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July 01, 2008

Farewell Address
by Antal E. Fekete

Gold Standard University Live: R.I.P.

The Inaugural Session of GSUL took place in February, 2007, at the Martineum Academy in Hungary. Subsequent sessions, including one in Dallas, Texas, showed a healthy increase in attendance, on average by fifty percent. Still, I am now forced to announce that Session Four in Hungary in July, and Session Five in Canberra, Australia in November will be the last. GSUL will fold tent as its sponsor, Sprott Asset Management, Inc., has withdrawn its financial support. Mr. Eric Sprott said in his letter that "we weren't attracting enough interest to justify that ongoing expenditure".

To give you an idea of the odds I am facing let me quote from the article in Wikipedia (June 9, 2008) captioned under my name: "It should be noted that mainstream economic theorists criticize gold standard-oriented monetary economists and monetary reformers such as Professor Fekete as 'fringe' or 'amateur' economists, not worthy of serious study. Professor Fekete has never held a teaching position in the economics department of any prominent university".

A deep, searing corruption

Pre-1936 theorists of the gold standard are likewise dismissed by the mainstream as "not worthy of serious study". I am proud that I have tried to continue that tradition in the footsteps of giants like Adam Smith, Carl Menger, Böhm-Bawerk, Ludwig von Mises, Frank Fetter, Benjamin Anderson, among others. Monetary scientist Walter E. Spahr, who served as Chairman of the Department of Economics at New York University from 1927 to 1956, wrote in The Commercial and Financial Chronicle on March 20, 1947: "A deep, searing corruption has afflicted monetary science. It may require many years of painful effort to overcome this disease if, indeed, it can be combated successfully. The well-being of our nation has been undermined by this affliction... When gold payments were suspended in 1933 and we embarked upon a sea of managed currency, a very large number of professors and organizations [list appended] urged a prompt return to a gold standard. The question arises what has become of those voices. Were they in error then? Did those 710 economists know so little about monetary principles in 1933 that they could not, a short time later, defend their earlier position? Or were they simply corrupted by a political movement which they found it inexpedient to oppose? There appears to be no valid defense that can be offered for men who pretend to be scientists but who adjust their so-called principles in accordance with changing political tides. A very great number of those who pass themselves off as monetary economists either have not understood the lessons of the past or have been willing to junk them, in the interest of expediency, for such personal gains as they may have supposed they might realize..."

Perpetuation of an immoral and dysfunctional monetary regime

One representative of the mainstream, Professor Jeff Frieden of Harvard, says that "the topic of the gold standard has received massive attention from scholars since the 1980's -- from Barry Eichengreen to Ben Bernanke with hundreds in between -- and a serious analysis of its implications requires a serious engagement with the existing scholarly literature."

I have studied most of that literature and I have not been able to find one iota connecting our crisis-ridden monetary system to the forcible removal of gold from it. Rather, the gold standard is portrayed as an anachronistic monetary regime, the removal of which was due to popular demand. Moral considerations, sanctity of contracts, the honor of the government, the opprobrium of declaring bankruptcy fraudulently, the question of tormenting widows and orphans did not enter into it. Nor did long term economic considerations such as the ticking time-bomb of capital destruction. The question is never raised how well the gold standard succeeded as the protector of savings, as the instrument of capital accumulation and, above all, as the stabilizer of the interest rate structure. A façade that the mainstream has provided a reasonably complete and balanced view of the gold standard, past and future, is maintained but is outright mendacious. The existing literature is in fact a stumbling block in the way of impartial inquiry. It is dedicated to the maintenance of the status-quo, the perpetuation of an immoral and dysfunctional monetary regime: that of irredeemable currency. This has led me to found Gold Standard University Live that is free to challenge the Keynesian and Friedmanite orthodoxy.

Let me mention just two broad areas of inquiry which have been overlooked by others, but which we have planned to tackle:

(1) Gold and the theory of interest. The latter cannot be understood without the former. We have to incorporate the theory of hoarding into the theory of interest. We have to study the problem of capital destruction in the wake of gyrating interest rates, the main consequence of ousting gold from the monetary system.

