June 16, 2012
My deepest thanks to Steve Forbes for reviewing my book in his Forbes column this month.
If there is one thing that politicians and other policymakers should remember, when they are in the thick of some sort of crisis, it is the principle of stable money and low taxes. Just four words. As you can see, the Europeans can’t remember such a thing at all today. They are going all the other way — higher taxes (“austerity”), and, potentially some sort of currency breakup such as “kicking Greece out of the euro,” whatever that is supposed to mean.
(This item originally appeared in the June 25, 2012 edition of Forbes Magazine.)
By Steve Forbes
Policymakers, economists, investors—everyone—should read and reread Gold: The Once and Future Money by Nathan Lewis (John Wiley & Sons, $27.95). It’s worth its weight in gold—and then some. If all grasped its basic conclusions, the world would be an infinitely richer and happier place. Economic disasters don’t come from inherent flaws in the free marketplace. They come from government policy mistakes, and, as we saw in the 1930s, those errors can have ghastly consequences.
Gold combines engrossing history with absorbing economic analyses and conclusions. Who would’ve imagined a book could give you what you need to know about economics without ever sounding like a textbook?
Not that everything Lewis writes is gospel—some of his interpretations of diplomatic history are way off base—but on the core subjects of money and prosperity he’s absolutely on target.
The basic keys to sustainable economic growth are sound money and low taxes. Countries can have lavish welfare programs or even a bevy of state-owned enterprises and still prosper if they get those two things right.
The fundamental importance of sound money has been virtually forgotten by the economics profession today, even though no country has ever achieved sustained prosperity without it. A stable currency is the foundation for the literally billions of transactions and economic arrangements that make growth possible. To simplify, imagine how difficult it would be to function if the number of minutes in an hour were constantly changing. Even cooking would be problematic: If a recipe called for cake batter to bake for 45 minutes, how long exactly would that be?
Why gold? Because it retains an intrinsic, stable value better than anything else. In that sense it’s like Polaris, a fixture.
The impact of cheapening money goes beyond economics: “Continuous inflationary periods are often accompanied by a conspicuous decline of morality and civility. Just as people cooperate in the money economy, they cooperate in their daily lives, forming unspoken agreements. During inflation, all the monetary contracts between people are warped and distorted. The deterioration of monetary contracts is matched by a deterioration of social contracts, because monetary contracts, in the end, are also agreements between people. … Currency devaluation has been tried literally hundreds of times since the 1940s as a remedy for all manner of economic ills, and it has failed every single time.”
Lewis builds his irrefutable case for gold and low taxes with fascinating accounts of economic successes and failures. Britain moved to a gold-based monetary system in the early 1700s, which helped set the stage for the Industrial Revolution and an era of British financial dominance that would last until the First World War.
Japan enjoyed extraordinary economic growth after the U.S. forced it to open up in the 1850s, which continued after the Meiji Restoration in the late 1860s. Japan’s 2,000 or so different currencies were unified under the yen, which was tied to gold. More than 1,500 taxes were eliminated, as were virtually all tariffs. For a while Japan was the world epitome of free trade. It fumbled badly in the 1920s and 1930s, but from 1950 to 1975 it enjoyed growth rates greater than that of post-Mao China. During that era the yen was effectively fixed to gold, and every year Tokyo reduced taxes.
The 1920s are particularly instructive. Britain kept its high WWI taxes and, despite wartime inflation, fixed the pound to its pre-World War I gold parity. The result was deflation and economic stagnation. In contrast, the U.S. sharply reduced taxes and boomed. In the mid-1920s France did the same, while refixing the franc to gold. Paris prospered.
So why the 1930s’ Great Depression? The root cause was that classical economics virtually ignored the impact of taxation on economic activity. Amazingly, “the economics profession proved unable to incorporate taxation in its framework of analysis,” Lewis observes. One of the Victorian era’s noted economists was Alfred Marshall, whose Principles of Economics was enormously influential. Yet that treatise has “no mention of taxes in its 858 pages.”
