Someone rather more partial to Ron Paul's arguments in favor of the gold standard than I am asks me to write a post outlining my objections to it. All right, here goes.
Money is a mysterious thing. It is a store of value, it is a medium of exchange. It is, in a fiat currency economy, worth only what people think it is worth, and what they think it is worth can be oddly affected by what they think it may be worth in the future, resulting in self-fulfilling feedback loops (at least in the short term). Even in non-fiat currencies, such as the gold standard, the value of the underlying asset can be changed by rising (or shrinking) demand for money. Economists studying this fascinating topic tend to suffer from migraines as they suffer from all the mysterious--hell, nearly mystical--attributes of money.
However, over the last fifty years, economists have settled on some very broad areas of consensus. The first is, as famous libertarian monetary economist Milton Friedman wrote, "inflation is always and everywhere a monetary phenomenon". When the supply of money outstrips the demand, prices rise. And this is by no means limited to fiat currencies; see the great Spanish inflation of the 16th & 17th centuries, thanks to the steady influx of gold from the New World. Or check out the price of basic commodities in mining towns during the Gold Rush, when all anyone had was gold.
The second is that a little bit of inflation is okay--possibly even beneficial, since it helps the economy to overcome the problem of sticky wages when the relative value of labour has fallen. But a lot of inflation is very, very bad. Exhibit A is Zimbabwe; Exhibits B-∞ are every other economy that has had inflation near or above the double-digit mark; the higher the inflation, the worse the economy did. The feeling that the currency will experience an unpredictable amount of inflation dampens the willingness of the citizens to save and invest, which is why so many third-world loans are denominated in dollars.
The third is that deflation is also bad, and at the lower percentage values, often even worse than inflation. This surprises/offends/meets with the frank disbelief of many "sound money" types, who think that, barring local shortage, in an ideal world everything ought to cost the same or less than it did when Grandpa was a boy. (These sorts of opinions are cemented further by the fact that Grandpa, who is often the source of them, is usually living on a fixed income, and therefore feels that he would make out better in a deflationary economy.) The problem is, deflation does rather devastating things to anyone who has debt, since they now have to repay what they borrowed in more expensive dollars. Deflation means that, thanks to the abovementioned sticky wages, the economy has to deal with demand shocks by lowering output. Deflation can result in what's known as a liquidity trap, a concept pioneered by liberal economist John Maynard Keynes and best elucidated by liberal economist Paul Krugman back before he left economics writing to focus on his hatred of George W. Bush. Deflation is what made the Great Depression so memorable. Deflation is so bad that almost everyone agrees that moderate inflation, in the range of 1-2%, is better than risking even a small amount of deflation.
Advocates of a gold standard dispute this. They argue that America experienced a long, slow deflation throughout most of the 19th century, without anyone getting hurt. What they neglect to mention is that people did get hurt, repeatedly, in the period's awful financial contractions. Though we don't have modern economic statistics for the period, it's pretty clear that recessions were longer and deeper than they are now.
This is not only due to the gold standard; the era's primitive financial system and its approach to financial regulation, which often ranged between lighthearted and foolhardy, also played substantial roles. But the gold standard also has to stand up and take a bow. There's a strong correlation, for example, between how long a country hewed to the gold standard, and how badly it suffered from the Great Depression.
The gold standard cannot do what a well-run fiat currency can do, which is tailor the money supply to the economy's demand for money. The supply of gold grows--or not--depending on how much of the stuff is mined. Demand also fluctuates for non-economic reasons; gold has uses besides being money, like industrial components and jewelry.
The lone advantage of a gold standard--and it is a real advantage--is that it prevents governments from inflating the currency. The problem is, this is only moderately true. The government, after all, can always modify its gold standard. Yes, you say, but it will pay a price in the markets, and this is true, but this is the same price it pays when it prints more fiat currency. Such practices do not go unnoticed for long.
As James Hamilton has pointed out, gold-backed currencies, like all money with a fixed exchange rate, are subject to speculative attacks whenever the government's financial position looks weak. Such speculative attacks often require punitive economic measures to fight off, which is one of the reasons that America suffered so nastily from the Great Depression--it raised interest rates in the middle of a recession in order to defend the credibility of its currency.
Also, since devaluations tend to produce sharp changes in the values of currencies, rather than smooth appreciations or declines, the economic dislocations are magnified. Imagine you're a company with a contract denominated in dollars. If the value of the dollar gradually declines, you lose a little, but not too much, since you periodically renew the contract, giving you time to adjust the amounts. If, on the other hand, the devaluation pressure builds up over a period of years, and then all at once the government has to devalue by 20%, you end up badly hurt. You might go out of business. Now multiply that all across the country, and you can see why recessions used to last for years.
In short, you don't get anything out of a gold standard that you didn't bring with you. If your government is a credible steward of the money supply, you don't need it; and if it isn't, it won't be able to stay on it long anyway. (See Argentina's dollar peg). Meanwhile, the limitations on the government's ability to respond to fiscal crises, the necessity of defending against speculative attacks in times of crises, and the possibility of independent changes in the relative price of gold, make your economy more unstable. It's a terrible idea, which is why there are so few economists willing to raise their voices in support of it.
People are forever seeking a mechanistic solution to the problem of human behavior, especially human political behavior. In this regard, advocates of the gold standard are much like advocates of campaign finance reform. The former wrongly think there is a sound mechanistic solution to politicians who wish to inflate the currency, and the latter think there is sound mechanistic solution to an electorate which does not wish to take the time to supervise the behavior of it's elected representatives. Both problems are the same really, and no legislative device will adequately replace an electorate which energetically holds it's elected representatives accountable, and any legislative device crafted with that goal in mind is likely to make things worse.
Well said. I've been trying to find some arguements for and against the gold standard, and you make some great points.
I'd be interested in whether or not changes ought to be made in our current system. Ron Paul believes there's too much secrecey in the federal reserve and that it shouldn't be run by private banks.
If governments can manipulate the money supply on the gold standard, then couldn't they also allow some inflation? Also, wouldn't there be loan offerings that would offset or plan for deflation?
I like Ron Paul (and have supported his campaign monetarily), but I don't understand the pros and cons of the gold standard. I do believe he's not for a pure gold standard, but something based on commodities, and that'd give regulators some wiggle room.
Thanks,
Mike
I'm curious why you imposed your political labels on Samuelson, Keynes and Krugman, but not on James Hamilton? Was it important to your point that these economists have the labels you attribute to them, particularly the snark about Krugman? If so, what was your point?
It's odd that so many libertarians, who generally believe that the Market does things better than the Government, advocate a government-monopoly Gold standard.
The free-market solution would be to phase out all regulations on banking and printing money (well, except counterfeiting another bank's money, of course, which is just fraud), truly privatize the federal reserve and the dollar, and let the best money win. If a gold-standard currency is truly better, then we'd all be using Liberty Dollars after a while, instead of those "evil, fractional-reserve, inflating fiat currencies."
What about David Friedman's idea of competing private currencies composed of a basket of commodities?
That would prevent any distortions resulting from a huge increase or decrease in any one of the underlying commodities, and would keep inflation in check, (assuming transaction costs were low) because you could just switch currencies when someone started cranking up the old printing press.
Steven Donegal:
She just doesn't get my 70% of the population dislikes The Decider. He lies us into wars. He spends money like drunken Democrats. What's there not to love?
Great post.
However, the one-line shot at Krugman ("back before he left economics writing to focus on his hatred of George W. Bush.") irritated me.
I think Krugman has lost some perspective, but I really don't see Megan as an exemplar of even-handedness either. And when it comes down to it, Krugman's fundamental point was right - Bush has been an awful president. Megan is correct to regret her endorsement of Bush. I'd admire her if she took the next step and re-examined her views of his critics.
My apologies, if she has done so and I missed it.
Tom
Tom G. wrote: I think Krugman has lost some perspective, but I really don't see Megan as an exemplar of even-handedness either. And when it comes down to it, Krugman's fundamental point was right - Bush has been an awful president. Megan is correct to regret her endorsement of Bush. I'd admire her if she took the next step and re-examined her views of his critics.
And what re-examination would that be? Krugman has done considerably more than make a "fundamental point" about the Bush presidency; he went obsessive about his dislike, to the point of skewing his ability to honestly and carefully respond to the administration's economics policies, something he should have been able to do with both hands figuratively tied behind his back. Megan was ocassionally taking aggressive swipes at Krugman's gradual loss of depth way back in the Live from the WTC days, very early in the first Bush term, so I'm guessing you haven't been a reader for very long.
