Death of the Gold Standard

...The final step in this progression, and the real boon to everyone, would be the ultimate creation of a system of flexible exchange rates pegged to supply and demand rather than to the dollar...

...These dollars were a welcome?indeed a lifesaving—supplement to gold in providing additional international liquidity, but for various reasons some holders cashed them in for gold...

...But false patriotism, fear of competition, and bureaucratic conservatism have prevented these adjustments from ever being carried out...

...Like outright currency devaluation, albeit less efficiently, these taxes and subsidies redistribute expenditure from outside to inside the deficit countries.* The danger is that protectionist measures taken by one country invite retaliatory restrictions on freedom of trade by other countries, thus canceling any impact on balances of payments...

...Hopefully, the monetary authorities will not inadvertantly restore the Gold Standard by resuming purchases when the free market price falls to $35, or by being seduced with an offer of gold at a "below market" price of $35...

...The obligation of the United States is not to gold producers or speculators but to those who have been cajoled or bullied into holding dollars, and they would be fully protected by the purchasing power guarantee...

...Precisely this kind of provision was made for the adjustment of exchange rates in the event of chronic foreign deficits—then called "Fundamental Disequilibrium"—when the imf was formed in 1944...

...unlimited amounts at an established price (with a small "service charge...

...First, most taxes are easily avoided (and subsidies misused) by changing the form of the expenditure...

...The U.S...

...Claims that the price of gold is unnaturally low regardless of these recent developments—that other prices have risen greatly since gold was pegged at $35 an ounce in 1934—strike me as unjustifiable...

...Under the new arrangement this guarantee is replaced by a prohibition...

...Every country with an unfavorable balance of payments would lose gold to those countries with favorable balances in the process of covering its deficit...

...A rise in the dollar price of gold would be matched by an equivalent rise in the price of gold in other currencies, thus canceling its impact...

...After all, at the present price the supply of gold from new production in recent years has been more than double the demand for industrial uses (including jewelry...

...The patient can more easily be persuaded to swallow this medicine because of an elementary confusion be* This "impure" devaluation is inefficient in two ways...

...Deficit countries are unable or unwilling to engineer sufficient depression to eliminate their deficits...

...gold stocks will be sold for industrial uses at whatever price they bring...

...balance of payments deficit...

...The chronic deficit continues until the gold, other reserves, credits, sdrs and the hypothetical cdrs are all exhausted...

...The surplus countries hoard vast quantities of gold to check price inflation, while in the deficit countries attempts to check the gold outflow produce economic depression rather than price deflation...

...The void here is for the continued financing of coimtries that cannot correct their deficits...

...for monetary purposes...

...The cure is therefore rejected and the deficit becomes chronic, calling for unlimited cdrs...

...The "impurity" is thus completely removed and the result is distinguishable only in name from a devaluation of the currency of the same magnitude as the taxes and subsidies...

...tween the balance of international payments deficit (which should be corrected) and the deficit in the domestic budget (which may be necessary for prosperity...

...The Dollar Standard would then completely replace the Gold Standard in form as well as in substance, differiag from it only in the greater availability of dollars —since it is easier for almost all countries to earn dollars than to produce gold, and there are so many more products that can be sold for dollars (to the U.S...

...gold stock led to a speculative splurge in gold purchasing based on the expectation that the monetary authorities—essentially the U.S...

...balance of payments deficit, would remain unsolved...

...The U.S...

...But even if the Central Banks should not reach such an agreement—and it does not seem very likely that they will—all is not lost...

...It could well be that this is exactly what was promised by the U.S...

...For international payments, however, gold continued in use...

...This cure for the deficit differs from the legendary Chinese method of roasting the pig by burning down the house primarily in that the roast pig really was preferable to the house, while none can claim that a depression is preferable to the deficit it would cure, or even to the devaluation threatened when all reserves have been used up...

...3. The U.S...

...The banks need merely provide surplus countries with such stocks of international liquidity that they would willingly let them decline by importing more, exporting less, or more openly raising their relative exchange rates so that the deficit countries automatically find their currencies devalued...

...Growing resentment would ultimately lead countries to liberate themselves from the dollar by letting the value of their currencies rise and fall in relation to it...

...The current tax hike and government spending cut burns down the house without even roasting the pig, since it offsets the depression from decreased spending with inflation from increased costs to the taxpayer, and thus may not even help solve the U.S...

...The devaluation of the deficit country's currency in terms of other currencies can then no longer be prevented...

...They would then discover that international liquidity is largely unnecessary if chronic deficits are cured by exchange rate adjustments...

...But the insufficiency visible here is not really a shortage of liquidity or international money...

...However, even if the patient were persuaded to swallow the depression medicine it would soon be vomited up...

...While the fairly stable size of the total world gold stock would preclude severe general price inflations or deflations, relative price inflations and deflations between different countries would automatically cure any balance of payments problems...

...Understandable unwillingness to suffer so much depression led to the abandonment of the Gold Standard for domestic purposes...

...Surplus countries have not had a balance of payments favorable enough to induce them to get rid of surplus international liquidity by discouraging exports or encouraging imports, and thereby dissolve the deficits of other countries...

