Response to the Rothbardians
Jude Wanniski
July 12, 2002


WMemo To: SSU students
From: Jude Wanniski
Re: Debating Frank Shostak

There are a great many variations in the realm of supply-side economics just as there are myriad differences among the demand-siders, who put consumers at the center of their universe. At Polyconomics, where we practice classical supply-side economics, we have had several exchanges with our cousins in the Austrian school – chiefly on the topic of money and gold. All Austrians are fans of a gold standard, but there are differing approaches within their family. We are closest to the ideas of Ludwig von Mises, whose broad views on money and banking we find almost identical to ours. There is another Austrian camp that is associated with the works of the late Murray Rothbard, an American who taught at the University of Nevada in recent years and whose followers at the Von Mises Institute dominate Austrian thinking in the United States today. An associate of the Institute, Frank Shostak, on June 27 wrote a critique of "The Supply-Side Gold Standard" as it is taught at SSU. I asked my colleague, Nathan Lewis, to write a reply, with the objective of finding common ground, as we believe our version would be within reach of our government today while the Rothbardian version would not, as its followers will readily acknowledge. Here is the link to Shostak, with Lewis following directly. I will have a note at the end.

The Supply-Side Gold Standard: A Critique by Frank Shostak

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The big difference between the Rothbardians and the historical Austrians is the Rothbardians’ descent into quantity theory, in this way mimicking the intellectual errors of Milton Friedman and the Monetarists. Like Friedman, the Rothbardians also champion a wide variety of other libertarian causes, many of which seem worthy. The problems come within the technicalities of monetary theory, which may seem abstruse, and thus unimportant, but which actually deal with the most critical issues facing the world today. Rather than simply dismissing the Rothbardians, as the mainstream economists have, we would like to engage them so that we can finally get to the bottom of the issues that have divided gold-standard advocates for decades. A group of genuine Austrians, who understand the gold standard as it functioned in the 19th and 20th centuries, would be a formidable intellectual and political force.

Shostak begins with a rather good description of a working gold standard - whether one operated by a government or by a private, independent bank. Then Shostak goes off into a strange tangent about whether gold is “money” or not under a gold standard. I might point out that when four private banks in the 1790s circulated paper money backed by gold redeemability in the U.S., the Founding Fathers of the U.S. considered this to be perfectly legitimate under the Constitution of 1789, which established that only gold and silver would be money in the new United States. Indeed, in 1791, with the ink still wet on the Constitution, the Fathers set up the government-sanctioned but essentially private First Bank of the United States. This provided a standardized paper currency redeemable for gold on demand.

The whole point of a gold standard is to use gold as a standard of value for paper money, which, through careful management of supply, allows worthless paper to trade as if it were gold. Thus a “gold price rule” is a gold standard, and a gold standard is a gold price rule. All gold standards function the same way, whether maintained by competitive private banks, as was the case in the U.S. until 1863; or a network of selected private banks under government oversight, as was the case from 1863-1913; or a mixture of private banks and government institutions, during the 1920s; or wholly by the government, during the Bretton Woods era from 1944 to 1971.

Shostak really does not seem to grasp how monetary systems work, either today or in the past. All gold standards have operated through the expansion and contraction of the supply of money (base money), in accordance with the gold/currency value peg. In practice, this means that the “money supply” tends to increase as demand for money increases with an expanding economy. As an example, I like to use the period from 1880 to 1912 in the U.S., the stretch between the reestablishment of the gold standard in 1879 and the creation of the Federal Reserve in 1913. We could also use the stretch from 1880 to 1930, during which the dollar was securely pegged to gold at $20.67/ounce.

In February 1880 there was base money* (currency held by the public and bank reserves) of $897 million. In February 1912 the figure was $3,330 million. That’s a 268% increase! But the value of the dollar remained the same, namely 1/20.67 ounce of gold. The amount of currency increased as the operation of the “gold price rule” allowed the expansion of the base money supply to meet the growing demand for money exhibited by the growing economy.

In February 1930, the figure is $6,999 million. The dollar was still worth 1/20.67 ounce of gold.

It’s worth pointing out here that there was very little expansion of the monetary base between 1925 and 1929, the Roaring 20s and the great bull market. In September 1925, the monetary base amounted to $7,036 million and in September 1929, the peak of the bull market, it was $7,075 million. This should throw something of a wrench in the Rothbardian theory that the bull market and crash of 1929 was caused by “monetary expansion” by the Fed (the Fed is only capable of creating base money).

