Returning to a Gold Standard Is a Bad Idea 200 comments
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Inflation is coming...
For as long as I can remember, Jim Grant has never been a cheerful fellow. In fact, there was a standing joke in my office that after reading Grant you could cheer up by reading King Lear.
The thinking in Grant’s latest missive in the WSJ runs parallel to my recent post Giving inflation a chance that with the massive fiscal and monetary stimulus coming down the pipe, inflation is inevitable. Jim wryly notes that “Frostbite victims tend not to dwell on the summertime perils of heatstroke.” He continued:
Prescience is rare enough in the private sector. It is almost unheard of in Washington. The credit troubles took the Fed unawares. So, likely, will the outbreak of the next inflation. Already the stars are aligned for a doozy. Not only the Fed, but also the other leading central banks are frantically ramping up money production…It is far less certain that, once the cycle turns, the central banks will punctually tighten.
A return to the gold standard would be disastrous
Given the enormity of the recent crisis, there have been calls for radical solutions. The hard money crowd, for example, has called for the return of the gold standard. However, a return to the gold standard would be disastrous. It would be a prelude to a global downturn of unprecedented proportions and doom future generations to heightened economic volatility.
First, a history lesson: Many years ago, people decided on the use of gold as a monetary standard. It turned out that gold has many nice properties that could be used as a store of value. Throughout human history, money has been predominantly based on gold but not always. It has also been based on other commodities. Peter Bernstein’s book The Power of Gold details the history of gold and commodity based monetary standards throughout history, from salt to large stones, some of which lay at the bottom of the sea.
As time went on, people found that gold, along with other commodity based monetary standards, was hard to carry around. Used in coinage, they could be difficult to divide and this division problem was a hindrance to commerce.
Then came the financial innovation called banking. You could deposit your gold in a bank. The bank would issue you a receipt and you could use that paper receipt for trade and commerce. The bank would lend out your deposit of gold to others. This was credit creation, which expanded the money supply. For every ducat lent out, that ducat would usually wind back up in the banking system, creating another ducat available to be lent out. Even with the imposition of reserve requirements that constrained the amount of loans they could make based on their deposit base, this form of fractional bank lending expanded credit and created an enormous number of jobs and raised prosperity.
When kings and political rulers got into financial trouble, there was always a temptation to debase the currency. The current episode of paper money debasement began in earnest when Richard Nixon took the U.S. off the gold standard and the world went to a dollar standard for monetary reserves. The trouble was, the U.S. dollar wasn’t based on anything, other than the good name of the U.S. government.
Today we stand on the edge of a precipice. America is in recession but deeply in debt. It is about to print money to try to climb out of its hole. This consensus has been supported by pretty much all of the central banks and governments around the world. Some analysts have argued that the imposition of a gold standard would create the discipline on the monetary authorities from debasing the currency in this manner.
What does a gold standard really mean?
Let’s think this through – what does a gold standard really mean? Does the hard money crowd want us to go back to carrying around pieces of gold coinage? In that case, how do we facilitate global trade?
Do we just want to revive a gold backing for money? There isn’t enough gold around in the world to support a gold standard at current gold prices. Rough back of the envelope calculations show that the Fed’s holdings of gold, assuming that it is unencumbered and not lent out, is worth around $200 billion at current prices. Remember that the U.S. Federal Reserve is one of the larger central bank holders of gold in the world. While that change might satisfy the gold bugs, it wouldn’t help the vast majority of the population around the world.
One of the assumptions of a gold standard is that the currency is backed by gold at a fixed rate. Anyone could turn in their dollars, euros, yens, pound sterling and so on, to the appropriate central bank and get gold at a fixed gold price. Such a monetary regime also implies a fixed exchange rate arrangement like Bretton Woods. Instead of allowing the market to determine currency prices, the world would return to fixed exchange rates and periodic exchange rate revaluations. Is that really the regime that we want to return to?
A gold standard also creates economic volatility in the economy. Monetary theory is based on the elegant formula MV = PQ. Holding V (monetary velocity) constant, changes in money supply directly changes the GDP level. Under a gold standard, money supply is restricted by the supply of gold, based on world mine output. National gold supply could shrink because of shocks. As an example, the Roman empire was subjected to credit crunches during wartime when hostile forces captured Roman gold and territory.
The problem of fractional lending remains under a gold standard. The banking system could still create credit. Under such a regime, if everyone decided to redeem their paper currency for gold, the money supply would collapse and the result would be another Depression. Do we want to get rid of the banking system?
If we were to take the radical step of eliminating fractional lending, going to a gold standard would mean a drastic shrinking of world GDP given the amount of money sloshing around the world today.
Culling the herd?
This is financial Armageddon. The result would be the financial equivalent of mandatory infection of the population with the Ebola virus. Maybe we could get Disney to lend a PR hand as we play “The Circle of Life” while we infect everybody with Ebola so people would be persuaded to sacrifice themselves for the Common Good.
The end of the Dollar as THE Reserve Currency
Let's face it, the days of the USD as the principal reserve currency are numbered. Roger Ehrenberg over at Information Arbitrage believes that the US is at a strategic inflection point and the start of a downward spiral and I would tend to agree. The long term path of the dollar and US influence is downward. Investors should prepare themselves for that eventuality.
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This article has 200 comments:
Accountability.
We can't have that now can we? That means if we have accountability in our finance system, we have to have accountability in government. If we have accountability in government, that means our citizens have to be more accountable, and return to an ethical and moral country.
We can't have that though. That means minimal corruption, less graft and greed. Our country would have to do what is best for the majority instead of what is best for the select few.
Good golly we can't have that now can we????
So on or off, now and then we got over-extended both publicly and privately on credit encouraged by a consumer driven Non-Term-Limited Congress who will never want the punch bowl taken away
A hangover is to remind you that you overindulged. A recession reminds you that you are overextended. Both are good for you in the longer run if you pay attention the their message, which is another problem.
"Let’s think this through – what does a gold standard really mean? Does the hard money crowd want us to go back to carrying around pieces of gold coinage? In that case, how do we facilitate global trade?"
If anyone can think up such a world, and how it would be better than what we currently have, I'm all ears.
"This is financial Armageddon. The result would be the financial equivalent of mandatory infection of the population with the Ebola virus."
I think gold bugs would agree with this, since they hold gold as a doomsday hedge. So, what's the bright side when it comes to "investing" in gold?
1) Are you saying that money - as a means of facilitating the exchange of goods and services - should be backed by nothing other than an empty promise?
2) Why is getting rid of fractional reserve banking so radical in your opinion? It's essentially the same thing as creating money out of thin air.
I think your reasoning is flawed where you state that returning to a gold standard "would mean a drastic shrinking of world GDP " - if money is returned to a note that is redeemable as some real commodity (gold, oil, or anything with a limited supply) - then the value of the commodity goes up, certainly, but that doesn't diminish the reality of the items being exchanged with those notes.
And I think you make a good case for returning to a gold standard - albeit unwittingly - the Roman empire lost a good chunk of its gold when it was invaded, and it was invaded BECAUSE it was a militaristic empire. Forcing a powerful nation to be restricted to a gold standard does two things: 1) it minimizes its ability to fund aggression through fiat currency, and 2) it forces a nation to be wiser in its foreign relations and focus on its defensive capabilities rather than its offensive capabilities.
When the Roman empire suffered a credit crunch, that may have been bad for the Romans, but it was probably a relief to the rest of the known world which had a short breather from Roman imperialism. Of course, the Romans, due to their militaristic imperialism, probably responded by starting up new campaigns to loot the gold from less powerful nations. Hmm...I wonder if there could be some parallels in this for our times...
If we were on the gold standard during this crisis, gold itself wouldn't have prevented the majority of Americans from borrowing to the hilt. Gold may bring your much-sought-after accountability, but it wouldn't have prevented the leverage that destroyed so much wealth.
In this case, your accountability would have dire consequences. America would have been stripped of its gold by foreigners as they redeem their dollars for gold instead of Treasuries, and we would only have one way to regain it back: war. If we do not wage war, our economy would have been so crippled from this bout of euphoria that we would have not only lost our pre-eminence, but quite possibly our nationhood due to the subsequent lowering of our per capita consumption. Remember, we don't really produce as much anymore, and without large gold stocks, it would cost us dearly as a percentage of gold stocks remaing to purchase what others produce.
This doesn't sound like a reasonable solution for fiat to me. Your "accountability" only comes as the consequence of inane choice. It does not counsel or deter stupidity.
On Dec 30 08:56 AM archman82011 wrote:
> Return to the gold standard would mean one thing:
>
> Accountability.
>
> We can't have that now can we? That means if we have accountability
> in our finance system, we have to have accountability in government.
> If we have accountability in government, that means our citizens
> have to be more accountable, and return to an ethical and moral country.
>
>
> We can't have that though. That means minimal corruption, less graft
> and greed. Our country would have to do what is best for the majority
> instead of what is best for the select few.
>
> Good golly we can't have that now can we????
>
>
The result is that adoption of a gold standard means continuous deflation and the serious impediments to financial growth this entails. It would be a disaster to revert to a gold standard.
Prior to the Great Depression there were several major world wide depressions during the 19th century. These all had one thing in common - a shortage of money because the gold standard did not allow expansion of
the money supply fast enough to support the economic growth of the time.
Gold has no intrinsic value. Its use as currency is based merely on tradition and habit. In famines gold has no value - people will not sell food or the means of producing it. Gold is just like any other money, fiat or not - its value is dependent on the idea that at some future time you will be able exchange it for goods and services. If people lose interest or faith in gold, its value decreases. It has no guarantee of value any more than any other proxy for real goods and services.
2) A citizenship outsources it's governance in this era. Ultimately, it is the citizenship itself that becomes educated through financial pain which is a powerful catalyst. Our Republic form of government works, the citizenship will oust the corrupt and lazy, this is called voter revolution and occurs historically four years after the start of a deflation/depression.
3) America as a model outsources almost everything. The middlemen get cut during depressions and producers are once again rewarded in full for there efforts. America will become a producer once again at a certain point in time, I guess this transition period to be 2013 where it will be the best time to invest and the start of a true bull market.
4) I agree with your analysis Mr. Hui.
The problem with a gold standard is that there is no single person in charge, what a shock! Politicians and those in academia cannot fathom having a monetary system where there isn't one enlightened person running the show. Central planning is loathed and has been discredited for every single industry yet miraculously everyone thinks we NEED it for our money.
As another commenter said, gold, wampum, I don't care. We just need to take the power to create money out of thin air away from governments.
"Then came the financial innovation called banking. You could deposit your gold in a bank. The bank would issue you a receipt and you could use that paper receipt for trade and commerce. The bank would lend out your deposit of gold to others. This was credit creation, which expanded the money supply."
While this is a good description of modern banking, what is left unsaid is that your gold now has two claims upon it. Your bank has loaned it to others (who now "own" it) and the depository receipt which you hold. If you attempt to regain possession before the loan is paid off the bank cannot make good on your receipt without taking gold from another depositor.
"Even with the imposition of reserve requirements that constrained the amount of loans they could make based on their deposit base, this form of fractional bank lending expanded credit and created an enormous number of jobs and raised prosperity."
The 'prosperity' is an illusion because there are now more units of gold receipts circulating than actual gold. The 'fake' receipts have enabled the "raised prosperity" at the equivalent cost of the burden of debt taken to borrow the gold which doesn't really exist. The 'excess' gold will also bid up general price levels and possible create bubbles in some asset classes. If continued to an extreme, the borrowers will eventually not be able to service the debt payment required to support the system and the excess debt will overhang the entire economy. This is how we got to where we are in today's economy.
As an historical aside: Bank reserves were much higher during the free banking era prior to the creation of the FED and its reserve requirements. Free banking reserves were rarely below 50% compared with today's requirement of 10%. (Current day banks with reserves above 30% are very rare.) Now instead of two people having a claim on your gold, there are 10 people with a claim to it. If that's progress then I'm a monkey's uncle.
"When kings and political rulers got into financial trouble, there was always a temptation to debase the currency."
Ah, so it's bad when Kings or political leaders debase the currency, but it's good when bankers do so via 'expanded credit'. Both avenues lead to the same end point. This is one of the main blind spots in the author's reasoning. Debasing the currency is not a good thing in general, whether done by politicians OR bankers via 'expanded credit'. Debasing the currency robs every saver in the economy of purchasing power by lowering the value of prior money.
There are several other areas in the author's article where his grasp of economic cause and effect are tenuous, but there isn't enough room here to address them all. The author would be well rewarded by a more thorough search through Rothbard's books on banking.