I thought it was kind of odd that she chose to throw that snark into this post, but OTOH, it's hard to be bothered by it unless one objects to hearing a gold-plated spade referred to as a manure shovel when it has, in fact, been employed for that purpose.
So anony-mouse, do you think Bush has been a good president? Do you think Megan was right to endorse him and Krugman wrong to oppose him?
Tom
Not one reference to the the work of Great libertarian economist, Dr. Rothbard titled " What has government done to our money" and neither is there any reference to the case against the Fed.
None of these so called arguments against Gold standard, could the stand any half hearted scrutiny. I recommend that you watch the video from the Mises Institute ( Austrian Free Market ) school.
http://mises.org/MultiMedia/video/Salerno/Salerno10.wmv
I don't favor the gold standard, but this is a weaselly paragraph.
The lone advantage of a gold standard--and it is a real advantage--is that it prevents governments from inflating the currency. The problem is, this is only moderately true. The government, after all, can always modify its gold standard. Yes, you say, but it will pay a price in the markets, and this is true, but this is the same price it pays when it prints more fiat currency. Such practices do not go unnoticed for long.
If it is a real advantage (and I do think it is) then its not the "same price", its a higher price which makes it harder for a government to inflate the currency.
Megan, great post.
I have one point to make about the idea that the government engineers inflation. Many supporters of the gold standard seem to believe that congress and the white house have a real influence in terms of creating inflation. That's not true, but it would be true if we abolished the Federal Reserve.
The government can enact policies that are inflationary, but their influence pales in comparison to the Fed's ability to set short term interest rates. This idea that the government can now create inflation, and would be unable to do so if THE GOVERNMENT PEGGED OUR CURRENCY TO A COMMODITY AT A RATE OF ITS OWN CHOOSING, is absurd on both counts. The Fed governors are appointed by elected officials, true, but short-term they really have a tremendous amount of independence when it comes to setting rates and pushing toward deflation or inflation.
If you don't want elected officials creating inflation, you should support our current system and oppose the gold standard.
When I look at how many self-identified libertarians drift into territory where they can support the gold standard (I'm pretty sure Churchill wrecked the British economy in the 20s by taking it back on the gold standard when he was chancellor of the... you know the finance minister), it makes me feel like Stalinists are credible by comparison (look up Stalin's response to the scissors crisis to see what a fiscal and monetary genius he was).
If it is a real advantage (and I do think it is) then its not the "same price", its a higher price which makes it harder for a government to inflate the currency.
It is "a real advantage" if and only if the government keeps the exchange rate fixed. Megan's point is that there's nothing forcing them to do that -- they can change the exchange rate from "$500 per ounce" to "$50,000 per ounce" overnight if they wish, creating instant 9900% inflation. Actually printing 99 times as much fiat money would actually take more effort!
The arguments for the gold standard are fundamentally ridiculous, since we know from past experience that the government can go OFF the gold standard whenever it wishes to. The only way to prevent it from doing that is for a solid majority of the public to be vehemently opposed to such an action -- but with a solid majority like that, the government couldn't get away with inflating a fiat currency either.
Tom G wrote: So anony-mouse, do you think Bush has been a good president? Do you think Megan was right to endorse him and Krugman wrong to oppose him?
Still missing the point, Tom. It's not the opposition, it's the degree of opposition that lends an air of kookery to Dr. Krugman.
That he leans to the left politically is unquestioned, so why the problem with identifying him as a liberal?
I'd be interested in whether or not changes ought to be made in our current system. Ron Paul believes there's too much secrecey in the federal reserve and that it shouldn't be run by private banks.
The Fed isn't really run by private banks, whatever its complicated formal structure. It is run by the members of the FOMC, most of whom are appointed by the President.
As for changes, Milton Friedman favored replacing the Fed with a simple computer program following an automatic rule (like increasing the money supply by 5% per year, no matter what), but few economists agree with him.
On the whole, since about 1980, the Fed has done a good job. If it ain't broke, why fix it? As our knowledge of monetary theory has increased (thanks in large part to the aforementioned Friedman) our monetary policy has improved.
P. S.: I wish to second anony-mouse's insightful comment above and to commend Megan for a lucid exposition of the flaws of a gold standard.
Um, wasn't it silver, not gold, that swamped the Spanish Hapsburg Empire?
Kevin,
I did not object to characterizing him as a liberal, but rather to Megan's put down that "he left economics writing to focus on his hatred of George W. Bush."
I can't think offhand of any partisan error of Krugman's in the same league as Jane's endorsement of Bush in 2004. Krugman was right about the fundamental point and Jane was wrong. I think that calls for more self-reflection and less taunting.
That said, I have not read all of Krugman's columns so I am open to the possibility that he's written something worse than I realize.
Tom
I have not read all of Krugman's columns so I am open to the possibility that he's written something worse than I realize.
Try this from column shortly after the trade center attacks: "Ghastly as it may seem to say this, the terror attack -- like the original day of infamy, which brought an end to the Great Depression -- could do some economic good." So, according to Paul Krugman, smashing buildings and killing 3000 workers will bring us economic growth. It's hard to believe a serious economist could write something so laughable--but Krugman did.
Isocrates,
Krugman was referring to the massive Keynesian stimulus to the US economy brought by wartime spending in the 1940s. Since 9/11 was viewed as being another Pearl Harbor, and since Pearl Harbor led to the US involvement in WW2, which brought about that massive wartime spending, Krugman was merely pointing out that since 9/11 was going to lead to massive increases in military spending in order to fight the War on Terror, 9/11 would lead to the same sort of massive Keynesian stimulus that the US economy saw in WW2.
Only someone like you, who is neither a serious economist nor historian (even on a amateur basis), would so laughably fail to grasp that basic point,
Here is the man himself Ludwig von Mises talking about Gold standard in his classic book - "Human Action"
http://www.mises.org/resources/f0b01a91-2079-4a19-a409-bd1450abe9cf
Dr. Shostak : The Supply-Side Gold Standard: A Critique
http://www.mises.org/story/991
The Case for a Genuine Gold Dollar
by Murray N. Rothbard
http://www.mises.org/resources/8a1b9cc7-6569-4876-a608-91f70d8c0e58
What Has Government Done to Our Money?
by Murray N. Rothbard
http://www.mises.org/resources/7184a3af-b7ff-4465-aab5-68a3c773b48b
My political beliefs are in a rather obscure branch of libertarianism called geolibertarianism. Geolibertarians support the free trade and exclusive ownership of private property that is created through the effort and intelligence of man, but considers land (and by extension, natural resources like clean air, water, and the like) to be the common inheritance of all mankind. Because of this, the fair-market value for the use of such resources should be paid to society in the form of land value rent. It's a coherent form of libertarianism that neatly sidesteps the "pillage the earth" and "tragedy of the commons" arguments directed at most libertarians, since if you put a landfill or smokestack next to my house, you get to pay for the clean air and water, and the lowering of land value of the surrounding community.
Anyway, if we are going to amend the constitution anyway (and things like getting rid of the IRS would require it), rather than waste a perfectly good commodity as a monetary basis, or have a strictly fiat currency like our current system, why not use land rent valuation as a basis? Something like (Total land value/population) = constant. You could go one step farther, and set (Total taxation/population) = constant, and make any changes in the rate subject to a constitutional amendment.
Under such a system, the government couldn't debase the currency -- they can't create more land, and it's time-consuming to create more people. People couldn't horde land, since the more they held the more rent they would have to pay. It doesn't affect the use of natural resources -- if you make a gold coin, it takes a bit of gold away from other uses, but if you are taxed for land value, it's in your interest to use it for a profit or let someone else use it. People would have an incentive to circulate the money -- at the very least, to trade it back to the government to pay for their tax burden.
It's hard to say if there would be an inflationary or deflationary pressure -- as an industry became more efficient, products would be cheaper (deflationary), but the price per acre of land would increase in proportion to the population (inflationary). I'd be interested in seeing a critique on the basic idea, both in relation to the gold standard, and in relation to fiat currency (not sure how "sticky wages" would affect it).
Try some common sense that is backed by history people!
Name one fiat currency in history that has survived more than 40 years without becoming worthless. Has an ounce of gold or silver ever become worthless?
Why is it that people will spend a small fortune to find gold and silver coins in sunken Spanish ships at the bottom of the ocean? Could it be that it hasn't lost it's value over the centuries?
