During a 2011 congressional banking subcommittee hearing, Texas congressman Ron Paul asked Federal Reserve Chairman Ben Bernanke if gold is money. “No,” replied Bernanke, “It’s an asset.” Video of this exchange went viral in the gold-bug community, because the difference between money and an asset is, to people who care about such things, both profound and crucial to the future of the global financial system.
The subtext of the Paul/Bernanke exchange was a slightly different but equally important question: Can a government simply decree that what has functioned as money for 5,000 years no longer be money? This question has been debated in various forms and forums since the first government began debasing its currency eons ago. But the modern iteration can be traced back to the Great Depression. Recall that at the time the US was on a gold standard, and a paper dollar was simply a warehouse receipt for 23.222 grains of gold (approximately 1/20th of a troy ounce), while a dollar in a bank account was in theory exchangeable for those paper receipts (dollar bills). But because the Federal Reserve issued up to 2½-times more receipts than gold and because banks operated on a fractional reserve system, the total quantity of claims vastly outnumbered the weight of gold held in reserve.
After the 1929 stock market crash, the fractional reserve system began working in reverse (see Chapter 15), leaving the US – and much of the global – economy on the verge of imploding.
For countries on the gold standard, currency devaluation was seen as an admission of failure and deemed dishonorable because it allowed a country to pay off its debts in currency that had less purchasing power than at the time the loans were made. Nevertheless, devaluation was grudgingly accepted as last-ditch strategy for badly-run countries to boost economic growth and avoid a depression or more direct form of default.
The US, as it turned out, chose to both devalue its currency and default on its debts. Shortly after his inauguration in 1933, President Franklin Roosevelt concluded that US problems were serious enough to warrant devaluation of the dollar, among other aggressive policies. Under Article I, Section 8 of the Constitution, only Congress had the power to “regulate”6 the relationship between the dollar and gold, but FDR claimed that authority for the presidency. And instead of simply decreeing that henceforth the dollar was worth less gold than before, FDR first confiscated Americans’ privately-held gold and made it illegal to own the metal – and then devalued the dollar against gold, effectively taking the difference between the purchasing power of the gold citizens turned in and the dollars they received in return. This was, to put it bluntly, theft. It was also a partial default on US debt, much of which carried “Gold Clause” provisions specifying that it was payable in specific weights of gold.
The implications of FDR’s actions, however, went far beyond a garden-variety asset confiscation or currency devaluation. By making gold ownership illegal, FDR was asserting the primacy of government over the market in deciding what constitutes money. In the process, it made the right of private contract – a fundamental pillar of law heretofore considered sacrosanct – subservient to the government’s conception of the “national interest.”
By lifting the restraint that sound money places on federal spending, FDR fundamentally altered the relationship between Americans and their government. Previously, governments could borrow modestly (by today’s standards) but for the most part could spend only the money that they had on hand. Money was gold, and the coins and bars in the national treasury helped define the government’s wealth while limiting its ability to promise all things for all constituencies. In the future FDR created, governments would be free to act as they saw fit, simply creating a desired amount of paper fiat currency and spending it to make the world a better place – as defined by the people in charge. Perhaps FDR’s goal was the public good rather than what is now often called an “imperial presidency.” But regardless of his intent or motivation, as the brief tour of monetary history in Chapter 1 makes clear, a government with a printing press is a monster in the making.