Posted on 02/29/2012 6:20:32 AM PST by 1rudeboy
TWO of America’s Republican candidates – Newt Gingrich and Ron Paul – have dared to toy with the idea of bringing back the gold standard. Their remarks have in turn triggered a fusillade of indignant replies, from pundits and professional economists alike, the general theme of which is that no one fit to be America’s Commander-in-Chief can possibly have a good word to say about gold.
Of all the reasons usually given for condemning the gold standard, perhaps the most common is the claim that it was to blame for the Great Depression. What responsible politician, gold’s critics ask rhetorically, wants to relive the 1930s?
But the criticism misses its mark. Fans of the gold standard are no more anxious to repeat the 1930s than their critics are. Their nostalgia is instead for the interval of exceptional international monetary stability that prevailed from the mid-1870s until World War I. That was the era of the classical gold standard – a standard policed by the citizens of participating countries, all of whom were able to convert their nations’ paper money into gold.
This classical gold standard can have played no part in the Great Depression for the simple reason that it vanished during World War I, when most participating central banks suspended gold payments. (The US, which entered the war late, settled for a temporary embargo on gold exports.) Having cut their gold anchors, the belligerent nations’ central banks proceeded to run away, so that by the war’s end money stocks and price levels had risen substantially, if not dramatically, throughout the old gold standard zone.
Postwar sentiments ran strongly in favour of restoring gold payments. Countries that had inflated, therefore, faced a stark choice. To make their gold reserves adequate to the task, they could either permanently devalue their currencies relative to gold and start new gold standards on that basis, or they could try to restore their currencies’ pre-war gold values, though doing so would require severe deflation. France and several other countries decided to devalue. America and Great Britain chose the second path.
The decision taken by Winston Churchill, then Britain’s chancellor of the exchequer, to immediately restore the pre-war pound, prompted John Maynard Keynes to ask, “Why did he do such a silly thing?” The answer was two-fold: first, Churchill’s advisers considered a restored pound London’s best hope for regaining its former status – then already all but lost to New York – as the world’s financial capital.
Second, Britain had other cards to play, aimed at making its limited gold holdings go further than usual. Primarily, it would convince other countries to take part in a gold-exchange standard, by using claims against either the Bank of England or the Federal Reserve in place of gold in international settlements. It would also ask the Fed to help improve Great Britain’s trade balance by pursuing an easy monetary policy.
The hitch was that the gold-exchange standard was extremely fragile: if any major participant defected, the British-built house of cards would come tumbling down, turning the world financial system into one big smouldering ruin.
In the event, the fatal huffing and puffing came then, as it has come several times since, from France, which decided in 1927 to cash in its then large pile of sterling chips. The Fed, in turn, decided that pulling back the reins on a runaway stock market was more important than propping-up the pound. Soon other central banks joined what became a mad scramble for gold, in which Britain was the principal loser. At long last, in September of 1931, the pound was devalued. But by then it was too late: the Great Depression, with its self-reinforcing rondos of failure and panic, was well under way.
So the gold standard that failed so catastrophically in the 1930s wasn’t the gold standard that some Republicans admire: it was the cut-rate gold standard that Great Britain managed to cobble together in the 20s – a gold standard designed not to follow the rules of the classical gold standard but to allow Great Britain to break the old rules and get away with it.
So does this mean that those Republican candidates are right to pin America’s hopes on a return to gold? Alas, it doesn’t: the collapse of the gold-exchange standard forever undermined the public’s confidence in governments’ monetary promises; and absent such confidence there can be no question of a credible, government-sponsored gold standard, classical or otherwise. Sometimes with monetary systems, as with life, you can’t go home again.
I'm all for educating people. But who doesn't understand that inflation eats away at the purchasing power of the dollar? The harder thing to educate people in is how to develop the habit of saving and investing those savings. People know they should do that, but they either don't understand how, or they don't put it into practice.
I don't agree that the money supply needs to expand as the economy expands. With a stable money supply, prices would adjust downwards instead of upwards as they do now. In other words, the purchasing power of the currency would increase.
the combination of a gold standard and fractional reserve banking was toxic all during the 1700s and 1800s
Yes, it was. But fractional reserve banking without any semblance of a standard to fall back on is even more toxic. And, despite the bank-skullduggery, the recessions were short and, once over, prices reverted quickly to pre-boom levels.
I agree, but it is the ability to redeem that provides the safeguards the gold standard can provide. A minimum exchange amount of, say, one ounce wouldn't seem unreasonable to me.
“You don’t understand. The profit isn’t the 2% inflation a year.