If you had 1000 ounces of silver coins from the Roman Empire, and $1,000,000,000,000 of Confederacy paper money from the Civil War, which would be of more valuable today?
It's not rocket science people...
"Krugman was referring to the massive Keynesian stimulus..."
Yes of course. He was espousing a kind of crude Keynesianism. But it turned out that he was wrong. Economists now widely agree that the terrorist attacks deepened the recession. See for example Alan Greenspan's speech of 1/11/02:
So clearly Krugman was wrong. But his error is quite informative. It shows just how badly he misunderstands markets--and how, despite his impressive academic credentials, he has never really understood classical economics.
Name one fiat currency in history that has survived more than 40 years without becoming worthless.
I can't think of any, and that's because until 1971 countries didn't issue fiat money unless they were in dire financial straits. But I'll bet you an ounce of gold that the US Dollar will not be worthless in 2011.
If you had 1000 ounces of silver coins from the Roman Empire, and $1,000,000,000,000 of Confederacy paper money from the Civil War, which would be of more valuable today?
Confederate money is actually fairly valuable as a curiosity these days, but I see your point.
Holding specie as a hedge against inflation does make a certain amount of sense because it's almost certain to still be valuable even if the economy tanks or the goverment collapses, and you can do that whether we're on a gold standard or not. But that's not the same thing as a gold standard. In a gold standard, you're still left with a worthless piece of paper when the government collapses; the only difference is that the piece of paper says you're entitled to gold that isn't there.
>Name one fiat currency in history that has survived more than 40 years without becoming worthless.
Bretton Woods collapsed and took the gold standard with it in 1971, so give the worlds' major currencies another 4 years (grandfathering the Euro, natch).
Isn't another of the major problems with the gold standard that fixing currencies wrt each other leads to foreign trade distortions? Nowadays trade imbalances are to some extent self correcting because goods from net-importers become cheaper with time.
Another Krugman blunder (as pointed out by Greg Mankiw), not long before the scandal at Walter Reed exposed how poorly the VA functions:
Isocrates, I don't know why I bother with you anymore, but Walter Reed is NOT A VHA HOSPITAL. The VHA continues to have the best-run hospitals in the country. Your above post is worthless.
Isocrates is making a silly argument. I'm sure you could reread all the Paul Krugman's columns and find some silly things - that is the nature of writing two columns a week for a decade. The point is that on the big issues, he's been proven right WAY more than wrong.
But in all honesty, these days, columns about how Bush is screwing things up even more don't count as insight - they just demonstrate a basic level of sentience.
Hi. It appears that I am the first Ron Paul spammer to comment on this post.
I very much enjoyed reading the article, and all of your posts. It's nice to see some intelligent people debating an issue as important as our money supply.
Congressman Paul often uses the term "sound money," implying that it wouldn't necessarily be a gold standard as we've used before. What are the various other options available for a sound currency, and what are the pros/cons?
Again, thanks for addressing this.
The best argument against the gold standard I've seen since William Jennings Bryan. Nice work.
Megan, you write:
Fiat? Yes. Gold is not so much. And when you look at it with your state-fiat money spectacles, you are seeing a lot of problems that states create, not gold. (a) We've discovered all the New Worlds that are cheaply reachable. (b) Inflation did not cripple Spain. A powerful state engaging in endless warfare in Europe did. Perhaps the riches of the New World caused the state to become more powerful, thus in part causing its own self-destruction, but this is hardly an argument against the gold standard (nor for it). It is an argument against promiscuous warfare. Yes. A lot of inflation is what a gold standard cannot have, unless perhaps a gold asteroid falls to Earth.
Zimbabwe is running the printing presses. Nobody can run the gold printing press.
No, it isn't. Unexpected deflation may be. But that is not the effect of a gold standard, where the money supply is far more predictable than the flailings of Helicopter Ben.As for deflation making the Depression memorable: well, that's not what I was taught. Rather, it was mass unemployment that seared the event upon the brains of the masses, and idle factories that seared it into the memory of the captains of industry. This is all quite adequately explained by the business cycle, as a blunder of the Fed in printing too much money. They pumped up the economy with unbacked money in the "roaring" 20s. They reaped what they sewed.
I will mention it: people did get hurt, repeatedly, in the period's awful financial contractions. Nobody thinks that nobody got hurt in the recessions and depressions of the 19th century.The disagreement is about causes of that hurt. I would suggest that people in the 19th century were much poorer then than now. Thus a recession might affect them more strongly, being closer to the edge of ruin all the time.
As for their depressions being longer and deeper: well, the Fed is responsible for the Great Depression, which was at least equal of any in the 19th c.
As for the statistics, there it is again. You don't have any numbers and you admit it. So, all we are left with is dueling anecdotes. I suggest that in the absence of data, one might be a bit humble about one's claims.
Any supply of money is fine. The idea that there is one ideal level of demand that must be met... where did you get that? Proof? Money is not like other goods, you know. If we have twice as much grain, that's a good thing. Twice as much money means all prices will eventually halve. Changing the size of the money supply is a wash, outside of distribution effects. And that is what this is all about: the state has a corner on the money supply, and can thus use inflation as a hidden tax. It's a great tax from their POV, because nobody understands it. No resistance, except from "cranks" like me.You are looking at a feature with your statist ideology and seeing a bug. That the state cannot control money is a good thing, not a bad thing. Less power to them.
I might also reverse it on you. The fiat standard cannot do what a well-run, or poorly run gold standard can do, which is not attempt to tailor the money supply to any political constituency's demand.
Fiat requires philosopher king-bankers. Commodity money requires mere humans.
As for your contention that the state messing with a gold standard can cause havok, well I'll concede that. There was a gold standard before the great Depression, after all, and it did not prevent the governments from inflating the money supply. Fraudulent money creation is what caused the "lack of faith" in the governments (and thus speculative attacks on the currencies): they were not credible and people knew it. The solution is simple: disallow the practice of issuing fraudulent money. All circulating currency must be backed by existing gold. This is a gold specie standard, and that is what I am thinking of when I think of a gold standard.
I don't know what Ron Paul thinks, but a gold standard is a step towards a gold specie standard.
Of course, completely severing state and money would be the best solution. The state has no business in money, other than in punishing fraud. But we need a path to do it, and a gold standard is one such path.
Leonard, anything politicians "disallow" today is something politicians can allow tomorrow. There is no mechanism which can withstand inadequately supervised politicians, be it fiat money, or currency backed by gold.
It's truly amazing how many people one can find sticking up for the gold standard. This is a really stupid idea that has no support among any respected economists, bankers or business figures. It does however have the merit of being superficially simple, and it seems to appeal to a certain kind of intellect for that reason.
Megan has done a good job of demolishing the argument for a return to this medieval superstition. The one thing she didn't include, I don't think, was the point that the money supply expands in part because of the extension of credit, and the gold standard does nothing to restrain the extension of credit. Also, her summary of the evils of deflation didn't include one of the standard points about it: deflation gives consumers a strong incentive to wait rather buying now, which decreases demand, which kills economic growth and causes unemployment.
Prices were stable for most of the 1920s. The Fed's monetary policy was price stability. From 1928, the policy shifted to monetary contraction because the Fed believed that it had previously "pumped up the economy with unbacked money." When financial markets declined, the Fed believed that credit extended earlier in the decade was not backed by "real bills" and was inflationary, and so needed to be squeezed out. Deflation began. Real interest rates soared. The IS curve shifted left. Output fell. The aggregate demand curve shifted left. Unemployment increased. Demand for money fell and deflation intensified. Real interest rates climbed higher and the cycle repeated. M1 fell by a third from 1929 to 1933. What was a bad recession in 1930 became a depression. This is all adequately explained in any basic macro textbook.
Price x quantity = money x velocity.
Nobody would borrow money when there is a -50% inflation rate. All activity based on credit would cease. Output would collapse. Existing borrowers would be ruined.
Seignorage is well understood. Our govenrment does not rely on it, preferring to borrow money.
How much gold do you have? U.S. gold reserves are a little over 8,000 metric tons, or $180 billion at the current spot price. The monetary base in the United States is $820 billion.
The idea that there is one ideal level of demand that must be met... where did you get that? Proof? Money is not like other goods, you know. If we have twice as much grain, that's a good thing. Twice as much money means all prices will eventually halve. Changing the size of the money supply is a wash, outside of distribution effects
You are not thinking about increases in productivity, which is the be-all and end-all -- otherwise known as "everyone getting richer". Money supply affects productivity; deflation retards productivity growth, and that is one reason why central bankers need to be able to manage the money supply.