While it would be quite painful to implement, the most stable base for a sustainable and growing economy would be one based on a fixed money supply (such as gold or silver) with a strict ban on any sort of fractional reserve lending. This would restrict the use of savings to uses which were most likely to satisfy actual consumer demand.
The comments above regarding issuing notes denominated in weights of gold would be a good start. Divisibility is a non-issue with today's compters (and absent fractional reserve tom-foolery).
Of course, GLD is pretty volatile--it has quite a fever-chart--which would make it undesirable for businesses that want stability. But, OTOH, if it were being routinely used as a hedge, the massive offsetting positions involved would (or should, I speculate) stabilize its price level. Further, half (??) of gold's volatility is really a reflection of currency fluctuations--and that kind of volatility is really stability in disguise.
The 'authorities' who would supposedly stand guard over sound money are the very same people who presently stand guard over the SEC, Fed and Treasury. Wall St investment banks figured out how to tie their money creation multiplier to volatility measurements in order to massively exceed commercial bank asset:capital ratios to create all those now evaporating trillions of derivatives. This was all done under the watchful eyes of people who were appointed to make sure this didn't happen.
The Euro is kind of like a European gold standard, but to save themselves now that the s___ has hit the fan the member nations are all willing and able to abandon the monetary discipline Euro membership legally or theoretically imposes. People figure out ways to cheat. We always have. We will not accept the discipline.
Mr. Hui makes a good point about the "financial Armageddon" that would occur in the US if we had a gold standard and a multi year balance of trade deficit. About half of the US trade deficit is from oil imports. As oil flows into the US gold flows out. When you run low on gold you cannot create new money to buy more oil. Without oil your economy is dead in the water. So you go to war rather than accept the "discipline" of a collapsed economy. Debt may not be great but I think it's preferable to this kind of money-wars.
In recent SA articles it has been both argued theoretically and shown historically that money creation and economic prosperity go hand in hand. There have always been booms and busts throughout known history, regardless of what kind of money was in use. But money creation and debt and economic prosperity are historically linked.
Fractional reserve banking is where the money-creating rubber meets the economic road. Millions of loans officers at banks across the world micromanage the creation of money via the loans they make. I think this is about as close to a 'market' approach to money creation as we could realistically hope for.
Remember, the conditions for this whole financial meltdown were set in place by government social housing policy that compelled and induced bankers to make mortgages to people who didn't qualify under normal prudent banking practices. Banks could then sell these bad loans to Fannie and Freddie and Wall St could package them into MBS and sell them to the world. You can't blame bankers and dealers for making money in ways the government who regulates them tells them is just fine, especially when government removes banker's risk by immediately buying the crappy loans and stamping AAA on them. Markets don't care if they profit from good policy or bad. Policymaking is up to government, not commercial bankers and investment dealers.
It has recently been established (I think this came out of the Chicago School) that homo economicus, economically rational man, is a fiction. Entire nations, even the whole world, get caught up in irrational exuberance and irrational gloom. Bankers are no more rational than you or me. In a boom the loans, and the purchases or investments the money is to be used for, look just as viable to the banker as they look to the borrower. They looked good to Chairman Greenspan, too, and the Bush government.
I've said before, we have no gods or rational machines to control the creation and use of money. It's just us, in all our wisdom and flights of fantasy. For the most part we do a pretty good job of it, I think. No period in the history of this planet has achieved the level of broad based economic prosperity that we have today.
Sure, it's not perfect. We are not perfect. Maybe we can tweak the money system to make it better. But from what I am seeing fractional reserve bank-money is the most successful and economically beneficial kind of money we've ever invented.
While the US economy may be at an inflection point so are the economies of everyone else and it is hard to see a real rival to the greenback in the forseeable future. The Euro is just celebrating 10 years of history and there are some awkward divergences within the eurozone economy that could make it difficult to continue with a single central bank and monetary policy for the diverse set of states that have adopted the Euro. Sterling is hardly a contender and I suspect that looking towards the Japanese yen as a reserve currency would have even more damaging unintended consequences than staying with the dollar
It does not look feasible for the Chinese currency to take on any leadership role until it develops much greater depth in its capital markets which is probably a generation away at least.
Who are the only ones to gain from an inflationary credit system? Governments, central banks and fractional reserve banks. Do you think there may be some connection here?
Inflation takes money from the pockets of the non-government, non-banking public and gives it to the legal money counterfeiters. The article is entirey one sided and ignores the severe inflationary credit cycles (typically misunderstood as the business cycle) which arise from monetary policy. The accordian effect of fractional reserve banking greatly magnifies the inflationary and deflationary effects which are inevitable due to the Fed's and other central banks corrupt practices.
But the U.S. doesn't have a currency problem today as much as it has a political problem. Without the need for Treasury to borrow, the Fed would not need to print massive sums of paper. The end of the gold standard came at the inauguration of the Great Society and the end of the Vietnam War. The current crisis arrives following the Medicare prescirption drug bill, retiring boomers, and a War on Terror.
The U.S. could have a workable fiat system, if it was run by a tight money Fed that refused to purchase U.S. Treasuries, essentially making a political decision to withstrain U.S. political ambitions. Since no person can withstand the public in a democracy (or the King in a monarchy) every society eventually turns to the one thing that can: gold.
On Dec 30 12:35 PM Socialism cannot compete! wrote:
> Mr Hui actually states points FOR gold-backed currencies, though
> he does not realize it!! It is precisely the case that going off
> the gold standard has created an economic bubble of artificial growth,
> triggered by manipulation of the money supply!! How can anyone deny
> that the easy money policies of the Fed are a core component of this
> current debacle?? We are now seeing the disastrous effects of fiat
> currencies. His argument that there is not enough gold to back current
> money supplies, except at much lower values is PRECISELY an argument
> FOR gold-backed currencies -- the growth in our economy has been
> ARTIFICIAL. It's time to end the manipulation of the currency for
> the benefit of the few.
1) The definition of money as a social or psychological phenomenon that allows us to get beyond the horribly inefficient barter system by attaching value to practically useless objects like currencies or metals that were easier to trade.
2) A description of how money supply is controlled by the issuing government via interest rates, open market activities, and reverve ratios.
3) A review of history comparing the economic performance and currency stability of the US on the gold standard with the US post-gold standard, a review of how fractional-reserve banking allowed for the growth of both industry and consumption by freeing people from the sharecropper society that came before, and a review of currency history such as the economically devastating bouts of uncontrollable deflation and inflation in the gold standard era, episodes of past hyperinflation and high inflation, and the deflationary era of the depression and Japan in the 90's and why that occurred.
Of course, some people won't be interested in mere facts, having read a book or blog one time that made up their mind, but many readers who have only been exposed to economics information on the internet would appreciate the summary. Misinformation is everywhere online and in popular media too.
In theory I totally agree with a gold backed monetary system. However, in reality I agree it would be a disaster at this time in history and here's why:
Out of control corruption and power grab in the public sector; would you trust today's governing representatives and/or Fed Reserve to honor this system? with all the existing corruption, I believe a return to gold standard this would only truely serve as a front for gold confiscation from private citizens. After all the polititions fancy footwork I guarantee their "new gold standard" would NOT allow anyone to go into a bank and trade their gold certificates for real metal, no chance... We'd just have to have trust and faith that our notes are truely backed by gold (which we would never get to see or touch again, in fact it would be illegal for private citizens to own at this point).
I see a return to gold standard as a PERFECT ENDING CHARADE for the elite ruler dynasties as it would seemingly satisfy everyone: (1) the massess - because we'd finally get our so called "gold standard" back, (2) the central banks - because they'd finally get all the gold (no longer the need to manipulate it or fear it), (3) government elite rulers because they would get full control and power over the citizens as gold would no longer be legal for private citizens to possess (No longer act as a competitive threat against the goverenment currency). Best of all, this would certainly go down simiilar to how it did in the 1920's (i.e. confiscate from citizens first, then devalue the dollar on the order of 10-50x (only after they have all the gold)).
Also there would still be the fractional reserve issue as raised by the author (money would need to be broken into two or more classes, i.e. debt backed fractional reserve vs. gold backed). A nightmare, and an open window for more financial magic tricks and slick maneuvers.
So if you appreciate the fact that today YOU can own and hold gold. Then be extremely cautious about getting behind a new gold standard. it would be a wolf in sheeps clothing at this point in history.
Please do think about this.
"Money is only as 'sound' as the people who regulate it." - derryl
While this is true as far as it goes, it does not go far enough. Our problems today are the result of gub'mint control of the money supply. Correcting that problem will require thinking outside the box of having any sound money 'regulated' by the gub'mint.
The only true regulation that will work must be supplied by the market itself. This is one reason why a money denominated in weights of gold is a good idea. You can't debase weight and fineness of gold as long as you are allowed to test the metal personally (it's not that hard, you can buy a tester for about 1/4 oz of gold).
www.goldtestsolution.c...
The goal for sound money would be to allow free circulation of gold coin (or receipts for same with exchangability) and for everyone to have the opportunity to test the gold they receive if they desire and demand full payment if it is diluted in any manner.
That would be more work, but you would know that you can always ensure your money is 'whole'. Once money has a known 'stable' value, then you won't have to worry that your savings are being eroded via inflation and prices on most items will stabilize or drift downward over time as your money becomes more valuable (more efficient production = more goods with same inputs, fixed supply of money + more goods = the price of goods declines = same money will buy more stuff).
The nice thing about a fixed money supply and declining prices is that the same salary will buy more stuff next year than it did this year. No more need for a raise just to break even next year.
History proves this is the case. Go google the history of the CPI. From 1800 to 1900 when the US was on a strict gold standard the CPI dropped by 50% from 51 to 25. You could buy twice as much stuff with the same income in 1900 as you could in 1800.
Look at what has happened since the FED was founded in 1913 however, CPI has increased from about 30 to over 582 in 2005, and increase of 19,400+%.
So, with gold backing the purchasing power of money doubled in 100 years and without gold backing the purchasing power of money dropped nearly 95% in 95 years (most of the drop in the past 50 years).
I don't know about others, but if I want to save money I'd much rather have it buy twice as much stuff in the future as have it buy 1/20 as much.
Wouldn't you?
It means that trade deficits lead to an outflow of gold from america to other countries,
AND
THE MONEY SUPPLY HAS TO SHRINK AS A RESULT,
LEADING TO DEFLATION.
The 1946 full employment act opposes this type of action,
not to mention current political realities.
Don't you think that companies cutting prices every year might lead to reduced employment? Declining prices during the Great Depression were great for the employed, not so great for the unemployed.
"History proves this is the case. Go google the history of the CPI.
From 1800 to 1900 when the US was on a strict gold standard the CPI
dropped by 50% from 51 to 25"
Or you could google the Cross of Gold speech?
"CPI has increased from about 30 to over 582 in 2005, and increase
of 19,400+%"
From 30 to 582 is an increase of 1840%.
On Dec 30 02:37 PM Smarty_Pants wrote:
> Several good comments in the discussion.
>
> "Money is only as 'sound' as the people who regulate it." - derryl
>
>
> While this is true as far as it goes, it does not go far enough.
> Our problems today are the result of gub'mint control of the money
> supply. Correcting that problem will require thinking outside the
> box of having any sound money 'regulated' by the gub'mint.
>
> The only true regulation that will work must be supplied by the market
> itself. This is one reason why a money denominated in weights of
> gold is a good idea. You can't debase weight and fineness of gold
> as long as you are allowed to test the metal personally (it's not
> that hard, you can buy a tester for about 1/4 oz of gold).
>
> www.goldtestsolution.c...;cPath=13&prod...
>
>
> The goal for sound money would be to allow free circulation of gold
> coin (or receipts for same with exchangability) and for everyone
> to have the opportunity to test the gold they receive if they desire
> and demand full payment if it is diluted in any manner.
>
> That would be more work, but you would know that you can always ensure
> your money is 'whole'. Once money has a known 'stable' value, then
> you won't have to worry that your savings are being eroded via inflation
> and prices on most items will stabilize or drift downward over time
> as your money becomes more valuable (more efficient production =
> more goods with same inputs, fixed supply of money + more goods =
> the price of goods declines = same money will buy more stuff). <br/>
>
> The nice thing about a fixed money supply and declining prices is
> that the same salary will buy more stuff next year than it did this
> year. No more need for a raise just to break even next year.
>
> History proves this is the case. Go google the history of the CPI.
