Gold and Economic Freedom

                    by Alan Greenspan

Published in Ayn Rand's "Objectivist" newsletter in 1966, and reprinted 
in her book, Capitalism: The Unknown Ideal, in 1967.

An almost hysterical antagonism toward the gold standard is one issue 
which unites statists of all persuasions. They seem to sense, perhaps 
more clearly and subtly than many consistent defenders of laissez-faire, 
that gold and economic freedom are inseparable, that the gold standard 
is an instrument of laissez-faire and that each implies and requires the 

In order to understand the source of their antagonism, it is necessary 
first to understand the specific role of gold in a free society.

Money is the common denominator of all economic transactions. It is that 
commodity which serves as a medium of exchange, is universally 
acceptable to all participants in an exchange economy as payment for 
their goods or services, and can, therefore, be used as a standard of 
market value and as a store of value, i.e., as a means of saving.

The existence of such a commodity is a precondition of a division of 
labor economy. If men did not have some commodity of objective value 
which was generally acceptable as money, they would have to resort to 
primitive barter or be forced to live on self-sufficient farms and forgo 
the inestimable advantages of specialization. If men had no means to 
store value, i.e., to save, neither long-range planning nor exchange 
would be possible.

What medium of exchange will be acceptable to all participants in an 
economy is not determined arbitrarily. First, the medium of exchange 
should be durable. In a primitive society of meager wealth, wheat might 
be sufficiently durable to serve as a medium, since all exchanges would 
occur only during and immediately after the harvest, leaving no 
value-surplus to store. But where store-of-value considerations are 
important, as they are in richer, more civilized societies, the medium 
of exchange must be a durable commodity, usually a metal. A metal is 
generally chosen because it is homogeneous and divisible: every unit is 
the same as every other and it can be blended or formed in any quantity. 
Precious jewels, for example, are neither homogeneous nor divisible. 
More important, the commodity chosen as a medium must be a luxury. Human 
desires for luxuries are unlimited and, therefore, luxury goods are 
always in demand and will always be acceptable. Wheat is a luxury in 
underfed civilizations, but not in a prosperous society. Cigarettes 
ordinarily would not serve as money, but they did in post-World War II 
Europe where they were considered a luxury. The term "luxury good" 
implies scarcity and high unit value. Having a high unit value, such a 
good is easily portable; for instance, an ounce of gold is worth a 
half-ton of pig iron.

In the early stages of a developing money economy, several media of 
exchange might be used, since a wide variety of commodities would 
fulfill the foregoing conditions. However, one of the commodities will 
gradually displace all others, by being more widely acceptable. 
Preferences on what to hold as a store of value will shift to the most 
widely acceptable commodity, which, in turn, will make it still more 
acceptable. The shift is progressive until that commodity becomes the 
sole medium of exchange. The use of a single medium is highly 
advantageous for the same reasons that a money economy is superior to a 
barter economy: it makes exchanges possible on an incalculably wider 

Whether the single medium is gold, silver, seashells, cattle, or tobacco 
is optional, depending on the context and development of a given 
economy. In fact, all have been employed, at various times, as media of 
exchange. Even in the present century, two major commodities, gold and 
silver, have been used as international media of exchange, with gold 
becoming the predominant one. Gold, having both artistic and functional 
uses and being relatively scarce, has significant advantages over all 
other media of exchange. Since the beginning of World War I, it has been 
virtually the sole international standard of exchange. If all goods and 
services were to be paid for in gold, large payments would be difficult 
to execute and this would tend to limit the extent of a society's 
divisions of labor and specialization. Thus a logical extension of the 
creation of a medium of exchange is the development of a banking system 
and credit instruments (bank notes and deposits) which act as a 
substitute for, but are convertible into, gold.

