Posted on 08/24/2016 3:29:29 AM PDT by expat_panama
When World War I began, many analysts believed that the international gold standard would keep the war short. A war of attrition was not thought to be possible because the disciplining effects of the gold standard — capital flight and gold outflow — were supposed to restrain the ability of states to mobilize resources in times of war. As many believed at the time, states under the gold standard would quickly run out of money to pay for soldiers and resources. No one ever imagined that the war would last four long years and that most countries would stop using the gold standard, turning instead to debt and inflation to pay for the war.
The gold standard was never the same after World War I. It survived in a modified form until August 15, 1971 — 45 years ago this month — when President Nixon cut the last link between the world monetary system and gold. The initial idea was to temporarily suspend the limited convertibility that existed; only governments could request reimbursements of gold against dollars. Unfortunately, there is nothing more permanent than temporary emergency measures. We are still living with a 45-year-old monetary experiment in which central banks have no direct link to gold.
Convertibility acts as a mechanism that constrains the arbitrariness of the monetary authorities. The United States dollar was little more than a promise made by the US government — or its central bank — to deliver a specific amount of gold: one ounce of gold for every $35.
If governments plan to spend more than they earn, they are forced to issue debt. If a government’s debt level is already too high, the market might refuse to keep lending or might only lend with very high interest rates. If this happens, governments can then turn to their central banks to monetize the debt; for example, a new currency may be issued against the debt that the market would not buy.
If monetizing debt reaches high levels, inflation quickly follows. However, the inflationary mechanism will differ depending on whether or not there is convertibility:
Debt monetization is a way of introducing the debt rejected by the market in monetary form in the absence of currency convertibility. It works as follows: The government spends more than it earns, issuing debt which is not accepted by the market. The central bank then takes it over and extends a new currency. The new currency is the recipient of the rejected debt. Inflation is nothing more than excess of public spending made into a currency.
If the gold standard and the currency convertibility are really a restraint to public spending and inflation, then it should be seen in the pre-1971 and post-1971 figures.
The period from 1951 to 1971 had an average federal deficit to GDP of 0.6%. From 1972 to 2015, this figure rose to 3.0%. These numbers suggest that the gold standard effectively controlled public debt, as the risk of gold loss by the central bank would have prevented debt monetization.
Source: Federal Reserve Bank of St.Louis.
Likewise, inflation numbers after 1971 show a significant increase. Inflation from 1951 to 1971 averaged 2.2%. This figure almost doubled from 1971 to 2015, rising to 4.1%.
Source: Federal Reserve Bank of St.Louis.
Therefore, the record of the current monetary standard — floating rates — has a dismal record compared to the last gold standard.
It is important to clarify the concept of the “last gold standard,” the modified gold standard that followed World War I. In the classic gold standard that existed prior to 1914, the general public was able to withdraw gold from the central bank if they wished. This was gradually restricted until after World War II, when only states could redeem coins in gold (everything was reduced to dollars and the exchange of gold for dollars was left to other states). Beginning in 1971, gold completely disappeared from the picture.
For ordinary people, the result is an inability to maintain their wealth without risk. With gold as the monetary base, the saver has three possibilities:
In a system without convertibility, like the one we have lived in since 1971, the third option disappears. In other words, if a person thinks the economy is entering a recession (economic instability) and that the monetary authorities are behaving irresponsibly by, for example, monetizing too much debt (monetary instability), she is forced to choose between losing her assets with an investment project or by keeping liquid balances that will depreciate as a result of careless monetary policy.
Economic agents who want to protect themselves against inflation must either forcibly buy illiquid real assets — capital goods or real estate — with the danger of losing them (because of economic or housing crises) or maintain a currency that will lose its value because of bad monetary policy. Leaving the system by remaining liquid is no longer an option, effectively turning everyone into a speculator.
In short, gold acts as protection against fiscal and monetary abuses by governments. The proof of this is that both public deficit and inflation have dramatically increased since the gold standard ended.
Moreover, it forces economic agents to find other forms of non-monetary wealth to store their assets. Less risky agents will be hurt the most, because instead of keeping their assets in cash, inflation will push them to speculate on the purchase of assets and force them to take risks that they never intended to take.
These past 45 years have been a monetary experiment that has not ended well.
This article was first published by Universidad Francisco Marroquín. Reprinted with permission by the author.
Daniel Fernández Méndez is a lecturer in economics at Francisco Marroquín University in Guatemala and is director of UFM Market Trends, an economics/finance newsletter. Contact: email.