...balance of payments would be solved for a long time, the deficit being covered (or indeed turned into a surplus) by the export of dollars to provide other countries with international liquidity...

...There would be the same rigidity of exchange rates as under the Gold Standard, and for the same reasons...

...The consequent outflow of much of the U.S...

...Yet the seemingly conservative decision of the leading Central Banks and the International Monetary Fund (imf) to continue trading gold with each other at $35 an ounce, taken at a conference in Washington last March 17, was actually a revolutionary act: In a fit of absent-mindedness, they finally liberated the world from the last remnants of the Gold Standard, replacing it with what is in reality a Dollar Standard...

...While international liquidity would be increased (providing, incidentally, a handsome reward to gold producers and speculators), the concept of cdrs would not have been made more attractive...

...For, apart from its being insanely costly, humanly inexcusable, and socially explosive, the medicine is also, fortunately, politically inapplicable in a democracy that has learned that depressions can be avoided by more government spending...

...And the basic problem, the U.S...

...The words "engineering a depression" would not be used, of course, but rather some phrase like "putting our house in order...

...A perfect example of this was the announcement in Paris on June 26 that import quotas would be imposed on foreign goods and export subsidies granted for French goods...

...Second, to the degree that taxes are not avoided (and tile subsidies not perverted), they do not concentrate the redistribution where there is the least difference between internal and external prices and therefore the least interference with the gains in economic efficiency arising from the international division of labor...

...It is clear that the monetary authorities, by holding these vast amounts of gold, have been maintaining an unnaturally high, rather than an unnaturally low, support for gold...

...The sensible solution to the U.S.'s (and all other countries') balance of payments problems has been made much easier by the March 17 isolation of monetary gold from the free market...

...For its proper functioning a true Gold Standard requires a perfect flexibility of wages and prices in response to supply and demand...

...As a result of these measures the price of gold would almost certainly collapse...

...So long as this does not happen, the approximately 40,000 tons of monetary gold (comprising $40 billion out of the $72 billion of international liquidity) play only the ceremonial role of counters or "chips" representing dollars...

...Yet despite such supplements as dollars, pounds sterling and other currencies, there has been what looks like an overall insufficiency of international liquidity...

...The essence of the Gold Standard is the guarantee of governments to buy or sell gold for their currency in Abba P. Lerner, a previous contributor, is Professor of Economics at Berkeley...

...This would lower demand and prices in the deficit countries and raise them in the surplus countries, stimulating exports from the one and discouraging exports from the other...

...But even reasonably adequate overall levels of international liquidity do not solve balance of payments problems...

...What is called for in this circumstance is not Special Drawing Rights, which can only provide additional international liquidity to cover temporary gaps between a country's payments and receipts, but "Chronic Deficits Rights ("cdrs...

...Surplus countries are unable to expand enough, and unwilling to inflate enough, to eliminate their surpluses...

...In fact, it would worsen the balance of payments of those countries that felt the need to import dollars for the purpose of filling the gap in international liquidity left by the demonetization of gold...

...Treasury—would be panicked into raising the price of gold above the established $35 an ounce, perhaps doubling it or possibly even increasing it to a nice round $100...

...Only the expectation that the U.S...

...The recent South African offer to sell gold to the Central Banks at $35 an ounce is, in effect, a last ditch attempt to keep the price of gold from falling on the free market by not unloading additional quantities there...

...The greater danger for the United States is that if all other methods fail to reduce its balance of payments deficit, the government might take the despa-rate step of engineering a domestic depression...

...dollars, to provide additional international liquidity...

...government will fully compensate all holders of dollars, or dollar securities guaranteed by the U.S., for the loss...

...If there were such flexibility, the Gold Standard could serve as a single monetary system for the whole world...

...The supply was often inadequate—that is, insufficient to maintain prosperity at the current price level—so substitutes were developed, such as British pounds sterling and U.S...

...But the March 17 separation of monetary gold from free market gold, if maintained, puts an end to this expectation and will lead to a sharp fall in the free market price of gold—at least to the level where industrial demand will absorb the whole of current new production...

...Alternatively, they can create new international money without reference to gold—by issuing new sdr's, for example...

...2. Except for a single symbolic ingot, the currently held U.S...

...The deficits and surpluses would automatically disappear...

...If great care is taken to adjust the taxes and subsidies so as to minimize the interference with efficiency, this approach develops into an even tax on all imports and a subsidy, equal to the tax, on all exports...

...to get the Central Banks to agree to the March 17 arrangement...

...The U.S...

...All countries would be free to manage their monetary and fiscal policies for domestic prosperity, stability and growth...

...His books include Essays in Economic Analysis and Everybody's Business...

...The United States then can and should unilaterally declare the following measures in effect, which would achieve all the important objectives: 1. No more gold will ever be bought by the U.S...

...or to other countries that have obtained dollars in return for their products...

...The Central Banks are now in a position to adjust monetary exchange rates to meet changing conditions, as the imf attempted to do when it was established in 1944...