Think of an economy which produces 100 cars per year, where productivity is rising such that it will eventually be able to produce 200 cars per year with the same labor input. Unless this economy can expand the money supply, the price of cars will ultimately fall from $10,000 per car to $5000 per car. (Pretending this economy produces nothing else but the cars, for simplicity's sake.)
If you are a consumer in such an economy, at what point does it make sense to buy a new car? If you wait a little longer, you'll be able to buy the same car for less. So, logically, you should wait, and use your expected savings to do something else. But this means that fewer people are buying cars, which retards the car-makers' incentives to increase productivity. They will slow down their car production to prevent prices from falling further.
If, on the other hand, the economy is able to expand the money supply to keep pace with increased productivity, then the price of cars does not fall. This means there is no reason for consumers to delay buying a car, which means car makers will keep increasing productivity as fast as they can, to meet demand. Such an economy will be much faster to reach the point at which it produces 200 cars, and everyone can own two cars, instead of one. In other words, people in this economy will be richer. And since that is the goal, flexible money controlled by intelligent central bankers is better than a fixed money supply.
This is also why every rich country in the world has a flexible money supply, and why we are vastly richer now than when we had the gold standard.
"Isocrates, I don't know why I bother with you anymore, but Walter Reed is NOT A VHA HOSPITAL."-brooksfoe
Yes it's true. Walter Reed is technically under the Defense Health Administration, but how exactly does that rescue Paul Krugman? His basic argument is that government provided care is superior to private care. The Walter Reed scandal undermines that argument. But if you want something more, Newsweek investigated the VHA and found:
So much for Krugman.
I'm sure you could reread all the Paul Krugman's columns and find some silly things... the point is that on the big issues, he's been proven right WAY more than wrong.
Well, I was just answering Tom G. above who wrote:
I have not read all of Krugman's columns so I am open to the possibility that he's written something worse than I realize.
Regardless, I think Krugman has been wrong more than just a few times. He has been badly wrong about most public policy. Yes, he hates Bush, and Bush has made some big mistakes, but I don't see why that should lead us to ignore all of Krugman's blunders.
Paul Krugman is an intelligent and learned man. I dont doubt that. But he has allowed his passion to overwhelm his reason (like some who post here). His hatred for Bush and Cheney has so consumed him and distorted his thinking that he makes fundamental errors even concerning economics--his area of expertise.
To give an important example, it's fairly clear now that Krugman was wrong about the tax cuts. As Robert Barro of Harvard tried to explain to Krugman:
brooksfoe: Yes, increasing productivity causes prices of labor-intensive goods to fall, giving consumers a reason to delay purchases. A consumer always has a choice of storing his wealth in hard assets -- land, commodities, buildings, businesses -- rather than in a fiat currency. Therefore the consumer has every incentive to delay purchasing a car, computer, medicine, surgery, etc. -- because better, cheaper ones will be offered tomorrow. Of course in the long run we're all dead, so a lengthy delay is of limited utility; we may wish to indulge in pleasures today, and view these purchases as disposables.
Government manipulation of a fiat currency won't alter this consumer's incentive to delay or not to delay.
More generally, concerning the arguments for and against a gold standard: I would propose that so long as the citizen-consumer is permitted to store wealth by owning hard assets -- and to hedge his bond holdings and personal debt against hard assets if he wishes -- that there is little reason to advocate for a gold standard. If we wish to limit government irresponsibility, perhaps we should rather focus our efforts on a constitutional ammendment to prohibit government borrowing, and to place an absolute limit on tax rates.
It doesn't really matter what we use for money - Gold, numbers in a computer, or big round stones with holes through the center. Paper currency for convenience of transaction is similarly without inherent goodness or badness.
The principle that must be maintained is that no one, not the individual, not the bank, and especially not the government, be allowed to create currency without any backing of the underlying money.
High-def laser color copies, Fractional reserves, and full-bore printing presses are the same problem, only the first is done by individuals, the second by banks, and the third by government.
All are engaged in the same fraud.
Just a few mildly off-topic points on the Krugman meta-debate:
1. Friedman was also labeled a libertarian economist, so I don't think you can say she was denigrating Krugman as a liberal economist (particularly when she is agreeing with him).
2. That said, the blurb about Bush-hatred was indeed an unnecessary diversion which detracts from an otherwise thoughtful post on monetary policy. Is it really anything other than a milder version of HH ranting against libertarians in the comments to a post a on, say, puppies?
3. My issue with Krugman is the same issue I have with most political discourse - it's one thing to say that Bush is a lousy president, and it's quite another to suggest that he's evil incarnate. This seems to be far more common amongst the left/liberals right now (though, judging from the Clinton years, I suspect it's more a symptom of being the party outside of the White House).
I have to agree about the Krugman aside being unnecessary. Similar comments about Bush in the Stalin article were also unnecessary.
Krugman has lost his mind. I've seen numerous examples where his blind hatred for Bush has unhinged his thinking to the point where he is totally irrational.
As far as the gold standard goes, my problem with the whole concept is the choice of gold over any other commodity. Why not silver? Platinum? Uranium? Diamonds? Oil? Tying the money to a commodity that has practical uses, whose availability is unknown/uncontrollable, and whose availability can be manipulated by other countries seems to set you up for some serious economic changes driven by factors completely outside of your control. What if gold is found to be a vital component in a new type of engine? What if a cheap way to transmute lead to gold is found? What if someone discovers a HUGE gold deposit that doubles the supply? Do we really want our money tied to a kind of metal?
The idea of tying money to land or some sort of commodity basket might make more sense but I don't have the background or time to figure that one out. And it seems like there would be similar problems with those systems, too.
Fiat money is exactly and only what it should be. A way to keep score in the market. True, the government can change the value of "points" but that would be true of any system. If Zimbabew had a gold standard, Mugabe would have just taken it off the gold standard or done something else. A system that limits government power only if the government agrees to be limited isn't really limiting government power.
Independent George, Megan has already observed what you describe about parties in and out of power. To wit:
Jane's Law: The devotees of the party in power are smug and arrogant. The devotees of the party out of power are insane.
From this post on her old blog:
http://www.janegalt.net/blog/archives/004185.html
EI
Ack... Zimbabwe!
EI
Economics is the study of other people's money and there is no shortage of sadistic monkeys who, having studied it, want to control it's value and spend it too.
Free market money is how money began, like free market charity. Force improves neither. Monetary policy means counterfeiting. Welfare means robbing the rich to buy votes from the poor.
Corruption is hidden in a lot of snakey rhetoric and that's why corruption wins. As Lenin advised, "First, confuse the vocabulary".
Krugman was a really, really good economist, but the longer he writes for the Times, the more likely that will be forgotten. Potentially he'll end up like Noam Chomsky, brilliant in his specialty, but too tiresome to listen too because that's not what he wants to talk about.
As Lenin advised, "First, confuse the vocabulary".
I don't believe Lenin actually ever said that, though I may be wrong. Do you have a primary source?
Government manipulation of a fiat currency won't alter this consumer's incentive to delay or not to delay. - lary9999
I repeat what I said: when the money supply grows as productivity grows, it is possible to avoid deflation, which means consumers have no incentive to delay purchase. I don't really understand what your statement above is supposed to mean; it sounds to me like saying "Rising or falling prices are not going to alter the consumer's incentive to buy or not to buy." That simply doesn't make any sense. I'm perfectly willing to keep discussing, but not when people say things that don't even have any internal logic.
Can anyone point me toward the latest M3 data? I figure all this talk about money and printing it out of thin air, I should at least be able to see what is the current money supply. That is the great thing about the FED, with figures like M3 data we can see what they are doing.
I mean, since early 2003, the economy has done extremely well. - Barro
The people who make up the economy, mostly not so well. Most households still earned less last year than they did in 2000.
But go ahead, keep talking about how great "the economy" is doing, while the voters still have less money in their pockets. That's a great way to win elections, as George Bush Sr. found out in 1992.
Brooksfoe, since you bring up this old canard many times, I guess I should address it:
Deflation does give an incentive to wait. But then, the possibility of saving in an interest-bearing account has the same effect.
Do you think saving money is bad because it "gives consumers a strong incentive to wait rather buying now, which decreases demand, which kills economic growth and causes unemployment." ? Perhaps we ought to ban the payment of interest in the interests of the economy?