Happy Wednesday! New highs for stocks --for a minute there --in mixed volume. Gold continues to hold stead ($1,338.15) and silver continues to fall ($18.93). Futures traders predict stock indexes are looking up +0.31% and metals +0.15%. All seems to say it's time to do now whatever we've been doing all along. Major econ stat reports today:
7:00 AM MBA Mortgage Index
9:00 AM FHFA Housing Price Index
10:00 AM Existing Home Sales
10:30 AM Crude Inventories
Slow news day...
The Fed Heads West For A Divorce - Greg Robb, MarketWatch
Shut Out the Pessimists - Brian Wesbury & Robert Stein, First Trust Advisors
The Economic Effects of Hillary Clinton's Tax Proposal - Various, NCPA
Myths and Facts About Hedge Funds - David Kotok, Cumberland Advisors
They say necessity is the mother of invention when obviously it’s beer.
;) So much for “them”...
No-necessity is just a mother
I must confess that I was wrong a few years back. With the fantastic increases in the federal debt, I believed that an inflation bound was to follow and that there would be some move back toward a gold standard.
Neither has happened.
I can’t understand why there has been no general inflation
There certainly has been a lot of inflation. It’s partially masked because US currency and money in general is still sought around the world as a hedge against even less-stable currencies.
You are correct but......
In my mind, there is no American general inflation a major component of which is wage inflation that then drives the general inflation. The quest for a $15 minimum wage seems to me to be a quest for inflation that will devalue the debt and pay for Obamacare.
Sooner or later, everyone has to sit down to a banquet of consequences, momma always used to say.
Reminder: Flooding America with Third-Worlders blunts wage inflation.
Officially recognized inflation pumps interest rates, which would spiral government debt. I think the lack of officially inflated dollars indicates the Fed thinks the inflation necessary would not be controllable.
The dodge is clever, but the ultimate price is grinding debt and eventual poverty for the middle classes.
-—the Fed thinks the inflation necessary would not be controllable-—
Than is my conclusion........... the pressure will build however and inflation is bound to happen.
The thought of the third worlders as an inflation safety velvet is a good one
The Monetary Velocity and Multiplier numbers are tanking
No inflation? Have you checked housing prices in major cities? Health care costs? Even if you’ve tracked the real price of bread and bacon that you actually pay (as I do) you’ll find there’s been significant inflation. It just hasn’t repeated in exactly the same ways or goods, as it did in the 1970’s - but those $$ Trillions have gone somewhere
Where do you believe they have gone?
And now there appears to be no way back - can't put the toothpaste back in the tube, as is said.
For all the lambasting Nixon (and Repubs, by extension) gets from the Dems and their National Media he was very good to them.
1) He gave them the Watergate club with which to forever politically bash their foes.
1) He created the EPA - a control-freak's (Democrats) sadistic dream work of malleable regulations.
3) By okaying going off the Gold Standard he laid the groundwork for the perpetual deficit spending gimmick called baseline budgeting.
I suppose one can throw in "opening up China" as a Nixon accomplishment - a 50-50 deal at best.
I also think this may be true. If expected, hoped for and necessary, as viewed by Keynesians, inflation does not naturally occur because of low demand for goods and services, it must be manufactured.
Someone a lot smarter than me should write an article linking the progressives' obsession for a high-as-possible minimum wage to their need to "inflate away" the existing debt - to allow for continued runaway spending.
Have a crack at it, bert.
Most of our new debt is being bought by China with the huge trade surplus that they have with us. And they are keeping the prices of the goods they sell us low because they prefer keeping their people employed and avoid any social unrest.
In other words all the money that’s being printed is being taken out of circulation by China, that’s why there is no inflation here.
“Economic agents who want to protect themselves against inflation must either forcibly buy illiquid real assets — capital goods or real estate — with the danger of losing them (because of economic or housing crises) or maintain a currency that will lose its value because of bad monetary policy.”
The other option is farmland and adjoining woodlots. The land value keeps going up, and the timber grows more valuable every year.
“The land value keeps going up, and the timber grows more valuable every year.”
Prices for chip & saw are OK, but down from recent years, and the market for poles or saw timber is way down right now. The mills have plenty of wood at the moment.
The truth is that timber will wait until next year if the prices aren’t good. Really can’t say that about other crops.
——Have a crack at it, bert-—
to do so would mean I am smarter than you and I am not at all certain that is true.
“The truth is that timber will wait until next year if the prices aren’t good.”
True, but regardless of timber prices at the time, the trees grow bigger every year and a result are more valuable.
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