Below I have excerpted 2 paragraphs from a Henry Hazlitt article (Gold Versus Fractional Reserves) that I had no problem following (I am new to Austrian Theory) till I got to the second of these two paragraphs. (I am including the paragraph above the one that I don’t understand, so that whoever can help me out here, has some context.)

It is the last three sentences of the second paragraph that give me trouble. If you’d like to help, please respond to the blog (others would appreciate the help I’m sure, as well as to my email address trund@optonline.net)

Here are the two paragraphs, and my questions follow……….

The World Adrift in Turbulent Seas of Paper Money – Henry Hazlitt
My chief concern in this article has been to show that in addition to being the principal institution responsible for bringing about the cycle of boom and bust that has plagued the civilized world since the early nineteenth century, the fractional-reserve standard, once its principle of “economizing the use of gold” has been fully accepted, itself encourages an inflation that has no logical stopping place until gold has been “phased out” altogether, and the world is adrift in the turbulent seas of paper money.
In emphasizing this weakness of a fractional-reserve standard, I do not intend to imply that I have solved the baffling problem of creating an ideal money — assuming that that problem is even soluble. An opportunity now exists — for the first time in a couple of centuries — to introduce a 100 percent gold reserve standard. But if sufficient new gold supplies were not regularly available, such a standard could conceivably result, over time, in a troublesome fall in commodity prices. Moreover, unless there were rigid prohibitions against it, a private no less than a government money would soon tend to become a fractional-reserve standard. And if we allowed this, would we not soon be on the road once more to a constantly diminishing fraction, and at least a constant mild inflation?
———————————————-

Without explaining WHY Hazlitt assumes that
“….if sufficient new gold supplies were not regularly available, such a standard could conceivably result, over time, in a troublesome fall in commodity prices.”

My question is, “so what?” Am I missing something here? If prices should drop, eventually people will come in and gobble up the “cheap” commodities. And the “gold supply shortage” that Hazlitt laments, is the same for all of us. If that’s our currency, so be it. It hits us all. When and if gold is found, it will be adjusted into our money supply’s buying power, and prices will simply adjust. Also, if there is not enough gold to keep our transaction economy going, I’m sure silver or some other item(s) that can serve as a safe haven for future transactional power, will fill the void. Again, I don’t see why Hazlitt has this as a problem.

Next…….from Hazlitt’s last two lines:

“…Moreover, unless there were rigid prohibitions against it, a private no less than a government money would soon tend to become a fractional-reserve standard. And if we allowed this, would we not soon be on the road once more to a constantly diminishing fraction, and at least a constant mild inflation?”

Something is very wrong here with Hazlitt’s reasoning. It’s the “rigid prohibitions” that Hazlitt proffers that would certainly ensure a monopolistic (or oligopolistic) stranglehold on what would pass for “honest money”, but would in the end degenerate into prostituted money as in generations past. To me, it seems that there ought to be NO prohibitions as to who is in the private minting game, thereby ensuring that competition among mints trying to get consumers and sellers to use their “product” will keep their “money honest”.

Thanks in advance,

Ted Rund

A gold standard using gold by weight will solve all our monetary problems.

This should give you guys some insight on how / why a pure gold standard isn’t the way to go.

Reason: To avoid inflation, your prescription has been to advocate that monetary policy be pursued with the goal of maintaining stability in the value of money. Is it necessary to trust the politicians to regulate the money supply? Can’t market forces adjust to correct for a gradual deflation?

Hayek: Yes, they do occasionallv. The trouble is, in the mechanical system what forces politicians is the gold standard. The gold standard, even if it were nominally adopted now, would never work because people are not willing to play by the rules of the game. The rules of the game that the gold standard requires [say] that if you have an unfavorable balance of trade, you contract your currency. That’s what no government can do–they’d rather go off the gold standard. In fact, I’m con- vinced that if we restored the gold standard now, within six months the first country would be off it and, within three years. it would completely disappear.

The gold standard was based on what was essentially an irrational superstition. As long as people believed there was no salvation but the gold standard, the thing could work. That illusion or superstition has been lost. We now can never successfully run a gold standard. I wish we could. Its largely as a result of this that I have been thinking of alternatives.

Reason: You have, at various times, championed a commodity-reserve monetary system and competition in the money supply. Are these practical alternatives to a govemment con- trolled central banking system?