> From 1800 to 1900 when the US was on a strict gold standard the CPI
> dropped by 50% from 51 to 25. You could buy twice as much stuff with
> the same income in 1900 as you could in 1800.
>
> Look at what has happened since the FED was founded in 1913 however,
> CPI has increased from about 30 to over 582 in 2005, and increase
> of 19,400+%.
>
> So, with gold backing the purchasing power of money doubled in 100
> years and without gold backing the purchasing power of money dropped
> nearly 95% in 95 years (most of the drop in the past 50 years).
>
>
> I don't know about others, but if I want to save money I'd much rather
> have it buy twice as much stuff in the future as have it buy 1/20
> as much.
>
> Wouldn't you?
"Don't you think that companies cutting prices every year might lead to reduced employment? Declining prices during the Great Depression were great for the employed, not so great for the unemployed." - Jim Myrtle
This is the nature of capitalism, increased efficiency increases productivity and lowers the labor needed to produce the same amount of goods. However, some of that labor will be retained to produce a larger amount of goods to meet increased demand at lower prices while other parts of that labor will have to become productive at another task.
To say this is a bad thing is the equivalent to saying Ford should still be hand assembling cars at a rate of 10 per day because automating would have resulted in laying off a dozen people 100 years ago.
Instead automating has allowed Ford to manufacture tens of thousands of cars a day employing orders of magnitude more employees than when Henry Ford started up the assembly line AND a larger segment of the population can afford to buy a car as a result. (Ignoring the fact that Ford is nearly bankrupt the principle remains valid, productive efficiency means lower costs to the consumer, more consumers can afford to buy so more need to be produced and thus more labor is kept employed)
If maintaining jobs were the prime goal of an economy we would all still be subsistence farmers. Division of labor and the constant improvement in productive efficiency is what improves the general standard of living for everyone. That means that there will always be people who lose jobs and have to find other lines of employment. It's part of life. I've been laid off twice myself. I survived it and am better for it.
Do you think your standard of living would be as good as it is if you had to build everything you own? Plasma tv? Car? Clothes? iPod? I don't think so, and I'm pretty sure you'd rather pay less for any of them next year than it would have cost this year.
It's probably a good bet you don't really care if 5% of the company's work force got laid off when you see the lower price at Best Buy next month, isn't it? Not enough to stop you from buying it anyway.
As a general rule consumers are pretty harsh and selfish. They only have their own self interest in mind and couldn't care less about cost of production, transportation, labor, tarrifs, or profits. They want a specific good at the best price possible. Period.
The most efficient way to provide those goods is a free market with sound money.
The Cross of Gold speech as I understand it was in support of a plan to debase the currency (replace gold standard with bimetallism) as an aid to farmers who had encumbered debts they couldn't pay off. The intent is the exact opposite of sound money and is more in accord with supporting a fiat currency - creating money because the circumstances "require" it.
I maintain that honest money must also entail acknowledging failure as well as success. If you use credit for an unprofitable purpose and cannot repay the debt then you should have to endure the consequences and not expect to save the day via debasing the currency as William Jennings Bryan urged in his speech.
What Bryan tried to do in 1896 is not much different than what the FED is doing with the TARP today, using monetary debasement to favor one group at another group's expense.
"While it would be quite painful to implement, the most stable base for a sustainable and growing economy would be one based on a fixed money supply (such as gold or silver) with a strict ban on any sort of fractional reserve lending. This would restrict the use of savings to uses which were most likely to satisfy actual consumer demand. "
"The nice thing about a fixed money supply and declining prices is that the same salary will buy more stuff next year than it did this year. No more need for a raise just to break even next year. "
Smartypants, you apparently condemn the current education that college students receive in basic economics. To you, deflation is better than inflation.
Wow. Well, let's see. First of all, Jim Myrtle is absolutely correct:
"Don't you think that companies cutting prices every year might lead to reduced employment? Declining prices during the Great Depression were great for the employed, not so great for the unemployed. "
Not to mention that deflation probably exacerbated the Depression to no small degree.
About your ban on fractional reserve banking....How would one earn interest? Gold doesn't just magically multiply by 5% a year. Or would there be no banks as well? Maybe we should go back in a time machine to ancient Rome and put all of our money into the Temple of Jupiter, because Apollo told me to.
I'd like a fuller picture of your world without banking...something tells me it would involve a toga and some really wild parties.
I also think his argument is flawed and his argument for how inflated money has benefited society. It has only benefited a segment of society, in this case Wall Street, Corporate America and a few favored entities. Since Mr. Nixon took us off the Gold Standard, it appears that living standards have risen but that is largely (in the U.S. anyway) because households now have two earners. It used to be that most households were supported by one wage earner. Now, two-income families are necessity except for those fortunate enough (or good enough scam artists) to be on Wall Street.
It's always pontificators like Mr. Hui, Greenspan, Bernanke et al. who want to tell us how big a disaster an alternative monetary system would be.
Oh YEAH!!! I forgot: you guys have been so successful with the current one, we should just keep listening to you.
"I maintain that honest money must also entail acknowledging failure as well as success. If you use credit for an unprofitable purpose and cannot repay the debt then you should have to endure the consequences and not expect to save the day via debasing the currency as William Jennings Bryan urged in his speech."
I cannot agree more with your first sentence. But, I must profess, I don't know the difference between currency debasement and today's alternative: mass foreclosures and unemployment. Either way, you will lose great standing amongst other nations (since they own the mortgages), except with the latter, you have civil unrest to boot. Something tells me the Fed is choosing between the lesser of two evils, and future inflation seems less toxic than rioting in the streets.
For all of those savers that may feel robbed by future inflation, it stands to see whether or not we are capable of protecting ourselves from it. TIPS sound better and better, I think.
Notice how none of this had anything to do with gold.
Two comments:
1) If general price levels are decreasing you are getting ahead even without interest as every piece of gold you can manage to save will buy more tomorrow than it does today.
2) You can still earn interest on your gold deposits, but it will entail giving up your right to claim the gold at any time. Without fractional reserve banking only one person may have a claim to any piece of gold at a given point in time.
If you want to earn interest you would have to deposit the gold in a Certificate of Deposit (CD) equivalent (ie. interest bearing time deposit of known duration) that you cannot redeem until the end of the time period. This releases the 'title' to the gold for that duration and allows the bank to lend it out at interest for the time period specified. When the time period is up, the borrower must repay in gold or be foreclosed upon.
I would imagine banking would change so that your local banker would find loan opportunities for your money and arrange for you to move it from a demand account to a CD for the purpose of loaning it out at interest.
Naturally the bank would have to charge fees to earn their income, but there's no reason you couldn't arrange the loans yourself other than convenience.
You could also invest your gold in capital projects (buy equity in a business) and earn a return there (ie. dividends or profits) instead.
"Smartypants, you apparently condemn the current education that college students receive in basic economics." - Ricard
I received the same college economics education myself and, yes, I do condemn it. The Keynesian drivel doled out in today's colleges presumes that only the gub'mint can 'regulate' the economy, from soup to nuts, money included.
What is never allowed to be discussed in those classes is the cost imposed on the economy by the Federal Reserve system and fractional reserve banking. Most economists still won't admit that the FED's easy money policies of the last 6 years are the source of today's economic 'crisis' and that the 'deflationary' environment is the market's means of correcting the misallocation of resources during the easy money boom period. The country went on a borrow and spend spree and now we're paying the piper. The idea that borrowing even more to 'fix' the problem with ever more spending is ridiculous.
"To you, deflation is better than inflation."
More properly stated, to me sound money is better than depreciating money.
I'd prefer my money to have the same purchasing power tomorrow, next week, next month, and next year, that it has today. Given that, I will make do with whatever productive improvements my fellow man may devise to help lower my cost of living and be happy about it.
I find that much preferable to having my purchasing power decline continually while bankers and politicians print ever more money to spend on wasteful pork projects at my expense.
And so remaining in the fiat system we have will not be disastrous?
A new and improved gold/silver standard could be created to coexists with debt money and innovatative ways to do this could evovle. People could choose whatever currency they felt confident with. Debt currency could carry a risk but pay a reward. For example bonds could be issued to finance a government project or whatever and currency could be issued against this. This currency could circulate with the understanding that it will receive interest at maturity of the bond and could be retired at that time. A lot of thought and ideas could be tried and over time would evolve. 1st step thought is get rid of the Federal Reserve System.
Please ignore the global downturn of unprecedented proportions dooming future generations to heightened economic volatility behind the curtain.
It wasn't that the farmers and small businessmen of William Jennings Bryan's era were being irresponsible in taking out mortgages to build farms or businesses, it was that the price of gold suddenly fluctuated upwards, which caused the dollar to rise in value uncontrollably as its value was tied to gold (massive deflation), which caused the prices the farmers could get for their goods to fall and the cost of their mortgages to rise, which wiped out a lot of dirt-poor farmers and businesses. The only winners were the Wall Street holders of these debts, which had to be paid back in more valuable, deflated dollars. The result was populist outrage about how the masses had been ruined just because the price of one commodity, gold, had risen - on Wall Street - and the perception that the bankers who established the system were profiting from their poverty and bankruptcy. High inflation occurred a few years later, as the price of gold fell, causing a bank crisis. As you can see, there was a reason the gold standard was abandoned - the currency swings were as uncontrollable as a commodity price, and these swings ruined banks, businesses, and farms regularly.
The gold standard was abolished in steps over several decades. Not surprisingly, the dollar has become more stable and controllable, not less, and we just don't see the destructive monetary swings of the 1800's, current fluctuations notwithstanding. Economic growth and productivity in recent decades has skyrocketed compared to the past. This is not a coincidence - a stable currency is critical for a strong economy. History says gold doesn't provide it.
On Dec 30 04:02 PM Smarty_Pants wrote:
> The Cross of Gold speech as I understand it was in support of a plan
> to debase the currency (replace gold standard with bimetallism) as
> an aid to farmers who had encumbered debts they couldn't pay off.
> The intent is the exact opposite of sound money and is more in accord
> with supporting a fiat currency - creating money because the circumstances
> "require" it.
>
> I maintain that honest money must also entail acknowledging failure
> as well as success. If you use credit for an unprofitable purpose
> and cannot repay the debt then you should have to endure the consequences
> and not expect to save the day via debasing the currency as William
> Jennings Bryan urged in his speech.
>
> What Bryan tried to do in 1896 is not much different than what the
> FED is doing with the TARP today, using monetary debasement to favor
> one group at another group's expense.
We already have mass foreclosures and growing unemployment (higher than 'official' gub'mint numbers - see shadowstats.com). It is an unfortunate truth that we have travelled a long distance down the wrong path of monetary policy. Any choice we make now will be extremely painful, but opting for the easy way out without making the end goal the optimum solution will only kick the can down the road and make the problems worse in the future.
My great fear is that it may be too late to 'save' the system by any means. If we continue on down the TARP-esque print and spend path we will eventually discover that our foreign creditors will stop buying our debt and start selling it instead along with their dollar reserves. We could devolve into a banana republic economy whose currency is shunned world wide. What happens then?
Rioting could only serve to bring out the swat teams and push us toward a 'national emergency' which "requires" a dictatorship (only for a while naturally) to resolve.
Every perceived problem today is already addressed by swarming it with gub'mint agents.
Think TSA. How many billions do we need to spend on preventing hijackings? Give every passenger a club and tell them anything goes between takeoff and landing and you will find no hijacker will ever make it to the cockpit alive. Inflight manners would improve greatly too for fear of being mistaken for a highjacker.
Think Waco. Was it really necessary to swarm a peaceful compound with dozens of armed agents to arrest a man who went jogging alone every morning? And then to burn the place to the ground killing nearly everyone inside after the shooting stopped for a couple days when the original intent was to arrest Koresh? Wasn't that overdoing it just a bit?
Think Northcom. Suddenly, after 230+ years with posse comitatus we need to station regular army units in the continental US for 'homeland defense' when there are enough bubbas with rifles to keep an entire foreign army busy should they be foolish enough to invade. Our army is having a pretty tough time with the Iraqi resistance fighters.
I'm not saying things are going to fall apart, but we getting closer to that point than we ever have been. If things are really that bad, then our goal should be to restructure the system so that it is sustainable and avoid repeating the mistakes that got us to where we are now.
Yes, that would be very painful, but pain cannot be avoided at this point. We will just have to grit our teeth and move forward if we ever hope to make this a better place in the future.