(2) Gold and the theory of speculation. To understand the causes of the Great Depression we must understand speculation. The theory of speculation covers such topics as arbitrage, futures trading, basis (especially gold and silver basis), contango, backwardation, short squeeze, corner. Speculation is virtually ignored by conventional economic theory. The hurly-burly on the floor of the exchanges apparently does not reach the ears of inhabitants of the ivory tower.

The economic consequences of Mr. Keynes

Once these two gaps are filled, it becomes clear that the gold standard is naturally ordained as the only system that can stabilize interest and foreign exchange rates. By contrast, the regime of irredeemable currency has been inflicted upon the people through fraud and chicanery. Its foundation is no firmer than the gullibility of people who are, for the time being, willing to exchange real goods and real services for irredeemable promises to pay. But as the prices of crude oil and various foodstuffs convincingly show, there are definite limits to gullibility.

The claim of Keynes parroted by most mainstream economists, that the Great Depression was due to the "contractionist tendencies of the gold standard", is untenable. Just the opposite is true. Here is what happened.

In 1933 the forcible removal of gold signaled to bond speculators that the one and only competition to government bonds has been knocked out. They were quick to realize that their chance to bid bond prices sky high has come. The result was continually falling interest rates causing widespread capital destruction, as well as falling prices. Producers were bankrupted en masse. Economists have never bothered to study the untoward consequences of the forcible removal of gold, even though common sense would suggest that it cannot be done with impunity.

A careful and impartial examination of the record shows that the scuttling of the gold standard, as advocated by Keynes, was the main cause of the Great Depression and, unless it is rehabilitated with all deliberate speed, a new depression may be waiting in the wings.

Theory of speculation

Speculation is man's main tool to deal with risks and future uncertainties. Mainstream economics fails to make a distinction between risks created by nature and risks created by man. This distinction is fundamental. Speculation can effectively confront the former, while it will only aggravate the latter.

Risks created by man include risks involved in foreign exchange and interest rate fluctuations. They are certainly not created by nature witness the fact that such risks are non-existent under a gold standard. Clearly, they were created by governments while abandoning the gold standard.

It is untenable to assume that under the regime of irredeemable currency speculation will tame the fluctuations in foreign exchange and interest rates. Just the opposite is true. Futures markets make them even less stable and more volatile. It is not possible to predict whether bond prices go to zero as they would under hyper-inflation, or whether they go sky high as they would under hyper-deflation. This problem is crucial and it can be approached only through understanding bond speculation, especially as it is helped by tail-winds provided by the central bank.

The following facts are either not widely known or not well-understood. Open market operations of the Federal Reserve (Fed) were introduced in the 1920's in violation of the Federal Reserve Act of 1913. They were legalized retroactively in the 1930's. There was hardly any public discussion of the wisdom of the move or the stakes involved. Pre-1936 economics was categorical in its condemnation of the monetization of government debt. Introducing the catchy name "open market operations" has made it possible to monetize government debt through the back door.

Economists failed to predict the disastrous consequences of this ex post facto legislation. Bond speculators were given a risk-free opportunity to profit. In pre-empting the Fed they would buy the bonds beforehand, dumping them after the Fed has completed the purchase of its quota. Risk-free speculation imparted a bias to the market favoring rising bond prices or, what is the same to say, falling interest rates.

It speaks volumes about the degradation of economics in the wake of the Keynesian revolution that an illegal trick could be elevated to the holiest of gestures whereby high-powered money is created, and nobody points to the downside of the prestidigitation.

Revisionist theory of the Great Depression

Most importantly, economists have also failed to identify falling interest rates as the main cause of the Great Depression. They have concentrated on falling prices, not realizing that in doing so they are confusing cause and effect. The true chain of causation is as follows.

Persistently falling interest rates result in the erosion (ultimately, destruction) of capital deployed by the producing sector. In effect, bond speculators siphon off money stealthily from the capital accounts of the producers. The latter are unaware of being victimized by this vampirism of the financial sector. But they are, whether they recognize it or not. Profits of the bond speculators do not come out of nowhere. They are the flipside of the opportunity loss suffered by the producers who have to continue financing their capital at the higher rate. Unable to escape from the clutches of debt, the producers are squeezed. They scramble to sell more of their product at fire-sale prices in order to fend off bankruptcy. In this way a downward spiral of prices is created.

