Tuesday, August 9, 2011

Cross of Gold

One of the best things about living in the U.S. is the abundance of economic and political ideas. This is a diverse society of both ethnic groups and ideas, and I wouldn't change either of those. So I won't attack the existence of loony ideas, just their particular merits and demerits. I won't even throw the label "loony idea" around since that would antithetical to my belief that most political ideas have strong reasons behind them.

With that in mind, maybe I shouldn't consider a return to the gold standard a loony idea. It's one of tenets of Ron Paul's long campaign to return the US to the straight-and-narrow of the constitution or die trying. But the drive to reestablish the gold standard is a poster child for the blindness of adherents to the disadvantages and risks of an idea.

Here are the highlights for the advantages of the gold standard:
  • Paper currency has no intrinsic value because it isn't gold and isn't convertible to gold.
  • Governments, politicians, and central banks often cause massive inflation of the currency.
  • A gold standard makes it impossible for politicians or a central bank to inflate currency. The value of our national currency can stay stable for decades or longer.
  • A gold standard forces the government to behave soundly, to avoid budget or trade deficits, in order to preserve the country's gold store.
  • If there's a gold standard, we can return to using gold coins, which have intrinsic value in the precious metal.
Here are some risks and disadvantages:
  • The gold-based currencies are subject to attack by currency speculators. That's why there are no longer any gold-based currencies.
  • A gold-based currency doesn't necessarily stop governments from misbehaving. Governments have been known to run deficits and ended up bankrupting their precious metal reserves.
  • The gold standard favors one kind of wealth over all others. Gains in non-gold wealth (agriculture, housing, infrastructure, a varied economy) are devalued unless there is also significant growth in gold holdings. That was possible during the mining boom in the 1800's, but not likely now.
  • The inflexibility of the gold standard can lead to deflation, which has much worse economic effects than slight inflation rate of 1-2%.
  • The history of financial panics in the 19th century doesn't support the idea that the gold standard promotes economic stability.
When I look at these two lists, the disadvantages clearly seem the weightier side of the equation. I don't know how someone supports the gold standard unless they completely ignore the mountain of evidence against it. When supporters embrace the policy as a magic cure to vagaries of financial systems, they look more like an unquestioning cult than a reasonable political movement. No, Paulites, the gold standard will not be our salvation from ourselves.



Anonymous said...

I agree with your conclusion, but not with all your reasoning. Here are my three (additional) objections to reverting to a gold standard:
1) A gold standard preserves currency stability only if the amount of gold in circulation remains stable. But although the amount of gold on the planet is finite, the amount in circulation could grow quite easily. When it does, it can cause massive inflation. That's what destroyed the economy of the Spanish Empire in the 16th century.
2)Much of Earth's gold reserves are in the hands of countries that are not necessarily our friends, such as Russia. Going on a gold standard would place the health of the American economy in the hands of our rivals.
3) While gold has intrisic value--it makes pretty jewelry--it doesn't have a lot of intrinsic value for the things Americans need and want, such as energy, housing, health care, food, electronic gadgets, etc. Why should we measure the wealth of our nation on the basis of a single, not very useful, item?

ModeratePoli said...

Anon 4:52, We may differ on which disadvantages are the worst, but to be in agreement on the conclusion, as you said. I thought the strongest reason not to have the gold standard was the artificiality of using only one kind of wealth, and the way it would hold back and distort the economy. In researching the topic, I did find that gold doesn't always confer stability, and it was a huge bane to the farmers in the late 19th century.

I'm surprised that the people who support the gold standard haven't done more research, and realized how weak the arguments for it are. Ron Paul dropped a few more notches in my estimation.

Please keep reading my blog. Well considered comments are always welcome.

Anonymous said...

Gold has many valuable industrial uses, primary due to its physical property of not oxidizing. Hence it's used heavily in electronic.

Also, while the quantity gold is finite, as are all natural resources on Earth, new veins of it are discovered and mined all the time, precisely because of its intrinsic value and the fact that it's used in industry as well as a store of wealth.

