The Tyranny of Gold

We’re heading down to Markets and Money headquarters in St. Kilda today and so don’t have much time to write.

Instead, we revive the wise words of Benjamin Anderson, who wrote Economics and the Public Welfare: A Financial and Economic History of the United States, 1914–1946.

This is probably one of the best books we’ve read on US Depression era economics. Obviously not bedtime reading for everyone. But if you’re so inclined, we highly recommend it.

First a little background.

After lecturing at Harvard during the Great War, where he was assistant professor of economics, Anderson moved into the real world – an unusual career path today. He joined Chase National Bank and soon after began writing the highly respected Chase Economic Bulletin from 1920–37.

During this time his contact with bankers, industrialists and politicians was immense. This vast knowledge, combined with an intimate knowledge of how economies and economics really work, shines through in the book. If you want any further proof that government meddling in the private sector just makes things worse, the chapters covering the Great Depression years make for compelling reading.

But today we want to give you Anderson’s thoughts on gold. He wasn’t a gold bug. He simply saw gold as money with a definitive role to play in the monetary system. Despite the best attempts of governments and ignoramuses to discredit it, it still does. Only now, Gresham’s Law has pushed gold out of circulation. But hidden doesn’t mean dead.

If you’re a gold investor, you may have been getting a tad nervous these past few months. If so, don’t despair. As gold continues to correct and consolidate, keep Anderson’s thoughts (below) in mind. History doesn’t really change that much. There are different actors in different places but man makes the same mistakes over and over.

So while the state of the global economy might appear very uncertain, there is one thing beyond doubt: the inmates are running the asylum and the value of paper money will – year after year – continue to diminish.

Over to you Benjamin…

‘Gold needs no endorsement. It can be tested with scales and with acids. The recipient of gold does not have to trust the government stamp upon it, if he does not trust the government that stamped it. No act of faith is called for when gold is used in payments, and no compulsion is required.

Men everywhere, governments everywhere, and central bankers everywhere are glad to get it. When paper is offered instead of gold, it will be accepted on faith if the government or the bank which has issued the paper has proved itself worthy of confidence by a satisfactory record of redeeming the paper in gold on demand.

Complaints are always made about gold and the behaviour of gold when there is irredeemable paper money. Under Gresham’s Law, gold is hoarded, or leaves the country. It ceases to circulate, leaving the dishonoured promissory note in possession of the field. Gold will stay only in countries that submit to its discipline.

Gold is an unimaginative taskmaster. It demands that men and governments and central banks be honest. It demands that they keep their promises on demand or at maturity. It demands that they keep their demand liabilities safely within the limits of their quick assets. It demands that they create no debts without seeing clearly how these debts can be repaid.

If a country will do these things, gold will stay with it, and come to it from other countries which are not meeting the requirements. But when a country creates debt lightheartedly, when a central bank makes rates of discount low and buys government securities to feed its money market, and permits and expansion of credit that goes into slow and illiquid assets, then gold grows nervous.

Mobile capital funds of all kinds grow nervous. There comes a flight of capital out of the country. Foreigners withdraw their funds from it, and its own citizens send their liquid funds away for safety.

When suspension of gold payments comes, speculators in the foreign exchange market treat paper currency most disrespectfully. They sell it short. They buy it only at a discount. The amount of discount in a free gold market or in a free foreign exchange market will be governed primarily by speculative expectation as to whether and when the government and the central bank will reverse its unsound policy and work back toward orthodoxy. Gold is blamed, speculators are blamed, capital movements are blamed, ‘hot money’ is blamed.

[Ed note: The key phrase there is free gold market or free foreign exchange market. Many would suggest, us included, that these markets are not free as they have the heavy hand of government fiddling away at them.

Anderson then goes on the explain how the fledgling (and irredeemable) US dollar was all over the shop vis a vis gold during the Civil War. As ususal, gold got the blame.]

In June 1864 the Congress undertook to punish the speculators by closing the gold market and forbidding futures in gold. The results were disastrous. In isolated markets the greenbacks fell to approximately 35c in gold, and Congress, two weeks later, without debate, repealed the measure.