In any case, the world did not end in the 19th c. This proves that the free market can, somehow, work out the problems caused by all those greedy common people not spending money because it might be worth 2% more in a year.
BTW, the economy grew faster then than it does now. So much for the idea that mild, predictable deflation "kills economic growth".
Good post and great Krugman one-liner! He has turned into a liberal! (I always assumed that it was more likely to see Richard Dawkins become a new-born-evangelist...?) But it is NOT his hatred of Bush that has bothered me in the past.
Rather - I find it puzzling that whenever he speaks of poverty - he automatically assumes a closed economy model without any explanation as to why... that makes any realistic discussion with him impossible as there is no such thing as a closed economy on earth (unless he refers to the whole earth - which he does not).
Will, you wrote:
This is true enough. However, I have two points in response.First, put broadly your argument either proves nothing, or too much. If politicians really cannot be controlled, then it is hopeless to do anything, and we might as well accept the status quo. The politicians will continue to take our money and fight wars, gradually tightening state control (as they always want to) until we all march in unison, and the USA swirls down into ruin. There are strong elements of truth here. We probably will swirl down into ruin; I don't see any hope of reversing the state except its bankruptcy.
If on the other hand you allow that we can, possibly, make incremental changes for the better even given the fact that we are ruled by fickle politicians, then I don't see why we should not try. At least arguendo.
Point 2 is: even though there is no mechanism in a gold standard to restrain politicians, there can at least be a realignment of political perceptions that make it hard for them to abjure it. Consider hyperinflation: there's no "mechanism" preventing that, either. But I do not fear it because the politicians and state apologists know it is bad.
A gold specie standard, with modern levels of information technology keeping tabs on it, would a lot harder for policitians to subvert that the gold standard that the Fed inherited and destroyed with its bumbling.
You Krugman haters are one deluded gang of nincompoops.
It was his work as an award winning economist and his patriotism that made him step into the public sphere when the press and pundit corps refused to refute the Bush campaigns blantant lies about their tax policy. Yes Krugman was on to Bush before he became President. Read his 1999 book Fuzzy Math.
Krugman's question to us is basic. What good is a democracy when lies are allowed to carry the day? Especially lies at the highest levels of public service? He saw Bush for what he was and did his best to point it out. What detractors always ignore is that every Krugman objection is rooted in public policy. It's not about adultry, earth tones, or haricuts. Policy matters, so the President's policies and untruths can not be ignored. In my experience people who object to Krugman object to having their pet partizan notions shot down by a solid mind. He drives NRO types nuts because they can't refute him except via personal attack, which is ultimately boring and unsatisfying. As for comments on 'tone' and 'blind hatred' it's always a sure sign that you are dealing with a wimpering crackpot thinker whose ego can't admit that it's wrong. What can you do. America is full of nutters it seems. 27% of the voting public to be exact.
http://kfmonkey.blogspot.com/2007/01/repost-crazification-factor.html
Speaking of crackpot thinkers have you seen the excellent article by Chait on economic wingnuts in TNR? I like what the new Canadian ownership is doing for that place. The Aspers may be likudniks but they are "reality based" when it comes to US domestic politics. No more bell curve baloney or laffer curve free lunches on those pages. Maybe the liberal magazine will actually be liberal again. Whod a thunk it.
http://www.tnr.com/doc.mhtml?i=20070910&s=chait091007
PS - oh look 152 comments. Wingnuts attack! Wingnuts attack! Wingnuts attack!
Nobody would borrow money when there is a -50% inflation rate. All activity based on credit would cease. Output would collapse. Existing borrowers would be ruined.
If bonds can be indexed to inflation , why not deflation?
The crux of the matter is Central Planning vs Multiple Competing entities. Multiple competing entities in a probablistic universe give rise to more stable and complex sytems.
Is it any wonder that evolution occurs this way?
Needless to say, a fractional reserve system will brand a private system as being to risky and irresponsible. All the while devaluing the governments debt and claiming the federal budget is always in deficit.
Which in turn means it needs to raise tax rates despite the fact that the Fed has puffed up your Capital Gains vis devaluation.
I'm not sure if Ms. McArdle's Krugman allusion was appropriate to the topic, but I remember reading column after column by him in 2001 about GWB's tax cuts arguing that the US Tax code was irrational and it was GWB's fault. I remember thinking at the time how a guy who wrote such idiotic columns about economics got the then towering reputation he had.
Money is fascinating though. I worked for two months on a currency desk and my takeaway thought from the experience was that money, dollars, yen... were just commodities and a currency trade was not different than a trade involving a Derek Jeter baseball card for a Alex Rodriguez.
Originally people used gold and silver for trading just because they were widely desired commodities that were easily moved. The first coins were minted just to standardize the weight to eliminate the problem of measurement. A dollar and, more obviously a pound sterling, were units of weight, they weren't though of as 'money', the metal was a valuable commodity, just like in the case of 'talents'. The US Constitution puts Congress's power to coin money and regulate the value thereof in the same sentence as it's power to set standards for weights and measures.
It seems that sometime during the period when people used backed by, or exchangeable for, gold, paper money to effect transactions, rather than gold and silver coins themselves, that dollars and pounds stopped being a units of weight like a short ton in the popular mind and turned into that mysterious thing they are today, money. The only need one has for fiat money is that the govt insists you give them some every year in the form of taxes upon pain of death or imprisonment, otherwise fiat money is worthless, except for funky wallpaper.
I agree, sort of, with Ms. McArdle about the gold standard. Most govts borrow, and it is obvious that when a govt creates fiat money inflation, at least if is unanticipated, what it is doing is defaulting on it's debt. If the govt were to double the money supply, thereby doubling prices, it's done the same thing as a bankruptcy court halving the outstanding debt of debtor.
What happened in the 70's, when Nixon 'closed the gold window' is that the US govt defaulted on it's debts. It could have just said every T bond coupon and principal amount will be halved, and gotten the same result. Going off a gold standard, not keeping one's promise with regard to exchanging currency for gold, is a default.
Going 'gold' doesn't eliminate the problem either. Unless one writes the unit of weight that a dollar shall be into the Constitution, Congress can always redefine a dollar, like they can redefine a foot or a gallon, and thereby default on it's debts, unless the bonds carry some clause like a 'dollar as defined by law in year x'. Some old insurance contracts were actually so defined way back when and I remember reading about some 'private bills' specifically voiding such contracts.
Enough for now.
"If you had 1000 ounces of silver coins from the Roman Empire, and $1,000,000,000,000 of Confederacy paper money from the Civil War, which would be of more valuable today?"
That 1000 ounces of silver Roman coins might have as little as 20 ounces of silver in them.
If think the Krugman aside was necessary. Some folks may not remember when Krugman was a serious and respected economist. I think it is useful to point that yes in fact he once was a serious and respected economist.
Besides - snarky asides about Krugman are de rigueur on economics blogs. Get with it.
We who hate Krugman hate him because he used to be a very good columnist as well as a great economist. His work at Slate was wonderful. Then Bush got elected, he was writing for the NYT, and everything went to hell.
He chooses to go over the top in partisan rhetoric when he knows better, or let his "knowledge" that Bush is the worst president evar color all of his writing and analysis. If you aren't familiar with his past work, and aren't a member of Daily Kos or MoveOn, respect for his previous work from people across the spectrum will seem odd. Hence Megan's explanation.
The problem with using any commodity as "currency" is that it is just as much fiat currency as anythign else. When coins were specie, they were routinely debased by kings inflating their way out of debts. Running the printing press isn't a new idea. Look at Roman attitudes towards the coins of various Emperors and Consuls, whether of gold, silver, or copper, and the changing price levels over the course of Roman history. Gold itself has fluctuated widely in value in the past 20 years, not just in terms of dollars but also relative to all other goods.
Gold is not the only commdity that has been widely agreed to be "money". Wampum, cattle, large stones, and cowrie shells are just a few examples of commodity "money" that did or do serve as currency. Any commodity relies on relatively stable demand and supply for its inherent value. New supplies and new methods of production can cause massive shocks that such a system is completely unprepared for. It is bad enough for a key commodity such as oil to swing wildly, but if you get 100% inflation one year because of a new mine or new method of processing gold it will devastate the economy just as the mines of the New World destroyed the economy of Spain. Spain was the first country to see the dangers of the resource curse, and the damage mirrors that done to African and Middle Eastern countries suffering under despotic rulers and vast bounties of commodities.