I am beginning to think that all of the hubbub about the U.S. Gvt. debt is simply to drive the price of gold higher and higher, since those most pushing the meme are also those who purchase gold and sell it via Fox News demagogues.

ModeratePoli said...

Anon 8:13,
I disagree that the debt ceiling debates were just about raising the price of gold. There are real issues there. OTOH, talking about it didn't do any harm to those already invested in gold. --M.P.

vman said...

So let me get this straight - using a system in which money represents value is somehow inferior to using a system in which money represents debt. Do you guys realize that in our system there are multiple types of money with majority being M1 type or "commercial bank money" created by virtue of loans (both those given to individuals as well as to companies for needs of their business). Most of you probably think that when a bank lends money that they lend you what they have in their reserves. That's not how modern banking works. Whenever you get a loan from the bank they don't "lend you" their money - they just create credit relative to their reserves based on the multiplier allowance set by the central bank (FED in our case). In effect - whenever a loan is taken a new money is created. For this new money to ever be repaid back to the bank all the money loaned would have to be spend back into the economy in a way that the original borrower can fully re-earn it otherwise the loan could never be repaid. This never happens however, which necessitates need for adding more money to the money supply. And again - that means creating new loans by the banks. That's why FED is trying to get banks to lend - by the process of lending they create extra credit , which is basically new money in the money supply (and if it fails to get them to lend that's when they resort to "printing money" - which is again a form of debt, just public debt in this case) The problem with this is that it creates a requirement that to have more money we need to have more debt. And because the system is debt driven deflation would have disastrous consequences (much worse than it would have under sound money standard. All deflation is not equal) since everyone is pretty much in one type of debt or another. Contracting money supply would drop wages with debt staying the same and would cause major problems, defaults , foreclosures, companies filing bankruptcies etc. This is why this system favors moderated inflation. The problem is - perpetual inflation of money supply , with money supply essentially representing debt, implies perpetual increase in debt. Further as the system grows it requires increased growth , at an increasing pace (otherwise it can collapse due to deflation). This requirement of infinite growth applied on a finite environment, such as resources of the planet simply won't work in the long run. This is why sound money, whether gold or not, essentially money represented a resource, not debt, is much more stable than this. Sure this has an illusion of growth but once it reaches its limit it won't be pretty. Far from it.

vman said...

Ok, after that long post just to adrress a couple of other things that were mentioned in various posts:

"The gold-based currencies are subject to attack by currency speculators..."
ANY currency is subject to attack by currency speculators. You can't prevent human greed no matter what you do. However, paper currency is much more open to manipulation. As for why there are no longer gold-based currencies - I doubt that's the case. I wholeheartedly believe it's because gold-based currencies and full reserve banking would not allow bankers to issue credit they can't cover.

"A gold-based currency doesn't necessarily stop governments from misbehaving...."
Agreed - and this is a good thing. You can't have infinite currency representing resources in a finite environment. Sound money has a self-regulatory feedback if you will, of which this is one example. Such misbehavior would be detected early enough (due to depletion of currency) and people would be able to observe it and push for a regime change. Currently however, devaluation of currency is happening over the course of decades with the ever growing debt being passed on to other generations and is very hard to notice unless you're researching it (or you happen to be in the generation that starts noticing it). But to sum up - yeah, nobody is saying that gold standard would prevent a country from doing stupid things. But it'd be found out much sooner and couldn't be done for as long as with paper money.

"The gold standard favors one kind of wealth over all others..."
You trade your agricultural products, etc with other countries which causes growth in gold reserves. Housing and other domestic industries wouldn't grow at the rate that is above the demand of the market. Did growth of housing industry in the past few years help us somehow ? No - it has caused problems and will be causing problems for years to come.

