My recent article “A Creditors’ Protection Bill” has been criticized because of its call for the insertion of a partial gold clause into existing contracts, with or without the consent of debtors. The criticism is that this would be an interference with the freedom of contract.
This claim is made on the grounds that the parties may have contracted precisely on the basis of the government’s having arbitrary power over the purchasing power of the monetary unit and one of them (the debtor) may want it to continue. In the words of one critic, “Lots of people contracted with the intention of taking advantage of inflation, and the counter parties are responsible for evaluating their own risk. Changing the rules of the game is cheating someone.”
This criticism, which appears to be the assertion of some sort of divine right to the continuation of inflation, is based on a failure to understand what the actual rules of the game are today. Superficially, the rule is that contracts are payable in fixed sums of dollars, the purchasing power of which the government steadily depreciates through the use of its power to increase the money supply.
More fundamentally, however, the actual rule of the game today is that the purchasing power of what is paid and received in the fulfillment of contracts is determined by the government. This wider, more fundamental and abstract rule of the game remains unchanged when the government inserts a gold clause into existing contracts. And it was this rule which the parties implicitly accepted when they signed contracts in a world in which the government determines the purchasing power of money.
What the insertion of gold clauses into existing contracts signifies is the use of government power to determine the purchasing power of what is paid and received in the fulfillment of contracts in a way that diminishes the further such use of its power. Henceforth its power of money creation will not serve to enrich debtors at the expense of creditors, or at least not to the same extent. Creditors will have a measure of protection from the exercise of the government’s power. The case is analogous to the government using its power to enact and maintain a Bill of Rights.
Furthermore, the fact is that no creditor has ever entered into a contract payable in a fixed sum of paper money in anticipation of the purchasing power of that money so radically declining that what he will receive is likely to be of substantially less purchasing power than what he lent. If that were the anticipation, credit markets would soon cease to exist in that money.
The existence of credit presupposes a monetary unit whose future purchasing power can be more or less be reliably estimated. When the government accelerates inflation even to the level seen in the United States in the 1970s, credit markets break down, as witness the virtual disappearance of long-term fixed rate mortgages in 1979, after a few rounds or prices rising more rapidly than could be compensated for by inflation premiums in interest rates. The market was beginning to form the idea that no inflation premium would be sufficient, because, however high, inflation could soon be even more rapid.
The implication of this is that once inflation becomes more than modest, it necessarily violates creditors’ rational understanding of the terms of the contracts into which they entered. It thus represents a defrauding of creditors and therefore a violation of their freedom of contract. Stopping that process is not a violation of the freedom of contract but an attempt to uphold it.
I find it the very height of gall for anyone to believe that his freedom is any way violated because he is deprived of such opportunities as being able to pay the proceeds of a life insurance policy with less purchasing power than is required to pay for the postage stamp needed to mail said proceeds. (This is an example out of the German inflation of 1923.) If he borrowed money in this kind of expectation, then he deserves to be disappointed. His freedom is certainly not violated because he his prevented from fulfilling it. To the contrary, the freedom of those whose wealth an unrestrained policy of inflation would have brought him is given a measure of protection.
Postscript: It may be objected that the insertion of any kind of gold clause into existing contracts would serve to protect the rights of creditors only by means of shifting the violation of rights to debtors, who, in some cases at least, might be obliged to suffer unanticipated real and substantial additional burdens of debt. This objection falls if it is held in mind that the proposal I made was for the introduction only of a partial gold clause. The example I used, purely for the sake of illustration, was a 25 percent gold clause that at a price of gold of $1,000 per ounce would impose a contingent gold debt of 250 ounces on the borrower of $1,000,000. Such a gold clause would not increase the number of dollars actually owed unless and until the price of gold reached $4,000 per ounce. Twenty-five percent may be too high a percentage. Ten percent might be a better number. In that case, starting at $1,000 per ounce, the price of gold would have to reach $10,000 per ounce before the number of dollars owed by any debtor actually increased.
Such an arrangement would give debtors ample time to join with creditors in opposing increases in the quantity of paper money of such magnitude as to drive the price of gold beyond $10,000 within the life of existing contracts. It would serve simply to remove debtors from the category of a vulture-like pressure group seeking to feast on every last scrap of meat left on the financial bones of creditors. Hopefully, it would gradually serve to make debtors join with creditors in demanding an end to inflation, which would then be perceived as harmful to both groups instead of to just one.
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Well said, I think you cleared that up very well.
one mystery still remains – if the gold clause is not to give rise to a capital gains tax liability on realization of nominal profit, then effectively gold is being treated as money, not as a separate asset.
so wouldn’t abolishing legal tender provisions be a more satisfactory and simpler solution with the same effect?
Certainly repeal of legal tender laws would be a good thing and something to ultimately aim for. I don’t think Reisman’s gold clause proposal is intended otherwise than as a modest first step in the right direction.
And, by the way, there is a lecture by Reisman called “The Path to Sound Money”, which is available on this site. In this lecture, he also discusses some other steps in the right direction that could be taken.
The big problem, I think, is to get politicians to listen…
1. its call for the insertion of a partial gold clause into existing contracts, with or without the consent of debtors.
2. wouldn’t abolishing legal tender provisions be a more satisfactory and simpler solution with the same effect?
