Edward Chancellor in The Financial Times (requires free registration) after a few paragraphs on the perversities of the current international monetary system, asks “What’s to be done?”. Replying:
Some yearn for a return to the strict discipline of the gold standard. But there is not enough of the precious metal and it would be absurd to restrict global growth to the rate of future gold extraction. There are no clear alternatives to the dollar.The euro is not a candidate since it is a “currency without a state”, in Mr Eichengreen’s words. China hopes to challenge US financial supremacy, but its capital account remains closed and the banking system is state-controlled.
That an economy needs an increasing quantity of money in order grow is widely believed, yet false. In this article, Chancellor makes an even strong claim: that the rate of growth of the economy must be equal to the rate of money growth (which is the rate of gold extraction under a gold standard). In the financial media, where this belief is regarded as fact, I have never seen a reason given by anyone for thinking so. And, even if there were money growth and restricted economic growth, what reason is there to think that the rates should be identical?
Austrian economics gives us reasons for thinking the opposite. Economic growth, defined as an increase in the quantity of goods produced per capita, requires the capital to labor ratio increases in favor of more capital per unit of labor. Capital accumulation must be funded by real investment. However, while nominal investment depends on the quantity of money, real investment does not. Any amount of real investment can take place with any amount of money because prices adjust not only to the quantity of goods but the quantity of money.
Economic history also suggests the contrary: during the 19th century, the economy grew faster than the rate of gold mining. Prices remained constant or slowly fell over time.
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just to be pedantic, the rate of money growth in a gold-money regime is the gold extracted from mines plus gold sourced from existing non-monetary sources.
minus gold sank into jewelery, buried on tropical islands, stashed at fort Knox etc.
The idea that real production can outstrip monetary growth isn’t even necessarily Austrian. Plenty of neoclassical economists have come to similar conclusions, including Milton Friedman and Anna Schwartz. Edward Chancellor is simply ignorant of economics.
do people really believe that more dollars = larger economy, and is that really how they justify inflation? the mind boggles
@r. Well think about it a moment. The GDP and all the kind of stuff is measured in “nominal” money values. So having a deficit of 2% but having an Inflation of 3% or higher. Then you still can say the economy is growing. And guess what that’s what the fed supports. They print money driving inflation the the economy is “growing”, recession is over. Problem solved, we can go to bed and sleep well.
What’s so special about gold? Once legal tender laws are done for, we the people can use all the suitable mediums of exchange we need.
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I for one would hope for comeback of 19th century style Real Bills, because the production structure can always use the flexibility of a good credit. And there’s hardly a better kind of credit than this one: privately-generated, quickly-self-liquidating, built-upon-delivery-of-most-demanded-goods, as written about by prof. Fekete.
pass the silver stake!
Silver and gold as the “cannot-be-counterfeited-out-of-thin-air” store of value, granted. Then there is room for other stuff on top of that. The hard part is to keep out the fraud, especially of the ponzi/pyramide/frb type. Too bad UK missed their 1844 chance, letting the demand deposits slip.
When I’ve looked at the inflation data both for the UK and USA during the period of the classic gold standard (1830-1914), it seems that it was broadly flat. Sometimes slightly negative, sometimes slightly positive. This then suggests that over the whole period there was a general correlation between economic growth and monetary growth.
However, it is eroneous to conclude from this that it was monetary growth that drove (or even allowed) economic growth. Indeed, there is good reason to believe the causual relationship is the the other way around. As productivity increased and this put a downward pressure on prices, the profitability of gold mining would have increased thereby leading to more of it taking place (and, indeed, more gold being diverted from non-monetary uses). As the gold supply increased, this would reduce the profitability of gold mining and therefore acted as a natural limiter. In otherwords, during the period of the gold standard, economic growth drove monetary growth.
to simon maynard:
along the lines of your comment, you might find this interesting.
http://www.guidohulsmann.com/pdf/Demand_Money_Time_Structure_Production.pdf
http://www.guidohulsmann.com/pdf/Time_Preference_Investment_Expenditure.pdf
If only gold is allowed as money then there could be a shortage of money. During the early years in the New World there was a shortage of money and so many things were used, wampum, salt, jewlery and trinkets, and of course all types of coined money from Europe.
Chancellor does not understand monetary economics and especially a gold standard. There are very few serious monetary economists who do not believe that there should be money substitutes. The critical element in money substitutes is that they do not change in value when used. Under a gold standard like the 19th Century there was paper money, but it exchanged freely for gold. In times of high economic activity money substitutes would rise in value as a shortage would develop. This shortage would be reflected in the price of gold or the amount of exchange of money substitutes for gold. The monetary authority would then resolve the problem by creating more money substitutes and the value of the money would return to its previous level.
