Gold standard #2 by mattsteinglass
June 2, 2010, 7:45 am
Filed under: Uncategorized

Commenters from my previous post have asked for more substantive arguments against the gold standard. As I understand it, the contention of advocates is that the gold standard is necessary because people lack confidence in the worth of fiat money. It seems to me that every single time an American accepts a US dollar as payment for goods or services rendered, he or she proves this contention wrong. The average American proves it wrong over 40,000 times per year.

Now it could be true that people have some confidence in the dollar, but more confidence in gold. If this were true, people would prefer to be paid in gold, rather than an equivalent quantity of dollars. But I certainly don’t want to be paid in gold. I don’t think anyone I know wants to be paid in gold. Gold is inconvenient to hold, exchanging it for other goods or services involves high transaction costs, and its price is volatile, much more so than currencies (especially within their own economic zones). I know I can buy a movie ticket tomorrow for $10, but I really couldn’t tell you how many grams of gold it will cost. Which is partly why I prefer to be paid in dollars or euros, as does everyone else I know, rather than the equivalent market price in gold.

And this would still be true even if the Federal Reserve mandated that each dollar was redeemable for a fixed amount of gold, unless the reserve set the amount redeemable artificially high to compensate for the transaction costs. But in that case you could arbitrage up by redeeming your dollars for gold, selling the gold for more dollars, redeeming those dollars for gold, etc. And of course such arbitrage would lead to the collapse of the gold standard as government gold supplies ran out. You could get around this by letting the amount of gold redeemable float, but that would make the idea of a “gold standard” meaningless; it would be more correct to simply say that the US government had entered the gold sales business, like anybody else who owns gold. By this standard we already have a “gold standard” today, in the sense that you can, if you wish, exchange your dollars for gold. Another solution would be for the government to set the amount of gold redeemable artificially low, to eliminate arbitrage. But this, again, would mean that people preferred to hold dollars rather than gold, which makes the point of the supposed gold anchor unclear. Or, finally, the government might prohibit people from trading privately in gold, in order to maintain the validity of the government’s gold standard price point. This did in fact take place in the 1930s when the black-market price of gold rose higher than the US government’s price point, and the resemblance to the kinds of price-setting and black-market problems faced by command economies (the USSR, etc.) is a good indication of why you don’t want to get into the whole thing.

A final way of putting this is that when you talk about a “gold standard”, you’re talking about some kind of finite supply of thing to which all other forms of currency refer back, a thing the supply of which can’t be arbitrarily increased. But we actually have such a thing. It is the cash dollar. There is a finite supply of cash dollars in the world, all notional US dollars in bank accounts, credit cards, T-bills and so forth can be redeemed for cash dollars, and no one but the US Treasury has the authority or the capability to make more of them. But the advantage of the cash dollar over gold is that you don’t have to deal with all these silly issues of how to set the price of a cash dollar in order to avoid creating black-market problems and so forth. The price of a cash dollar in dollars is always basically 1=1. (This isn’t quite true, in fact cash dollars do have some transaction costs, they’re hard to carry around, so the price of a cash dollar in notional dollars is often slightly below 1, as for example when you keep your money in a bank account even though you know the ATM may charge you a fee to withdraw cash. This could alternatively be expressed as the cash dollar having a value higher than a notional dollar when you’re walking around in the city and want to buy a hot dog from a vendor, but I think it’s clearer to think of it the other way around.)


12 Comments so far
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Plus, without a secretive cabal of life-stealing bankers to manipulate the money supply in shadow the unemployment rate among ghouls will go through the roof. You want those critters busy.

Comment by citifieddoug

I have a feeling that if we had a gold standard we’d soon find all those life-stealing central bankers had begun conspiring with the folks at Fort Knox to do all sorts of ghoulish things. In fact I bet it would only be a few years before we discovered they were scheming to suck our value out by forcing us to adhere to a gold standard rather than using fiat money. It’s amazing how flexible the vampires can be in terms of what they’re getting up to, once you’ve accepted that they exist.

Comment by Matt Steinglass

Wasn’t that (your second sentence) essentially the position Williams Jennings Bryan ran on? He wanted to add silver to the gold standard to create inflation, rather than just using fiat currency, but same idea right?