It is possible that Dr. Reisman misses a subtle point being made by those who object to his plan as he summarizes it in #1.
His point seems to be that, since we all must obey the same laws, why not have the laws be those proposed by a particular sub-school of libertarian thinkers? This surely will be better than having to obey the laws of welfare state socialists.
But this misses the point, because it assumes (and worse, it reinforces) the idea that libertarians are for centralized control, albeit centralized libertarian control. Dr. Reisman does not call for the right of libertarians to choose their own monetary vehicles, he specifically states that he wants to force everyone, including libertarians to accept contracts of his own design. He assumes that people would, or should, accept involuntary social arrangements proposed by libertarians, since those would ostensibly be libertarian proposals.
But there is another possibility. It might especially gall some, to be involuntary subjected to someone else’s envisioned contract arrangements, when that person or group is part of the libertarian movement. Socialists are supposed to control; it’s what they do. Libertarians are supposed to understand the nuances of voluntary arrangements.
It’s not the particular proposal at issue. It’s the voluntary or coercive nature of it.
Quote number two proposes to abolish existing laws that bind our socialist brothers. (hey, let’s be nice!) As Reisman wants to force everyone to accept his contract proposal, quote number two wants to force socialists to abandon their own legislation, i.e., wants to specify what laws socialists may or may not implement (even amongst themselves).
What is missing here? The assumption and mistaken premise (check your premises Dr. Reisman) is that everyone living in a geographical area must live according to the same set of laws. This is the mistaken premise of the objective ethicists.
As long as this premise persists, there will be libertarians who offer reasoned and principled resistance to proposals which seek to utilize the powers of a monopolistic political system to implement the designs of social theorists, be they libertarians or statists.
Yes, now I see that, in the full context, the proposal is in support of the freedom of contract, not an interference in it.
Correct me if I’m wrong, anyone: George_Reisman here is saying that,
“When you wrote the contract, you stipulated it in dollars. Therefore, you stipulated it in terms fo a currency that you know the government will, whenver it wishes, increase or decrease the value of. Therefore, to redefine the dollar does not violate your rights, because you accepted all the things the government would do to it.”
Sounds good to me.
Mr. Knott: “His point seems to be that, since we all must obey the same laws, why not have the laws be those proposed by a particular sub-school of libertarian thinkers?”
Apart from the rest of your anarcho-capitalist nonsense (which I cannot even comment civilly on), this wasn’t his point at all. His point was that a gold clause would prevent creditors from losing money from inflation. It doesn’t matter a hoot whether tose creditors are libertarians, socialists, anarcho-capitalist, objectivists or whatever.
the tax aspect still seems to have escaped serious scrutiny, despite being the principle stumbling block. here’s a blog post from mises contributor n joseph potts which speaks to this very problem:
‘Happily, the second step that Mises described has already been achieved: “All restrictions on trading and holding gold must be repealed.”‘
Not so happy, there, Ron (he wrote just after Congress had repealed the 1934 prohibition on Americans owning monetary gold, in 1975). Certain very important restrictions remain. For one thing, increases in the DOLLAR value of your gold are taxed as capital gains at such time as you might exchange the gold for dollars (who would do that?) and/or other possessions. Not only that, the rate of this tax is not the usual rate applied to, say, pork bellies or shares of British Petroleum – it is the HIGHER rate applied to “collectibles” such as wine, old cars, and oil paintings. It’s currently 28%, versus 20% for the first-mentioned kind of asset.
Secondly, purchases and sales of gold are subject to (state) sales taxes, at least when the transaction occurs within a state having such a tax.
Yes, gold can be traded and owned “freely,” but it is still subject to restrictions NOT applied to money that keep it from competing on a level playing field against money.”
http://blog.mises.org/archives/007662.asp
I didn’t notice any anarcho-capitalist ‘nonsense’ in what Mr Knott said. Just an outline of consistent libertarian principles.
to per-olof samuelsson:
i don’t agree that prof reisman’s gold clause represents a modest first step. i believe that treating gold as money for taxation/usury purposes, even within the confines of a credit transaction, would remove any possible defence of legal tender laws (why is gold money in this instance, but not in other situations?). this would be revolutionary.
prof reisman’s suggestion is like tickling mike tyson in the ribs as opposed to punching him on the nose. you’re going to get a thorough beating in any case, so you may as well put a bit of “nasty” into it. and it’s not all bad, you’re going to see pretty stars on the way to the pavement.
Isn’t what you propose the same thing as monetary correction?
Changing existing contracts without the consent of both parties, is generally anti-libertarian and anti-Austrian. Both parties knew inflation existed at the time the contract was written and presumably took into account their best estimates of what it was and what it would be over the life of the contract at the time of negotiating that contract.
I doubt many people would object to “allowing” such a clause in new contracts, but it shouldn’t be mandated.
Inquisitor: Mr. Knott wrote:
“The assumption and mistaken premise [...] is that everyone living in a geographical area must live according to the same set of laws.”
The idea of people living together in the same geographical area according to different sets of laws certainly sounds like anarchism to me.
It is, but what about it is nonsense? How does it not follow from consistent application of libertarian principles?
Inquisitor, do you mean that consistent application of libertarian principles leads to anarchism? Well, if so, it explains why I have never been able to stand libertarians.
Whence does the dislike for market anarchists stem?
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