"The inflexibility of the gold standard can lead to deflation, which has much worse economic effects than slight inflation rate of 1-2%."
For this one - please reread my earlier post. This is basically trying to apply theories from "modern banking" to gold standard. Deflation in our current system would have very very bad consequences because the entire system is debt driven. Gold standard is mainly savings-driven so while both prices and wages would be pushed downwards during gold deflation it wouldn't be disastrous since there isn't a significant debt in the system. Also those with savings, especially businesses, would see relative worth of their money increase, encouraging investment. Further - dropping prices would most likely make the country's exports become more attractive to other countries and would cause subsequent recovery in gold supply (inflation) though trading.

"A gold standard preserves currency stability only if the amount of gold in circulation remains stable. But although the amount of gold on the planet is finite, the amount in circulation could grow quite easily. When it does, it can cause massive inflation."
I'm sorry but this just isn't the case. When Spaniards were plundering gold from South America in the 16th century the maximum rate of inflation was 1.86% per year. No stretch of imagination can be used to call this a "massive inflation". Massive inflation is signature of fiat money - 300% per day in Hungary or hyperinflation in Weimar republic and other paper money regimes. Those are "massive inflations". I wholeheartedly suggest reading a book "Monetary Regimes and Inflation" by Peter Bernholz. The book doesn't advocate one standard over another - just looks at various standards and analyzes them from historical perspective.
And yes - you can have inflation and deflation under gold standard as well. That's the nature of money. But it's nowhere as near (nor is deflation as devastating) as it is in modern debt based banking.

ModeratePoli said...


I will try to answer some of your points and indicate their weakness. But (to get the conclusion out of the way) I remain unconvinced of your argument.

To start with, you deride our current system as money "representing debt," but I'm not accepting that as a given. The money you call "representing value" is an amount of a precious metal, that the value of that metal fluctuates, as does the value of all valuable things (land, water, housing, transportation, fine art, etc.) The value of gold is not fixed, and its relative value to other forms of wealth is also not fixed. So I reject your first assertion.

I agree that there is a problem with loans that are constantly rolled over, though it isn't the biggest problem as long as the business can always service the debt.

I think you are wrong when you say debt deflation is worse than other kinds of deflation. The deflation in Great Depression was certainly devastating, despite the gold standard.

You shrug off my strongest point, that the gold standard inhibits and devalues other forms of wealth, many of them more useful than gold. Do you really think that one housing boom sinks this issue? How about all the many good expansions that we've had, like telecommunications, computers, and homes that people do want and will spend for? A gold standard makes this kind of expansion of wealth difficult (a negative) even as it prevents inflation (a positive). I believe the negative is worse here, that we have benefited greatly from other forms of wealth, despite the inflation we've also had. I don't see why the amount of wealth we can create in other forms should be constrained by how much gold we can extract from the earth.

You don't adequately address why no currency is gold-based, and why every currency has abandoned the gold standard. It's very likely that no one has a gold standard because it doesn't work in this age of global trade.

My point about currency attacks and bankrupting the treasury is that the gold standard isn't a cure for those problems. They can still happen under the gold standard as they can happen with fiat currency. So no advantage to either gold or fiat on that score.

Finally, you assert that if we had a gold standard, we would know sooner when we had a crisis and could prevent it. It didn't happen when we went off the gold standard, so it could happen again. The key is vigilance, not gold.

My argument against a gold standard doesn't mean I think the Fed's management of our currency has been perfect. I think there have been mistakes, like Greenspan keeping interest rates so low and allowing too much growth. But these problems can be addressed with reform and learning from mistakes. A gold standard is not the only answer. The choice is not only 'gold' or 'terrible monetary handling.' More conservative monetary management is an option too, and that's what I want.

vman said...

Ok, let's get a couple of things hashed out.