Comment by voxoctopi

The conservative arguments against fiat currencies are quite correct, except for one glaring omission: They all apply equally to gold-standard currencies. Gold is just another fiat currency. The only thing different about gold is that it’s the oldest fiat currency, so people traditionally have more faith in it. But in the end it’s just as inedible as paper money.

Comment by darthfurious

More inedible than paper money, I daresay. Unless you hammer it very, very thin.

Comment by Matt Steinglass

Mr. Steinglass,

The gold standard for currency is solution in search of a problem to solve. Where is there any evidence for this “lack of faith” in paper money? Where is there any evidence that a gold standard would solve this problem if it were to actually exist?

Comment by davidlosangeles

There’s a great scene in Cormac McCarthy’s ‘The Road’ where the father finds a bag full of krugerrands in a bunker. He looks at them, considers them, and immediately puts them back where he finds them. Because in the world of a true apocalypse, they’re useless.

Gold is certainly useful as a storage of value if you’re fleeing one jurisdiction and heading to another. Say you’re a Jew fleeing Nazi Germany or a Nazi fleeing a successful allied invasion of Germany. In that circumstance, yes, I’d like to have gold.

But how does gold help you or me in any other circumstance as a store of value? If you’re not planning to flee the jurisdiction to some place that will be untouched, or less touched by the coming imagined fiscalpacalypse that is proffered as the reason gold is worthwhile, you’re just sitting there with a bunch of gold that you can’t use. You can imagine, perhaps, that the dollar will be scrapped in favor of another currency, which you can then buy with your gold. But if that were to occur, there are so many intervening events that could occur that I think you’d have a lot more to worry about.

Comment by Michael Roston

Look, I’m not for a return to the gold standard, personally, but your arguments here are beyond weak, to the point that I have trouble believing you really know anything about monetary policy. If you have a gold standard, you are in essence being paid in gold when you are paid in dollars, because your dollars represent an amount of gold. Nobody actually exchanges for gold– it’s just to provide a basis for the dollar. The whole arbitrage thing is a straw man at best. There’s no trading in and out of gold going on for everyday people, and prices lag far, far behind the daily fluctuations of the value of gold (hence the need to restrict trading of gold, which slowed the harmful deflationary pressures of the depression). The point is that you can effectively halt inflation using a gold standard, and achieve greater price stability than is normally seen with fiat currencies. Which is why the dollar remained fairly constant for so long, and the end of the gold standard led to huge inflation.

And cash dollars? How is that in any way pertinent? You do realize that cash dollars are a tiny, tiny fraction of the dollars currently in circulation, right? That it would be beyond impossible for all people to convert their electronic currency to cash? Do you even understand how reserve banking works? And even aside from that, if the US Treasury can print more, then the money supply certainly can be arbitrarily increased. That’s what it means to have a fiat currency. The gov’t tells the federal reserve it wants a bunch of money, the fed marks it on a sheet, and loans the money into existence. Then, if deemed appropriate or necessary, they print more cash rather than just leave it as numbers on an electronic ledger. Completely arbitrary.

I think we need to build a new global reserve currency, pegged not just to gold, but to a basket of commodities, including gold, silver, aluminum, and other minerals, as well as the price of grains, meat, and other grown renewable resources like wood, plus the price of oil, natural gas, coal, fresh water delivery and the price of electricity production through renewables. In that fashion, the reserve currency for the world can be intimately tied to the state of the global economy’s productive ability as a whole, not nearly as subject to whims and follies of the market. Meanwhile, hopefully after a global day of jubilee following the imminent collapse of the global debt markets (most certainly including sovereign currencies), national currencies should be rebuilt based on labor, of the sort that allowed the recovery from the total economic collapse of the weimar republic (a measure many would credit Hitler with, though it was actually well before he came to power). I consider labor currencies a more honest and less corrupt form of fiat currency, and with reserves held in actual resources, we can be assured of a vastly more intelligible, stable system.

