GOLD IS THE CURE FOR THE JOB-

DRAIN
by Antal E. Fekete,
Professor, Memorial University of Newfoundland
September 22, 2003
Executive Summary

Falling (as opposed to low but stable) interest rates are lethal to the economy, especially if
prolonged. They make the rate of marginal productivity decline. As it does, it prompts capital
export. Migrating capital takes industrial jobs with it. This paper analyzes job-drain that is
threatening America with de-industrialization. The process will continue as long as wild swings in
the rate of interest do. The cure is to be found in the stabilization of interest rates. It can be
effected by opening the U.S. Mint to the free and unlimited coinage of gold, as mandated by the
U.S. Constitution.

De-Industrialization of America

The true story of the de-industrialization of America has never been told. It started with the U.S.
Treasury defaulting on its gold obligation to foreigners in 1971, thereby foisting a regime of
irredeemable currency upon the world. An unanticipated side-effect was the setting of the rate of
interest adrift. It then started its wild roller-coaster ride, first up well into double digits by 1981,
then down to zero, a move that twenty years later is still in progress. Greenspan takes credit for
the low rates as a measure of his success in “licking inflation”. The claim is an empty one. The
credit belongs to bond speculators, the big money-center banks among them, that have got away
with obscene profits on their bond holdings and long positions in the derivatives markets. It is too
early to say that the plunge of interest rates is over. There is more dough still where these profits
have come from.

At whose expense are those obscene profits made? Why, at the expense of the producers and
laborers, naturally. Economists have missed the curious coincidence that pari passu with the
unprecedented swings in interest rates America is being de-industrialized. Of course, they noticed
the migration of industrial jobs from America to Asia. But they blamed it on the sweatshops in
China and India. However, Asian wage rates had been lower for the entire period of modern age,
causing no migration of jobs as long as industrialized countries adhered to the gold standard. The
difference in wage rates in itself does not establish a cause for the job-drain.

Greenspan in a testimony before a Congressional committee stated that the de-industrialization

process is market-related as Americans demand ever more services. This is as false as it is self-
serving. The real cause of the de-industrialization of America is the mega-swings in the rate of
interest. They are far from over. Unless interest rates are stabilized soon, America will be
denuded of its park of capital goods and American labor will be reduced to poverty. Labor leaders
should pay attention and demand that interest as well as foreign exchange rates be stabilized
forthwith by opening the U.S. Mint to the free and unlimited coinage of gold, as mandated by the
U.S. Constitution.

Marginal Productivity
Here is the evidence that causal relation exists between the swinging dollar-rate of interest and
progressive de-industrialization, as manifested by the massive export of industrial jobs from
America to Asia. To understand it we have to make the concept of productivity precise.

Every industrial plant and equipment has its own rate of productivity that can be calculated as the
annualized percentage of increase in the value it imparts to the goods under production. Not all
plant and equipment will find employment, however. Even though in each case the value of
output is greater than that of input, the opportunity cost of employing certain capital goods may be
too high. This is a point that has been missed by all discussions of productivity so far. If we rank
all capital goods according to their rate of productivity, then we find that there is a lowest-ranking
one that can still be employed profitably in production, but all others with a lower productivity must
remain idle as their application would be uneconomic in view of their high opportunity cost. It is
the marginal item of industrial capital, and its productivity is called the rate of marginal
productivity. It goes without saying that the marginal item shifts constantly, and with it changes
the rate of marginal productivity.

The key question to ask is what determines this rate. This is important because capricious
changes in it could play havoc with the economy. Contrary to conventional wisdom, an increase
in the rate of marginal productivity is not beneficial. It is actually harmful to the economy when
prolonged, as it is the chief cause of unemployment. Indeed, the new marginal item has a higher
ranking than the previous one, therefore all capital goods below its rank must be idled, making
the labor-complement superfluous. Superficial thinking may suggest that a decrease in the rate of
marginal productivity is beneficial as it would press idle plant and equipment back into service
restoring employment. Not so. Actually, the decrease is also harmful if capital is mobile
internationally, as it is today under globalization. When the rate of marginal productivity drops,
capital will be exported to foreign countries with abundant cheap labor. Note that the only way to
keep industrial jobs in the country is to keep the rate of marginal productivity relatively stable.
Violent changes in the rate cause capital and labor to divorce, whereupon capital migrates abroad
taking industrial jobs with it, and leaving domestic labor unemployed.

What then determines the rate of marginal productivity? Since capital goods are an earning asset,
they are in direct competition with other earning assets. In particular, capital goods compete with
bonds. When the yield on the bond rises (the market price of the bond falls), the opportunity cost
of employing capital rises with it. Arbitrage from physical capital to bonds takes place. Seeking a
better return owners of capital goods sell their plant and equipment, and buy bonds with the
proceeds. From producers of real goods they become coupon-clippers. Moreover, not only do
increasing interest rates discourage production, they actually destroy domestic capital. This is so
because an irreversible process is at work. Please note the difference between finance capital
that is mobile, and domestic capital consisting of producer goods that is not. If and when interest
rates turn around and start falling again, arbitrage goes into reverse. Bondholders take profit.
They sell their bonds and want to put the proceeds into capital goods. They look for the most
profitable applications. They will find them abroad where labor costs are a fraction of that at
home. They will send their capital abroad. Thus capital goods at home that have been idled
earlier when interest rates were rising will not be re-employed. They are doomed. Falling rate of
marginal productivity is the leading cause of the export of industrial jobs, the destruction of
domestic capital, and unemployment.