First - I'll get to this later but I may have made a mistake of not specifying what I mean when I say gold standard. In my previous posts whenever I used the word "gold standard" I meant "full gold standard", meaning that every note issued means that it covers that amount of existing physical gold.
What we had before / during the great depression is pseudo-gold standard with I think between 20%-40% reserve requirement. This is not what I m talking about when I say gold standard. That's probably even worse in some ways - having elastic money supply but tying it to the reserve of physical resource.
All that did is caused them to inflate money supply in the 20s , then they hit the wall in the 30s and got in trouble. No - I m specifically talking about full gold standard - one paper that says it represents, say 1oz of gold , always represents 1oz of actual physical gold in the safe.
As a matter of fact I'd probably be against pseudo-gold standard as much as you are. This system of banks creating promises to give you what they don't have would not be allowed in any other form of business. It's only because most people never wonder about it nor do they think about future consequences is that it has managed to keep itself afloat so far.

Second - why gold ? You seem to have problems with the idea of using a seemingly worthless metal (can't eat it, can't use it to provide energy, can't do too much with it)
to be exchanged for other more valuable things (food, fuel, cars, etc). So I want to address that. I can't claim to know for sure but I'd venture to say that the reason gold is used is :
1. Human vanity - we like shiny things
2. Scarcity so you don't need to carry around a lot of it.
3. Durability - lasts for a very long time.
Now we can debate the validity of this reasoning by our ancestors and our fellow humans, but I don't want to get into it. The reality is that entire empires have come and gone but even thousands of years
after their demise you can still buy things with their gold (even if collector's value is completely taken out of equation). As an example - I'll take one ounce of 1900s gold over any paper value that represented 1oz of gold at that time.
But for the rest of this discussion I will not use word "gold" any more, so we don't get hung up on the gold standard. Instead I'll replace it with the word "valuable resource" whatever that may be (something needed for energy, food or whatever). Now on to second part of the post since this will be too long.

vman said...

This is second part of the post - it was too long - read the one immediately above before this.

...Ok, I didn't shrug off the point that "valuable resource" standard inhibits and devalues other forms of wealth. I may have just missed that as I was typing other stuff. So I m going to talk about it now.In all honesty I can't see how that is true. Are you saying that the entire nation or the entire world would be engaged in just digging up that resource and doing nothing else. I don't think so. Opportunity cost as you probably already know is the basis for trade and would ensure that some people (or companies, or countries) are specialized in extracting and/or processing that "valuable resource", and others would be providing other resources or services in exchange for that resource so they can trade it for yet another set of services and resources.
Now does it mean that countries with more of that resource would be wealthier - probably , but that's the nature of things - we live in the world with finite reserves. Would that mean that other countries wouldn't be able to develop or not be able to achieve a comfortable standard of living?
Not at all - they would have comparative advantage over that
resource rich country in a sense that they'd be able to produce other goods that would have cost the "resource rich country" too much of the valuable
resource if they were to extract those other goods/services themselves. Hence the trade would be established and now other countries would see inflow of that valuable resource.
That's how the world has operated for 99.99% of its' existance so I don't really see how the argument that valuable resource standard would somehow
devalue development of other industries and technologies and/or countries. We have progressed from stone age to the early industrial era with "valuable resource"
standard just fine. The fact that in 20th century, the same century we switched to global debt-based standard, we have shot up into post-industrial age does not necessarily establish causality between debt-money and progress. ow... did debt-based system speed it up a bit. Maybe a bit but at what cost ?

But would progress continue under "valuable resource" standard - certainly. To say otherwise is to ignore 10s of thousands of years of human history.

This 4096 character limitation is annoying so I have to cut this off here and coninue in yet another post

vman said...

Ok, hopefully I can fit the rest here. please read previous two posts before this one.