Similarily, when there was a lower need for money the price of gold or the exchange of money substitutes for gold would tell the monetary authority to reduce the quantity. This was not done by some arbitrary decisions. It was done because there was a firm relationship between real money, gold, and money substitutes.
This system created the most sound and flexible money system ever devised by man, but the greed of government destroyed the system. In the name of a more flexible system they removed the connection between real money and money substitutes then used their new ability to create to steal goods and services.
The system of floating rates is not a flexible system. Many metals are flexible but that means that they have the ability to bend then return to their previous condition depending on the need. If metal is bent to the extreme, to its breaking point, it becomes useless. This is the system of flexible rates. It is a system of broken flexibility.
The purpose of money is to allow you to exchange valuable goods and services for other valuable goods and services. Think of a pawn broker. Think of the old company store. Paper and electronic money is a convenience. The problem is with fiat money where there is nothing but thin air backing up the paper. When the currency gets debase, people barter. Think of the old USSR- people would use packs of cigarettes, boxes of Pringles chips, or Levi jeans.
You could, in principle, use any basket of commodities. Incidentally, there have been a spate of robberies of people stealing copper.
There is a general misunderstanding of what the supply of money really means, especially in terms of its consequences. The key thing is that money is not a consumption good, but rather a ‘rental’ good, for lack of a better term. This means that money is not consumed when it is a part of a transaction, but merely transferred from one owner to another instantaneously, without theoretical limit. Rather the fact that a given piece of money can only be possessed by a single entity at a time means that it is the time of possession of money which is scarce, and which interacts with the supply of money.
To see what a ‘rental’ good is, consider the following:
Assume that the auto rental industry consists of a single firm in each of the 50 states. The firm in each state has a fleet of 100 rental cars for a total of 5000 rental cars in the US. Does the number 5000 cars usefully define the total US supply of rental cars?
No. It tells us next to nothing without knowing how long each rental is for. The actual capacity of the auto rental industry is not 5000 cars, but 150,000 car rental days per month. So the unit of measure for the supply of rental cars is wrong if we just use cars. The statistical distribution of rental demand timing means that the full 150,000 car rental days cannot be achieved because of timing conflicts, but it is the maximum.
The supply of money works exactly the same way. The unit of measure of the supply of money must be dollar-days per month.
This means that the supply of gold for money does not limit the number or size of monetary transactions. The main problem with a limited amount of gold as money would occur in a time of a rapid population increase having a demand to hold money.
Regards, Don
Don,
The main problem with a limited amount of gold as money would occur in a time of a rapid population increase having a demand to hold money.
Why would that make any difference? Wouldn’t prices and interest rates adjust to reflect that reality?
Let’s say you united two halves of an island nation using only the gold that only one half used as its money standard. You would instantaneously reduce the money supply per capita by 50% for the half that was already on the gold standard, not to mention the transition problem in equalizing out the distribution.
You are correct about the adjustment, if you could survive the civil war likely to be involved.
Regards, Don
Your example denies human action.
No doubt, the two halves would be trading and an exchange rate already pre-determined. This means that many people on the non-gold half would already possess gold or currency equivalents. (Not much different than today where the American dollar is used/accepted as currency in other countries.)
Civil war would not be the result but more trade and goodwill.
Don,
A return to a gold standard doesn’t necessarily mean that what circulates will be gold. It can very well be inside money, or banknotes (money substitute). If this is the case, then there will be no problems in accommodating a rise in the demand for money.
Jonathan,
Correct me if I’m wrong, but you seem to be assuming a fractional reserve system. This works against several of the motives for going to a gold standard in the first place. For one, it impairs the effect of increasing the cost of producing a new unit of money, a desirable feature of a gold standard, since it helps deter the increase in the money supply.
Of course, in a modern economy, many activities don’t need an actual medium of exchange to be accomplished, but rather just a financial asset that can be converted to and from money and can be held without using up the time of possession of actual money.
Regards, Don
Don,
There is plenty of literature available on the limitations of fiduciary expansion in a free banking industry (including Mises’ Human Action and The Theory of Money and Credit). If the note is superfluous it will eventually be returned to the issuing bank for redemption. Thus, a bank is limited in fiduciary expansion by its ability to meet these clearing requirements.
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