The real profit is a stable productive growing economy. A slight amount of inflation facilitates that. “
We also have a far higher inflation rate than 2%. They take energy and food prices out of the inflation calculation for a reason. But anyone who shops for groceries knows the truth. (same with healthcare and education, although they have their own set of issues/lack of competition).
If credit expands too fast, i.e. money gets to cheap then people borrow to much money and mal-invest it. I.e. the money gets destroyed. Housing bubble... The root cause of our current economic troubles.
A more honest money system would be based on a basket of commodities. If the government needs to expand the money supply they would have lots of options to do so.
Won’t happen in my lifetime. The system is setup the way the banks and government want it set up.
“I’m all for educating people. But who doesn’t understand that inflation eats away at the purchasing power of the dollar? The harder thing to educate people in is how to develop the habit of saving and investing those savings. People know they should do that, but they either don’t understand how, or they don’t put it into practice.”
You would be surprised at how little the average person understands inflation. Just show someone an inflation calculator and you will get the same result I did with a friend. They knew in general that the dollar was worth less over time, but the amount even modest inflation cases over time is shocking to most people. Education point #1.
Point #2. Unless a person can learn to save and INVEST their money to beat the true inflation rate, their is no point in them saving in the first place. Might as well enjoy the fruits of their labor before it is stolen by inflation.
That would be terrible for us.
Well, if you have the time, I'd be fascinated to know why a dollar with increasing purchasing power would be terrible for us. Now, if you're a dyed-in-the-wool inflationist, I probably won't change your mind. I think inflation is ruinous.
Say the dollar increases in value 3% each year.
Would you buy a house?
Would you delay major purchases as mush as possible?
Would you borrow money to build a factory to manufacture goods?
I disagree that consumers would put off purchases because of dropping prices. We have never, for example, seen that with electronic equipment. When you need a new computer, you go buy one and are simply happy that it costs less than your old one.
And businesses would still invest in expansion because their costs -- as well as their selling prices -- would be falling. They would still make a profit.
Your view, which is quite widespread, presumes that consumers have something to gain by forever stocking up on dollars and never buying anything.
Now, I would agree that increasing purchasing power would be an incentive to save, but that would increase the pool of loanable funds, lowering interest rates which would encourage entrepreneurs to invest in capital improvements to make their operations more profitable.
It sounds like economic nirvana to me. But I don't expect to see it in my lifetime.
Electronic equipment doesn't cost $200,000 or carry a 30 year mortgage.
And businesses would still invest in expansion because their costs -- as well as their selling prices -- would be falling. They would still make a profit.
And the cost of paying off their loans would be rising and rising.
Yes, it would. Dropping prices would provide a disincentive to borrow and an incentive to use current savings for purposes of investment. It means a reward for well-capitalized companies and individuals.
In an inflationary economy, we incentivize debt. In a deflationary economy, we incentivize saving. In an inflationary economy, capital is lost through the inability to properly predict future economic conditions.
Just one last note. A deflation caused by the central bank's tightening credit is damaging. But price deflation caused by a stable money supply is, in my opinion, desirable. Thanks for a good discussion.
Yes, it would. Dropping prices would provide a disincentive to borrow
And industries that depend on a lot of borrowing would suffer. Like manufacturing, farming and housing, for instance.
and an incentive to use current savings for purposes of investment.
Companies that need to borrow to expand typically don't have "current savings".
Just one last note. A deflation caused by the central bank's tightening credit is damaging. But price deflation caused by a stable money supply is, in my opinion, desirable.
Keeping the money supply from growing with output is tightening.
I've had this discussion before and I understand that the belief in the benefits of an ever-cheapening currency run deep. After all, it's the only system we've ever experienced.
The problem is that it is politicians and bankers who decide on a whim how much money we "need." A gold standard, properly implemented, takes them out of the loop. From that point on, money is supplied by the market.
And, given current production trends, the money supply probably would not be static. Historically, there is around a 2% growth in the supply of gold each year. That's probably where Friedman came up with his number.
Nonetheless, business can adapt to a static money supply. It would be different from what we have now. As I said, debt would be less attractive (though certainly available for sound projects) and saving would be more attractive.
I've got a thread up tonight on Japan's experience in the last decade with a stable money supply. Contrary to popular opinion, they're doing quite well.
That's not true. We've had several nasty bouts of deflation.
The problem is that it is politicians and bankers who decide on a whim how much money we "need."
Bankers can't increase the money supply without borrowers.
A gold standard, properly implemented, takes them out of the loop.
We had bouts of nasty deflation under the gold standard.
Nonetheless, business can adapt to a static money supply. It would be different from what we have now.
One way they could adapt is by lowering salaries every year. Makes it harder to pay your mortgage when that happens.
