November 18, 2014 Print

During a special session following the 2014 Liberty Forum & Freedom Dinner, Dr. Judy Shelton and Seth Lipsky, founder and editor of the New York Sun, presented a session on Sound Money. Below are Dr. Shelton's full comments. She is an Atlas Network senior fellow and the co-director of Atlas Network's Sound Money Project. The session was generously co-sponsored by Foundation for Economic Education. 


It is so nice to be with like-minded people who understand that we need fundamental monetary reform. It’s so comfortable to be among those seeking an alternative to central banking, which increasingly seems like central planning. We think money is supposed to function as a useful tool for measuring value – not as the means through which government attempts to implement economic and social policy.

But if we’re going to forge a viable path to reform—the subject of this panel—it’s going to require broad acknowledgment outside this auditorium that the world’s current monetary arrangements are broken and dysfunctional.

Let me tell you about a monetary conference I attended earlier this year in February, in Vienna, because what I heard there surprised me. The keynote speech was delivered by a distinguished man who was much revered by the members of that audience, mostly European banking and finance officials, and quite a few people from the International Monetary Fund.

I was listening very closely to this speaker as he explained how, in the years leading up to the 2008 global financial crisis, we had “volatility, persistent imbalances, disorderly capital movements, currency misalignments, currency wars and capital controls.”

“We had no system,” this gentleman said. He continued, “Central banks were focusing exclusively on a misleading yardstick (inflation targeting) while they turned a blind eye to the massive expansion of credit and the formation of huge asset price bubbles.” 

The speaker was Jacques de Larosiere. He was Managing Director of the IMF for nine years, starting in 1978, which was not so long after the Bretton Woods system had ended.

Larosiere is 85 now. And in that same speech, he noted that our current monetary state of affairs is sometimes called a non-system. But in his opinion, it’s actually something much worse. It’s an anti-system. And this anti-system brought about the 2008 global financial crisis, the fallout of which today, he has warned, is threatening the very fabric of our societies.

Now, if someone like that is sounding the alarm in those kinds of intellectual circles, does it mean policymakers will be emboldened to find an alternative to central banking?

Well, it helps. But central banks have such tremendous power and such enormous influence over financial markets and whole economies. They are so firmly entrenched as agencies of government, headed by government-appointed officials, with near-total discretionary authority, that forging an alternative approach or even putting modest restraints on their power is difficult. Is it doable? Maybe. But we need to define in tangible terms what we mean by free-market money. We need to offer concrete proposals.

One thing we’ve learned is that floating exchange rates do not qualify as free-market money. They haven’t worked out in practice as theory predicted. We’ve had more currency volatility, not less, since the end of Bretton Woods. Milton Friedman thought that destabilizing speculation would not take place under floating rates. He didn’t anticipate that governments would build up huge war chests of foreign exchange reserves to thwart demand-and-supply pressures on currencies. He did not foresee that delinking the dollar from gold would substantially empower central banks, particularly the Federal Reserve, and strengthen government control over the private sector—his absolute worst nightmare. 

So, while we all treasure Milton Friedman, he turned out to be wrong on floating rates. In the 1990s, at the Hoover Institution at Stanford, my office was close to Milton’s. He was a senior research fellow—I was, too—and he was always willing to discuss floating rates versus fixed rates. In a 1994 National Review article, Friedman acknowledged that, since 1971, there had been “large, sometimes violent movements in exchange rates,” which he blamed on government intervention. He also declared in that same article, “A true gold standard—a unified currency—is indeed consistent with free trade.”

Free trade was the primary reason for creating the gold-linked Bretton Woods monetary system, which began operating in 1947. It was a matter of both efficiency and morality. Nations devastated by World War II needed to rebuild. A stable monetary platform would encourage international trade and capital flows, increase economic growth, raise productivity, raise income levels, and raise living standards.

That all happened. French economist Thomas Piketty, in his book Capital in the 21st Century, describes the two decades from 1950 to 1970 as the “golden age of growth” for Europe; after 1970, the growth rate dropped to less than half. But Piketty doesn’t mention the near-perfect correlation between that golden age of growth and the Bretton Woods era. His book is 700 pages; there’s not a single reference to Bretton Woods. 