The private sector will set up its own parallel gold system, such as that which now exists at GoldMoney.com. It's basically an electronic currency pegged to physical gold bullion in vaults over in London (an electronic "Gold Certificate" concept, using the convenience of a PayPal-like system to transfer ownership of real gold grams among account holders worldwide.
In effect, those who are concerned about the value of their money will migrate over to such parallel systems, making the "official" government-issued money less relevant, especially after the big inflation-bang occurs.
Increased efficiency? You mean maybe borrowing huge sums of money to automate your factory? Knowing that money you borrow in a deflationary environment is paid back with more expensive money in the future? Knowing that every year, your prices for goods sold must decline?
"However, some of that labor will be retained to produce
a larger amount of goods to meet increased demand at lower prices
while other parts of that labor will have to become productive at
another task"
And some will stay employed, at a lower salary. Kinda ruins your original point.
"To say this is a bad thing is the equivalent to saying Ford should
still be hand assembling cars at a rate of 10 per day because automating would have resulted in laying off a dozen people 100 years ago"
Let me know how the UAW reacts when you explain that due to deflation, their salary and benefits will be reduced 3% each year.
"Instead automating has allowed Ford to manufacture tens of thousands
> of cars a day"
Lower prices due to productivity gains is different than lower prices due to deflation.
"Do you think your standard of living would be as good as it is if
> you had to build everything you own? Plasma tv? Car? Clothes? iPod?
> I don't think so, and I'm pretty sure you'd rather pay less for any
> of them next year than it would have cost this year"
I'd love to pay less next year. You think that might lower demand for those goods as people delay their purchases? So now you see another problem with deflation.
"The Cross of Gold speech as I understand it was in support of a plan
> to debase the currency (replace gold standard with bimetallism) as
> an aid to farmers who had encumbered debts they couldn't pay off."
Yeah, farmers crushed by debt selling their goods for less each year. I wonder if that might cause any problems?
"The intent is the exact opposite of sound money and is more in accord with supporting a fiat currency - creating money because the circumstances "require" it."
As opposed to creating less (or no) new money as the economy grows?
"What Bryan tried to do in 1896 is not much different than what the FED is doing with the TARP today, using monetary debasement to favor one group at another group's expense"
The gold standard was favoring the Eastern bankers at the expense of everyone who owed money or who produced goods for sale. Keeping prices steady by adding silver to the money supply sounds fair to everyone, or do you disagree?
On Dec 30 04:02 PM Smarty_Pants wrote:
> Good catch on my math error Jim. I forgot to adjust for the initial
> 100% and slipped a decimal place too far. Still 1840% is a significant
> loss of purchasing power.......
>
>
.
Lower prices, bankruptcy, massive unemployment and reduced GDP due to a deflating money supply is a bad thing. A very bad thing.
On Dec 30 04:51 PM huangjin wrote:
> If deflation is so terrible, how does the electronics industry survive?
> Deflation isn't better than inflation because of a value judgement.
> Deflation is better because it is the natural state of affairs.
Apparently we're not discussing the same topic or we are using different definitions for the same words.
If there were an actual fixed gold standard and no fractional reserve banking, exactly how does the money supply 'deflate'?
The amount of gold is nearly fixed except for losses of very small amounts used in industry and additions of mining output. I would expect that mining output would outweigh industrial use and leave a slowly growing supply of gold. Not what I would call 'deflation' which is usually defined as a decrease in the money supply.
The only 'deflation' I can forsee under a gold standard is falling prices resulting from lower costs of production.
The only ways I am aware of to 'deflate' a money supply are:
1) to use fractional reserve banking to inflate the money supply via credit, then offset the fractional reserve credit and extinguish the 'excess' phony money you created
2) Print unbacked currency and spend it (or debase metal content of coins), then reverse the process by gathering up the 'excess' currency or coin and destroying them.
Either way requires the initial INFLATION of the money supply before it can be DEFLATED. Under a fixed gold standard without fractional reserve banking there isn't an initial inflation, hence no deflation will follow.
Am I missing something? How do you see a 'deflation' in a 100% gold backed monetary system without fractional reserve banking occurring?
I cannot see how it is possible to 'deflate' a money supply that is 100% based on a tangible asset and not allowed to be leveraged via fractional reserves.
(Well, I guess Spanish galleons could sink off the coast of Burmuda, but that would only 'lose' a very tiny fraction of the entire money supply, and it could be salvaged eventually.)
If there were an actual fixed gold standard and no fractional reserve banking, exactly how does the money supply 'deflate'? "
Deflation is a general decline in prices.
Thanks for your replies. I really wasn't sure if you were serious about throwing the econ 101 textbook out the window.
"How would one earn interest? Gold doesn't just magically multiply by 5% a year." - Ricard
"Two comments:
"1) If general price levels are decreasing you are getting ahead even without interest as every piece of gold you can manage to save will buy more tomorrow than it does today.
"2) You can still earn interest on your gold deposits, but it will entail giving up your right to claim the gold at any time. Without fractional reserve banking only one person may have a claim to any piece of gold at a given point in time. "
I'm going to return to this point, because I'm still not sure where the "interest" will come from. In fiat, it is obvious because we have an expanding money supply...we "create" interest. But, in something as rigid as a gold standard, let's say we deposit 100 ounces of gold in a "bank", and after a year, we get 105 ounces of gold. Where did those five ounces come from? Gold dug from the ground will more than likely be 1) erratic and 2) not enough to pay simple interest payments, let alone account for productivity gains. I suppose this is where your argument comes in that the same gold would be worth more later...but here's the paradox. If my gold is worth more later, and there is about the same amount of gold later, what makes it worth more? It's certainly not interest, because gold doesn't grow at 5% a year if we put it in a bank, or bury it in our back yard and water it. It stays the same. Therefore, for someone to "earn interest" on their gold, someone else's gold would have to...be worth less?
I think the answer to this is that gold itself becomes deflationary. Without the fractional reserve banking we have in place today, gold held for any amount of time would not yield any benefit - it is still that yellow coin or bar that it was last year. It cannot grow, and yet we have lost time - in fact, the longer we wait, the more time we lose, while that gold still just sits there. As we would be living in a deflationary environment, it would follow that whatever currency we use would deflate as well. This sounds like a self-defeating ideology to me - society would have one objective - head to 0.
Jim Myrtle also made a great point:
"This is the nature of capitalism, increased efficiency increases productivity and lowers the labor needed to produce the same amount of goods."
- "Increased efficiency? You mean maybe borrowing huge sums of money to automate your factory? Knowing that money you borrow in a deflationary environment is paid back with more expensive money in the future? Knowing that every year, your prices for goods sold must decline?"
When the money supply remains steady and output grows, each dollar will buy more.
On Dec 30 09:16 PM Ricard wrote:
Jim,
I can tell you're a very patient person LOL.
On Dec 30 09:35 PM Jim Myrtle wrote:
> " If my gold is worth more later, and there is about the same amount
> of gold later, what makes it worth more?"
>
> When the money supply remains steady and output grows, each dollar
> will buy more.
>
The beef is, you cannot do any level of realistic planning on this basis when the measuring stick (the money) is constantly fluctuating in value. The lion's share of the "money supply" isn't currency issued by the government, it's bank deposits lent out at interest. If I didn't care about interest, I can of course simply buy assets, including gold, and hope to swap them later for a share of other goods and services I really need. In this way, we could possibly function without government-issued money of any kind. But whatever asset was chosen, there is a risk that it's value will not be constant with respect to other things you'll need to consume in the future. Like all assets, even gold's value can fluctuate.
I think the key point in the above essay is that it would be difficult to function without any form of debt or lending, i.e. with a 100% equity/asset-based system. Everyone would always have to lay claim to some share of annual production, even if unneeded, as a means of bartering it for something else in the future. And anyone needing to temporarily consume more than their share (for example, to start a new business, or do anything that will improve production in the future) would have to either sell shares in their enterprise, or engage in some sort of direct or indirect loan agreement. Banking would be reduced to depositors putting money into irredeemable certificates of deposit with fixed, longish terms, geared to match the loan portfolio's term structure. We'd lose the flexibility of being able to lend short (as depositors) to people who are borrowing long, relying on the collective rate of inflow/outflow to bridge the gap. This seems like a recipie for a much more constricted, low-tech economy to me.
Fantastic comment! You nailed it with each swing! Thank you.
On Dec 30 05:15 PM Smarty_Pants wrote:
> My great fear is that it may be too late to 'save' the system by
> any means. If we continue on down the TARP-esque print and spend
> path we will eventually discover that our foreign creditors will
> stop buying our debt and start selling it instead along with their
> dollar reserves. We could devolve into a banana republic economy
> whose currency is shunned world wide. What happens then?
>
> Rioting could only serve to bring out the swat teams and push us
> toward a 'national emergency' which "requires" a dictatorship (only
> for a while naturally) to resolve.
>
> Every perceived problem today is already addressed by swarming it
> with gub'mint agents.
>
> Think TSA. How many billions do we need to spend on preventing hijackings?
> Give every passenger a club and tell them anything goes between takeoff
> and landing and you will find no hijacker will ever make it to the
> cockpit alive. Inflight manners would improve greatly too for fear
> of being mistaken for a highjacker.
>
> Think Waco. Was it really necessary to swarm a peaceful compound
> with dozens of armed agents to arrest a man who went jogging alone
> every morning? And then to burn the place to the ground killing
> nearly everyone inside after the shooting stopped for a couple days
> when the original intent was to arrest Koresh? Wasn't that overdoing
> it just a bit?
>
> Think Northcom. Suddenly, after 230+ years with posse comitatus
> we need to station regular army units in the continental US for 'homeland
> defense' when there are enough bubbas with rifles to keep an entire
> foreign army busy should they be foolish enough to invade. Our army
> is having a pretty tough time with the Iraqi resistance fighters.
>
>
> I'm not saying things are going to fall apart, but we getting closer
> to that point than we ever have been. If things are really that
> bad, then our goal should be to restructure the system so that it
> is sustainable and avoid repeating the mistakes that got us to where
> we are now.
>
> Yes, that would be very painful, but pain cannot be avoided at this
> point. We will just have to grit our teeth and move forward if we
> ever hope to make this a better place in the future.
On Dec 30 09:59 PM Ricard wrote:
>
> Jim,
>
> I can tell you're a very patient person LOL.
>
> On Dec 30 09:35 PM Jim Myrtle wrote:
The entire legal system in the United States would have to be re-written. How much Gold would a speeding ticket cost?
What if some group that controlled a particular asset (ie OPEC and Oil) decided they wanted more gold for their oil than it was worth in the eyes of the public? Or milk or corn or whatever?
If their is money (gold or fiat currency) involved, people are going to try and will ultimately succeed at maniuplating it. Switching to a gold standard will not get rid of GREED. Accountability? What does Accountability mean? There is a guy that robbed people out of $50 billion dollars sitting in a mansion right now laughing at all of us. He will never go to jail. Just like the guy from Enron...died of a heart attack...yeah right!! He is probably chilling on a tropical island somewhere.
The one thing this whole "crisis" has uncovered is that the markets are manipulated and corruption is rampant. It will never change no matter what the currency standard is.
There will always be a group of people sitting in a dark room smoking cigars deciding how to slice up the big piece of the pie.
If you want to do something about it then gather up your friends, grab your pitch forks, and head to Washington.
Lots of good comments. I don't know where to begin exactly.
"We'd lose the flexibility of being able to lend short (as depositors) to people who are borrowing long, relying on the collective rate of inflow/outflow to bridge the gap. This seems like a recipie for a much more constricted, low-tech economy to me." - DougM
Doug, you made several astute observations. Money isn't the end all, whether fiat or asset backed. What counts is wealth. With a fixed money supply there would be a much smaller debt market, but the competition for the money available would be fierce and interest rates would be set by auction and change with the amount of savings available to lend.
While this would mean some projects requiring borrowed funds would not get off the starting line, it also means that only projects which prove to be most profitable would be able to afford to outbid others for the loans.
This money rationing mechanism would mean that available funds (savings) would be directed toward creating items or services that were most desired by the consuming public (ie. more demand for the product means higher prices and bigger profit margins, hence the better ability to pay higher interest on the loan).
The end effect of this rationing is that scarce resources (all resources are 'scarce' by definition since they are finite) will be directed to the products or services that the consumers most desire until the available savings run out.
The scarcity of money reflects the fact that consumers wish to spend now at current prices (ie. little or no savings) and so less money is available to improve productivity by spending savings on automation which would lower prices in the future.
If the consumers would rather spend later more of their money would be available for use in improving productivity that would lower the future prices of goods.
