil servants in gold coins. In order to make this legally possible they declared banknotes "legal tender". Thus governments started sabotaging the gold standard cum real bills system. The effect was fatal. Finance and treasury bills gradually "crowded out" real bills from the portfolios of central banks. Thus fake financial paper assets replaced real manufacturing/consumer asset bills in the balance sheets of major banks.
How exactly did the old system work? The transition from the barter economy of the Middle Ages, when workers were journeymen who were fed at their masters' table, to the modern factory system with workers on wage rates, raised a problem unsolvable by real bill circulation. Wages had to be paid immediately but could not be paid in actual bills because the bills usually bore large unsuitable amounts. How was this problem solved? Well to use the expression of an intelligent farmer, the banks exchanged the large bills backed by goods for "chopped up" bills. The banks accepted from their customers their bills of trade and returned to them typified and guaranteed "chopped" pieces to the same amount (ignoring discounting). These chopped bills; these "banknotes", were also usable in small transactions and for wage payments. When the large bills became due the trader paid in gold coins; the proceeds were thus used to clear off the loaned "chopped" balances. Thus we can see that the coins were used as a clearing function in the banking system. The circulation of the real bills, that is short-term liquidating credit, greatly facilitated trade. The then functioning gold standard pre-supposed the ebb and flow of bills of credit, which facilitated the journey of goods from producer to con- sumer. A rigid 100% gold standard is a pipe dream, it has never existed. If one were put in place it would collapse during the first Christmas season.
By its nature even though this gold standard had a flow of credit it had a natural restraint which does not exist under the paper tender mechanism. Under the rules of automatism the business community that was guilty of over-creation of paper money would be penalised with a loss of gold. Gold would start to flow out of the business community leading to a tightening of money supply and causing a rise in price until the rules of balanced budgets and sound finance were observed again. Gold acted as a natural curb and there was no need for central banks.
Under the legal tender paper system there are no automatic constraints in the amount of money that can be issued. More paper means more inflation thus is explained the contemporary curse of spiralling modern inflation. A modern industrial society cannot be maintained without a sound accounting unit with which to calculate long-term depreciating schedules and set long-term contracts of all kinds. In particular a society needs to be able to adequately record savings, life insurance policies and pension funds in real rather than fictitious values. The tremendous capital investments required for a modern industrial nation cannot be maintained, replaced and renewed without correct instead of false accounting. Management in terms of constantly inflating paper tender units has become a moving fiction incapable of providing "value" information essential to the operation of large-scale and long-lasting enterprises. In essence a solid money system is also a solid moral standard protecting and defining real value in real independent units.
Ideally any money should perform 3 functions:
1. As a means for clearing and payment
2. As a means of transfer of claims and debts
3. As a means to measure and maintain a value unit in the long-term.
Now many would contend that legal tender performs the first two functions adequately but when we truthfully consider the third function, that of storing value, we must surely admit that as a system legal tender it is fatally flawed. This observation is proved by the fact that since the introduction of the Federal Reserve in the U.S. in 1913 the dollar has lost over 90% of its purchasing value. For pension funds this situation is terminal for when long bonds reach maturity their nominal "unit" value is repaid by the borrower, normally the Government. However the real purchasing value being repaid is marginal due to destructive reality of paper inflation. In the long-term this situation leads to the ruin of "assets" held for pensioners and retirees and ultimately undermines the very economic basis of a nation.
To prevent the problem of continuous rampant inflation under legal tender paper the central banks including the ECB and The U.S. Fed should allow discussion on the possibility of a negotiated currency devaluation coupled with a return to a modern gold standard that facilitates international world trade. But what exactly is the benefit of a gold standard? A gold standard is a mechanism whereby people exercise their God-given right to create or extinguish money, while denying the monopoly power of money creation to national and international governments. The individual, if he or she thinks money is scarce, or the rate of interest is too high, can do something about it. She can take old jewellery or newly minted gold to the mint and convert it into the coin of the realm free of charge. Conversely if the individual thinks that money is too plentiful, or the rate of interest is too low, he can melt down coins or export them. In this way a freely operating gold standard can guarantee the lowest level for the rate of interest. Of course such a system should be operated in tandem with a real bills exchange mechanism as explained earlier. This system allows the free market to set the rate of interest. But most significantly under its order there is no bond market for the simple reason that there is no sufficient volatility in the price of a gold bond to make speculation profitable.
Apart from removing free market control of interest rates, the destruction
of the gold standard had a disastrous effect on worldwide employment. The unprecedented unemployment that started in the 1930's and which is still very much with us but for the fig leaf of the welfare state (that pays workers not to work and farmers not to farm) was a delayed consequence of the legal tender legislation of 1909. Since the wage fund of the workers in the consumer goods sector was financed by the bill market, and no other way of financing it was available, massive unemployment threatened the globe. This event had been foreseen by German economist Heinrich Rittershausen. His prediction came true in the 1930's when up to half of the work force was idled. Economists failed to diagnose the problem correctly and America tried to solve the problem with "New Deal Socialism". Conditions for full employment in the world will not return until the wage fund has been re-established through the rehabilitation of a new gold standard cum real bills; however researching the question is forbidden. Young economists are brainwashed by the Keynesian and Friedmanite orthodoxy into thinking that the regime of irredeemable currency represents a great advance over "obsolete" metallic monetary standards.
Obstacles in the way of monetary education are enormous. A case in point is to realise the fact that the global clearinghouse for the system of irredeemable currency is a private company called the Deposit Trust and Clearing Corporation (DTCC). Its shares are closely held by multinational banks and financial institutes. DTCC's turnover in 2004 exceeded 1000 trillion dollars. More than half of this amount was generated by trade in government securities and foreign exchange derivatives. In comparison the combined GNP of all nations was a paltry 40 trillion dollars. In other words two weeks' turnover was all it took to clear transactions generated by the production and distribution of all the goods and services deemed necessary to keep the whole world fed, transported, clothed and sheltered for the entire year. The other fifty weeks' turnover was pure froth and speculation. This speculation is disengaged from the real world of most peoples lives yet controls the cost and value of money. It is made possible because the legal tender mechanism has created such an enormous quantity of tender that it constantly circles the globe looking for returns yet achieves no real economic action other than a speculative gain or loss. This derivative monster undermines the real economy and because it is growing exponentially each year it has prompted such luminaries as Mr. Warren Buffet to state that it is an aspect of the current financial structure that could cause a global financial crisis of incalculable magnitude. Many believe the time is now to start looking for the solution that will inevitably be required to fix the problem. The issue is not "if" the storm will arrive but "when".
Published In Financial Sense Online 2007
Sources:
1. Prof. Antal E. Fekete, Professor Emeritus,
Memorial University of Newfoundland.
www.goldisfreedom.com
2. Prof. Heinrich Rittershausen,
Monetary Theory, Version V.
Translated by T. Magelli, assisted by John Zube.
3. Ferdinand Lips
Gold Wars
www.fame.org, New York, NY, USA.