How anyone who purports to be economically literate can utter the phrase "the supply of X outstrips the demand" - for any X, whether it is gold, dollars, cowrie shells, or 1967 Mustangs - is entirely beyond me.
The above post is the most confused collection of inflationist mythology I've ever heard in my life. The average newspaper reader in 1907 had a far stronger understanding of economics. Megan's post is simply a testament to the intellectual destruction of the 20th century. She starts by confessing that she doesn't understand money. She should realize that she's right, and stop right there.
First, any supply of money is adequate. No new money ever needs to be created for any reason at all. Because moneyholders do not care about the denomination of currency they hold, monetary systems can be redenominated neutrally (for example, by adding or removing zeroes). What matters to a moneyholder is the fraction of total currency that he or she holds. Diluting the money supply, therefore, is logically equivalent to transferring money from all other moneyholders to the recipient of the diluted (effectively counterfeited) new money. If forced wealth transfers are unnecessary, dilution is unnecessary.
The primary flaw in the gold standard is not that it is too inelastic, but that it is too elastic. A fixed-quantity fiat currency would be superior. However, the advantage of gold is it can restrain a reasonably honest, but not totally righteous, government from diluting the currency, more effectively than any paper system. If you are dealing with a criminal like FDR or Mugabe, of course, nothing can help.
The reason that the gold standard failed in the 1930s was that it had been brutally abused in the 1920s. Not that it hadn't been abused before the Great War, but the abuse was at a whole nother level. The monetary base of "gold-standard" currencies in the '20s exceeded the actual gold supply, in all countries, by a considerable factor. When you issue five times as many notes redeemable in gold as actual gold, you shouldn't be surprised when people start taking you up on your promise.
Yes, deflation is painful. So is withdrawal from heroin. This does not mean that what you're putting into your arm is "Vitamin H." An addiction to diluting the money supply is a very serious disease, and the West has had it for quite some time. That it has not proved utterly lethal does not recommend it.
Probably what should have been done in the 1930s is that the paper and gold currency supplies should have been brought back into balance, by devaluing the gold currencies (ie, raising the gold price) until a 1:1 balance was achieved. Destruction of fiat is not the only way to return to sound money. Although it does make a pretty good strawman.
"The people get money from their employers and banks. Employers get money from their customers, and banks. The banks get money from government employees, vendors, and contractors. The government gets money to pay its employees from the Federal Reserve. The Federal Reserve gets money by monetizing the debt of the U.S. Treasury - the debt of the State. See The Federal Reserve: Fractional Reserve Lending for a detailed explanation.
This is the reason the bankers are allowed to function by a different set of rules than other businesses.
The Federal Reserve Monetizes The Government's Debt.
Without one hand washing the other, the State would have to get their financial house in order; they would not be able to run the deficits they presently do. They would not be able to run up the debt they do. And the bankers would not be able to lend out that which they do not have on deposit; and to then charge interest on it - to make a profit thereby.
The greatest monetary mind of the century - Sir Alan Greenspan has decreed such to be the case:
"Deficit spending is simply a scheme for the 'hidden' confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights." [8]
"
from:
http://www.safehaven.com/article-4285.htm
And:
http://clusty.com/search?input-form=clusty-simple&v%3Asources=webplus&query=purchasing+power+of+the+Dollar+1913-
a Clusty search of: The purchasing power of the Dollar since 1913(the inception of The FedRes)
Say I had $25,000 in currency backed 100% by gold. The money supply stands at $25,000. I deposit this gold backed currency in a bank to be lent at interest. Someone comes and gets a loan to buy a new Toyota. Toyota deposits the currency in it's account. Now the money supply is $50,000. $25,000 in my account and $25,000 in Toyota's. Say we both want our money at the same time - how will that work with an all gold economy?
Currently if such a event were to occur the Fed would simply create an extra $25,000 to hold the bank over until it could collect on the loan for the car. On a gold standard the bank would fail.
But it is much harder to put over frauds when money is tangible. Compare the difficulty of calling in and recasting all coins to debase them, with punching some new bits into a computer. When you recast coins, lightening them, it is patently obvious what you've done. Anyone can judge using a simply scale and two coins, one old, one new. I can explain the fraud inherent in the practice easily, to anyone. Whereas, it's very difficult to even understand how our money system works, much less why fiat money creation is essentially fraudulent.
That's true, but you're leaving out a key fact. All societies that have had access to gold use it as money, except for societies with states powerful enough to force fiat money on the subjects. Furthermore, many societies have used only gold for money. The only money superior to gold from the POV of societies adopting it, is fiat money. And that is for the perfectly sufficient reason that fiat money enriches privileged classes at the expense of everyone else. What's not to like?Gold is the best commodity money humanity has yet found, according to the best "opinion" we have access to -- that of the free market.
Jmo: yes you've got the essence of it. But what you're getting at has little to do with the gold standard, per se, and everything to do with fractional reserve.
The bank ought to fail, because it engaged in fraud. That's what fractional reserve lending is: fraud. In your example, they had a 0% fraction, so the bank was extreme in its exposure to the risk of a run. In the real world, the fraction is 10% or whatever, and the banks are huge with many, many depositors and loans. But the fraud is still inherent in the system.
You simply cannot have a situation where "your" money is in a demand deposit -- supposedly available at any time -- and it is also loaned out. Money creation via lending money which is not yours is inherently fraudulent. In any other context, a business which engaged in this kind of activity would be judged a fraud.
For example, say the bailment in question was not currency, but a nice car. You take it to the shop for repair, and tell them you want to leave it there a week while you're gone on business. They fix it quickly, then rent it to someone else, making a nice interest on it. You come back early and demand your car. Should there be a car lender of last resort created by the US government to cover these cases? Of course not.
What's the proper solution here? Banks, like everyone else, should not engage in money creation. Instead, when you deposit your $25000, you should be given a choice. Either you can deposit it as a demand deposit, or you can buy a CD -- an IOU. In the latter case, the money becomes the bank's, and it can then lend it out, and pay interest. In the former case, the money never becomes the bank's; it cannot lend it, and it will not pay interest.
Of course, the proponents of government fiat currency overlook one important point- fiat currencies always eventually fail and bring their governments down with them. The United States government and its dollar will not escape this fate- it is a certainty. In the present case, the fall of the dollar will bring much of the world down with it since the dollar serves as a pseudo world currency.
The gold standard is only as good as the standards of fraud that exist, since transforming the gold into claims for gold for ease of trade is going to be the first step taken when gold returns as a currency. I think we are destined to repeat history over and over until the end of time, but hopefully it will be a process where we take two steps forward and only one back.
As for returning voluntarily to the gold standard-it will never happen. Government will never give up fiat money until they, themselves, are liquidated.
Leonard/Mencius:
I understand the problems of fiat inflation, but do not understand how a fixed supply of money would be immune from effects of changing demand, unless it was fiat as Mencius suggests. Isn't Megan correct in asserting that having an inadequate supply of (or increased demand for) specie-backed money would increase the market value of that money, and thus the underlying asset? Wouldn't the market for money have to be in equilibrium at all times to avoid these feedback loops?
On the other hand, do we have any idea how markets would respond to a fixed supply of fiat money? I have trouble reasoning about the eventual free-market fate of a currency that signifies nothing (aside from tax credit I suppose).
Lot of good points here both ways. Allow me to add my own:
1. Money is nothing more than a barter proxy that is agreed can be redeemable later. It can be a commodity, it can be FRNs, it can be a rock, it can even be baseball cards if the people in the transactions agree on a worth of the cards. The value is a state of mind and nothing more.
2. The Fed control of interest rates only controls their own lending profit rate. That is, it controls their percentage margin on what they loan to the banks and the Treasury. Those rates in turn cause their borrowers to raise their own rates to their borrowers, and so on, all the way down to the end of the line, the consumer. All banks do that, BTW. That's why we don't see mortgages at the Fed rates and why we don't see savings interest at anything resembling non-zero percent. The economic impact on the average consumer is secondary in that way, but they also take the position that it is primary because if the rates are too high, then too few people will be chasing too much money, and that's where the hokey-pokey starts. It's all smoke and mirrors, which is why by some estimates a 1913 US dollar is worth only 5 cents FRN today.