A free banking system based on gold is able to extend credit and thus to 
create bank notes (currency) and deposits, according to the production 
requirements of the economy. Individual owners of gold are induced, by 
payments of interest, to deposit their gold in a bank (against which 
they can draw checks). But since it is rarely the case that all 
depositors want to withdraw all their gold at the same time, the banker 
need keep only a fraction of his total deposits in gold as reserves. 
This enables the banker to loan out more than the amount of his gold 
deposits (which means that he holds claims to gold rather than gold as 
security of his deposits). But the amount of loans which he can afford 
to make is not arbitrary: he has to gauge it in relation to his reserves 
and to the status of his investments.

When banks loan money to finance productive and profitable endeavors, 
the loans are paid off rapidly and bank credit continues to be generally 
available. But when the business ventures financed by bank credit are 
less profitable and slow to pay off, bankers soon find that their loans 
outstanding are excessive relative to their gold reserves, and they 
begin to curtail new lending, usually by charging higher interest rates. 
This tends to restrict the financing of new ventures and requires the 
existing borrowers to improve their profitability before they can obtain 
credit for further expansion. Thus, under the gold standard, a free 
banking system stands as the protector of an economy's stability and 
balanced growth. When gold is accepted as the medium of exchange by most 
or all nations, an unhampered free international gold standard serves to 
foster a world-wide division of labor and the broadest international 
trade. Even though the units of exchange (the dollar, the pound, the 
franc, etc.) differ from country to country, when all are defined in 
terms of gold the economies of the different countries act as one, so 
long as there are no restraints on trade or on the movement of capital. 
Credit, interest rates, and prices tend to follow similar patterns in 
all countries. For example, if banks in one country extend credit too 
liberally, interest rates in that country will tend to fall, inducing 
depositors to shift their gold to higher-interest paying banks in other 
countries. This will immediately cause a shortage of bank reserves in 
the "easy money" country, inducing tighter credit standards and a return 
to competitively higher interest rates again.

A fully free banking system and fully consistent gold standard have not 
as yet been achieved. But prior to World War I, the banking system in 
the United States (and in most of the world) was based on gold and even 
though governments intervened occasionally, banking was more free than 
controlled. Periodically, as a result of overly rapid credit expansion, 
banks became loaned up to the limit of their gold reserves, interest 
rates rose sharply, new credit was cut off, and the economy went into a 
sharp, but short-lived recession. (Compared with the depressions of 1920 
and 1932, the pre-World War I business declines were mild indeed.) It 
was limited gold reserves that stopped the unbalanced expansions of 
business activity, before they could develop into the post-World War I 
type of disaster. The readjustment periods were short and the economies 
quickly reestablished a sound basis to resume expansion.

But the process of cure was misdiagnosed as the disease: if shortage of 
bank reserves was causing a business decline, argued economic 
interventionists, why not find a way of supplying increased reserves to 
the banks so they never need be short! If banks can continue to loan 
money indefinitely, it was claimed, there need never be any slumps in 
business. And so the Federal Reserve System was organized in 1913. It 
consisted of twelve regional Federal Reserve banks nominally owned by 
private bankers, but in fact government sponsored, controlled, and 
supported. Credit extended by these banks is in practice (though not 
legally) backed by the taxing power of the federal government. 
Technically, we remained on the gold standard; individuals were still 
free to own gold, and gold continued to be used as bank reserves. But 
now, in addition to gold, credit extended by the Federal Reserve banks 
("paper reserves") could serve as legal tender to pay depositors.

When business in the United States underwent a mild contraction in 1927, 
the Federal Reserve created more paper reserves in the hope of 
forestalling any possible bank reserve shortage. More disastrous, 
however, was the Federal Reserve's attempt to assist Great Britain who 
had been losing gold to us because the Bank of England refused to allow 
interest rates to rise when market forces dictated (it was politically 
unpalatable). The reasoning of the authorities involved was as follows: 
if the Federal Reserve pumped excessive paper reserves into American 
banks, interest rates in the United States would fall to a level 
comparable with those in Great Britain; this would act to stop Britain's 
gold loss and avoid the political embarrassment of having to raise 
interest rates. The "Fed" succeeded; it stopped the gold loss, but it 
nearly destroyed the economies of the world, in the process. The excess 
credit which the Fed pumped into the economy spilled over into the stock 
market, triggering a fantastic speculative boom. Belatedly, Federal 
Reserve officials attempted to sop up the excess reserves and finally 
succeeded in braking the boom. But it was too late: by 1929 the 
speculative imbalances had become so overwhelming that the attempt 
precipitated a sharp retrenching and a consequent demoralizing of 
business confidence. As a result, the American economy collapsed. Great 
Britain fared even worse, and rather than absorb the full consequences 
of her previous folly, she abandoned the gold standard completely in 
1931, tearing asunder what remained of the fabric of confidence and 
inducing a world-wide series of bank failures. The world economies 
plunged into the Great Depression of the 1930's.

