Thomas Tooke

How to cheat the Gold: The failure of the Gold exchange standard was highly predictible in 1920.

In Gold vs monetary base on May 19, 2012 at 9:28 pm

Kemmerer argues that the inflation forces since 1896 resulted in a 3% annual inflation until 1913, which according to Milton Friedman has to do with the cyanide process.

[…]

Even without the war, therefore, we might reasonably have expected, as the result of a continuation of pre-war forces, an increase in prices from 1913 to 1920 of something like 20 per cent.  But much more important that this is the fact that the war period has probably wrought important permanent changes in our currency and banking systems — changes which will greatly improve the efficiency of these systems and thereby enable a given amount of gold to carry on its shoulders a larger load of exchange work than in pre-war days. This is a large subject and only a few phases of it can be suggested here.

It appears likely that in the future the world´s supply of monetary gold will be found to an increasing extent in the vaults of central banks and will be used to a decreasing extent for purposes of hand to hand circulation. This will greatly increase the monetary efficiency of the average ounce of monetary gold. Furthermore the establishment and development of our federal reserve system, the increasing movement for bank consolidation in Europe and America, the reduction of gold shipments both national and international through the creation of such devices as our gold settlement fund, and the increasing use of funds located abroad for making international payments through debits and credits without the necessity of shipping gold – these changes and others of a similar character are resulting to an ever increasing degree in economizing the use of gold and in thereby reducing the ratio of the gold base to the credit superstructure it supports. We can do a given amount of money work with less gold because gold is being made to work harder and more efficiently.

[…]

Here we should add that indeed the objective of the super structure is to make creation of money easier and credit easier. The continuous build up of the super structure and the elimination of the Gold constraint since 1971 has further increased the build up of this structure to truly unprecedented level (the total leverage of 2007 surpassed the one of 1929.

Later Kemmerer brings the counter argument to an excessive quantity of paper currency against the monetary gold quantities and reflects upon the necessity to change the Bullion- currency parities. Evidently from his writings the failure of the Gold exchange standard seems quite visible, there is no free convertibility so that market participant can not force the contraction of the paper by redeeming the paper currency and therefore regulating its quantities, there is no Gold flow, the Gold is impounded in the central bank vaults. The money is nationalized and the gold to paper quantities are excessive.

Here is what Kemmerer writes in 1920.

[…]

A factor which may possibly reduce the structure of circulating credit in proportion to the gold base is the debasement of hte gold units of value in certain foreign countries. When on notes the tremendous depreciation today in gold values of the paper money units of many belligerent countries, at a time when the value of gold itself in terms of commodities has been more than cut in half in six years, and when he notes the staggering burdens of debt these countries are carrying he need not be surprised to hear increasing demands among their peoples for debasing the legal gold unit of value.

[…]

My comment here is that clearly the Gold is artificially tied to an artificially low amount of currency units. There is no floating of Gold against paper money like there was during the greenback period.

Kemmerer continues.

[…]

Advocates of debasement will point out that the government in floating its domestic debt received its pay largely in greatly depreciated paper money. They will show that even if it were possible for the government ultimately to pay these domestic debts in the old monetary units, at a parity with gold, such payment would involve an oppressive burden of taxation that would be grossly unjust in that it would give to the bondholder a much more valuable money than he originally loaned to the Government. They will stress the depressing influences on all kinds of business of a currency contraction that would bring the value of the present paper monetary unit back to par, a contraction in some countries as, for example, in Germany, Austria and Russia, of thousands per cent. It appears probable that we shall witness in the near future widespread and vigorous movement in many countries in favor of the adoption of new gold units of value somewhere in the neighborhood of their de facto paper money unit of today, or at least much lower than their pre-war gold units.

Monetary history is full of examples of such debasement. If the existing paper money unit should appear to be an inconveniently small value, its name might be continued and also its legal power in settlement of domestic debt, while a new unit might be superimposed upon it of which the old unit would become merely a division. Suppose, for example, the mark should be stabilized at a gold value of 2.5 cents United States currency, retaining its name and its present domestic debt-paying powers, and suppose this mark should  be made the “dime” of a new German unit worth, say 25 cents, United States currency, and called perhaps a “Hindenburg”. Obviously by such a process such a process a given weight of gold in Germany would have its efficiency for reserve purposes multiplied approximately ten times, and the return to gold basis would be greatly expedited. That this would be a form of domestic debt repudiation and be open to many serious objections is of course obvious.

Here we are neither arguing for or against such a proposition, but merely pointing out that to a large number of people in the most debt-burdened and paper money-ridden countries of Europe such a course is likely to appear, with all its difficulties, to be the least objectionable road to day-light. The adoption of such a program by some counties would obviously reduce the amount of deflation necessary in other countries to bring the structure of circulating credit down to a reasonable safe multiple of the gold base.

[…]

A personal comment here. It is abundantly clear that the British were very stubborn in thinking they could pull a 1816-1821 return to gold-paper parity after the Napoleonic wars and necessary gold-paper conversion “bank restriction”. Despite very high level of debt in the 1816-1821 it was feasible, so Britain probably thought they could do it again. The bankers and the government were wrong this time. Had the parity of been changed and gold flow re-established, the artificial monetary system than ensued might not have happened, nor the need to do a devaluation of the dollar in 1932, nor the need to confiscate people´s gold. Short term political expediency did cost massively down the road. Kemmerer was probably not the only one to call for a more balance gold-paper ratio after the war, yet the right course of action was not followed.

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