The Gold Standard
The traditional alternative to fiat money is what is commonly called the gold
standard. There are three types of gold standards that have been used in different stages
of history (Paul, R. 2009). The first is the gold specie standard which is when actual gold coins or monetary units are used and exchanged. This gold standard is what America was
using prior to President F.D. Roosevelt doing away with and switching the U.S to the
gold exchange standard in 1932 (Rauchway, E. 2013).
The gold exchange standard
doesn't involve the circulation of gold coins but makes it so that government guarantees a
fixed exchange rate to the currency for gold. This creates a de facto gold standard.
However, President F.D. Roosevelt confiscated all US citizens' gold through the Gold
Reserve Act of 1934 at $20 an ounce and then made the fixed exchange rate $35 an
ounce, creating a $15 per ounce profit for the U.S government essentially out of thin air
at the expense of the citizens who could no longer legally own gold (Richardson, G.
2013). The third gold standard option is gold bullion standard in which gold coins don't
circulate, but government agrees to sell gold bullion at a fixed price for currency. It
wasn't until 1975 when President Ford signed bill Pub.L. 93-373 allowing U.S citizens to
purchase, hold, sell and deal with gold.
Now the average citizen could at least own gold
again, even though the dollar was no longer connected to gold but instead to the trust and
credit of the United States government.
It was President Nixon in 1971 that officially and completely took the American
dollar off of the quasi-gold standard that Bretton-Woods system had created. No longer
was the dollar redeemable for any amount of gold at all. It was just paper backed by trust
in the U.S. Government and nothing more. While President Lincoln had taken the United
States off the gold standard during the civil war and created greenbacks, they were
abolished and American switch from a fiat currency back to the gold standard with no
major issues ensuing (Bye, J. 0. 1963). Roosevelt's damage to the gold standard through confiscation was the second major blow to the gold standard, but Nixon put the final nail
in the coffin. This act was completely unconstitutional and was known as the Nixon
shock (Paul, R. 2009).
This was unconstitutional because it clearly states in the U.S
Constitution Article I, Section l 0: "No state shall. .. make anything but gold and silver
coin a tender in payment of debts."
The effects of the Nixon shock caused the US to
initiate price controls for ten days through Executive Order 11615. Price controls were
something the U. S. hadn't used since World War 11. As well the Nixon shock was a
primary cause of the stagflation that occurred in the l 970's and causing the dollar to lose
a third of its value just within the decade (Ghizoni, S. 2013).
Why is the gold standard so powerful and so important It primarily comes down
to inflation. A stable money supply that is backed by gold cannot be inflated in the way
that fiat money can be inflated. Currently the Fed doesn't even need a printing press,
everything is done digitally, with a few strokes of some keys, and trillions of dollars can
be created. In fact this was done for quantitative easing after the Great Recession of 2009
up to 2014 when the Fed was printing tens of billions of dollars a month (Finger, R.
2013). With a gold standard, the Fed cannot create money out of thin air. It forces
countries, banks, corporations, and politicians to have financial discipline because they
cannot use inflation to create money to bail their way out of bad situations.
Moral Hazard Created by Central Banks
The term moral hazard, according to dictionary.com, means "the risk that an
individual or organization will act irresponsibly or recklessly if protected or exempt from
13
THE EFFECTS OF CRYPTOCURRENCIES ON THE BANKING INDUSTRY AND MONETARY POLICY
the consequences of an action". Having the Fed act as a lender of last resort for banks
motivates banks to make riskier and riskier loans because they know they will be bailed
out and their customers deposits protected thanks to FDIC. The Fed is technically an
independent organization that is not officially part of the Federal Government. However,
all of the Feds "profits" go into the treasury and all of its board members are hand
selected by the President and approved of by the Senate.
Also the Fed must report twice
annually to congress and at technically any moment congress could vote to abolish the
Fed, the Fed is as "independent" as a five year old child is independent of adults
(Zarlenga, S. 2008). The Fed allows the government to expand, offer welfare programs,
and enter into wars, more easily because the government can use inflation to pay for
everything and not direct taxation. While congress doesn't explicitly ask the Fed to do
such things, the underlying effects of the Fed purposefully creating inflation has this
effect for politicians. Remember that inflation is bad for the economy but greatly benefits
the first spenders of newly minted money. Since the Fed's "profits" go to the treasury
first, government is one of the first spenders.
The Fed allows politicians to make more
promises for social welfare programs that don't require explicit taxation or bonds to pay
for. This allows politicians to essential "bribe" the public for votes by offering favorable
programs and projects to the demographics that vote them in. This process weakens
everyone's dollars instead of directly and overtly confiscating those dollars from them in
the form of traditional taxes. Allowing moral hazards to create mat-investments is what
caused the financial crash of 2008 and nearly all crashes that have come before (Mises, L.
V. 2007)
The other reason is that, unlike gold, using a fiat currency allows the Fed to
distort price signals. In his book The Theo,y of Jvloney and Credit (1 953) Ludwig Von
Mises explains that prices are signals in a market place that tell investors, entrepreneurs,
and consumers, how to behave in the market. Expanding upon this, Nobel laureate F.A
Hayek wrote about the phenomena for his highly influential article The Use of
Knowledge in Society (1 945). In the article he explains that no central organization
regardless of how intelligent it may seem to be, can know all of the information necessary
in an economy to know what the prices should truly be. The true price should be what the
market demands under the laws of supply and demand. When a person, group, or
organization attempt to control prices and they don't obey the laws of supply and
demand, they distort the market and create artificial shortages and surpluses. True prices
are when businesses are allowed to set their own prices, unhindered, based on supply and
demand. When the Fed sets interest rates, they are using price controls and distorting the
market, sending out unclear signals into the market. For Mises, distorted price signals are
what causes mat-investment and causes bubbles and thus booms and busts in the
economy. The boom is from people thinking that there is wealth and resources that are
being created because of a bubble in the economy. The bust when the bubble bursts and
people start to realize that it was all illusionary and there is truly little or no value in what
they were investing.
Bubble bursts come from the market fixing itself and re-stabilizing
to where it should naturally be, although this can often take years or even decades
depending on how severe the Fed has artificially tampered with the economy. The market
is constantly trying to guess what the Fed is going to do and when the Fed will do certain
things. which creates what historian Robert Higgs (1997) calls "regime uncertainty". He
THE EFFECTS OF CRYPTOCURRENCIES ON THE BANKING INDUSTRY AND MONETARY POLICY
explains that this is a large reason why markets sometimes take so long to recover from
monetary mistakes and distortions. Often the worse the Fed tampers with prices, rates,
and markets, the longer the recovery will take.
Inflation and Money YS \Vcalth
There is a very important distinction to make between money and wealth.
15
According to Dictionary.com, money is simply a medium of exchange, meaning it's a
unit of measurement and has value that people are willing to exchange goods and services
for.
There is nothing intrinsically valuable about money. Having all the money in the
world and nothing to spend it on makes having trillions of dollars not only useless but
also pointless. Wealth is simply stuff. Wealth is a bed, a car, a book, anything of value to
the owner. It's very easy, and very dangerous to confuse money for wealth. This
confusion can cause bankers, politicians and bureaucrates to try and manipulate money,
thinking they will change wealth. They are only changing the units of what valuable
things are worth, not actually creating any new wealth. New wealth is only created by
entrepreneurs in the market who build businesses that sell products or services that other
people in the market find valuable (Dom, J. 2007).