The U.S. began the disastrous chain of events when it enacted a massive protectionist trade bill in the spring of 1930. The global trading system blew up. “More than 1,000 economists signed a petition protesting the Smoot-Hawley Tariff Act, adding their voices to the complaints of 30 foreign governments. But,” notes Lewis in astonishment, “when the act was passed and trade predictably shriveled, not one of those economists drew the connection!”
As economic activity fell, governments raised taxes to keep their budgets balanced. Britain, for example, raised levies on income in 1930 and again
in 1931. The U.S. enacted the biggest domestic tax increase in its history, with the top income tax rate going from 25% to 63% in 1932.
Economists were at a loss as to why the slump deepened. “Unaware of the fiscal policy catastrophe swirling around them, [economists’] excellent monetary training told them that, with currencies solidly pegged to gold and no evidence of a liquidity-shortage crisis, a swift return to economic health should be soon forthcoming,” just as happened in the U.S. during the 1920–21 depression. “When their predictions and policy prescriptions didn’t work out, they were cast aside.” The government-spending and cheap-money nostrums of John Maynard Keynes became dominant.
Under the post-WWII Bretton Woods monetary system the dollar was fixed to gold, and every other currency was fixed to the dollar. Japan and Germany systematically reduced their tax burdens, and with their money fixed to the gold dollar their economies made rapid recoveries.
Unfortunately, most economists had drunk the Keynesian Kool-Aid of cheap money, which held that printing a lot of currency would painlessly lead to rapid economic growth. By the late 1960s the understanding of a gold standard had virtually disappeared. Few tears were shed when the U.S. destroyed the Bretton Woods system in the early 1970s. The result was a hideous decade of inflation, economic stagnation and political chaos globally. Ronald Reagan put an end to the terrible inflation of the 1970s, but a new gold-based system was never established.
The U.S. expanded in the 1980s and 1990s, but progress was periodically checked by continued monetary instability. In 1987, for example, the stock market crashed when the U.S. made clear it was going to weaken the dollar and push for new major trade barriers.
In the late 1990s, when the Fed inadvertently deflated the dollar, the U.S. went in the opposite direction. Agriculture, steel, oil, mining and other traditional industries were hit hard. Even though stock market indexes rose until 2000, profits peaked in 1997, and most common equities declined in the latter part of that decade.
The Fed lurched in the opposite direction in the 2000s, which led to the disaster we now have. Lewis’ book was written in 2007, so it doesn’t include an account of our current woes.
But Lewis does tell the grim tale of how countries have suffered from bad U.S. economic advice and the even more poisonous prescriptions of the IMF, which wreaked havoc on Latin America, Russia, the former Yugoslavia, South Korea, Thailand, Indonesia, Turkey (IMF policies led to the election of an Islamist government) and numerous other countries. Notably—and to its immense profit—China in the mid-1990s ignored U.S./IMF prescriptions.
What’s amazing when reading a book like this is to realize how much of a vise-like grip bad economic ideas have on economists and policymakers, even when they fly in the face of all experience.
Despite all the turmoil of the past decade—the catastrophic housing bubble; the quintupling of the price of oil and many agricultural commodities; a sovereign debt crisis that threatens to economically upend Europe to a degree not seen since the 1930s; the slow-motion self-strangulation of Japan, whose gross national debt, proportionately, vastly exceeds those of all other developed countries, including Greece—political leaders and economists resist the idea of returning to a monetary system that history has shown countless times to work far better than any other in creating conditions for sustainable prosperity.
As this book makes compellingly clear with its sweep of history and fascinating analyses, a gold-based system will emerge because the global economy needs it. The question is under what circumstances? Ronald Reagan would have done it in the 1980s, but he had virtually no support, intellectual or political, to make it happen. At the time, most conservative economists, particularly Milton Friedman and his fellow monetarists, vigorously opposed the idea. But today there is growing support. And creating a gold-based currency would, astonishingly, be fairly easy.
Gold is right: Because the yellow metal has a fixed, intrinsic value that greatly facilitates commerce, it is the ultimate future money.