The amount of excess money (savings) drives the increases in productivity to reflect the desires of consumers.
While that may seem "restricted" compared to today's fractional reserve system, it is also much more stable. It would be impossible for asset bubbles to form as there wouldn't be enough money to support the leverage necessary to inflate the bubble.
Any irrational pricing would either be resolved via increased production (higher profit margins due to bigger demand) or by loan defaults and bankruptcies for a small number of participants. While those participants would suffer, the entire system would not. The lack of extra money would prevent many from entering the bubble in the first place.
Instead of 'restricted' think 'slow and steady'.
Today, with fiat money, derivatives, fake off-book Base I balance sheets that hide losses, money being pumped up and sucked out in tidal waves by the Fed, and sheer crookery by loaning more than you can after the abolishment of Glass Stegal, the same thing is happening. All banks keep much less than 10% of their assets in reserve. In fact I'd be surprised if they even had 3%. This is because they have convinced everyone to put it in accounts where no reserve requirement is required.
If the government backs all accounts regardless the banks are safe at the cost to the taxpayers which is what's happening. It amounts to free insurance, save all money becomes worth less as more money is printed to back the surge of lost money that is magically made to pay for the money that never really existed.
In summary, crookery and financial deviousness becomes nothing more than a farce, and those running the show are but charlatans. It is not suppose to be this way. As other posters pointed out more succinctly, money is based on trust. If there is no trust it doesn't matter what money is based or backed on because the accounts won't match up no matter how you calculate them.
What if they decided tomorrow that they wanted more dollars for the same products?
You either buy it or you don't. Haggle until you agree on a price that suits you both. Same with gold, just different units.
Very true. The entire economy is based in trust at some point unless everyone is completely self sufficient. Does your employer pay you every day? No? You are trusting that he will pay you at the end of the pay period then, aren't you? Otherwise you would think that you are working for free.
When you pump gas into your car either the station attendant is trusting you to pay after you pump, or you are trusting him to properly charge your credit card after you swipe it (before you pump).
Division of labor requires trust. The problem with fractional reserve banking is that the banker takes advantage of that trust for his own benefit by lending your money out multiple times and counting on the fact that enough depositors will leave enough money in the bank to cover all withdrawls.
A gold standard without fractional reserve lending would minimize this (some would try anyway, but be caught and imprisoned eventually) as it would not be allowed for any piece of money (gold) to have more than one claim on it at any instant. Since the banker can't "print" more gold they can't cheat the depositors for their own gain. This puts a firm lid on starting and inflating manic behavior in the market.
Besides, physical exchange would give depositors the power of a bank run. This is an important means of keeping banks in line.
PS. Those who wish to claim that banking was on the gold standard for the great depression are only partially correct. When the FED was established in 1913 they started printing more paper money than there was gold to cover (much smaller amounts than today).
This is what fueled the Roaring 20s, excess money that was unbacked by gold and loaned into the economy. This was the first FED induced economic bubble whose deflating led to the Depression when tariffs were raised and even more money printed and spent on public works. The Great Depression was a deflating bubble just like our financial crisis today is.
Even though we were officially on the gold standard with convertibility, the banks were using fractional reserve banking to blow a bubble.
at the cost to the taxpayers which is what's happening. It amounts
to free insurance"
Banks pay for FDIC coverage based on their risk as well as assets under management.
On Dec 30 11:23 PM constructe wrote:
I'll start with a simple economy that only produces consumable goods, like food and clothing. Every year, all participants produce a certain amount of these items, and then consume them. We don't all produce the same things - some people raise cattle, some raise corn, etc. We could inefficiently barter these items, or we could trade them in a more efficient "hub-and-spoke" manner with one of the goods standing in as a unit of value against which all others are measured. Loans in this world would take the form of someone foregoing some portion of his consumption to enable someone else to consume more, receiving an IOU from the other person.
Throw in services, things don't really change. After all, the workers in the earlier economy were doing things like growing corn and raising cattle. The folks working on the cattle ranch will accept from the ranch's owner some portion of the eventual cattle sales. The rancher doesn't really have any other way to "pay" them except in the form of either actual goods from a stockpile laid in earlier, or in the form of IOUs that can be redeemed when the cattle are marketed. Now this situation doesn't really change no matter what the service is.
Throw in more durable items, things change a little. For example, someone has to put in the time to construct the bulidings making up the cattle ranch, and has to do this well before any cattle will actually be sold. We're well beyond the point where a single person or family can construct such businesses entirely by their own efforts. Somehow, other actors in the economy have to be encouraged to help construct the ranch. Once again, we have the problem that either a stockpile of goods is available to pay them with, or they can be paid with IOUs, or (and finally a difference from the original example) they can be paid via part-ownership in the ranch and a claim on its future productivity.
I don't actually need money per se for any of the above. In a sense, "money" has shown up once we instituted the "hub-and-spoke" valuation system, but no actual quantities of the hub commodity need to be in "circulation" to support the system described. It's true that a durable commodity such as gold could take the place of the hand-waived "stockpile of goods" with which to pay various actors, eliminating the need for IOUs. But what exactly are "savings"? Is the definition simply to stockpile some goods? Or just particular goods, namely quantities of the hub commodity? How does a stockpile of the hub commodity differ, fundamentally, from a stockpile of any other commodity? Do all savings have to be in the hub commodity? For that matter, the hub commodity was produced through some amount of effort. So was the ranch, though. Except the ranch has the potential to produce more value in the future (more than going out and hunting wild cattle, say). Isn't this also a form of savings (an investment)?
Specifically to the inflation/deflation question, it strikes me that even with a hub commodity such as gold, that had to be physically circulated, you might nevertheless have inflation if the velocity of transactions was high enough. In other words, the speed at which it was flowing in and out of different stockpiles. And I don't see how you've eliminated fractional reserve banking. Consider again the workers at the ranch. Suppose the rancher has to borrow gold from someone who has a large stockpile and is willing to lend out their gold in exchange for a share of the ranch's future profits. Now suppose that the workers are going to "save" some of their "money". Where, exactly? The instant that they decide they'd rather earn some "interest" on the "money", you are back to banking again, as their savings collectively form the large stockpile that was in part lent to the rancher. By choosing to "save" some of the gold they were paid, the workers are saying (to the economy as a whole) "please produce less consumable items such as food, and please hire more people and engage them in the business of constructing things (like the ranch) that will provide even more food in the future. And this then creates more "supply" of money to accept the projects that are "bidding" for loans.
So even with gold as the hub commodity, you'd still IMO end up with lending, and therefore an expansion of the effective "money supply", as well as velocity effects that could drive the relative prices of things up or down relative to the currency. Although obviously the big danger is that the velocity would be too slow, and the economy would be held back or even slide into deflation as people began to over-value the hub commodity, which is in limited supply relative to it's special role, even though it's in abundant supply relative to actual (industrial) uses. This is IMO the big danger of sticking to a gold-based system.
So where's the problem here? Presumably the amount of lending wouldn't just expand to infinity even if there were no lower limit on bank reserves. Reason: you'd run out of projects looking for loans at some point (or at least, reasonable projects). Where else might there be trouble? One big problem is "human capital". Every actor in the system has some economic value based on their expected future contributions to the overall production. This future value is very high compared to what most people have in stockpiled "savings". There is a temptation to overconsume now at the expense of future consumption, given a lending mechanism that facilitates this. Some of this is good (borrowing to acquire productive or durable assets), and some isn't (borrowing to fuel short-term consumption). Indeed, arguably the government is the worst actor of all on this score.
I would still argue that it's best to manage the money supply (whatever the money's based on) to grow in line with the economy, avoiding both inflation and deflation. I'd define the money supply in terms of the amount of IOUs in the system (including the ones issued by the government itself, otherwise known as currency).
It appears to me that you are equating lower prices with lower profits, but that doesn't have to be the case if productivity gains are involved.
Example:
Say I own a lumber harvesting business. I buy the trees from the land owner, have hired help cut them down, and transport them to a sawmill whose owner buys them from me for his own lumber producing operation.
Let's assume there is plenty of work to support my business and several others for many years within a reasonably small area and that current technology consists of using axes and hand saws to harvest the trees.
Let's say that, in a big picture sense, the money breaks down like this:
Costs are per tree.
buy the tree: -- $10
labor: ----------- $5
transportation: - $2
Supplies: --------$1
Net Cost: ----- $18
I sell each tree to the sawmill for $20, and net $2 profit per tree. My competitors have the same general numbers and skilled labor as I do.
Now lets say one of my workers dreams up the idea for a chainsaw and builds a sorta-working prototype at home on the weekends. I see the utility in his invention and borrow $500 to perfect it and build a couple that work reliably.
Using the chainsaws my workers can cut down twice as many trees in the same time. Now my numbers look like this:
buy the tree: -- $10
labor: ----------- $2.50 (half the labor per tree)
transportation: - $2
Supplies: --------$1
Net Cost: ----- $15.50
I still sell the trees for $20 so I now net $4.50 per tree instead of $2.
I can raise my bid to landowners to $11 per tree and still make more money than before. This extra profit ($1.50 per tree) will pay for the cost of the chain saws in the first 335 trees we harvest. After that it will become extra profit.
I can even lower the price I sell to the sawmill by $0.50 if I want and still pay off the cost of the chainsaws in 500 trees, at which point I can use some of the extra profits to pay my workers more money while still receiving more profit myself.
I will get more business than my competitors because they cannot afford to bid $11 per tree and maintain their profits even while my profits grow at that price. I will attract some of their workers to my business for more pay than they get now.
Eventually everyone will figure out what I'm doing and begin to copy it, if they can figure out how to make chainsaws. Some lumber cutters will lose their jobs as there won't be enough work to keep them all busy with the increased productivity a lot of chainsaws will support.
But they can go into business making chainsaws! Either they can start their own business or I will start one. This will put my extra profits to work improving productivity for other businesses too in areas farther away, lowering prices in a wider circle while increasing their profits just like I did.
The landowners will also have more money to spend. The sawmill will make more money with a lower cost of logs, so he can lower his prices too and still make more profits.
Everyone can afford to buy more lumber on their same old pay.
It becomes a mutually supporting system. Productivity improvements lead to higher profits and more opportunity to improve productivity elsewhere.
Saying that lower prices from productivity increases will destroy the economy is taking a very limited view of a small piece of the puzzle.
Lose a job hand building cars due to automation? Hey, figure out how to make better headlamps, or brakes, or tires and sell them to your old boss.
That's capitalism, use one successful improvement to begin a new improvement. Meanwhile, everyone benefits from the lower prices on products which are produced less expensively than before.
I disagree with the assessment on the predicted downfall of the dollar as a reserve currency. The worldwide meltdown has resulted in a much larger flight to US Treasuries than a flight from the dollar. Sure there was a lot of talk, but it was mostly that. Until someone (not a gold freak) can point out a safer currency, the dollar will be the default choice.
There isn't room to respond sufficiently here, but I would suggest you try reading through 'Human Action' by Ludwig von Mises.
You can download the book in .pdf here:
mises.org/humanaction/...
or peruse the table of contents here:
mises.org/resources/32...
I must warn you that this is a very long book (about 1,000 pages). The first three chapters are devoted to defining concepts which form the basis of the remainder of the text.
It covers a great many aspects of economics starting with the classic 'Robinson Crusoe on an island' scenario and building from that to a very complex economy in a systematic method that makes sense.
Plan to spend several weeks (it took me 6+) working your way through it, but you will learn a great deal if you persevere.
Given your comments and questions above I would guess you will eventually get to a point where the lightbulb goes on while reading and everything makes a lot more sense.
Smarty_Pants understands and uses both definitions and is referring to a potentially stable alternative money supply, while Jim Myrtle is referring to price deflation only and is using the example of the Great Depression which took place in the setting of an unstable money supply managed by the Fed and its fractional reserve banking system. The problem is that Jim Myrtle is using the example of the terrible deflation of the Great Depression as an example of what would go wrong with Smarty_Pants potentially stable alternative money supply, when it is very possible that a stable money supply would have prevented the rampant speculation that led to the stock market bubble, subsequent crash, and disastrous deflation.
In 1929, due to the immense amount of credit created under the Fed’s fractional reserve system, it was possible for a self-reinforcing deflationary spiral in the money supply to occur. When money = credit = debt, and credit is tightened, that is exactly what occurs, and it has occurred repeatedly since the establishment of the Fed, despite the Fed being established precisely to prevent such “business cycles”. It happened in 1929 and it is at risk of happening again in 2008/2009.
