Friday, October 20, 2017

The Case Against Gold as a Central Bank Asset

What I'm about to write here, I have believed for close to 40 years. I wrote about it decades ago in Remnant Review. I'm not going to look through all of the published issues to find when I wrote it.
What good is gold in the vaults of any central bank? I understand why it's a good idea to have bullion gold coins in your "vault." I don't understand why it's a good idea for central bankers to put gold bullion bars in their vaults.
Central banks buy gold from the general public. They also buy gold from each other. Why do central bankers buy gold? They have to pay good money for it, meaning bad central bank fiat money.
They can buy any financial asset. Why do they buy gold bullion? They never intend to sell gold to the public. So, they don't intend to make a profit on their holdings of gold. It just sits there.
Central bankers don't own the assets that the banks hold. It doesn't matter to them personally whether it's gold or government bonds.
In the era of the gold coin standard, when citizens could bring in paper money and demand gold coins from a local bank, this transferred tremendous authority into the hands of the general public. The public could participate in a run on a local bank's gold. If this took place nationally, this would cause a run on the central bank's gold. This would force the central bank to stop inflating through fiat money. That was the great advantage of the gold coin standard. It transferred power into the hands of the general public. The general public could veto central bank policies of monetary inflation.
This is why all the governments of Western Europe outlawed the gold coin standard soon after World War I began in August 1914. Commercial bank runs began almost immediately. So, central banks and governments allowed commercial banks to break their gold contracts with their depositors. Then the central banks confiscated the gold in the commercial banks. They wound up with the public's gold. It was a gigantic act of theft. It was the end of the gold coin standard. There was a huge loss of liberty.
This happened in the United States on Monday, March 6, 1933, at 1 AM. President Roosevelt unilaterally allowed the federal government to steal the public's gold at $20 an ounce. Then, when the government had a lot of the gold, Congress hiked the price to $35 an ounce, thereby enriching the federal government by 75% on the stolen gold. This was a gigantic act of theft. The public did not care. Most of the economists did not care.
The only logical case for having government ownership of gold was under a gold standard. The government had to sell its gold at a fixed price. Because the government always asserts a monopoly over the monetary system, and because the gold coin standard did allow a veto of central bank policies, there was a case -- weak -- for a central bank's vault full of gold.
It would have been far better if the governments of the world had never been allowed to exercise any control at all over the monetary systems. Money is like anything else of value. It is best managed under liberty. It is best managed by private ownership of the means of production. Government monopolies over money always lead to inflation, and the inflation creates the boom bust business cycle. But economists, other than Austrian School economists, do not believe this.
As soon as the gold coin standard is abolished, there is no further economic case for letting the government hold gold. If the public cannot veto central bank policies of monetary inflation by joining bank runs across the country, then there is no free market case in favor of the government ownership of gold. There is no free market case for the government ownership of any of the means of production.
Calling for the government ownership of gold is, in principle, the same as calling for the government ownership of the railroads, the airline industry, and the housing mortgage markets. Oh, I forgot. That is what we have today: Fannie Mae, Freddie Mac, and VA loans. The public loves it. The public loves government-subsidized mortgages. Does this come as a surprise?
Similarly, gold bugs love government-subsidized gold prices.
The argument in favor of large amounts of gold in government vaults goes back to mercantilism in the 17th century and 18th century.
Mercantilists believed that it was a good policy for the government to build up gold reserves. They believed this was a mark of the wealth of the nation. In order to build up these reserves, governments were supposed to pursue policies that would lead to more exports then imports. Mercantlists discouraged imported goods. They encouraged subsidies to exports. This would lead to an inflow of gold into the country, they argued. Then the government could tax businesses and stick more gold in the government's vault.
The great opponent of this argument was Adam Smith. Smith argued that the government should not interfere with trade. It should not subsidize exports. It should not restrict imports. It should let the free market work.
Smith argued that the basis of national wealth is the nation's economic output, not the amount of gold held in a government vault. Free trade leads to increased output. Therefore, interventionist policies that are designed to increase the amount of gold in a government vault should not be implemented. Here is a summary of Smith's position by Eamonn Butler, head of Britain's Adam Smith Institute.
The first theme in The Wealth of Nations is that regulations on commerce are ill-founded and counter-productive. The prevailing view was that gold and silver was wealth, and that countries should boost exports and resist imports in order to maximize this metal wealth. Smith’s radical insight was that a nation’s wealth is really the stream of goods and services that it creates. Today, we would call it gross national product. And the way to maximise it, he argued, was not to restrict the nation’s productive capacity, but to set it free.
Smith also said that the gold will not do the government much good. In a war, the gold would be depleted rapidly. The only way for governments to build up their own wealth is to encourage freedom of exchange. Let the economy grow. Then, if the government needs money, it taxes a growing economy instead of a stagnant or shrinking economy.
How can the government do this? By abandoning its programs of intervention.