In January 1933, there was $8,272 million of base money (which, by the way, throws a wrench in the notion that the Depression was caused by monetary contraction). In January of 1934, the number is $7,947 million -- a 9.6% decline in only one year! Oddly enough, during 1933 the dollar was devalued from 1/20.67 ounce of gold to 1/35 ounce. The devaluation took place with a contraction of the “money supply.” Indeed, it is very probable that the money supply contracted because the dollar was devalued, as the devaluation would tend to reduce the demand for dollars.

This should illustrate why classical economists always, always, always, concentrate on the value of the currency, rather than making vague and incorrect remarks about how monetary expansion leads to devaluation and inflation.

These numbers are all from Milton Friedman’s Monetary History of the United States, 1857-1960.


The Rothbardians seem to want to return to a system in which all currency in circulation consists of full-weight coins. As a means of assuring that the value of the coin is “pegged to gold” I suppose this is an effective system, since the currency is made of gold! In practice it is not as effective as it may seem, since coins wear down or can be clipped. The Chinese used to organize their coins into “strings” depending on how much they had worn down. A 100-coin string of new copper coins would be worth 100 cash, but a string of worn coins would be worth only 93 cash or 87 cash. One advantage of paper money is that it is redeemable for a fixed value of gold no matter what its physical condition. Technically speaking, paper money is a better “gold price rule” even than gold coins!

One supposes the Rothbardians like this system because it supposedly prevents an “expansion of the money supply.” Theoretically, the “money supply” would grow in tandem with the worldwide supply of gold or silver, which is to say, about 2% a year. This bears an eerie resemblance to Milton Friedman’s calls for a Constitutional Amendment mandating that the “money supply” grow 3% a year.

However, the big joke is that it wouldn’t work! If a small country - Thailand for example - were to abandon paper currencies and use exclusively gold (and silver) coins for money, the “money supply” would grow and shrink just the same as if they had used gold-backed paper.

There is one historical example of a country that abandoned paper money for bullion. China had used paper currencies since the early 11th century, but many disasters had ensued when the paper currency was separated from its silver redeemability and devalued. In the mid-15th century, the Ming leaders decided to chuck out paper money and return to an all-silver currency. The result was that China, which had exported silver previously, began to import enormous quantities of silver which it used for money. This silver came first from Japan and then from Europe. Indeed, one motivation for the plunder of the New World by the Spaniards was to assuage China’s bottomless demand for silver bullion. Ships laden with silver made the voyage directly from Acapulco to the Portugese colony in Macau. As the Chinese economy grew, its demand for silver grew alongside. Silver flowed into China for centuries.

All functioning monetary systems must have some mechanism to adjust supply in relationship with demand. In an all-metallic system, this mechanism is the import and export of bullion. Under a gold standard, it is the adjustment of the supply of paper money (base money). Proper adjustment of the supply in accordance with a gold standard, i.e., to maintain a stable parity with gold, does not produce “boom bust cycles.” The distortions of the economy known as inflation and deflation are caused by changes in the value of currencies – changes that do not occur when the currency is defined in terms of gold.

It has been our belief that Rothbard's basic error was in attributing the Crash of 1929 to the failure of gold to prevent a decline in prices. A gold/dollar has no power to prevent fiscal shocks from causing a temporary decline in prices while inventories are liquidated. Jude Wanniski has persuasively demonstrated that the Crash of 1929 was caused by the fiscal shock of the Smoot-Hawley Tariff. Ludwig von Mises did not live to see that connection made, but he was careful to exonerate gold from having failed to prevent what was an economic contraction, not a monetary deflation.

Nathan Lewis


Note from Jude Wanniski

Shostak writes that, in an unpublished memo, Rothbard actually dismissed my hypothesis of the Hoover tariffs and taxes causing the Crash and Depression: "Moreover, if, according to Wanniski, the Great Depression continued for a decade solely because of high taxes, then why didn’t we have a permanent depression from World War II, since tax rates have been much higher since then?"

Rothbard was correct that the tariff and tax rates themselves remained very high, but effective taxation declined dramatically on both counts. Just before and during the war, reciprocal trade agreements were negotiated with all the allied powers, permitting exchange at much lower tax rates. These were extended to the defeated countries after the war in what became known as "Most Favored Nation" rates. The Smoot-Hawley tariff rates are still on the books, but only apply to a handful of nations. Rates have been eliminated entirely with Canada and Mexico. The same is true of income-tax rates, which remained high until the Kennedy and Reagan tax cuts of the 1960's and 1980's. But from the late 1930's to the 1960's, there were hundreds of exceptions enacted to reduce the effective rates, either via increases in personal exemptions or deductions or through tax preferences, "loopholes."

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* Comparison adjusted to include bank reserves as of July 18, 2002. Original comparison was just to currency held by public.