Paul Krugman is another economist who praises the 1950s and 1960s when America was at its best, with a strong middle-class and lower income inequality. But somehow Krugman, too, misses the correlation with the period of Bretton Woods, from 1947 to 1971. In his New York Times column, Krugman has only disdain for any consideration of gold-linked money.

Speaking of the New York Times, though, there was an op-ed published in July promoting the advantages of a gold standard. It said: “With a balanced budget and a gold-backed currency, America’s economy could be even more formidable than it is today.”

Oops. What it actually said is, “With a balanced budget and a gold-backed currency, China’s economy could be even more formidable than it is today.” The author, Kwasi Kwarteng, is a member of the British Parliament, and he goes on to say that, if China went on a gold standard, it would provide a “more secure basis for an international monetary system” than the floating rate regime that inadvertently created in 1971.

I agree. But if it’s such a good idea for China as a way to demonstrate global economic leadership, wouldn’t it make even more sense for the nation with the dominant global reserve currency, deepest capital markets, and strongest commitment to free markets and free people? Shouldn’t America be the one to link its currency to gold?

I’d like to sketch out a rather uncomplicated way to start doing that. We should issue a gold-convertible bond. By “we” I mean the United States Treasury. A gold-convertible Treasury bond would be comparable to a regular 5-year Treasury obligation, with the face value representing what the bondholder receives at maturity. But with this difference: that face value is stated as both a dollar amount and a specified amount of gold. At maturity, the bondholder receives either the face amount in dollars or the defined amount of gold, at the bondholder’s option. So the bondholder is protected from losing purchasing power in terms of gold; if the dollar gets debased relative to gold, he is compensated by receiving the gold. It’s like a TIPS bond – a Treasury Inflation Protected Security – which compensates the bondholder for lost purchasing power from a debased dollar as determined by the CPI. This doesn’t have to be a big deal for the Treasury; just a new product being offered to investors.

But, it would be a big deal, because the next country to offer a five-year gold-convertible bond would likely be China.

And then just imagine: there’s a US financial instrument, a sovereign obligation, redeemable five years from now as either one ounce of gold or 1240 dollars (that’s roughly today’s price of gold times the yield on a 5-year Treasury). And there’s a Chinese government obligation redeemable five years from now as either one ounce of gold or 8300 yuan. Therefore we have an implicit fixed exchange rate between the dollar and the yuan because both financial instruments are worth the same thing – one ounce of gold – in five years. The world’s two largest economies would be taking an initial step toward what could become a major paradigm shift. The market would decide the value of each of those gold-convertible bonds, with investors paying a premium or purchasing at discount, depending on whether they expected the dollar or yuan to rise or fall relative to gold.

There’s one organization that might object to gold-convertible sovereign bonds: The International Monetary Fund. After Bretton Woods ended, the IMF changed its rules. Members can do anything they want on exchange rates: float, join a currency bloc, peg to a basket of currencies, whatever. Except for one thing: IMF members are not allowed to peg their currency to gold. Which is more than ironic; it’s downright perverse. 

As I see it—and I agree 100 percent with Milton Friedman on this—after Nixon closed the gold window in 1971, the IMF lost its reason for existence; it should have been abolished.

So now, if the US or any nation (China, Germany, Italy, France, or any country with large gold reserves) wants to forge a preliminary link between its currency and gold through the issuance of a gold-convertible bond; if it wants to join with other countries in building a new stable international monetary system, with fixed exchange rates, anchored by gold, and the IMF says no…?

Maybe it’s time to withdraw from the IMF…and for each country to ask the IMF to remit the gold it paid in when it joined. Because this monetary anti-system we have today is anathema to free trade, and anathema to the ideals of Bretton Woods. 

If America still believes in the power of free markets and the potential of free people, then we need to fix what broke. Our nation should lead the effort to build an orderly and ethical international monetary system.