...As to why there isn't any resource standard right now - I wouldn't say it's due to global trade. Global trade existed and was actually very intensive during times of resource based standards. But I can give my guess:

1. Human nature - we want things easy way and want "free lunch" whenever we can get it. The problem is that there is no such thing as free lunch.
Fractional reserve banking and it's inevitable path to debt-backed money on the surface offers exactly that.
This is due to its' effects not being seen immediately. This is also premise for the point 2.
2. Political reasons - like I was saying in my previous posts. Unlike fully backed resource standard this system allows governments to sacrifice future well being of the country and its' people for the current illusion of prosperity that will help them get reelected. This is great for politicians as it enables them to "spend the country
to prosperity" for the duration of their terms - the effects will be felt much later as they arrive at slow pace. This is essentially taxation through inflation and a very slow, gradual transfer of wealth from producers to "lenders", but most politicans will be long out of the office before that happens.
Under "valuable resource" standard they would have to tax the heck out of people in order to grow the government's physically limited resource reserves that
they would want to spend. This would be noticable very quickly (in relative terms).

The problem with this is - there is a systemic requirement for increase in loans (debt) both domestically and internationally. This is because most of the money created in the system is commercial bank money - essentially credit created by the bank according to reserve requirements (about 90% - only 10% is so called "high powered
money" which actually is real actual money). In order for this loan to be repaid an equivalent amount of money plus interest needs to be rearned. This assumes 100% flow of money from the borrower, into the economy and then back to the borrower over the course of time - this never happens due to savings, relending, loss etc.
So to inject new money the system depends on yet more new credit being created. And on and on. Just look at the history of debt in the US - it has a constant upward direction. This isn't the case with US alone however. If you take
a look at the chart of global debt one thing you'd probably notice that all the top "rich, industrialized" countries are also the ones with the biggest
debt. They are as rich as a person who has an expensive mansion, corvette and eats out in expensive restaurants every night, but behind the scenes keeps taking loans and then more loans to repay interest on those previous loans. It can only go for so long. Last year Bernanke even said that the
solution would be to have no-reserve banking - that's the level of desperation for infusion of debt-money into the system.

You and I can agree to disagree - that's fine. But over the past years I have become convinced that modern banking and economists are much like a doctor who you would see for liver problems because you drink too much. Then instead of suggesting you change your lifestyle he prescribes you
a medication that fixes your liver , but over time causes your arteries to clog so bad that you die of a heart attack. Personally I will stock on tangible assets, even if they temporarily drop in price (actually - especially then).

ModeratePoli said...

1. Let's not gloss over what the "valuable resource" will be. To me, it's at the heart of the problem.

2. Your proposal of a full gold standard might be better in a few ways, but it also bind the growth of a nation even more. Again that's at the heart of the problem.

3. Your doctor analogy is a double-edged sword. The disease you see is inflation/debt, and your cure would be pretty bad terrible. Not as bad as run-away inflation, but like a pair of handcuffs on the majority of people.

4. Be honest--do you recognize any weaknesses in a full gold standard? I think that should be on the table too. If you don't see any, I have no trust that you've thought things though.

vman said...

Like i said we can agree to disagree but I just want to quickly comment on number 4.

Do I see weaknesses in gold standard ? Absolutely - you can sweat the gold, shave the gold as well as debase it by slowly substituting it with metals that are not valuable. It's not perfect , but I still think it's better than fiat money as it, among other things, encourages savings as opposed to debt.

But I'll leave it at that - have a great 2012 and keep blogging - always good to exchange thoughts on various ideas.

ModeratePoli said...

@vman, I'll follow your good example, and leave it too.

ModeratePoli said...

I'm recording a comment from someone else that I liked a lot. To paraphrase, he said that under a gold standard, he couldn't have a mortgage until someone dug up enough gold to cover it. (Then he could borrow the gold, or someone would, and he'd be paying it back over time.)

I think that was an interesting encapsulation. In a gold based economy, other kinds of wealth might be devalued and gold would be the engine. But this isn't really a good or realistic view of wealth. In actuality, we have many kind of wealth and value, not just gold. Land, for example, and food, housing, household goods, cars, medicines and healthcare, etc. All of these have value to people, and they will pay or barter for them. In the absence of gold, people will still barter, or even accept promises. So gold is not essential at all. It's actually fair for the value of gold to float as do other goods. This is actually a more natural and market-driven state than having a gold standard.