Gold has made two historic milestones, which have prompted this three-part examination of its role in monetary and investment history.

First was the news that gold has outperformed the S&P 500 over the past 20 years. We have suggested before that this should not be. An element that produces no earnings, no dividends, and finances no new technologies should not outperform the world’s leading stock index during a period of breathtaking technological change.

Secondly, it was the ability of gold in April to approach a level 100 times its price when the last remnants of the gold standard were abrogated by President Nixon in 1971. Readers who remember the 1960s and 1970s  can remember having silver coins in their pockets, silver certificates in their wallets, and an official gold price of $35 per ounce. It wasn’t that long ago, just a few hours ago on the historical clock.

Both events tell us that something is seriously wrong with our monetary system and the way it has been managed. It may also suggest that we are on the cusp of significant changes in our economic system, as the lack of spending and borrowing discipline has put this great republic in financial peril.

The nation is not in a financial position to experience a major recession or fight a major war without blowing the deficit to uncontrollable levels. We are already at a critical point where tax collections can pay for everything except our debt and defense costs. We are chronically short by over $2 trillion a year. When you have to borrow money to pay interest, you know you are in trouble.

All of our huge social programs, like Social Security and Medicare, are underfunded and will be severely affected by families not forming and having babies. A civilization that can’t pay its bills, form families, and have babies, by definition, can’t survive. A more recent estimate, using accounting methods required in the private sector, put the U.S. obligation in the range of $158 trillion.

Yet neither recession nor war is outside the realm of reasonable possibility. As a further complication, losing the reserve status of the dollar or making our debt unacceptable to world markets will have a lasting impact on all our lives for years to come.

The Trump Administration may be the last opportunity to correct the course of our financial ship before we hit the monetary rocks that have sunk previous empires. We share a lot with failed past empires in that we seem to have lost the discipline to issue money that holds its value over time.

This survey is brief by its nature. We have attempted to tell the story by focusing on its essential points and highlights, rather than bogging down the reader with unnecessary details, even if those details are interesting and vital. What will follow is a journalistic survey, not an academic thesis.

Part I – What Is A Goldbug?

What is a gold bug? The definition of a gold bug has varied through history. At one time, it meant someone who adhered to the gold standard. Advocates believed the currency should be redeemable in gold by the holder of government-issued money. Gold was money, and paper was just a warehouse receipt for the real stuff. They felt any deviation from gold redeemable money would prove to be a disaster.

While gold coins circulated alongside paper money, most money was paper or credit that was redeemable for gold or silver upon demand. Thus, even paper was treated like gold.

It was felt that only external control of government spending, through the mechanism of the gold standard, could provide stable purchasing power over time. Politicians, even when constrained by a constitution limiting their power, would not be sufficient. It would take both to do the job.

Otherwise, the government would find it too easy to spend and borrow, and it would be too likely to depreciate the value of money.  Besides the financial impact, it was felt that without financial restraint, the government would become so large and powerful that it would lose sight of its primary function, which is to protect liberty.

America’s Founders were, in this sense, gold bugs, as they were keen students of history and concerned about the control of power. They were close followers of Roman history. In 301 A.D., a pound of gold could be purchased for 7,200 nummi. A century later, it would take 500,000 nummi, implying an annual inflation rate of about 5% over a century. That number doesn’t seem excessive compared to our recent history.

The Western Roman Empire collapsed in 476 AD, but it continued to function in the East as the Byzantine Empire. The Eastern Roman Empire continued to use gold and metal coins until about the 15^th century. It would fall in 1453, overrun by Muslim soldiers.

Moreover, the American Founders had their own recent experience with the Continental, a paper money issued during the Revolutionary period that was used to finance the war. By 1783, at the end of the Revolution but before the Constitution in 1789, the Continental was listed at 1/1000^th of its original value.

During the American Civil War, in 1861, the Confederate dollar was worth about one U.S. dollar.  By 1865, although values varied by location, a Confederate dollar was worth approximately 2 cents. That is about the same amount the dollar has dropped since the founding of the FED.  The speed of depreciation is directly proportional to the social pain.  Slow-moving inflation does not seem to excite the public any more than it prompts the frog to leap from the cooking pot.

Almost all the Founders supported either a gold or a silver standard. Some, like Jefferson, were biased towards silver, while Hamilton supported bimetalism, which involves using both gold and silver as money. Sometimes there were technical disputes over the ratio of the two metals, but what was common was that they believed that money must be redeemable in valuable metals. They did not believe in fiat (money created by government decree).  They did not think political authorities could restrain their spending without the institutional constraints of precious metals-based money.

In a 1819 letter to Thomas Jefferson, John Adams wrote, “The only true money is gold and silver… paper is a delusion.”

Washington was even more explicit. In a 1787 letter to Thomas Stone, Washington wrote: “Paper money has had the effect in your state that it will ever have, to ruin commerce, oppress the honest, and open the door to every species of fraud and injustice.”

We could flood you with other quotes from other Founding Fathers. Because of this consensus, the requirement that money be specie (gold and silver) is found in the Constitution (Article I, Section 10), implicitly endorsing gold-backed money by prohibiting states from making anything but “gold and silver coin” legal tender for debts.

The wisdom of the gold bug continued to gain support from history. For the roughly 125 years that our government was on a precious metal standard, there was barely any change in the general price level, except during war, when governments typically went off the standard (such as the Civil War Greenback dollar). England had an even longer run of price stability from about 1717 to 1931.

There was even an extended period, from the end of the American Civil War to the outbreak of the First World War, during which prices declined —a condition known as deflation.

Thus, chronic inflation and chronic budget deficits, like those we face today, were not a problem. So much so that much of our political agitation was to break the ties to gold (“You shall not crucify mankind on a cross of gold”-William Jennings Bryan at the 1896 Democratic Convention) and issue more silver or paper money, the agitation of many in the Populist movement being to use inflation to help indebted farmers.

Farmers carried heavy debt, and gradually falling crop prices (disinflation) meant they would pay back the debt in more valuable dollars than they had initially borrowed. Still, they would receive lower and lower prices for their output. With 90% of the population on the farm, political agitation was often for more, not less, currency inflation.

But for the most part, our political system stayed with the gold standard because the benefits outweighed many of the costs. The falling price of crops was not due to gold, but rather because technology was increasing yields per acre, and we no longer needed as many farmers. Like all technological changes, it was painful, and many blamed their plight on the wrong thing. Stable money was not the cause of the farm sector’s pain.

Nevertheless, some of the crank monetary theories of the time combined with the new forces from the Progressive movement, which called for a larger government and an economic system that gave more flexibility and discretion to either political leaders or unelected bureaucrats. The automatic adjustments of the gold standard were increasingly considered outmoded, like the Constitution itself.

The process of leaving the gold standard was gradual but effective. As we mentioned, political agitation due to disinflation was part of the Populist movement in the late 19th century, which morphed into the Progressive movement of the early 20^th century.

Both had a distaste for free enterprise capitalism, and both disliked the idea of limited government. As Progressive legal minds went to work turning the Constitution into a “living and breathing document” which promoted the vast expansion of government powers, on the economic front, Progressives went to work dismantling the gold standard.

It was a two-pronged approach. Undermine the restrictive nature of the Constitution, at the same time undermining the mechanical constraints of the gold standard on the issuance of money.

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Image Credit: Vintage cartoon from Wikimedia Commons