Correspondence with Bank of England


12:05a EST Wednesday, December 29, 1999

Dear Friend of GATA and Gold:

Reginald H. Howe, lawyer and former mining executive,
examines the prospects of a world financial order
totally disconnected from gold in this essay, "Interest
Rates: The Golden Connection." Implied is a forecast
of hyperinflation for the United States and other nations
relying on the U.S. dollar.

Please post this as seems useful.

CHRIS POWELL, Secretary/Treasurer
Gold Anti-Trust Action Committee Inc.

* * *

Interest Rates: The Golden Connection

By Reginald H. Howe
December 27, 1999

The absence of an international monetary order rooted
in gold makes the century now ending unique. Professor
Robert H. Mundell emphasized this point in accepting
the 1999 Nobel Prize in Economics a couple of weeks
ago. (See R.L. Bartley, "Money: The Century's Agony,"
The Wall Street Journal, Dec. 10, 1999, p. A18. Cf. A.
Swoboda, "Robert Mundell and the Theoretical Foundation
for the European Monetary Union," IMF Views and
Commentaries for 1999,

Gold's propensity to retain over long periods of time a
reasonably constant purchasing power is widely
recognized. Less widely appreciated but just as
significant is the long-term stability of gold interest
rates. Both together are the defining attributes of
gold money, features that governments have heretofore
proven incapable of replicating with their fiat money

Relatively low and stable interest rates under the gold
standard were the product of measuring economic value
by a shared and real international yardstick. Money --
dollars, pounds, francs, etc. -- was a certain weight
of gold, not an artifice of bankers or governments. A
lawful dollar had a real cost of manufacture, related
to the cost of producing gold. Seigniorage was close to
zero, not virtually 100 percent. Money was not simply a
means to facilitate exchanges; it was both a store and
standard of value.

Because international balances were settled in gold,
small countries could trade on relatively equal terms
with larger ones. Trade deficits could be offset by
capital flows, but no country was required to hold
large amounts of another's paper in its reserves. Any
country, small or large, could achieve monetary
sovereignty and a sound currency simply by following
the prudential rules imposed by gold. Quality of
monetary policy and banking practices mattered more
than economic size, permitting Switzerland, one of
Europe's smaller countries, to become a banking and
financial powerhouse.

Of course the gold standard was not perfect, and some
of today's monetary problems were also issues a century
ago. For example, excessive credit inflation was always
a potential problem under the gold standard, and many
were the panics resulting from overexuberance in this
regard. So too, in the area of productivity, whether
the gold supply could grow enough to provide adequate
increases in the monetary base remained a constant
concern, particularly for expanding industrial

But as it turned out, gold discoveries in California,
Alaska, and later South Africa were adequate to the
task, enabling most major countries to maintain
substantially unchanged gold parities from the early
18th century to the outbreak of World War I. Indeed,
the gold discoveries in South Africa were large enough
to cause a short but unusual period of U.S. peacetime
wholesale price inflation averaging 2.5 percent
annually from 1897-1914. (See M. Friedman et al.,
"Monetary History of the United States," Princeton
University Press, 1963, p. 135.)

World War I so shaped the history of the 20th century
that it is hard to imagine what it would have been like
without this almost inadvertent cataclysm. The
classical gold standard could not accommodate at
existing gold parities the wartime financing
requirements of the principal belligerents.
Considerable gold flowed to the United States, swelling
its money supply and raising the general price level.
After the war, the British made a critical error in
trying to return to gold at the prewar parity,
effectively forcing a severe deflation. France, which
devalued after the war, faired somewhat better.

The gold standard, in a sense, fell victim after the
war to its own earlier success, for a century of
largely stable gold parities rendered the notion of a
"good" or "necessary" devaluation anathema to many.
Economists who assign major blame for the Great
Depression to the effort to stay on gold are partly
correct. But it was not so much the effort to stay on
gold as Anglo-American policies aimed at preserving
prewar parities that lay at the root of the difficulty.
The enormous credit expansion associated with World War
I was beyond remedy by a mere panic; it simply could
not be handled other than by severe deflation or

Although the gold standard could not prevent excessive
credit expansions or even fix permanently appropriate
gold exchange rates, it did effectively set interest
rates within a rather narrow range. Under the classical
gold standard prior to World War I, short-term interest
rates in both the United States and Britain tended to
cycle between 2 and 5 percent. Very rarely and never
for long did they breach these limits. (S. Homer et
al., "A History of Interest Rates," Rutgers Univ.
Press, 3d ed., 1996) pp. 207, 321, 357, 364-365.)