3. FRNs are based on only one thing: our labor. As a result when the debt notes come due, we're either out of house and home or indebtured servants to whomever holds the notes. That's why it's best to get and stay out of debt before that happens. (see #5 below for more)
4. The whole idea of a central bank is repugnant. The ongoing struggles I see every day against corporatism (of which most banks are on the wrong side, especially the Fed!) and other forms of centralization (Big Agriculture, Big Oil, Big Pharma, Big ANYTHING!) by epople just trying to survive and make a living comes back to the simple fact that centralization is eventually doomed to collapse on itself by its own sheer weight and inflexibility and inability to change. The key is to utilize the centralized networks that were built as infrastructure to support it, to use them in reverse to decentralize things. A perfect example is using the electrical grid as a transport mechanism from inidividual household power generators (like solar) to put energy back on the grid--decentralized production. Another perfect example is the Web itself and how it has used the semi-centralized telephony infrastructure to develop point-to-point networked routing of data. In banking the key is to get the money decentralized, meaning more types of money, but so what? The only reason we have a single currency type (FRNs) is because the rest have been demagogued in the courts of public opinion and law. Liberty Dollars are the latest one in the crosshairs. Decentralized, multiple currecnies may mean a commmodity standard, but there is no reason that it can't be multiple commodities. The trick is to get away from tying it to an intangible property such as labor and back to a tangible property like a commodity. In 1787 the problem was states printing their own money and not honoring each other's currency. Yet we have international currency exchange going on daily without any problems. There is no reason that could not be applied to commodity-based currencies as well, except the imagination required to make it work.
5. If labor is property (it is, see Coppage v. Kansas, 1915, et al.) then for there to be a gain or income from exchanging labor 1-1 for money in a private contract, protected from infringement by the Freedom of Association Rights under the Frist Amendemnt, and a tax on all of that income, then the labor must be worthless, else it would be exempt from income taxation. That is the underpinning of a fiat currency, that our labor is not ours, therefore it has no value, therefore when we get paid we are getting a gain for nothing, and that's taxable. It's all consistent, and it's all wrong. It's also the dark secret the Fed and the IRS don't want you to understand.
6. Treasury printing cash and selling it to the Fed for 1 cent on the dollar and then having the Fed loan it back at interest is the whole reason we're so far in debt. There is no need for the Fed, and there never has been. Andrew Jackson saw it and vetoed the US Bank. Wilson didn't and screwed us all. It's a giant scam. If any of us did that to our neighbors they'd laugh in our faces before they punched us out, and if they went for it they'd be called suckers.
Moral of the story: the Fed is an active symbol of a centralized economic system that is destined to fail (and soon!) because it has moved to exist for itself and not for the people it affects. So develop your own economy outside the Fed's schemes...see you at the yard sales!
Matt G,
I find your question slightly hard to parse.
Perhaps this is because some aspect of your thinking is based on the concept of "objective value." There is no such thing as value, only price.
Price is not a scalar - it has both numerator and denominator units. Typically in the context of monetary economics we are discussing the price of commodities, where a commodity is any functionally interchangeable item - naturally or artificially. For example, we can talk about the price of euros in yen, or the price of wheat in terms of dollars, or the price of gold in terms of wheat.
If we want to express ourselves precisely, when we describe prices, we need to specify both of those units. We cannot talk about the price of the euro, the price of wheat, or the price of gold, or the price of the dollar.
So when you say "the market value of that money, and thus the underlying asset," do you mean two prices, or one? And what units are these prices, or price, in?
If I may be permitted to take a guess on the subject, what I think you're referring to is the historical divergence between the officially-fixed gold price of currencies under the post-WWI gold exchange standard, and their market price. When these values diverged in the early 1930s, something about this event was in some way related or correlated to the period of massive economic contraction we know as the Great Depression.
There is a simple conclusion that one can draw from this: gold is evil, and its proponents are either cranks, conspirators, or both. No one should feel too embarrassed to hold, or at least have held, this opinion. It has been shared by many eminent political, economic, and even literary figures - I need only mention Adolf Hitler, John Law, and Ezra Pound. When we add Baron Keynes and Harry Dexter White to this list, it's clear we ain't talkin' no trash.
However, if I may be permitted to disagree with these great statesmen of the twentieth century, let me say again that if you have a stockpile S of good G, and you issue C currently redeemable claims to G where C is greater than S, you shouldn't be hugely surprised when the price of C in terms of G diverges from unity - just a thought, folks.
There is one fact convieniently overlooked in this article. And Milton Friedman's words were taken out of context.
Inflation is a tax. It is a hidden, insidious, and pervasive tax imposed on us entirely by our government.
Once you look at things in that light, a sound money policy is actually the guarantor against runaway government spending, individual liverty, and private property.
I would also like to point out that fiat money seems to have proven more successful in the world. While the "gold standard" may have been used for a long time, so were horses used for transportation for a long time.
What might be more interesting would be to allow competing currencies, issued by banks and other entities. Currencies would compete based on the reputations of the issuers. The only problem with this is that it would make collecting taxes very difficult for the government. This might be seen as a feature, though...
EI
A fiat monetary system is ruining our lives. :-(
This article, while informative in selective ways, is a straw-man. No gold bug, including Ron Paul, argues for a government-enforced gold standard on all money. They simply wish for the denationalization of money. Most gold bugs then believe that gold will once again become the preferred medium of exchange, but this is of course debatable. The real question on the political level is not gold versus paper, but fiat versus free money.
The author also fails to acknowledge the difference between monetary deflation and price deflation. Gold standards typically experience very mild monetary inflation as more gold enters circulation, along with mild price deflation as productivity rises. This is not at all the same as the massive monetary contraction which occurred during the Great Depression. That credit-crunch was a product of the massive inflationary period in the 1920s.
As any banker would know, the bank runs are caused by monetary deflation, due to the inability for borrowers to pay back money owed. A decline in the supply of money results in it becoming physically impossible for all the borrowers to make enough money to pay back their debts. While avoiding sudden deflationary (or inflationary) shocks is certainly a good argument for a managed money supply, it does not follow from this that government should maintain an exclusive monopoly over the management of the money supply. That would be like arguing that government should take control of any scarce good in order to prevent excesses or shortages.
The author also fails to mention that many of the monetary troubles of the United States were not due to a gold standard, but a bimetallic standard, which is really the worst of all worlds.
In short, I believe the author suffers from a fear of deflation, or apoplithorismosphobia. While the following (Austrian) article is undoubtedly biased and not to be taken too seriously, it should still offer her some much-needed treatment for her condition:
http://www.mises.org/journals/qjae/pdf/qjae6_4_2.pdf
The gold standard cannot do what a well-run fiat currency can do, which is tailor the money supply to the economy's demand for money.
Translation: One disadvantage of a gold standard is that it interferes with central planning of the economy.
Of course, you could say this is an argument for management to reduce unexpected, external shocks on the supply of money, and I don't think I'd disagree.
G,
Your defense of gold bugs would make sense except for the fact that a number of them (see "Liberty Dollar") support bi- and tri-metallism.
Given the fact that your argument contradicts reality, you have nothing to stand on.
I'm not defending gold bugs who support bi- (gold-silver bug?) or tri- (gold-silver-bronze bug?) metallism. I am simply trying to defend free money, and those who support it.
M3 is no longer published, but money supply data is at www.federalreserve.gov/releases. See H.6 for M1 and M2 and H.3 for the monetary base.
I thought inflation and deflation are general increases or decreases in the price level? Assuming you agree with the quantity theory of money, isn't inflation inflation? Or do you mean changes in the price level caused by changes in the money supply versus changes in the price level caused by changes in output? Also, what is the basis for asserting a "massive inflationary period" in the 1920s? The price level was stable. If guess if you agree with the real bills doctrine or are Robert Kiyosaki, you could conclude otherwise.
Monetarists maintain that the money supply should be altered to fit the price level. Austrians maintain that doing so will cause inflationary bubbles and malivestment within the economy, such as the recent dot-com and housing boom/busts.
In the 1920s I referred to monetary inflation; I should have been more specific. I'm also not sure on the exact causes of the monetary deflation during the Great Depression, I think a lot of it was the Fed trying to hold itself to the gold standard (after so much monetary expansion, thats obviously not such a good idea), as well as a credit-crunch from bad investments.
Leonard:
Deflation does give an incentive to wait. But then, the possibility of saving in an interest-bearing account has the same effect.
While your money is sitting in an interest-bearing account, it has been lent out for investment and continues to change hands and do work.