Hayek: Yes. I have been convinced that while the idea of the commodity-reserve system is a good one, practically it is unmanageable. The idea of accumulating actual stocks of com- modities as reserves is so complex and impractical that it just cannot be done.

Then I came to the conclusion that the necessity of actual redemption of the real commodities is only necessary if you have to place a discipline on an authority which otherwise has no interest in keeping its currency stable. If you place the issue of money in the hands of firms whose business depends upon their success in keeping the money they issue stable, the situation changes completely. In that case, there is no necessity of depending upon their obligation to redeem in commoditei: it depends on the fact that they must so regulate the supply of their money that the public will accept the money for its stability. This is better than anything else.

Rick, Those are good points. When the world was supposedly on a gold standard, governments and central banks did all they could to thwart it. We were on a gold standard in name only. The textbooks are full of “sterilization” techniques that central banks used. I don’t think a return to gold would be any better.

That’s why I advocate a Fed chair who would simply target the price of gold as Greenspan did in his first term. You get most of the benefits of a gold standard without the dishonesty.

“If there was a serious shortage of gold, it could lead to reduced economic activity. This occured in the american colonies due to gold shipments to britain and resulted in Ben Franklin’s support of a fiat currency.”

There’s nothing stopping people from using whatever they want as currency. People can print their own paper just as easily.

The problem is when certain people lobby for federal police powers, giving their paper “legal tender” status. And then they set up “taxes” that must be paid in that paper, forcing people to buy and sell with that paper in order to pay the tax. It’s no coincidence that the federal income tax was started in 1913, the same year as the Federal Reserve.

The only thing giving Federal Reserve Notes value is the threat of violence through “legal tender” laws and the threat of violence through “taxes”. People would rather take a loss in using that paper instead of suffering the violence, and that’s where the Federal Reserve Note’s “value” comes from.

“Also, the FED is indeed federal; it was created by the government, and it is supported by the government.”

That’s like saying any company that has a patent is a federal agency. In this case, a private corporation got a patent for fiat currency.

“There’s nothing stopping people from using whatever they want as currency.”

No they can’t or you’re back to currency being meaningless. After all, what of the goldbugs who refused silver to be used as money which spurred the ‘Cross of Gold’ speech? Goldbugs would say if there was less gold then prices should fall in kind (i.e. deflation). But to say “there wasn’t enough gold” doesn’t that even a true gold standard and therefore gold is unsuitable as a medium for money?

“… in a free economy, all prices are determinied(sp?) by supply and demand, then does not the value of money change?”

i dont know if it is the value of the money actually changing or the lessening of value of the item being acquired with money.

buying not-so fresh fish from market for instance.

“…didn’t he state that, within limits, almost any supply of gold would be sufficient?”

i am still unsure about the rothbards claim on that issue.

i received this response to a question about “the additional social benefit” claim by rothbard of adding more commodity money to an economic system…..
http://mises.org/Community/forums/t/8887.aspx

“No increase in the money supply will have a general social benefit. It will devalue the existing supply. The real question, then, is why add more money at all? The answer, of course, is that the increase benefits the first user of the new money, as the first user spends the new money at the current exchange rate, before the market adjusts to the inflation.
However, when dealing with a commodity as money such as gold, the mining of new gold and subsequent minting of new coins, while increaseing the money supply, also introduces more of a particular good, ouces of gold, to the market. Gold is valued on the market as a commodity, as well as the medium of exchange meaning along with the an increase in the money supply, there is also an increase in the total goods available on the market, if such a thing can be quantified.”

i am not sure.

from the forum post i received ,if true, with additional commodity-money on the market, purchasing power would decrease but overall available gold for any use
would be beneficial.

Rick, everything that you and Hayek said Hazlitt also said in this article. His idea here (not original to him) is to allow freedom for individuals and businesses to start issuing their own gold (or silver) coins (or certificates) until, step by step, the entire economy has transited back toward a market-based gold standard.

IMO, anything else (e.g. “price targeting”) is advocating authoritarianism and eventual tyranny. IMO, the slightest inch of fractional reserve compromise can lead only to a million miles of corruption. Absent fraud (clipping, shaving, sweating, etc.) a gold-or-silver standard is incorruptible — whereas anything else is automatically corrupt by design.