Cooking the Books 2:The yellow brick road to nowhere

The yellow brick road to nowhere

“In an economy where the currency is not tied to the value of gold, the central bank can simply print more and more money, to fund the expansion of the economy and of central government. Over time, that will erode the purchasing power of the currency, but as long as that happens slowly through moderate inflation, no one seems to mind.” So the Independent (2 December) reported the views of US Congressman Ron Paul who wants to abolish ‘the Fed’, the Federal Reserve, America’s central bank, as well as going back to a gold-based currency.

Paul cannot be called a currency crank. as he has a correct understanding of what causes inflation and his solution would work to stop it, if that what was wanted, even if it would be unnecessary, pointless and a waste of resources.

Money originated as a commodity, i.e. something produced by labour that had its own value, which evolved to be the commodity that could be exchanged for any other commodity in amounts equal to the value of the other commodity. Various things have served as the money-commodity, but in the end gold and silver were almost universally adopted. Paul offered a reason: “Most people think gold is beautiful, that’s why it’s money. It’s because it’s beautiful and rare and divisible and it lasts a long time. We don’t use lead.” Beauty didn’t have much to do with it, but being rare (i.e. requiring more labour to find and extract from nature, so concentrating – unlike lead – much value in a small amount), divisible (so easily coined) and long lasting did.

As capitalism developed it was found that gold itself did not have to circulate, but that paper notes could substitute for it as long as those accepting or holding it could be sure that they could always change them for gold. Up until WWI in most countries the currency was gold coins and paper notes convertible into gold. The Great Depression of the 1930s led to the major capitalist countries abandoning this convertibility. Since then the currency nearly everywhere has been inconvertible paper notes.

With an inconvertible paper currency, the amount of money is no longer fixed automatically by the level of economic transactions, nor is there any limit to the amount of paper currency that can be issued. It is this that Paul objects to because, if the central bank issues more paper money than the amount of gold that would otherwise be needed, then the result will be a depreciation of the currency; the paper money will come to represent a smaller amount of gold with the result that prices generally will rise.

If Paul had his way, the Fed would no longer manage the issue of the currency. This would pass to the Treasury Department which would only be allowed to issue paper money if it had the equivalent value of gold in Fort Knox. This would be a further absurd waste of resources as much more gold would have to be mined – just to store in places like Fort Knox.

Paul thinks that a return to a gold-based currency would eliminate crises such as in the 1930s and today. This is an illusion. There was a gold-based currency up until WWI, yet crises occurred regularly, including a Great Depression in the 1880s and a hundred years ago the same sort of banking crises as today. Capitalism goes through its boom/slump cycle whatever the currency. No monetary reform can change that.