While your money is sitting under your mattress because you don't want to spend it in a deflationary economy, it is not flowing and is doing no work. The genius of capitalism is the trick of turning "savings" into "investment". That cannot happen in a deflationary environment, because in a deflationary environment, banks cannot offer positive interest rates, and there is hence no incentive for people to put their money in the bank.
Krugman is still an economist? I thought they retracted his PhD for misuse?
brooksfoe,
Once when I ate way, way too many shrooms, I looked at a dollar bill and found that George had walked out of the frame and was turning the Great Seal into a little hemp plantation.
Other than this, I'm afraid reports of money "doing work" are entirely unfounded. Occasionally I hear a little rustling in my wallet as though the twenties and fifties were trying to get together and manufacture iPods, but I squeeze the thing tightly and they stop.
What you really mean is that the banking system has effectively created new money, by both promising you that your loan to it, or "deposit," is both "sitting in" the bank where you can reclaim it at any time, and has also been lent to someone else, who is presumably using his artificial flushness to "do work."
The same exact effect could be created without any banking system at all. Just have the state print money and lend it out. Effectively, fractional reserve is a bizarre algorithm for regulating how much money the state can print and loan, based on how much money people have under their mattresses.
I'm afraid the fact that you believe this is a good idea makes you an inflationist. Fortunately, you're not alone in this belief, so people are unlikely to mock you for it - at least on this board.
I am a Ron Paul supporter, he doesn't want a 100% gold standard. But he believes the money should be controlled by Congress, not the Fed Reserve (private company, evil bankers :P). And it should be backed by commodities, gold, assets, etc...I don't support a full on Gold Standard, but His plan sounds like it could work, he is an expert on Austrian Economics, and one thing I fully support is the abolishment of the Federal Reserve, and then the I.R.S. Funny how they both came about the same year.
I had some big problems with this article, ut here were my two biggest
1)
The author's mentions of the exceptions prove the rule. She has pointed out history's TWO examples of significant inflation of a metal currency (keeping in mind also that the gold rush of the mid-nineteenth century really only caused price increases locally...its effect on world gold values was minimal)
Shall we now list the examples of fiat inflation that exceeded these? I can't say for sure, but I would be surprised if the value of gold during the Spaniards conquest of the caused the value of metal to drop more than the alue of the dollar has dropped the last 90 years. And the dollar is supposed to be the "gold standard" of fiat currencies!
Gold is not immune to inflation. Just highly, highly, highly resistant to it.
2) The problems that the author lists (like being forced to deflate the money in order to stick to a gold standard) are caused because the government FIRST irresponsibly inflated it. The author points out that the government had to deflate the dollar during the depression which caused more pain. What she doesn't mention is that the dollar had to be deflated because the government INFLATED it so irresponsibly during the twenties. This seems to be more an argument against any government involvement in money creation whatsoever (since the government has surely proven itself a poor steward of the money supply)
My contention, however, is that the Great Depression was prolonged by the New Deal. When the money supply contracts, prices must lower as a result in order to recover. The New Deal worked at doing the exact opposite: price floors, minimum wages, destroying agricultural products in order to prop up prices. The New Dealers believed that the low prices were the cause of, rather than an effect of, the depression, and as such prolonged it for long after was necessary.
Inflation does punish debt, because debtors must pay back what they owe. This the natural mechanism that prevents "bubbles" from occurring. You may notice the empirical evidence indicates that downturns are longer lasting and more unstable after the introduction of fiat money than before.
"The gold standard cannot do what a well-run fiat currency can do, which is tailor the money supply to the economy's demand for money." -MM
If the demand for money increases, people are willing to pay a higher cost for money. They are willing to pay a higher cost because they need more purchasing power. Inflating the money supply while simultaneously devaluing the money they currently possess cannot increase their overall purchasing power. So inflating the money supply can never alleviate an increase in demand for money.
In short, the government does not produce anything (even money). They can only give to some what they have stolen from others. Inflation is a redistribution scheme no different from every other government action. If the government actually produced anything of value, people would buy it voluntarily, and there would be no need for taxes.
There's nothing magic about gold, and nothing magic about money. There's also nothing magic about government or fractional reserve banking that creates more resources than they consume. The author is a lazy thinker. People who believe that central banking is logical, moral, or practical deserve to die of starvation and cold while surrounded by bales of Argentine pesos and Zimbabwe dollars. What is magic, or at least amazing, is that people still exert so much effort trying to convince themselves and others that 2 and 2 add up to something other than exactly 4.
Paul doesn't advocate the gold standard. He advocates free market money, leaving it in the
hands of the participants: May the best money win.
See his words here.
Many of the 19th-century busts you're talking about are the result of what I consider improper government interventions (subsidization of rail, antitrust law, increasing regulation of industry in other ways). And while it's true that there can be gold booms and busts, they could never be as large or as systemic as the national booms, busts that invariably come after a nation leaves the gold (or some other physical material) standard. Having the power to create money without restraint, (and to force citizens to accept it through legal tender laws) is a recipe for national disaster. Twentieth-century American history is rife with examples!
No economic system can exist without "pain" for some people, some of the time. Incorrect choices, regardless of the reasons they are made, have to be "pruned", or they will lead to further economic inefficiencies ("damage").
All interventions in a market economy have consequences. By replacing an apparent patchwork (irregular interest rates across the country, booms and busts in different regions, people relying on the reputation of banks rather than a single, fallible central authority) with the Federal Reserve, an immense amount of economic information was destroyed or disconnected from the market. It took a long time for the situation to truly reach crisis, but the result was the Great Depression; the Fed took all the little booms and busts that should have happened across the country over sixteen years and turned them into one giant boom, which led to an even greater bust, *with interest*.
Gold itself doesn't have to be the answer, but it must be something physical because nonphysical currencies have no tie to the productive ability of an economy. Think about the technological advances needed in a vast number of fields to make it feasible to add to the supply of metals by mining the ocean floor - advances in materials, robotics, communications and so on, all of which really do represent incredible advances in wealth. There is no reason for this cycle to stop - would this relationship be any different if mining were done in space?
The gold standard isn't really the modern concept for maintaining a stable inflation rate. Many advocates of a inflation-proof monetary supply suggest using a currency pegged to the price of a basket of commodities or goods- food, CPI, etc. This would back the currency with the real items that people use in an economy. If those items stay the same, inflation should be stable.
Lets stop talking about the gold standard and start discussion more modern alternatives.
"It's odd that so many libertarians, who generally believe that the Market does things better than the Government, advocate a government-monopoly Gold standard."
You are mistaken. Libertarians do not advocate a government monopoly on currency, whether it's sound money or today's fictitious value notes.
Requiring the government to comply with the constitution's gold and silver provisions does not in any way impede any private issuer of currency or credit.
-jcr
Megan,
I submit that Dr. Paul has studied the gold standard and the history of fiat currency, for far longer, and in far more depth than you have. He literally wrote the book on the subject, The Case for Gold, and has written extensively on the resumption of sound money following the civil war greenback inflation. It can be done, it has been done, and it should be done now.
-jcr
Megan,
If fiat currency is such a good idea , how come the dollar bill in your pocket has lost 96%
of it's value? You have been robbed by the Fed and yet you support the thief as some humanitarian. Are you sure you aren't suffering from Stockholm syndrome?
Elect Ron Paul and return us to the Gold Standard
...Because Gold can't be diluted.No
dilution equals no inflation.
...Because most politicians can't be
trusted to balance spending.
...Because Gold stops needless wars.
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Ms McArdle, along with most current economists (except the Austrian economists) points out the standard problem with the gold standard -- and for that matter, fiat currencies as well: Governments, particularly in cahoots with central bankers, historically can't be trusted to keep their currencies stable.
But there's an alternative: Transactional hard money, that is, gold and silver coin in circulation concurrently with whatever I.O.U.s (paper money) the government/banking axis wants to circulate.
Sound radical? Well, if you're old enough, you may remember true silver coins -- dimes, quarters, halfs, and silver dollars -- circulating as part of the U.S. money supply. What you didn't see -- after they were criminalized by FDR in 1933 by Executive Order 6102 -- was circulating gold. And therein lies the fascinating story of the biggest heist in history.
Why was gold ownership criminalized in 1933? And gold treated as if it was a "controlled substance" like heroin or cocaine?
You can find that out -- and a lot more -- in That Barbarous Relic: Transactional Hard Money vs. The Gold Standard
...they'll eventually run out of gold and lose control.
Bingo.
Excellent link above.
Educate yourselves.