The Great Depression was certainly bad, but characterizing all price deflation as bad because of it is as wrong-headed as characterizing all price inflation as bad, because of the example of hyperinflation in Germany. Modest price deflation, due to productivity increases in an economy with a stable money supply is no more problematic than modest inflation and has nothing in common with the sharp monetary deflation that led to the Great Depression.
To give a realistic example of benign deflation in today’s world is very difficult, because we are all just so conditioned by perpetual inflation to think that prices always go up. But, to make it as simple as possible, just imagine a society that just farms and mines in the country and manufactures in the cities. If farm and mine productivity go up, food and mineral prices drop, but profits do not drop, because farm and mines sell more and their own costs drop. They have to eat, too. If they can’t sell all their product domestically, they can export. Also, the city factory margins improve because they are paying less for food and minerals; they can lower the prices of their products and keep wages stable simultaneously. Reduced prices for manufactured goods also improve farm and mine margins. Farm and mine wages can remain stable too.
The reason the Great Depression was so bad is that the price deflation was not the result of a beneficial increase in productivity in a stable currency regime; it was a catastrophic drop in the money supply due to a bank and brokerage credit freeze.
With our financial sector so screwed up at the moment, it is time that people learn that our monetary system isn’t some incomprehensible irreplaceable perfect system we cannot discuss or change. It is a private for-profit business cartel, not unlike OPEC, and it is not in business to help the average Joe.
Maybe a gold standard isn't the answer, but letting gold and silver circulate in parallel with the dollar as an alternative to legal tender paper would certainly be an interesting experiment. It's not the only alternative either, but this missive is too long already.
"The problem with fractional reserve banking is that the banker takes advantage of that trust for his own benefit by lending your money out multiple times and counting on the fact that enough depositors will leave enough money in the bank to cover all withdrawls.
A gold standard without fractional reserve lending would minimize this (some would try anyway, but be caught and imprisoned eventually) as it would not be allowed for any piece of money (gold) to have more than one claim on it at any instant. Since the banker can't "print" more gold they can't cheat the depositors for their own gain."
Technically, the banker's aren't doing this, the system as a whole is. When gold is lent to another person, the lender doesn't have a claim on that particular piece of gold anymore, the lender has a claim on the borrower, and/or on any collateral posted for the loan.
When the gold eventually gets redeposited in a bank, it's indistinguishable from a piece of gold that was, say, panned from a river and deposited. There's still only one claim on it, by the depositor.
Even there, the depositor gives up a direct claim on gold when he/she crosses the line from simply asking that the gold be stored, and agrees to lend out the gold, or have it lent, in exchange for interest. The depositor is now in the same position as the bank with respect to lending out gold - he has a claim on the bank, or the bank's collateral, but not on the gold per se. The depositor has, in effect, become a lender, without a direct claim on gold. The bank may well have collateral, in the form of a loan portfolio, to back up the depositor's claim. The depositor could, of course, have lent his or her gold directly to a borrower, and the state of affairs would, in the aggregate across the entire system, be no different.
Why then have the bank as an intermediary? It strikes me that the bank serves several economically useful functions in this example:
1. It serves, system-wide, to pool risk, so that no single depositor is exposed to a single bad loan. This is similar in principal to the economic value provided by insurance.
2. It is more efficient to centralize (for a fee, of course) the function of checking the credit of borrowers, servicing loans, and collecting on bad loans.
3. It allows for a decoupling of maturities that is useful but potentially dangerous - namely, it allows a large enough number of short-duration deposits to fund a smaller number of long-duration loans.
It's point (3) that you seem to argue most strongly against, so I'd like to drill into it. I'll assert that people need a goodly amount of gold in relatively short-duration deposits to fund day-to-day and month-to-month activities. In fact, there may be more gold of this sort in a large economy of relatively small actors than there is gold in the hands of very wealthy actors able to directly make investments or long-duration loans. Banks can make these short-duration deposits available for loans that almost always have longer duration, relying once again on pooling to ensure that demands are met with a smaller amount of gold kept on reserve. This is economically valuable because more worthwhile projects can be funded through loans, benefitting both the borrowers and, through the interest they earn, the depositors as well. The depositors must agree to this, of course - otherwise they can still choose to earn no interest by simply stockpiling their gold and making it unavailable to the pool. This system of using short-term money to fund long-term projects is obviously inherently unstable - as has been discovered many times, including recently, it depends on pool statistics, and is vulnerable to runs. Society has decided that this economic function of banking has enough value that we don't want to lose it, and so we have various mechanisms for preventing runs, namely government insurance on the deposits coupled with reserve requirements and regulations regarding prudent lending practices. Sadly, this last bit has been neglected recently. The old rules for trying to support this included having depositors wait for their withdrawals and allowing banks to call in loans. These rules were found to have disastrous consequences in the 1930s, so we abandonded them.
So either we forgo the economic benefits of (3), or we find a better system than the one we have now. If there's one in the book, I'll be glad to read about it. All I know now is that (3) appears to have benefit (I personally benefit from it as both a depositor and a borrower), and the current set of rules to fix the inherent vulnerability is better than what we had in the past.
All actors in the economic system will have to have a certain amount of gold to meet necessary short-term transactions. Small actors will have enough gold for a few days/weeks/months of food/rent/energy, large actors will have enough gold to meet their next payroll run, fund major purchases, or whatever. The problem is, there's not enough gold to support the one-to-one claim. In the distant past, perhaps, but the rate at which gold is being mined is much slower than the rate of economic growth. Even if productivity improvements cease, the rate of increase in the population ensures that the gold supply is eventually going to be challenged.
What happens when the supply of gold isn't keeping up with the economy? Lots of bad things. At first, the value of gold relative to all other goods and services goes up. This takes the form, eventually, of ever-decreasing wages and prices. Actors in the system early on benefit because their gold buys more and more. New actors have some trouble, though. What's worse, everyone can now see that by waiting, the value of everything relative to gold goes down. People begin to defer their consumption, holding their gold to buy things later. This reduces economic activity, eventually causing some actors to become unemployed. The potential wealth they might have created is lost - their time is a wasting asset similar to an unsold hotel room or airline seat. Things are worse still for debtors, who discover that they must pay back their loans in increasingly hard-to-obtain gold. People stop borrowing, knowing they cannot pay back, and so worthwhile projects begin to go unfunded. Lenders discover that simply storing their gold earns a better return than funding projects that might improve productivity, in terms of the goods and services that can be claimed later. Of course, huge numbers of people and resources are thrown at the gold-mining industry in a futile effort to wrest more gold from the earth, effort that is disproportionate to the actual value of gold as a commodity. This economy spirals down until people eventually get the gold monkey off their backs. At first, they begin to barter goods and services, bypassing the gold mechanism entirely. This is of course very inefficient, and so they begin to use IOUs backed by either assets or future productivity of known actors in lieu of gold. Eventually they realize that they could have kept the gold-based standard of measure for money but without restricting the supply of money to the physical amount of gold available, simply by allowing the gold necessary for short-term transactions to be lent out.
Further, if several countries would adhere to a gold standard, we would immediately have a world currency. Any country could join unilaterally, without approval by some central body and restrictions.
I fail to see the disaster imagined by the author.
don't adopt a gold standard unless you want to create a lot of pain & suffering.
as a standard of value, uranium has real value. gold is for jewelry, including your teeth.
> jack
"Saying that lower prices from productivity increases will destroy
the economy is taking a very limited view of a small piece of the
puzzle"
Where do you imagine I said anything like this?
Using your example, pretend prices were deflating 3% a year, because the money supply wasn't keeping up with GDP growth. Your $500 loan was at 5% and was 9 years interest only with a balloon payment in the 10th year. The first year your interest payment was $25. The second year the equivalent of $40, third year $55, fourth year $70, fifth year $85, sixth year $100, seventh year $115, eight year $130, ninth year $145. The last payment is $160 in interest and $672 in principle.
The trees that you sold for $20 at the end of the 10 year period only sell for $15. The loan that cost you $500/$20, 25 trees on day one cost you $672/$15, 45 trees in year 10.
Now, the mill that buys your trees makes lumber for the housing industry and for Home Depot, Lowes etc.
The retailers don't want to finance inventory that loses 3% in value every year, so they reduce purchases by 20%, to work off inventory. The housing industry shrinks as well, who wants to buy a house that will be 3% cheaper next year, 6% cheaper the year after that. Banks refuse to finance homes with less than 20% down.
Your mill goes out of business. The nearest mill is now 200 miles further away and your cost to transport the trees doubles. Demand for your lumber drops 50%. Your increased efficiency may leave yours as the last remaining lumber harvesting business, but the economy is killing your business too.
Do you understand why lower prices due to shrinking money supply (vs. GDP growth) are bad while lower prices due to increased productivity are good?
On Dec 31 12:24 AM Smarty_Pants wrote:
You could be "technical" and say we were "suffering" 1% inflation, but all people care about is the impact that 1% "inflation" has on prices, in this case it causes them to fall 2% a year.
And you can pretend that there was no inflation or deflation (in prices)while we were on the gold standard, before the Federal Reserve was created, but you'd be wrong.
On Dec 31 01:21 AM asleeper wrote:
Smarty_Pants understands and uses both definitions and is referring to a potentially stable alternative money supply, while Jim Myrtle is referring to price deflation only and is using the example of the Great Depression which took place in the setting of an unstable money supply managed by the Fed and its fractional reserve banking system. The problem is that Jim Myrtle is using the example of the terrible deflation of the Great Depression as an example of what would go wrong with Smarty_Pants potentially stable alternative money supply, when it is very possible that a stable money supply would have prevented the rampant speculation that led to the stock market bubble, subsequent crash, and disastrous deflation.
On Dec 30 11:43 PM Smarty_Pants wrote:
The problem with fractional reserve banking is that the banker takes advantage of that trust for his own benefit by lending your money out multiple times and counting on the fact that enough depositors will leave enough money in the bank to cover all withdrawls
> "In summary, crookery and financial deviousness becomes nothing more
> than a farce, and those running the show are but charlatans. It is
> not suppose to be this way. As other posters pointed out more succinctly,
> money is based on trust. If there is no trust it doesn't matter what
> money is based or backed on because the accounts won't match up no
> matter how you calculate them." - constructe
>
> Very true. The entire economy is based in trust at some point unless
> everyone is completely self sufficient. Does your employer pay you
> every day? No? You are trusting that he will pay you at the end of
> the pay period then, aren't you? Otherwise you would think that you
> are working for free.
>
> When you pump gas into your car either the station attendant is trusting
> you to pay after you pump, or you are trusting him to properly charge
> your credit card after you swipe it (before you pump).
>
> Division of labor requires trust. The problem with fractional reserve
> banking is that the banker takes advantage of that trust for his
> own benefit by lending your money out multiple times and counting
> on the fact that enough depositors will leave enough money in the
> bank to cover all withdrawls.
>
> A gold standard without fractional reserve lending would minimize
> this (some would try anyway, but be caught and imprisoned eventually)
> as it would not be allowed for any piece of money (gold) to have
> more than one claim on it at any instant. Since the banker can't
> "print" more gold they can't cheat the depositors for their own gain.
> This puts a firm lid on starting and inflating manic behavior in
> the market.
>
> Besides, physical exchange would give depositors the power of a bank
> run. This is an important means of keeping banks in line.
>
>
> PS. Those who wish to claim that banking was on the gold standard
> for the great depression are only partially correct. When the FED
> was established in 1913 they started printing more paper money than
> there was gold to cover (much smaller amounts than today).
>
> This is what fueled the Roaring 20s, excess money that was unbacked
> by gold and loaned into the economy. This was the first FED induced
> economic bubble whose deflating led to the Depression when tariffs
> were raised and even more money printed and spent on public works.
> The Great Depression was a deflating bubble just like our financial
> crisis today is.
>
> Even though we were officially on the gold standard with convertibility,
> the banks were using fractional reserve banking to blow a bubble.
>
Just to clarify, my example rests on the idea that the money supply is stable (ie. gold backed and no fractional reserves). I think my use of $ in the example may be leading people off on a tangent.
While my example shows that prices on goods would decrease, it also shows that the improved productivity allows me to pay my workers more, not less because my profits are increased.
Think of wages as being paid in gold, not $ (ie. 1 oz./ week).
Substitute some symbol for gold money instead of $, then you will see that as productivity gains outpace increases in the supply of gold, the same income will buy more stuff.