...As we have noted, the present trouble is due to the rigidification of exchange rates through national pride and bureaucratic arteriosclerosis...

...The price of gold will fall much below even this level when the hoarded gold is unloaded by disappointed speculators, and of course much lower still if and when the Central Banks realize that the ceremonial role of monetary gold can be played just as well by a symbolic microgram of the metal (or even by purely fictional gold) and decide to release for industrial purposes the 40,000 tons they are keeping off the market...

...President Johnson's references to "austerity" in recent months—and the welcome reception they have received in Congress—sound like an ominous indication of his having signed the pledge to drown the deficit in depression...

...There would, of course, be outcries of bad faith?wholly unjustified, I feel...

...The surplus dollars could be cashed in for U.S...

...Besides dispelling the fears of chronic deficits and relieving countries of the need for dollar reserves, this system would remove many of the temptations to restrict mutually beneficial foreign trade and capital movements...

...products for consumption or investment...

...will endeavor to keep the purchasing power of the dollar constant in terms of a specified index-number of American exports, rather than in terms of gold or other currencies...

...But in the U.S...

...Gold would lose all its usefulness as international money, and there would be a great increase in the dollar demand for international liquidity...

...In the absence of the necessary flexibility to correct the situation by a painless wage and price deflation, the natural cure for a shortage of any commodity is a rise in its price...

...Now Special Drawing Rights (sdr's) are to be created for this purpose...

...Devaluation is more easily accepted in the impure form of taxes on particular imports and on certain expenditures abroad, together with subsidies on some exports...

...4. In the event of a fall in the dollar's purchasing power (i.e., a rise in prices according to the index), the U.S...

...And a reminder that all acquisitions of dollars would be perfectly voluntary, or a proposal to turn the profits over to universally accepted charities and other good causes, might simply increase the resentment...

...The banks can raise the nominal price of the ceremonial monetary gold they hold—without paying tribute to gold producers, hoarders or speculators...

...But the change to the Dollar Standard would not reduce the foreign deficits of these other countries...

...Depression would eventually also cure the deficit by equalizing imports and exports, but not without exacting a great toll in unemployment and overall reduction of spending...

...Just as raising or lowering the price of gold would not help end the deficit, though, neither does the divorcing of international money from free market gold, as long as the rates of exchange remain fixed...

...The agreement of the governments to trade their monetary gold only among themselves and the imf means that their currencies can now be used to buy or sell anything at all except monetary gold...

...Indeed, the failure of all attempts to set up a world monetary authority capable of serving the international economy in the way a national monetary authority serves a national economy, is due to the unwillingness of surplus nations to accept permanent flows of ious from chronically deficit nations in exchange for real goods and services...

...The resentment would probably not be much reduced by pointing out that this is the same business—namely, providing international liquidity—carried on for so long by South Africa, except that we would be providing it not in the form of gold metal but in the much more convenient form of dollar bills and securities...

...It should be apparent by now that the price of gold is not the solution to the balance of payments problem...

...The deficit stems from the U.S.'s spending more abroad (on imports, foreign investment, foreign aid and overseas military outlays) than the foreign exchange it is earning by its exports, and covering the difference by paying out dollars...

...A million dollars, now represented by a ton of monetary gold, could just as well be represented by a symbolic microgram of the metal...

...This amounts to about three times the estimated total of privately owned gold hoards throughout the world, some 70 times the annual industrial use, or almost half the total quantity of gold ever mined...

...Consequently, the deficits have become chronic...

...would also be accused of swindling the rest of the world by getting useful goods and services in exchange for pieces of paper —dollars or dollar securities...

...Deficit countries have not corrected their own problems internally because, with fixed exchange rates and the absence of price flexibility, the only cure for a permanent deficit is a permanent depression, which they rightly regard as worse than the disease...

...This is why we have problems like the one that has caused so much excitement in recent months—the U.S...

...Although the conference concentrated on stopping the sale of gold by the monetary authorities to profiteering speculators at $35 an ounce, the important aspect of the new policy is that it prohibits the monetary authorities from purchasing free market gold...

...the natural cure is seen as a shameful devaluation of the dollar in terms of other currencies (and confused with a devaluation in terms of gold—a rise in the dollar price of gold...

...This means that the Dollar Standard could not be a permanent solution...

...But we do not have the required price and wage flexibility to make the system work...

...This flexibility is the only solution to balance of payments problems that avoids depression...

...might soon be paying a higher price has created a demand for gold among speculators larger than the new production of gold mines, so that there was an actual decline in monetary gold from $43 to $40 billion...

...In either case, what is important is not the quantity of international liquidity itself but the induced flexibility of the exchange rates...

...Thus monetary gold (what is held by the authorities) and non-monetary gold (held by all others) have become two different non-competing commodities...

...balance of payments problem...

...This eliminates the shortage by reducing the amount of the commodity that is demanded and increasing the amount supplied...

...A deficit in a country's balance of payments is fundamentally a shortage of foreign currency at the current price...

...Additional international liquidity can be provided in two ways...

...immediately announced that countervailing American duties would be introduced to offset the French moves...