Gold bugs still hold the mercantilist position. They think that the essence of wealth for a nation is for the national government to increase its gold holdings. They will not accept the arguments of Adam Smith. They have never read Smith. They know nothing about his arguments.
Consider this question. "Is it better for private citizens to hold a valuable asset, or is it better for the government to hold it?" Let me put it another way. "Is it better to have wealth in private hands or the government's hands?"
In matters other than gold, gold bugs say that they want to strengthen the private economy. They don't want government interference in the economy. They think that liberty is better for the creation of wealth. But if you ask them about gold, they love to hear about central banks buying gold and putting it in government or central bank vaults.
This is an economically self-interested argument. They want government intervention into the private sector: gold's price. They want central banks to issue fiat money to buy gold. They want the price of gold to go up. They want a central bank subsidy for the price of gold. They cheer when a central bank buys gold. "This is liberation. Let's have the governments of the world issue lots more fiat money, come into the market, buy gold, and thereby raise the price of gold!"
Adam Smith was right: we cannot trust capitalists to do the right thing when their personal profits are under consideration. They will sell out liberty every time in order to line their pockets with money.
People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices. It is impossible indeed to prevent such meetings, by any law which either could be executed, or would be consistent with liberty and justice. But though the law cannot hinder people of the same trade from sometimes assembling together, it ought to do nothing to facilitate such assemblies, much less to render them necessary. (Wealth of Nations, Chapter X, Part II)
Think this through. Most gold bugs have not thought it through.
Central banks buy investment assets with newly created money. They never sell assets, such as government bonds, in order to get money to buy gold. They always create money out of nothing in order to buy gold.
Therefore, asking the government's central bank to buy gold is asking for fiat money inflation. This fiat money is going to go into the economy. Prices are going to rise, or else not fall. People who own gold benefit. Most people do not benefit. People on fixed incomes are hurt. For them, the central bank's purchase of gold is a liability. Prices go up. Their income does not go up. They have to cut back on spending.
Here is the reality of civil government intervention into a private market. If one group is benefited by government action, some other group is hurt by the same action. This is as true of the purchase of gold by a central bank as it is true of the purchase of government bonds by a central bank. Somebody wins. Most people lose. That's the nature of civil government.
Gold bugs say they understand this. But they do not believe it as soon as their personal profits are on the line. Whenever they can make a buck, meaning a digital buck, they rush to get the government to take action. They love intervention as long as it lines their pockets.
Am I cynical? You bet I am. I have read Adam Smith on collusion, and I believe him.
Central banks should sell every ounce of gold in their vaults. Why do I say this? Because gold is a valuable asset. Valuable assets should be owned by individuals, not governments.
I don't want to see the expansion of government. I don't want to see a government get richer as a result of creating money out of nothing, and then buying assets from private citizens.
Governments tell their central banks to buy foreign bonds by going into the market with newly created fiat money and buying these bonds. The central bank could buy the domestic government's bonds just as well. But politicians want to hold down the value of the domestic currency in order to subsidize exports. This is mercantilism. It was a bad idea in 1650. It was a bad idea in 1776. It is a bad idea today.
If a central bank buys gold from another central bank, this increases the amount of money in circulation in the nation's commercial banks. This lowers the value of the domestic currency. This is a bad thing for the economy. The same is true if the central bank buys gold from South African gold mines. It doesn't matter what the government buys. The central bank is going to create money in order to buy it. This is inflationary. It is an intervention in the economy. This is a Bad Thing.
What can the governments do with the gold? It's useless to them. They don't sell it.
I wish they would sell all of it.
Most people can't follow long chains of economic reasoning. Actually, most people can't follow short chains of economic reasoning. Most people also love to see whatever they own as an investment asset get subsidized by the government. So, gold bugs abandon all traces of free market theory, and they call for more gold purchases by central banks. They don't care which governments buy the gold. As long as governments are buying gold, they rejoice.
I do not. Gold is a tool of monetary stability, but only when it is in private hands. It is a tool of production, but only when it is in private hands. Gold is an economic asset, which is why I do not want governments or central banks to have vaults full of gold.
They stole the gold in 1914 and 1933. Why should anybody who promotes the free market want these thieving governments not only to hang on to the stolen goods, but increase the amount of goods stolen from the public by issuing central banks' counterfeit money to buy more? Why is a policy of theft in 1914 and 1933 a bad thing, but exactly the same policy today -- theft through monetary inflation -- a good thing?
Ludwig von Mises had a term for this outlook: polylogism. He said that people don't apply the same logic of economics to every market. They exempt certain markets from the logic of economics. This is surely the case of gold owners who believe in the gold coin standard, but who also believe that central banks can and should buy the people's gold with newly created counterfeit money, and put the gold into the banks' vaults. This makes no economic sense, but it is almost universally believed by gold bugs.
End the Fed. (Deadline: next week. November 1 at the latest.)
Mint gold coins. (Deadline: end of fiscal year 2019: September 30)
Sell the coins. (Deadline: as soon as they are minted)