Those were bouts of monetary deflation that caused business failures and subsequent price decreases as business liquidated assets. Don't confuse that with so-called price deflation due to improved productivity and a stable money supply.
Bankers can't increase the money supply without borrowers.
That's right. It's why, after printing a few billion, the Fed lowers interest rates to attract borrowers for it.
We had bouts of nasty deflation under the gold standard.
Again. That was monetary deflation -- a contraction in the money supply caused by banks which had lent more than their reserves could cover. They were, gasp, dishonest. In those days, of course, banks that did that went bankrupt. Too-big-to-fail hadn't been conceived of yet.
One way they could adapt is by lowering salaries every year
Why would they do that? If they're profitable and improving productivity, there would be no need to lower salaries. I suppose that if they were losing money, reducing wages would be an option just as it is now.
Monetary inflation always results in a bust when the projects built on the fake money and below-market interest rates collapse.
The period from 1873 to 1913 when the U.S. was on the classical gold standard saw a spectacular increase in its wealth, income, and power. It can work.
I never do, that's why I said "nasty bouts of deflation" instead of "awesome bouts of deflation".
It's why, after printing a few billion, the Fed lowers interest rates to attract borrowers for it.
The Fed "prints" money by buying bonds. They don't need to do anything to "attract borrowers for it".
One way they could adapt is by lowering salaries every year
Why would they do that?
Monetary deflation. Prices decline across the board. Even the price of labor.
If they're profitable and improving productivity, there would be no need to lower salaries.
What if they aren't improving productivity? What if they are but still have debts to repay, debts that get more onerous every year. Despite your feeling that a steadily more valuable currency is a good thing.
The period from 1873 to 1913 when the U.S. was on the classical gold standard saw a spectacular increase in its wealth, income, and power.
As long as you weren't crushed by deflation.....
It can work.
No, deflation can't work.
Well, now it's obvious that you don't understand the concept and really aren't even trying to.
To begin with, under a gold standard there is no monetary deflation. Monetary deflation is a reduction in the amount of money in circulation. Under a gold standard, there is no monetary deflation. There is either monetary stability or a slight monetary inflation because of changes in the production of gold.
With a stable money supply, prices will tend to decrease because entrepreneurs strive constantly to make their operations more efficient. They introduce capital into the production process so as to produce more goods for the same or less cost.
With more goods produced at less cost, prices will drop as a result of competition. The same thing happens now but some of the price decreases are obscured by price increases caused by the inflation of the monetary unit.
The wages of labor, though, are increased by improved productivity. Employees' annual pay raises are not, contrary to popular opinion, taken out of their employer's profit, but are a result of the extra production each is able to achieve due to capital improvements.
The same would be true without government printing more money each year to make you feel better. Nominal wages might remain the same, but purchasing power (which is what everyone is really worried about) would increase.
What if they aren't improving productivity?
Then they're going out of business whether there's more dollars in circulation or not.
As long as you weren't crushed by deflation.....
If you were, you were a lousy businessman.....
Why is inflation so important to you? Why is the government's printing more money crucial to business development? If you don't answer that, but only throw another half dozen hypotheticals at me, don't bother to wait for a response. I've answered your questions. Do me the favor of answering mine for once.
Do you imagine the money supply under a gold standard is 100% backed by gold?
Monetary deflation is a reduction in the amount of money in circulation.
It can also be deflation when the money supply remains stable or grows more slowly than GDP.
The wages of labor, though, are increased by improved productivity.
If GM had to drop their prices 3% each year, do you feel their wages would increase?
Nominal wages might remain the same
Or they might fall.
but purchasing power (which is what everyone is really worried about) would increase.
If your wages fall but your mortgage remains the same, your purchasing power would decrease.
What if they aren't improving productivity?
Then they're going out of business whether there's more dollars in circulation or not.
Many industries with small (or no) increases in productivity manage to stay in business. Or course if deflation forces them to reduce prices, year after year, that would no longer be the case. I guess their employees wouldn't see increased purchasing power.
If you were, you were a lousy businessman.....
Yeah, lower prices year after year makes you a lousy businessman.
Why is inflation so important to you?
It's not. I just understand that deflation is worse. Much, much worse.
Why is the government's printing more money crucial to business development?
Money supply can increase, even if the Fed holds their balance sheet steady. You know that, right?
Exactly.
With a fixed money supply and an increasing amount of goods, prices will fall.
That concept encourages savings and investment, and discourages borrowing and the attached interest.
That’s why the bankers HATE it!
A system based on credit is the other way around.
Thank you. I was beginning to doubt my ability to explain it.
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