The prevailing optical illusion suggests that money is scarce. Everybody cries out for the Fed to create more money. The Fed complies and enters the open market to purchase more bonds. In doing so it provides bond speculators with another opportunity to make risk-free profits. Interest rates fall further and producers are squeezed more. A vicious circle is activated. At the end of the spiral producers go bankrupt in droves.

According to my revisionist theory the Great Depression, far from being caused by overproduction as suggested by Keynes, was caused by wholesale destruction of capital. The ultimate cause was risk-free profits granted to bond speculators through the Fed's open market operations.

This is a serious challenge with which the prevailing orthodoxy is confronted. The weakness of its position is shown by the unwillingness to take it up and have an open debate. It is with regret that Gold Standard University Live has to suspend its operation to let Keynesian orthodoxy win by default.

Witch-hunt in Washington

High energy and food prices have given occasion for a witch hunt in Washington. Politicians are trying to push the blame on speculators, calling for legislation to limit long positions in the futures markets. These laws, if enacted, would be counter-productive. All this goes to show that economics is a complete ignoramus when it comes to speculation.

Speculating in crude oil and in grains is not risk-free. Profits are the incentive for speculators to lend liquidity to the markets and to temper price swings. Indeed, speculation stimulates production or retrenchment according as the threat is scarcity or overproduction.

It is a blunder to regulate speculators out of the commodity markets. The result is predictable: illiquidity, more volatility, more scarcity. Consumers would end up paying even more for energy and food.

So much for commodity speculation. Bond speculation is another matter. As explained, bond trading does not address risks that exist in nature. It addresses risks created artificially by the government. Worse still, instead of promoting stability, it destabilizes the interest rate structure further. Worst of all, bond speculation is made risk-free by the open market operations of the Fed. The cap on bond prices has been removed, and continually falling interest rates may push the world into another Great Depression, possibly worse than the last one in the 1930's.

Farewell message

These are just some of the questions GSUL has set out to investigate in depth. Mainstream economics avoids these topics like the devil avoids holy water. Other schools such as the Austrian, for example, appear to be more interested in cultism and in regurgitating old tenets than in new research of new problems to which mainstream economics turns a blind eye.

It is with regret that GSUL gives up its plans to discuss these burning issues in public just at a time when the need for such debate appears to be the greatest.

I take this opportunity to thank everybody, participants as well as sponsors, for their support of our cause. I wish everybody a prosperous journey through what promises to be truly hard times.

Reference:
A. E. Fekete, Fiat Currency, Destroyer of Capital, www.financialsense.com, December 5, 2007

Antal E. Fekete
Professor, Intermountain Institute of Science and Applied Mathematics, Missoula, MT 59806, U.S.A.

DISCLAIMER AND CONFLICTS
THE PUBLICATION OF THIS LETTER IS FOR YOUR INFORMATION AND AMUSEMENT ONLY. THE AUTHOR IS NOT SOLICITING ANY ACTION BASED UPON IT, NOR IS HE SUGGESTING THAT IT REPRESENTS, UNDER ANY CIRCUMSTANCES, A RECOMMENDATION TO BUY OR SELL ANY SECURITY. THE CONTENT OF THIS LETTER IS DERIVED FROM INFORMATION AND SOURCES BELIEVED TO BE RELIABLE, BUT THE AUTHOR MAKES NO REPRESENTATION THAT IT IS COMPLETE OR ERROR-FREE, AND IT SHOULD NOT BE RELIED UPON AS SUCH. IT IS TO BE TAKEN AS THE AUTHORS OPINION AS SHAPED BY HIS EXPERIENCE, RATHER THAN A STATEMENT OF FACTS. THE AUTHOR MAY HAVE INVESTMENT POSITIONS, LONG OR SHORT, IN ANY SECURITIES MENTIONED, WHICH MAY BE CHANGED AT ANY TIME FOR ANY REASON.

Copyright © 2002-2008 by Antal E. Fekete - All rights reserved

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