Murphy’s latest response to Frum is excellent. There is one point that he did not meet that merits special attention. Frum says:
Gold is a commodity. Like all commodities, its price is highly volatile. A money fixed to gold must be highly volatile too. Signing up for a true gold currency would be signing up for an unending monetary roller-coaster ride.
However, it is not true that the volatility in the purchasing power of gold-as-it-is-now would be the same as gold-as-money. As Rothbard and Mises have noted, the total demand to hold the money commodity is the sum of the demand for use as a commodity and demand for use as a money. With a return to the gold standard, the demand to hold gold-as-money would increase (right now, this demand is negligible), causing its price in US dollars to increase. The volatility of the use-value component of gold will be swamped by the exchange-value component. No roller coaster there.
With regard to the demand to hold money, Mises pointed out:
Every economic agent is obliged to hold a stock of the common medium of exchange sufficient to cover his probable business and personal requirements. The amount that will be required depends upon individual circumstances. It is influenced both by the custom and habits of the individual and by the organization of the whole social apparatus of production and exchange.
This demand to hold is the dog of the monetary system, and the purchasing power of money is the tail it wags. During a recession, the demand to hold money broadly increases because many people forebear from unnecessary expenses. Against a relatively fixed supply of money, this will increase the purchasing power of money, which has the socially desirable effect of increasing the effectiveness of the money held by people in the recession. This is hardly a roller-coaster ride, either.
A roller-coaster ride is this: during a recession, the demand to hold money broadly increases because many people forebear from unnecessary expenses. The government greatly increases the supply of money to “heat up the economy”, which decreases the purchasing power of money, thwarting the intentions of people attempting to survive the recession.
More on this here, of course.
{ 7 comments }
The arguments in support of gold are very strong but politically are very tough to explain and see all the unintended or unforeseen consequences of fiat money.
A simple start would be to support allowing competing money. I think Ron Paul has a chance of making that point with his new found campaign money. And it can be explained in 30 seconds. Why can’t Liberty create gold backed dollars in competition with US government backed dollars.
Ed
Perhaps the market today would find another source of monetary-stability than the good old gold. Who knows? Gold today serves as a raw material for electronics. This was not the case during the old eras of gold-backed money.
However, gold is likely to become the anchor of monetary credibility just like before, should tender laws be abolished. The first action should be to abolish the ban of private money. The rest will take care of itself.
Murphy said, “A money fixed to gold must be highly volatile too. Signing up for a true gold currency would be signing up for an unending monetary roller-coaster ride.”
This exposes a serious fallacy of understanding. As Entrenched perception on the value of paper money explained, when Murphy is saying that, he is in effect,
The moment we calibrate the value of gold with fiat paper, then gold is not functioning as money. Rather, when we calibrate the value of fiat paper money with gold, then it is fiat paper that is in an “unending monetary roller-coaster ride.”
Sorry, the link mentioned in my previous post should be to What should be your fundamental reason for accumulating gold? instead.
I think you mean Frum, Contrarian Investor’s Journal.
the total demand to hold the money commodity is the sum of the demand for use as a commodity and demand for use as a money. With a return to the gold standard, the demand to hold gold-as-money would increase (right now, this demand is negligible), causing its price in US dollars to increase.
I am not sure I follow your argument here. Did you mean to also distinguish investment demand (*). I realize that, technically, gold is not an investment, but the major driver of the price of gold today is precisely investment demand. When (if) gold retakes its rightful place as money, no doubt the price will rise on account of monetary demand, but that does not imply that the price today is controlled by commercial demand. You have built a false dichotomy; use as commodity and use as money are not the only functions gold can serve.
(*) Think of investment demand as any non-commercial demand that is not monetary – investment, hedging, etc.
Raja,
When (if) gold retakes its rightful place as money, no doubt the price will rise on account of monetary demand, but that does not imply that the price today is controlled by commercial demand. You have built a false dichotomy; use as commodity and use as money are not the only functions gold can serve.
You are quite correct. The recent multi-year rise in the dollar price of gold is only partly the result of the past increase in the supply of dollars, but is mostly an increase in the investment hedge demand against the expected future increase in the supply of dollars. It is unlikely that true non-monetary demand has played a significant role.
If and when gold resumes its role as money, there will no longer be any investment demand for gold except to the extent that people believe that a new gold standard will not endure. Holding actual money, in any form, is always a sacrifice of both potential consumption and investment, balanced against the need to be prepared to deal with an uncertain day to day future.
Regards, Don
Comments on this entry are closed.