I will be able to pay my workers 1.1 oz/week instead of 1 oz/week due to productivity gains, while my business profits increase at the same time. Meanwhile the price of lumber (in gold) drops by 2%. My workers are much better off as long as I can keep them employed harvesting timber (ie. while demand for timber continues).
What logic do you use to deduce lower incomes for the workers? My example shows that I can afford to pay them more after productivity gains. If that pay is measured in gold, then their standard of living increases with increased production and the lower prices it brings, even if they continue to earn 1 oz/week instead off 1.1 oz/week.
Jim: I would make a similar argument for your comments. Think in terms of weight in gold and not dollars. Reprice everything in my example in terms of gold weight.
My loan payments, and interest, will be paid in gold. Granted, an ounce of gold tomorrow will buy more than it will today due to lower prices brought about by productivity gains, but I do all of my calculating in weights of gold.
If my effective payment cost due to lower prices increases by 3% annually as you suggest, but my profits increase by 50%, isn't that a good deal for me? The extra 50% of profit in year #1 is gaining in purchasing power by 3% per annum as well. If my initial annual profits exceed a gold equivalent of $1000 then I will GAIN over time because the extra profits will gain more in purchasing power than my payments cost me in purchasing power.
Let's extend my above Example and use weights of gold for everything:
Assume my original pre-chainsaw profits were 100 oz of gold annually and that my loan was for 10 oz of gold to 'upgrade' to chainsaws with a 10 year repayment plan of 1.1 oz/year (that's higher than 5% interest but it makes calculations easier).
Now after productivity improvements, my workers earn 10% more in gold, my landowner earns 10% more in gold, the sawmill saves 2.5% in gold on cost of logs, and my profits still increase by 50 oz of gold annually.
Let's look at my end results year by year and adjust for the effects of deflationary pricing at 10% annually (again for ease of calculation though it should exacerbate any problem you posit). The 'base' columns are the purchasing power in first year terms to account for price deflation.
--------------Base----...
Loan-------Equiv------...
Pmt---------Pmt-------...
-1.1 ------ -1.1 ---------- +50 ---------- +50 --------- +48.9
-1.1 ------ -1.2 ---------- +50 ---------- +55 --------- +53.8
-1.1 ------ -1.3 ---------- +50 ---------- +60.5 ------- +59.2
That's the first three years of my net result. Did the payments on my loan 'cost' me more in purchasing power? Sure did. But the gain in purchasing power of my extra profits far exceeded thoses losses.
I will happily pay that 1.1 oz of gold on the loan if it realizes 50 oz of extra profits each year. I am getting ahead faster and faster because my profits are increasing in purchasing power more than my payments are costing me in lost purchasing power.
At the same time:
1) my workers have a 10% increase in (gold) wages whose purchasing power is increasing every year;
2) The landowners have received 10% more for their timber whose purchasing power is increasing every year;
3) the sawmill is buying his logs for 2.5% less in gold, which he can split between lower his prices and increasing his profits.
4) Anyone who buys lumber will save by the amount the sawmill lowers prices.
Everyone involved is getting more gold out of the deal because of my productivity improvement, either through higher pay, larger profits, cost savings due to lower prices, or some combination of the three. Even the sawmill is making bigger profits because of MY productivity improvement.
Jim's other comment is an over-exaggeration:
"The housing industry shrinks as well, who wants to buy a house that will be 3% cheaper next year, 6% cheaper the year after that."
Well, computer prices today continue to fall rapidly for the processing power you buy. Are you implying that nobody will buy a computer this year because they know they can get a better deal next year? Same for cell phones or iPods or plasma tvs?
NO! Some people may wait, but most will buy because their time preference is such that they would rather have something NOW than wait a year to buy it 3% cheaper. The market will adjust to the demand for the products just like it does now.
Will an increase of purchasing power reduce sales? Probably some, but sales won't stop. If they did, then Dell would be out of business today rather than selling $billions of PCs every year.
Jim also stated:
"The trees that you sold for $20 at the end of the 10 year period only sell for $15."
No, they sell for a given weight of gold. That 'price' will be determined by supply and demand. If demand for lumber falls, the sawmill may only be willing to offer 15 gold weight units, but if I cannot buy, cut, and deliver the logs for less than that price I would decline to participate, closing down my business if things got that bad. Why continue if it costs me 16 gold weight units to produce something I can only sell for 15 gold weight units? That's how business works now. No profit, no deal.
However, the sawmill may also be improving productivity via better machinery and be willing to increase what it pays for logs, just as I was able to increase my payment to landowners. If the sawmill's improvements will generate larger profit margins it will be willing to outbid other sawmills to get more business and make extra profits from more volume.
Actually they can make a loan of $1000 with it. Which, if that loan is redeposited into the same bank, they can make another loan of $1000 against. If every loan is redeposited they can loan up to $2,000,000 in that fashion, at which point they will hit the 'exemption limit'.
It would work the same way if the original $1000 loan were deposited into a different new bank (as the only deposit). That bank could loan the entire $1000 out as well. If each loan is deposited in a different new bank as the only deposit, each iteration could lend $1000 against the new deposit. An infinite amount of loans could, in theory, be created based on the original $1000 (and a whole lot of new banks).
Until somebody tried to remove some money from one of the banks. Then the system would start to unravel and a huge monetary deflation would occur (decrease in the supply of money deflation, not lower prices).
Beyond the $2 million mark in deposits (assuming all loans are deposited in the same bank) they can only lend out $970, then $940.9, etc. decreasing by 3% each iteration until the 'low reserve' limit of $25 million in deposits is reached or the loan amount becomes so small as to be considered a loan of $0.
www.federalreserve.gov...
Col 1 is nominal loan payment
Col 2 is deflated loan payment
Col 3 is nominal profit
Col 4 is deflated profit
Col 5 is deflated net
As you can see the purchasing power gains of my extra profits easily outweigh the purchasing power losses of my payments and will increasingly do so over time.
That doesn't change my point. The gold you use to repay your loan gets more valuable each year, increasing the real interest rate of your loan.
"If my effective payment cost due to lower prices increases by 3% annually as you suggest, but my profits increase by 50%, isn't that a good deal for me? "
You bet.
"Jim's other comment is an over-exaggeration:
"The housing industry shrinks as well, who wants to buy a house that will be 3% cheaper next year, 6% cheaper the year after that."
Well, computer prices today continue to fall rapidly for the processing power you buy. Are you implying that nobody will buy a computer this year because they know they can get a better deal next year?"
Are you implying a computer purchase is equivalent to a home purchase? Did you take out a 30 year mortgage when you bought your last Dell?
"Jim also stated:
"The trees that you sold for $20 at the end of the 10 year period only sell for $15."
No, they sell for a given weight of gold. That 'price' will be determined by supply and demand"
But the supply and demand of money works the same way. If output increases 3% and money supply remains the same, prices must fall 3% on average. Obviously some will fall more, some will fall less and some will rise. But on average, down 3%.
When housing collapses, will lumber fall 3%, or 20% or 50%?
And forget your massive productivity increase for a moment, what about firms that have to make huge investments, just to maintain current output or to make very small productivity gains?
What about GM? Will they be more likely to stay in business if they had to reduce prices each year? Would car sales fall if people could wait knowing prices would drop?
"If demand for lumber falls, the sawmill may only be willing to offer 15 gold weight units, but if I cannot buy, cut, and deliver the logs for less than that price I would decline to participate, closing down my business if things got that bad. Why continue if it costs me 16 gold weight units to produce something I can only sell for 15 gold weight units? That's how business works now. No profit, no deal"
Exactly, even with your productivity rising, demand crushing deflation could even make your firm unprofitable.
On Dec 31 11:25 AM Smarty_Pants wrote:
On Dec 31 11:40 AM Smarty_Pants wrote:
> "If a brand new bank opens today and I make the only deposit of $1000,
> how much do you think the bank can loan?" - Jim Myrtle
>
> Actually they can make a loan of $1000 with it.
On Dec 30 08:56 AM archman82011 wrote:
> Return to the gold standard would mean one thing:
>
> Accountability.
>
> We can't have that now can we? That means if we have accountability
> in our finance system, we have to have accountability in government.
> If we have accountability in government, that means our citizens
> have to be more accountable, and return to an ethical and moral country.
>
>
> We can't have that though. That means minimal corruption, less graft
> and greed. Our country would have to do what is best for the majority
> instead of what is best for the select few.
>
> Good golly we can't have that now can we????
>
>
The principle is the same, however given the size of the purchase the difference in absolute price would be much larger for a house as you note. I would add that under a fully gold backed, no fractional reserve system there would be very few mortgages.
Most 'unused' money would be directed toward productive uses where payments could be funded from profits the loan generates. There's no profit in owning a home, so the homeowner doesn't really have a means of out-bidding a commercial borrower who expects to realize a return on the loan.
Any home mortgages would either be family funded (ie. fully owned family farm 'sold' to #1 son for stream of payments until bequeathed at death of parents) or from personal friends who had the money.
I would guess that most homes would be purchased for cash and funded by savings. It would certainly be a different world.
"what about firms that have to make huge investments, just to maintain current output or to make very small productivity gains? "
They would likely be shut out of the credit markets for lack of ability to outbid competing borrowers with high interest rates. If they can't make a profit without the loan, then they would fail and go under for lack of sufficient consumer demand (or poor management).
The market is a harsh place. A financial 'law of the jungle' applies. Compete and win, or die. The judges are consumers and their wallets.
"What about GM?"
GM deserves to go under even with our current fractional reserve, fiat monetary regime. They have squandered billions and have nothing but debt to show for it. They would fail without question in a gold backed, non fractional reserve system unless restructured from the ground up.
As for prices of anything and everything presuming a transition to a gold backed, non fractional reserve system, I will agree that there will be enormous discontinuities that occur. Homes will be foreclosed, businesses will go under, bond holders will lose everything, etc. etc.
But that's what we're getting now, and we're repeating the actions which brought us to this point on a larger scale to 'prevent' it. Things will only be worse at some point in the future if we continue as we have been.
If we're going to suffer those problems anyway, why not make the final goal a stable system like a gold backed, non fractional reserve system?
"The principle is the same, however given the size of the purchase the difference in absolute price would be much larger for a house as you note. I would add that under a fully gold backed, no fractional reserve system there would be very few mortgages"
That should help you sell your idea to the public. LOL!
what about firms that have to make huge investments, just to maintain current output or to make very small productivity gains?
"They would likely be shut out of the credit markets for lack of ability to outbid competing borrowers with high interest rates. If they can't make a profit without the loan, then they would fail and go under for lack of sufficient consumer demand (or poor management)"
What do you imagine unemployment would be in your deflationary world?
"GM deserves to go under even with our current fractional reserve, fiat monetary regime"
I agree, GM must restructure or die. But there are tens of thousands of much better run businesses that would be crushed by a long term deflationary environment.
"As for prices of anything and everything presuming a transition to a gold backed, non fractional reserve system"
I still don't understand why you think we can have a 100% reserve system. Even under a "pure gold & silver standard" we had fractional reserve banking. Why would it be different now?
" I will agree that there will be enormous discontinuities that occur. Homes will be foreclosed, businesses will go under, bond holders will lose everything, etc. etc.
But that's what we're getting now, "
Doctor, the patient has an irregular heart beat....quick, use this gun, maybe inserting a high speed bullet will help.
"and we're repeating the actions which brought us to this point on a larger scale to 'prevent' it"
The actions which brought us to this point were government regs to force unsound loans. Wall Street "innovations" to make these crappy loans "safe" and a reach for yield that made these MBS appear desirable.
Do you really think banks are eager to make risky loans today? People are eager to buy high yielding MBS?
"If we're going to suffer those problems anyway, why not make the final goal a stable system like a gold backed, non fractional reserve system?"
Not enough gold in the world. Not enough new supply to keep a large economy liquid and growing. It didn't work before, it really won't work now.
More like:
1st Mate: "Captain, the ship is taking on water and the pumps can barely keep up."
Captain: "Keep pumping and change course toward the nearest land mass and start plugging the holes." instead of "Drill more holes in the hull to let the water out and head out to open ocean."
One other item which enabled the mess today has been the extreme use of fractional reserve lending for leverage to fund all the crappy loans, etc. Absent the ability to make loans based on nothing there wouldn't have been enough money to drive the housing bubble to such insane heights.
"Not enough new supply to keep a large economy liquid and growing. It didn't work before, it really won't work now."