We conclude that FED policy of purchasing bonds in the open market in order to combat deflation
is not only counter-productive; it is distinctly anti-labor. The FED bids up bond prices, which is
tantamount to driving down interest rates. Falling interest rates do, in turn, lower the rate of
marginal productivity. The upshot is that capital is exported along with industrial jobs to low wage
countries.

Falling Interest Rates and Deflation

In earlier papers I showed that while a low and stable interest-rate structure is beneficial for
producers of goods and services, a falling one is an unmitigated disaster. Not only does it fail to
stimulate economic growth but will, in fact, underwrite deflation by actually increasing the cost of
capital for established producers. I must confess that most of my readers have found my
argument utterly counter-intuitive and contrary to their personal experience. They have not seen
any evidence of falling prices during the period of twenty-two years of falling interest rates.

This is because they ignore the invasion of American super-stores by cheap consumer goods
made in China and elsewhere in Asia. They also ignore the sales tactics of those stores in
keeping the sticker price high while selling merchandise at deep discount. Be that as it may, the
fact remains that capital has been exported from America to China and is used to assist Chinese
labor to produce merchandise which is then re-imported to America and sold at incredibly low
prices. There is no way American manufacturers using domestic facilities and domestic labor can
possibly match those prices, and they are going bankrupt in droves. American domestic
manufacturing and employment shrink. If that is not deflation, then I don’t know what is.

Moreover, the deflation has not been caused by cheap foreign labor. That has always been
available. The cause is the falling interest-rate structure that has, for the past 22 years, made the
rate of marginal productivity decline. This decline would, in and by itself, have produced deflation
even in the absence of export of capital and jobs. Suppose for the sake of argument that the
government controls the export of capital. In that case the falling rate of marginal productivity
would have pressed previously idled plant and equipment back into service, using new labor
component at lower wages. The additional supply of consumer goods would have depressed
prices and caused bankruptcies as well as unemployment. It is foolish to blame Chinese
sweatshops for the plight of American producers using American labor. You should blame our
unconstitutional monetary system that allows the rate of interest to shoot up to 20 percent and
then to plunge to 1 percent.

There is no comfort in the thought that the rate of interest is already so low that it can hardly go
any lower. In view of the Japanese experience, it can. In fact, it can go on falling indefinitely. This
is because the effect of a move in the rate of interest on the economy is commensurate, not with
the size of the move itself, but with its logarithm. In other words, cutting the rate of interest in half
has the same effect, whether it started from 20% (a 10% move) or from 1% (which is only a 0.5%
move). There are still lots of industrial jobs available for export in America--for example, in the
auto industry. What if China wants a piece of the auto market in America? Well, just cut the rate
of interest in half three or four more times and: bingo! Auto jobs, too, are gone to China.

Gold Standard: Protector of Labor

Keynes disparaged the gold standard as “contractionist” and “deflation-prone”. He also charged
that it has failed to stabilize prices. However, the great merit of the gold standard must be seen
not in its power to stabilize prices that is neither possible nor desirable, but in its power to
stabilize interest rates at the lowest level compatible with the productivity of capital and labor
available in the country.

Why are interest rates stable under a gold standard? We may define the going rate of interest as
the rate at which the market price of the bond is amortized by the stream of interest payments
plus the payment of face value at maturity. Under the gold standard a gold bond has a stable
market price because it promises to pay a definite value. Compare this with a dollar bond that is
exchanged for an irredeemable promise of uncertain value at maturity. The dollar returned to the
bondholder is not the same as the dollar he paid for the bond. Its value is lower thanks to
monetary debasement that has taken place in the interim. The market price of such a bond
changes with the fortunes of the issuer and is therefore inherently unstable. Since the market
price of the gold bond is stable, the rate of interest under a gold standard is stable. Historical
charts fully bear out this theoretical conclusion. The wild swings we have seen in the dollar rate of
interest since 1971 have no precedent under the gold standard. Noteworthy also is the fact that
there was no bond speculation, just as there was no foreign exchange speculation, under the
international gold standard.