Under the gold standard, business and credit expansions
were typically associated with higher interest rates.
Panics normally brought lower rates as fear reduced
both willingness to lend and demand for credit. Prior
to the stock market crash in 1929, short-term rates
moved over 5 percent as they had prior to the Panic of
1907 and during the war years. What was different in
the 1930s was that short rates not only fell but also
remained stuck under 1 percent for several years.
Central banking under the Fed, exacerbated by the
monetary excesses of World War I, managed to accomplish
what free banking and the Civil War never could: a
severe multi-year national bust.

Today what was once simply banking is "gold" banking.
Interest rates on gold are now "lease" rates. Yet their
levels cycle within substantially the same range as
before. Last fall's gold banking crisis demonstrated 5
percent gold lease rates to be as much a harbinger of
trouble as 5 percent short-term interest rates under
the gold standard. Both signaled too much paper gold --
too much gold credit -- relative to available physical

The question now is whether the recent gold banking
panic will prove a relatively brief episode caused
largely by temporary factors, or whether more
fundamental distortions were at work. In the latter
event, the 1929 experience suggests that gold lending
and gold interest rates could remain depressed for a
considerable time and that a fundamental revaluation of
gold may be necessary before the gold credit market can
fully recover.

As the millennium turns, U.S. economists hail the
"Goldilocks" economy. The Fed, originally formed to
stabilize the gold value of the dollar, instead wages
an undeclared hidden war on the discipline of gold. And
for now, at least, relegated to the realm of quaint
ideas from long ago is John Stuart Mill's admonition
("Principles of Political Economy," orig. ed. 1848, 5th
ed. 1877, Bk. III, Ch. XIII, s. 3):

"Although no doctrine in political economy rests on
more obvious grounds than the mischief of a paper
currency not maintained at the same value with a
metallic, either by convertibility, or by some
principle of limitation equivalent to it; and although,
accordingly, this doctrine has, though not until after
the discussions of many years, been tolerably
effectually drummed into the public mind; yet
dissentients are still numerous, and projectors every
now and then start up, with plans for curing all the
economical evils of society by means of an unlimited
issue of inconvertible paper. There is, in truth, a
great charm to the idea. To be able to pay off the
national debt, defray the expenses of government
without taxation, and in fine to make the fortunes of
the whole community is a brilliant prospect, when once
a man is capable of believing that printing a few
characters on bits of paper will do it. The
philosopher's stone could not be expected to do more."

For almost 70 years, the United States -- contrary to
its own Constitution and the most deeply held beliefs
of its Founding Fathers -- has led the world down the
path of unlimited fiat money. Its paper dollar has
become the de-facto international monetary standard;
its debt the world's principal international reserve
asset; and its trade deficits the world's main source
of international liquidity. As a result some 40 percent
of outstanding U.S. marketable debt securities are now
held by foreigners, up from 20 percent just five years
ago. (See M. M. Phillips, "Foreigners' Share of
Treasurys Is Growing," The Wall Street Journal, Dec.
20, 1999, p. A2.) And the U.S. trade deficit is now
running at an annual rate exceeding $300 billion, a
level previously quite unimaginable.

This situation would be dangerous under any
circumstances. A historic U.S. stock market bubble
fueled in large part by an out-of-control domestic
credit expansion makes it explosive. Why? Because a
simultaneous decline in the stock market and the dollar
could cause interest rates to rise sharply rather than
decline. The Fed cannot simultaneously support the
domestic financial structure with lower rates and
defend the dollar with higher ones. Its vaunted
domestic powers could be checkmated by international
demands, heightened by the dollar's role as the world's
main reserve currency.

Under the severest strains, a system of unlimited paper
money backed by a lender of last resort behaves quite
differently from a system based on gold -- the money of
last resort. Ultimately neither system can save
imprudent lenders or borrowers from the consequences of
their acts. But whereas the latter will stabilize at
lower interest rates with the underlying monetary
system still intact, a system based on unlimited paper
will tend toward hyperinflation unless checked by very
high interest rates, themselves business killers that
will prolong and intensify the economic downturn.

In recent years many small countries have learned this
lesson the hard way as international capital fled their
currencies and financial markets. Boom has turned to
bust, often quite suddenly. Few illusions are as
dangerous as: "It's different this time." Except,
perhaps: "It can't happen here."