1) The US went from agrarian backwater in 1800 to financial superpower by 1900 with an exchangable, fully backed gold based monetary system and we still held less than 20% of all the gold ever mined. Free markets and {semi-} sound money (see below) worked wonders without incurring huge amounts of public debt except during wars.
2) Even under the prior gold system private banks were allowed to issue fractional reserve loans, so you can't say "it didn't work before" because it really hasn't been tried since the onset of the industrial revolution and the birth of 'modern' capitalism. All of the 19th centuries 'panics' can be traced to excessive lending via fractional reserve banking at private banks and the eventual unwinding of those loans gone bad.
Adding new liquidity is the difference between trying to pump the water out and scuttling your ship immediately.
"The US went from agrarian backwater in 1800 to financial superpower by 1900 with an exchangable, fully backed gold based monetary system"
Imagine how much better we would have done without the periods of crushing deflation.
"Even under the prior gold system private banks were allowed to issue fractional reserve loans, so you can't say "it didn't work before" because it really hasn't been tried since the onset of the industrial revolution and the birth of 'modern' capitalism"
So explain again how 100% reserve banking would work.
"All of the 19th centuries 'panics' can be traced to excessive lending via fractional reserve banking at private banks"
Since there were no "public" banks, why use the word "private"?
On Dec 31 03:24 PM Smarty_Pants wrote:
Proposed 100% Reserve, Equity Backed Money and Banking Model
Comments welcomed and appreciated.
mb
The only reason those periods had "crushing deflation" was because banks first created money out of thin air via fractional reserve lending and issued it into the economy, thereby inflating prices above prior levels due to the extra money created. The "crushing deflation" was an unwinding of the effects of fractional reserve lending.
"Crushing Deflation" that results from liquidation of fractional reserve based loans is very much different than lower prices brought about by improvements in productivity. What we saw in the 19th century and are experiencing today was/is the former, not the latter. Under a gold backed, non fractional reserve lending system you wouldn't get the former, just the latter as in my logging example.
Please identify which party in my example was "crushed" by the deflation my productivity improvement brought about. Was it the workers who got a 10% raise and increasing purchasing power? Or the landowner who got 10% more for his trees? The sawmill who saved 2.5% on the logs I sold him? The consumer who could purchase lumber for less? Or was it me, whose profit increased by 50%? None of those were harmed at all and in fact all gained by my improvement.
The only parties who were adversely impacted were the hired workers whose labor was rendered unecessary through the use of chainsaws. But even they had a ground floor opportunity to get into the business of producing the latest 'high tech' tool in the chainsaw, where margins would be high for some time.
I see no party who does not have an opportunity to get ahead. Can you identify one from the example? Every person winds up with more money than they got before the improvement and that money has more purchasing power. How is that being 'crushed'? Or do you just like using the phrase "crushed by deflation" without any specifics?
From steady state conditions before the improvement to steady state conditions after the improvement, the parties wind up better off, not 'crushed'.
I too wish to avoid 'crushing deflation' but I believe in order to do so you must first remove fractional reserve based growth in the money supply in order to prevent the prior inflationary bubbles which then 'deflate' as the debt is liquidated.
"Since there were no "public" banks, why use the word "private"?"
By 'private' I mean independent and not part of the Federal Reserve system. Prior to the FED's establishment, each bank could (and did) issue its own currency based on it's deposits. They chose their own reserve ratios as decided by the owner(s) of the bank.
There was no 'lender of last resort' to paper over a shortfall exposed by a bank run like the FED does today. The bank was responsible to its depositors and required to provide exchangability for its notes. The fact that they were on their own in this regard is what greatly limited the fractional reserve lending they undertook (compared to today).
Even at the height of the bubble in 1837 the average bank had issued only $1.8 in notes for every $1 of gold, averaging 55+% reserves. This was the "towering" peak from which your "crushing deflation" took place under the gold standard. Hardly a molehill compared to today's <10% reserve levels.
Tell me again, how is it that the gold standard's "crushing deflation" with 55% reserves is worse than the "crushing deflation" the Federal Reserve system has foist upon us with less than 10% reserves?
Seems to me that the fiat standard is doing far more in the way of "crushing" than the gold standard ever did. There are certainly a lot more unbacked loans to liquidate now than the gold standard ever created, more than 4x as many. That's a lot of crushing.
mb
Once more time.
Enjoy your New Year's celebration everyone.
Drive safely and watch out for the dummy who isn't.
See you next year.
Why would banks want to create money out of thin air? Why would there be demand for this "thin air" money? Is it possible the economy was growing faster than the gold supply?
"Please identify which party in my example was "crushed" by the deflation my productivity improvement brought about"
Instead of a 50% increase in productivity, why not make a more realistic assumption? How about 100% or 200% increase in productivity?
Let me say it again, increased productivity is great. Lower prices from increased productivity is great. Lower prices because you strangled the money supply, not good. Shrinking GDP, because you're choking off money supply, not good.
"Even at the height of the bubble in 1837 the average bank had issued only $1.8 in notes for every $1 of gold, averaging 55+% reserves"
Even under the gold standard, we had fractional reserve lending.
So explain how 100% reserve banking would work.
"Tell me again, how is it that the gold standard's "crushing deflation" with 55% reserves is worse than the "crushing deflation" the Federal Reserve system has foist upon us with less than 10% reserves?"
The Panics we had every 10 years or so resulted in huge drops in GDP, much worse than the recessions we've had since the Great Depression.
Second, as Churchill said about democracy, the U.S. is very probably still the only economic game in town because all the alternatives are worse.
China is a tempting dream but only a dream as you probably know already.
Europe has proven, and continues to prove, that it can never unify under any banner, whether it is spelled Hapsburg, Hitler, de Gaulle or Euro.
What does that leave us? Russia?
At present, America is going through a similar dislocation that the technological advances of the 1920s and 30s produced during the Great Depression, as far as I can see, and we'll feel the consequences for some time before we learn to live in this brave new, and constantly changing, technological world.
In the meantime, work less and work at home and learn to love it. The leisure that technology promised to give us for so long is finally here.
It's up to us to make use of the new opportunities for happiness and not run into the street and shoot guns at each other out of confusion, fear and boredom, the way we have in the past.
(By the way, gold is excellent for filling teeth with. Tell your dentist about it if he hasn't heard yet.)
First, deflation and inflation are at all times, as Milton Freedman said, a MONETARY phenomenon. Here is the fractional reserve banking model in a nutshell:
1. Create money from NOTHING. This is inflation.
2. Loan it out for interest.
3. As the loans are repaid, the money goes goes back to NOTHING. This is deflation.
So, the only thing needed to cause deflation in our economy is for the banks to lend new money at a slower rate than old loans are repaid. Now a look at MV = PY:
M = total money supply
V = average no. transactions per year
P = price level
Y = aggregate output
An increase in Y, aggregate output, for constant MV must cause a drop in P, the price level to keep the equation balanced. This is normal progress. All to the good. But now look what happens when M drops (deflation):
A decrease in M (total money supply) must cause PY to decrease by the same amount to keep the equation balanced. Y is aggregate output and is relatively insensitive due to inertia. Thus we expect P, the price level, to drop one for one with M. Is this bad? Not permanently as long as production costs are allowed to drop too. But can they? Not always, as in the case of wages, which tend to be "sticky" as someone once said. So what happens instead is that marginal production is reduced to keep cost per unit in line with the new price level. This would involve layoffs of marginally productive employees. So Y, aggregate output, now drops by the reduction of marginal production. Also, as might be expected, V must drop too since both P and Y have now decreased to keep the equation balanced.
So, simply a decrease in the the rate of new FRB loans can cause a drop in aggregate output. This is the economy running backward. The culprit is FRB which must deflate eventually to prevent runaway inflation.
First off, my example was a 100% increase in labor productivity, doubling the number of trees in a given time.
Secondly, you ever try to chop down a tree with an axe or a hand saw? You can easily cut the time in half using a chain saw, especially when you consider the amount of time it takes to limb the fallen tree. In the example my 100% increase in labor productivity is probably on the conservative side, based on personal experience.
"Why would banks want to create money out of thin air? Why would there be demand for this "thin air" money? Is it possible the economy was growing faster than the gold supply? "
If what you're trying to suggest is that the economy is "strangled" BY DEFINITION whenever the amount of goods is growing faster than the money supply, then I disagree, and so did Murray Rothbard who believed that expanding the money supply at a fixed rate equivalent to the underlying growth rate of the economy can't work because it requires impossibly precise assumptions.
How does your local banker know whether there's "enough" unbacked credit based fractional reserve money in circulation to match GDP growth when someone comes in to get a loan at his bank? GDP numbers aren't released until well after they are measured, only released now and then (ie. not daily), and they are often revised after the fact.
If a banker makes a loan when there have already been "too many" made for the amount of growth in GDP, how do you get that money back out of circulation to prevent inflation? Multiply those issues by tens of thousands of bankers. How do they coordinate to limit the amount of loans they issue to "match" GDP growth when they have no way of knowing what that growth is at any point in time?
Seems to me that it's easy to say money supply should match GDP growth, but it's not really possible to do so in reality. Everyone will issue the loan if there's any doubt. Err on the side that makes the bank money. It turns into a loan-fest and degrades into the maximum money creation at whatever the minimum reserve requirement is set at for every bank, regardless of GDP. This is how bubbles are created.
No offense, but I'll side with Rothbard unless you can persuade me otherwise.
"Lower prices because you strangled the money supply, not good. Shrinking GDP, because you're choking off money supply, not good."
How is having a relatively constant supply of money "strangled"? How exactly in my example is the 'strangled' money supply shrinking GDP?
The supply of money is the same from beginning to end, yet it will support the purchase of more goods at the end than at the beginning. Is that not a larger GDP? Even if the GDP (amount of purchases) remains the same the economic actors will have more money left over after the purchases than they would have prior to the use of chainsaws.
Hmmm. Buy the same amount of stuff, have money left over, OR, spend the same amount of money and get more stuff.
Where exactly does this 'strangling' happen? I don't see it. Let's hear the specific details in relation to my example instead of vague claims of a 'strangled money supply'.
"Even under the gold standard, we had fractional reserve lending."
Yes, and that's what produced the overextended monetary conditions that led to the 'deflating' money supply in the periodic panics. That's also the reason why I believe that a non fractional reserve system is also necessary in addition to a gold backed standard. To prevent over expansion of the money supply and burdening the economy with excessive and unbacked debt which needs to be unwound via liquidation.
The reason there were periodic deflations under the gold standard was because fractional reserve lending was used. Unbacked money was 'created' and loaned into the economy and spent non-productively. The borrower "wasted" the money, and then couldn't service the underlying debt, which had to be liquidated.
No unbacked credit based money = no liquidation = no deflation.
For details on how a gold backed, non fractional reserve system would work see my previous comments with regards to fixed duration, non redeemable Certificates of Deposit for making loans of personal savings.
Best wishes for the New Year.
On Dec 31 08:01 PM moonbat1775 wrote:
Here is the fractional reserve banking model in a nutshell:
1. Create money from NOTHING. This is inflation.
I'm sure you know the formula, MV=PY
If M and V remain constant while Y increases, P must fall. Not a problem for you, your productivity just doubled. It is a problem for someone who needs to borrow heavily while their output drops in price.
Farmers after the Coinage Act of 1873 were especially hurt.
As prices continually fall, assuming M remains constant, V can also decrease. This can cause Y to decline, even as prices fall further.
Difficult to get out of a deflationary spiral once it starts. See pushing on a string. Or Japan in the 1990s.
"For details on how a gold backed, non fractional reserve system would work see my previous comments with regards to fixed duration, non redeemable Certificates of Deposit for making loans of personal savings"
Interesting idea, but that sounds like zero reserve banking.
Happy New Year to you as well.
I always enjoy an interesting discussion.
You admitted housing would suffer, not to mention any sector that requires lots of capital with little chance for large productivity gains (think utilities, as just one example).
On Dec 31 08:39 PM Smarty_Pants wrote:
Any method that allows money to be in two places at once creates money. For instance, with a 10% reserve requirement, a bank can loan out 90% of its depositor's money while retaining a 10% reserve. Since the depositors money is available on demand, the bank has thus nearly doubled the money supply of the bank. That 90% can be deposited in another bank and 90% of that 90% lent out (81%) and so forth. With a 10% reserve requirement, ten times depositors account balances can be lent out. See why we don't have many savers? Who needs them anyway with leverage like that? And FRB drives down the interest rates savers would be paid, thus discouraging them and encouraging them to get loans themselves and speculate. The whole purpose of FRB is to BYPASS the need for savers.