This means that the gold standard is a source of great benefits to labor. It doesn’t allow the rate
of marginal productivity to change capriciously. Compare this with the regime of irredeemable
dollar where the roller-coaster ride of the rate has wiped out whole industries such as the
manufacturing of TV sets and, by the same token, threatens to wipe out auto manufacturing. In
the end only the defense industry may remain. As we have seen, an increasing marginal rate of
productivity idles plant and equipment, while a decreasing one drives capital and jobs to low
wage countries. In either case, unemployment is the result. Keynes did great disservice to labor
when he instigated the overthrow of the gold standard. Far from being contractionist or deflation-
prone, the gold standard is the sole source of stability in an unstable world. Only when the
government lends credibility to unprincipled adventurers such as Keynes by paying attention to
agitation against the gold standard, does gold get nervous and go into hiding. But when the
government firmly stays the course of monetary and fiscal rectitude, gold comes out of hiding and
partakes in the great work of building up the productive and financial strength of the country to
benefit all segments of society, first and foremost labor that needs protection most.

It is customary to make a case for the gold standard by referring to features such as relative price
stability; protection of the value of savings, pensions, and life insurance; obstacle to the “beggar-
thy-neighbor policy” of predatory governments using foreign exchange rates as a weapon
promote exports; protection of the assets of individuals against encroachment by banks and the
government; obstruction to credit abuse and unlimited debt creation; keeping fair play between
the productive and financial sectors, etc. The merit of the gold standard in protecting the
individual’s right to work, and as an obstruction to exporting capital and jobs and so to prevent the
impoverishment of labor, is never mentioned. It is time to lay out these merits as well before
American labor is put through the wringer as it is being robbed of the industrial jobs remaining in
the country.

Under the gold standard the rate of interest and, by implication, the rate of marginal productivity,
are not set by politically motivated central bankers and Treasury bureaucrats. They are stable. If
they change, they do so almost imperceptibly, reflecting capital accumulation and its effect on
productivity. Recall that in the early 1980's the U.S. Treasury cavalierly printed double-digit
figures on the interest-coupons attached to its bonds, because they wouldn’t otherwise sell. But
these double-digit figures were a death sentence on capital goods that consequently became idle
as higher interest rates pushed up the rate of marginal productivity, causing wide-spread
unemployment. It was a capricious transfer of wealth from the productive sector to the financial
sector. It was highway robbery. This puts the gold standard in a new light: the policeman to
prevent highway robberies.

“Honey, I have shrunk the jobs by mistake!”

Greenspan himself admitted that the FED’s war plan against deflation is wholly experimental, as it
has never happened in history that deflation had to be confronted under a regime of fiat money. It
is atrocious and revolting that unelected bureaucrats are allowed to experiment with American
society in pushing laborers, producers, and savers around like the player pushes pawns around
on the chess board, in an effort to prop up an unconstitutional monetary regime. As a result of this
experimentation American capital and jobs are being exported. America is in the process of being
de-industrialized. America has been turned from the greatest creditor to the greatest debtor
country. All for no better end than protecting the turf of the FED. How much more
experimentation, sacrifices, and suffering is needed before we are allowed to conclude that the
fiat money regime established by deceit and stealth is an abysmal failure? Greenspan, being
responsible to no one but himself, can shrug. If he is compassionate, he may utter words to the
effect: “Sorry, a mistake has been made”, and get on with another experiment.
It is time for a wake-up call. Under the fiat money system the FED has arrogated unlimited
powers to itself, namely, the power to print unlimited amounts of money. The justification offered
for this unconstitutional arrangement is the woolly theory of a monetary adventurer from Britain,
one John Maynard Keynes, who has been dead for over 50 years and can no longer be
summoned as a witness. But Keynes was willing to admit that he might be wrong, in which case
he would have let us fall back on the gold standard. Greenspan, on the other hand, stands in the
way of drawing that conclusion.

If You Don’t Use Your Eyes for Seeing You Will Need Them for Weeping

It is not well-known that Keynes published a eulogy of the gold standard in the Manchester
Guardian Commercial (Reconstruction Supplement, April 20, 1922). This eulogy, of course, is
never cited by latter-day Keynesians.

“If gold standards could be reintroduced throughout Europe we all agree that this would promote,
as nothing else could, the revival of not only production and free trade but of international credit
and the movement of capital to where it is needed most. One of the greatest elements of
uncertainty would be lifted. One of the most vital parts of pre-war organization would be restored.
Any one of the most subtle temptations to improvident national finance would be removed; for if a
national currency had once been stabilized on a gold basis, it would be harder (because so much
more openly disgraceful) for a Finance Minister so to act as to destroy this gold basis.”

No one has the right to gamble with the welfare of the American people, neither the President,
nor the Chairman of the FED, not the politicians, not the judges, not the bureaucrats. That is why
the Republic has been given a Constitution. The Constitution denies power to the government to
monetize its debt. As we have seen, this provision is the first line of defense to protect labor, as it
acts to keep capital and jobs together and within the country’s own borders.

The Constitution’s monetary provisions have served this country well, and the unconstitutional
monetary experiments conducted by the FED have served it badly. The latter were a series of
unmitigated failures that have gone a long way to de-industrialize America, and threaten to drive
the remaining capital and industrial jobs abroad. Open your eyes and see for yourself. God gave
us eyes so that we may see.

As Friedrich Wilhelm Foerster (1869-1966), the great Swiss pedagogue once said: “if you don’t
use your eyes for seeing you will need them for weeping”.