Short History Of The Faux Gold Standard

Greetings from Sedona…

Insights and ideas often spring from unusual circumstances.  A little while ago during a discussion of the gold standard on CNBC the anti gold Keynesian laid a trap for the pro gold guy when he asked if it is the gold guy’s position that the gold standard prevents the kind of government profligacy and debt we see today.  The gold guy answered in the affirmative whereupon the Keynesian then asked how Britain could amass a national debt of 300% of GDP during the 19^th century (when it was on the gold standard).  The gold guy had no response and the argument for the gold standard had clearly taken a serious hit.

Now I know my history pretty well and figured that the most likely period for Britain to have that much debt would have been during the real first world war, more commonly known as the Napoleonic wars.  After looking it up I found that I was correct, and the Keynesian was a bit off because the actual level of government debt was closer to 250% of GDP as shown in this graph:

If my only quibble with the Keynesian was the exact amount of the debt you would not be reading this.  However, I also had a vague recollection of the British resuming the gold standard some years after the wars were over.   I dug a little deeper and found that by act of parliament in 1797 the Bank of England was authorized to cease redeeming its notes in gold, effectively abandoning the gold standard.  There are two key observations to be made here.  First, with the creation of the Bank of England late in the 17^th century (the Federal Reserve of its day) Britain was not on a true gold standard, but what I call the faux gold standard.  Predictably, the Bank of England ran up its liabilities but was able to get away with it until huge expenditures for European and North American wars made it give up the ghost in 1797.  Even without the expenses of its losing battle with the American colonists and France, the Napoleonic wars would also have resulted in Britain leaving the gold standard and a big increase in debt, following thousands of years of precedents.

This may sound arcane and irrelevant to your lives, but it is very relevant and worth understanding more deeply.  The Keynesian was dead wrong in his assertion of fact regarding British debt and the gold standard.  The lion’s share of the debt was incurred after the British officially abandoned the gold standard.  The CNBC Keynesian is supposedly an expert in his field and made his claim as if he just looked it up and really knew what he was talking about, though he clearly had no clue.  This kind of thing happens all the time!!!!  Supposed experts get their facts wrong and we make policy based on those many inaccuracies!!!

Even more important, further analysis indicates many dire implications for our fiscal situation today.  First, as I have often mentioned, the denominator (GDP) of the debt/GDP ratio back then was severely underestimated compared with today’s GDP calculations.  For example, huge portions of the economy were uncounted and virtually uncountable, like domestic services rendered by wives and mothers, many of which are counted as part of the market economy today.  The price of a washing machine is a good example.  The prepared frozen meal is another, as are things like carpentry, and a wide variety of goods and services that were routinely bartered rather than entered into the marketplace of money transactions which are so dominant today.

Second, it is a mistake to limit the GDP calculation to the domestic economy of the British Isles.  After the end of the Napoleonic wars Britain ruled the seas with a worldwide colonial empire.  While over the long term of many decades the empire proved unprofitable, over the shorter term Britain had access to tax revenues generated by the economic activity of those far flung holdings in addition to its domestic economy.  Such is not the case for today’s over-indebted industrial economies.

Third, nearly 65% of all government expenditures were for the military when this mountain of debt was incurred by Britain.  Cutting military expenditures is much easier than other types of government spending.  Cuts in the defense budget do not result in mass protests and riots like those occurring in Greece as this is written.

In This Time is Different, Reinhart and Rogoff note that a government debt/GDP ratio of 100% generally means big trouble.  Clearly Britain stands out as a great exception, though less so after adjusting for factors discussed above.  In fact, these same factors apply to virtually all the incidents of deep trouble prior to WWII.  This means a 100% debt/GDP ratio, so common today, is far worse than in the past.

Unfortunately, there is yet another major element to be considered – unfunded pension and health care liabilities for virtually all of the industrialized economies of the world.  When we add it all up, virtually the entire globe has long passed the key levels of debt that Rogoff and Reinhart considered the  threshold of deep trouble in their great work of financial history and global financial crises.

The outlook remains grim at best.  Forget the rhetoric.  If nearly every person in Congress were not a thorough hypocrite we would already have seen elimination of hundreds of outrageous programs of corrupt origin.  In addition, when our President again asks for more infrastructure spending, you can bet they will include a preponderance of projects like the personal airport for Harry Reid in Nevada and the bridge to nowhere for the former Republican senator Stevens from Alaska.

More on this in the weeks to come.

All the best to you all,

Stephen Reiss
[email protected]

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