Incidentally, China, India, Brazil and Russia have been meeting to discuss seriously implementing a similar global reserve currency, though it would include in its basket a variety of existing currencies. Personally, I don’t think that’s a good idea, at least until we can clean up the system as it stands.

Comment by Uriah Maynard

Uriah, think about this:

“If you have a gold standard, you are in essence being paid in gold when you are paid in dollars, because your dollars represent an amount of gold.”

What does that even mean? I’m already being paid in gold when I’m paid in dollars, because my dollars already represent an amount of gold. The difference with the gold standard is that the amount of gold represented becomes *fixed* and the government becomes the gold seller of last resort. In order to do that, as you say, you have to have government restrict the trading of gold by individuals on the free market. I have never understood why so many otherwise free-market laissez-faire folks find the fiat pricing of gold by the government to be a congenial idea.

The amount of cash dollars in circulation is far below the total size of the money supply in precisely the same fashion in which the amount of gold in Fort Knox was far below the value needed to cover all the dollars in circulation when we had the gold standard. This is, as you say, how reserve banking works.

There is an argument to be made that exchange rates should not be allowed to float entirely freely against each other because that generates too much irrational volatility. To keep exchange rates from floating freely, governments have to commit to some of the same kinds of macroeconomic restrictions they’d have to follow if they were all following the gold standard, except that they don’t have to do so via the kooky fetishistic intermediary of moving gold bars back and forth, and they don’t have to worry about the kinds of arbitrary problems that occurred in the 1930s when people physically moved their gold out of Europe to the US due to security fears and incidentally affected exchange rates as a result.

Your suggestion that the best way to reduce exchange rate volatility is via a global reserve currency keyed to the prices of a basket of commodities or to the price of labor may make sense; I don’t know anything about that. It’s clearly a very different idea than a gold standard, and eliminates a lot of the weaknesses.

Comment by Matt Steinglass

You only have to have government restrict gold trading in periods of extreme price volatility. This is for several reasons. First, having a gold standard doesn’t mean that you can hand the US gov’t a stack of hundred dollar bills and get back a bar of gold from Fort Knox or that you necessarily can’t have other buyers and sellers of gold certificates or metal gold, just that the dollar is pegged to the value of gold, and that it is backed by gold reserves, which is something of value which can act as collateral to create loans, both in the sense of banks making loans based on the stability of the dollar, and in the sense of selling government debt to investors. In fiat currency, this collateral does not exist. Fiat currency is based on the fact that actually collecting the collateral in the event of collapse is basically nonexistent anyway, so all currencies are inherently based in fiat, or the belief that the government will continue to exist and honor its debts, which is one reason why there was price variability between different gold standard currencies, the other being differences in the gold reserve for that currency (both the amount of reserves, the standards for reserves among lending institutions and the total debt load carried by the government).

Because of the inherently flexible money supply, regardless of the basically fixed gold reserves, you only need to restrict the trade of gold under a gold standard when the continuity of governance is in question to the point that the value of gold and the buying power of the dollar begin to diverge more than a few percentage points, particularly if there is enough gold to invest in privately to significantly shake the market. Taken to the extreme, this can spark deflation as currency leaves and the country increasingly eschews dollars for foreign gold, endangering the ability of the government to maintain its debts. Which actually happened in the 30s. Hence the gold trading controls.

Regardless, I agree that the gold standard is a fairly ridiculous idea in the modern global marketplace, no more stable than any other commodity. It’s an antique throwback to the way that financial markets used to work, when gold was necessary as a sort of universal currency. Its current overvaluing is based largely on the widespread nostalgia and fuzzy thinking around the inherent value of the stuff, predicated on a belief in the breakdown of financial systems necessitating a return to traditional, historical precedents rather than moving forward towards new and better systems. That and huge amounts of speculators playing on those ideas.

That said, we are at the end of the rope on pure fiat and absolutely need to do something better; and one thing about commodities is that they are more stable by sheer virtue of their limited nature (though that has been to a large degree destabilized in the insanities of the speculation-driven current market). If scarcity is again necessary for stable and honest currency, as a basis for trade, then what better to base a currency on than the limiting factors of global production?

Comment by Uriah Maynard

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