The country submitted to the tyranny of gold. It was old-fashioned and it was honest. It had promised to redeem its paper money in gold, and it settled down to get its house in order so that it could do so.

In 1876 a definite program promising gold redemption on January 1, 1879, was adopted by the Congress, and shortly thereafter John Sherman, one of the ablest financiers in the history of the country, as secretary of the Treasury, began to take definitive steps to redeem the greenbacks on that date.

Once the country was convinced that Sherman meant to do it, the greenbacks, like a discounted promissory note approaching maturity, moved up month by month to the redemption date, with the discount disappearing entirely in late 1878.

On January 1, 1879, we resumed gold payments. In 1879 the Treasury gained gold instead of losing it. Incidentally, commodity prices rose in 1879 and continued to rise for sometime thereafter. Credit was restored. The country was jubilant.

Greg Canavan
Markets and Money Australia

Greg Canavan
Greg Canavan is a contributing Editor of Markets and Money and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Crisis & Opportunity, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market. To follow Greg's financial world view more closely you can subscribe to Markets and Money for free here. If you’re already a Markets and Money subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Markets and Money emails. For more on Greg go here.

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7 Comments on "The Tyranny of Gold"

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Nathan Chattaway
Seems like solid advice, but Gold as money still doesn’t directly meet the basic human needs for survival of water, air, food and shelter. If gold is promoted as insurance, isn’t the best form of insurance still to secure the means of directly providing clean water, clean air, nutritious food and suitable shelter for your family and loved ones? If you’ve got a few kilos of gold bullion stashed away, you may be able to persuade someone who has these resources to part with some or all of their surplus, but what do you do when the gold runs out?… Read more »
Nathan Chattaway
Sorry, I was running from memory on that water price from 1890s Kalgoorlie. Here’s the actuals, which are 4 times worse: In Western Australia Kalgoorlie goldfields towards the close of the 19th century, a gallon of water from a clean well cost 2 shillings. 2 shillings and sixpence if you wanted it delivered. An ounce of gold could be sold for 20 shillings. So, you could buy 10 gallons of water for an ounce of gold if you were willing to cart it yourself. In today’s terms, using gold as the standard, that puts a value of $30 a litre… Read more »
“An ounce of gold could be sold for 20 shillings.” Hi Nathan Extracts from our local paper on July 11 1870 indicated the local alluvial gold was fetching 3 pound 7 shillings and 6 pents (67 and a half shillings) which was from a lower purity alluvial gold (near my place actually..I have had it essayed). The diggers of that day were quite miffed with their return. Another field close bye produced a high purity gold for which the Sydney mint paid 4 pounds 2 shillings and 6 pents (82 and a half shillings) back in 1864. These two examples… Read more »

oops, wrong assay in my essay

Nathan Chattaway
Hi Lachlan, Between your quoted prices from 1870 and those A.B. Facey quotes from around 1892 (which were prices the miners were selling gold for in the field – would have been worth more back in the city I assume) we find you would need between 3 and 13 ounces of gold for a family’s water at today’s water use norm. Even if you only needed 1 ounce of gold for a week’s worth of water, how many of us are used to that? We get water almost for nothing. The food examples you quote equate to $3.80 per kilo… Read more »

Its a very interesting subject Nathan. Those food prices were on field prices however the field was close to larger settlements. Water was abundant there. If you look at far flung gold fields prices could be much much higher for food again. Yes hasn’t technology made food cheap. A disruption to oil flows……oh boy.

Steve Pearson
I don’t think, Nathan,that quotes from a unique case, when gold was cheap and water dear, is a particularly strong assault on gold, particularly in the capacity that Anderson is writing about. Gold is the basis of an advanced, but honest, economy, involving the division of labor. Gold is the impartial tyrant that, ceteris paribus, forces an accounting of promises. If everything breaks down, some sort of autarky may be helpful for a while. Self sufficiency could get you through a real crises. But after a time you’ll need to replenish supplies. You can’t make or grow everything you need.… Read more »
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