With a logic reminiscent of a generation earlier, statists argued that 
the gold standard was largely to blame for the credit debacle which led 
to the Great Depression. If the gold standard had not existed, they 
argued, Britain's abandonment of gold payments in 1931 would not have 
caused the failure of banks all over the world. (The irony was that 
since 1913, we had been, not on a gold standard, but on what may be 
termed "a mixed gold standard"; yet it is gold that took the blame.) But 
the opposition to the gold standard in any form, from a growing number 
of welfare-state advocates, was prompted by a much subtler insight: the 
realization that the gold standard is incompatible with chronic deficit 
spending (the hallmark of the welfare state). Stripped of its academic 
jargon, the welfare state is nothing more than a mechanism by which 
governments confiscate the wealth of the productive members of a society 
to support a wide variety of welfare schemes. A substantial part of the 
confiscation is effected by taxation. But the welfare statists were 
quick to recognize that if they wished to retain political power, the 
amount of taxation had to be limited and they had to resort to programs 
of massive deficit spending, i.e., they had to borrow money, by issuing 
government bonds, to finance welfare expenditures on a large scale.

Under a gold standard, the amount of credit that an economy can support 
is determined by the economy's tangible assets, since every credit 
instrument is ultimately a claim on some tangible asset. But government 
bonds are not backed by tangible wealth, only by the government's 
promise to pay out of future tax revenues, and cannot easily be absorbed 
by the financial markets. A large volume of new government bonds can be 
sold to the public only at progressively higher interest rates. Thus, 
government deficit spending under a gold standard is severely limited. 
The abandonment of the gold standard made it possible for the welfare 
statists to use the banking system as a means to an unlimited expansion 
of credit. They have created paper reserves in the form of government 
bonds which, through a complex series of steps, the banks accept in 
place of tangible assets and treat as if they were an actual deposit, 
i.e., as the equivalent of what was formerly a deposit of gold. The 
holder of a government bond or of a bank deposit created by paper 
reserves believes that he has a valid claim on a real asset. But the 
fact is that there are now more claims outstanding than real assets. The 
law of supply and demand is not to be conned. As the supply of money (of 
claims) increases relative to the supply of tangible assets in the 
economy, prices must eventually rise. Thus the earnings saved by the 
productive members of the society lose value in terms of goods. When the 
economy's books are finally balanced, one finds that this loss in value 
represents the goods purchased by the government for welfare or other 
purposes with the money proceeds of the government bonds financed by 
bank credit expansion.

In the absence of the gold standard, there is no way to protect savings 
from confiscation through inflation. There is no safe store of value. If 
there were, the government would have to make its holding illegal, as 
was done in the case of gold. If everyone decided, for example, to 
convert all his bank deposits to silver or copper or any other good, and 
thereafter declined to accept checks as payment for goods, bank deposits 
would lose their purchasing power and government-created bank credit 
would be worthless as a claim on goods. The financial policy of the 
welfare state requires that there be no way for the owners of wealth to 
protect themselves.

This is the shabby secret of the welfare statists' tirades against gold. 
Deficit spending is simply a scheme for the confiscation of wealth. Gold 
stands in the way of this insidious process. It stands as a protector of 
property rights. If one grasps this, one has no difficulty in 
understanding the statists' antagonism toward the gold standard.

contact: Bruce A. Peterson
3047th access Last modified: Fri 22 Jan 2016