“For example, let us say in the ideal Gold Standard world a pound of flour costs 0.0001 oz of gold.”

A gold standard does not set prices of goods. Nor do Austrians want a “gold standard”. What they want it a free monetary system. Something different.

Taxation does not increase the money supply.

Price ceilings and price floors do not increase or decrease the money supply.

You are confused.

“Every time the State needs more money, it can simply raise the taxes, which essentially what the inflation indirectly is.”

This is wrong along with many of your other statements, which I don’t have time to correct. In fact, I couldn’t find a single sentence in your last comment to me that was completely correct, in context. Most were not even remotely correct.

I agree. The Gold Standard is better than any other existing solution in term sof keeping the money supply near constant, and I agree that it would be much, much harder to raise the taxes and excersie favouratism under the Gold Standard.

I just wanted to point out the true reason why Gold Standard is more beneficial – not because it can absolutely prevent inflation or increase in money supply, but rather make it very, very difficult for it to happen – politically speaking…

it’s clear why inflation is well-liked by rulers. less apparent to joe six-pack is that inflation sets up the boom/bust business cycle.

you seem to be confusing a government raising revenue with a government raising the money supply. the first is harmful, but not inflationary. the latter is harmful and inflationary.

Brian,

My point is that one cannot limit money supply even by tying it to the limited commodity such as precious metals.

For example, let us say in the ideal Gold Standard world a pound of flour costs 0.0001 oz of gold.

Now, assume that the State decides to create more money. It would simply raise the taxes (income and/or excise), and mandate that now everyone has to pay a greater percentage of their income or of the price of the item being purchased, which will effectively increase the price of flour and hince reduce the purchasing power of gold.

This would be tantamount to diluting the purchasing power of gold, since now everyone has less effective gold left, and the State – more. Or conversely, the state could have set upper/lower limits on the prices, thus manipulating the purchasing power of the medium of exchange…

This example clearly demonstrates the political nature of the control of money supply . There is no way to limit the money supply if a certain entity holds absolute control and hegemony over its quantity.

In other words if there is X amount of rare commodity considered as medium of exchange, it can be distributed among the State and the participants in the free trade in a certain way. The quantity of the precious commodity actually in the hands of the participants in the free trade actually sets the level of prices of the goods and services being exchanged. Every time the State needs more money, it can simply raise the taxes, which essentially what the inflation indirectly is.

So, I disagree with Austrians, that this is a matter of Economic theory. The problem is purely political in nature! Of course, everyone understands that more money supply corrodes its purchasing power. It is trivial. What is NOT trivial is how to keep it constant!

As I have demonstrated above, in a social-political system where there is the State that holds the hegemony of power, there is absolutely no way to implement sound money policy, since whoever has the power to tax or define unit of exchange, it has the power to re-define it arbitrarily…

So, by adopting the Gold Standard all we would have achived would have been re-defining the form of the indirect or direct taxation.

“Since most of the significant transactions are electronic, and since, in general, the rare commodity, such as gold, is not going to be physically traded or exchanged in the circulation due to the practical considerations, there will be again some substitute medium introduced to represent the rare commodity, such as paper money or electronic accounts.”

None of which would increase the money supply as long as there really is a backing commodity behind the “substitute medium”.

“So, nothing would prevent the state from diluting the ratio of the representation medium such as paper money to the actual rare commodity.”

Austrians are for free money which doesn’t involve any state actor.

“In other words, even if you map your money to gold, the state can always print more currency which is mapped to the gold, by diluting it. So, effectively, even the Gold standard will not do anything to stop the inflation if the State so wishes.”

Yeah, and the government can take you out and shoot you if it “so wishes”, what of it.

You are just making the argument that if the government sets up a fiat monetary system, by force, that you won’t have a commodity based monetary system. This is a suppose to be a big surprise? Of course a fiat system isn’t going to be a not fiat system. That’s by definition.

Since most of the significant transactions are electronic, and since, in general, the rare commodity, such as gold, is not going to be physically traded or exchanged in the circulation due to the practical considerations, there will be again some substitute medium introduced to represent the rare commodity, such as paper money or electronic accounts.

So, nothing would prevent the state from diluting the ratio of the representation medium such as paper money to the actual rare commodity. In other words, even if you map your money to gold, the state can always print more currency which is mapped to the gold, by diluting it. So, effectively, even the Gold standard will not do anything to stop the inflation if the State so wishes.

You, see many Austrians do not realize that the concept of Sound Money is not literally accepting some rare durable commodity as medium exchange, but rather, the concept states that the money supply shall be constant at all times. So, the means of ensuring constant supply of money shall be discussed rather than literally interpreting this principle as Gold or other precious metal-based money…

I fail to see how on earth can one limit the money supply while the State holds the monopoly over what is considered medium of exchange, and it can always redefine the unit of measurement at any time.

So the solution to the sound money is purely political, rather than economic in nature!

i think rothbard was at odds with his own natural rights framework with this pragmatic (bygones be bygones) approach. i think hulsmann makes rothbard’s inconsistency clear in “deflation and liberty”

the problem of separating the demand for money, and its supply, is that the first is totally unknowable and unquantifiable. money supply is known and quantifiable, allowing for disagreements about which aggregate most accurately defines “money”.

so the inference is that you’re in favour of continuing efforts by the monetary authorities to inflate. here’s where mises criticizes people like you:
“In the opinion of the public, more inflation and more credit expansion are the only remedy against the evils which inflation and credit expansion have brought about.”

you really should read the article more carefully, here’s what polleit actually says:
“When commercial banks stop making new loans and demand their borrowers to pay down their debt, the economy’s credit-and-money supply contracts. At this point inflation — the increase in the money stock through circulation credit — turns into deflation.”
this is merely a statement of fact, the bubble bursts and deflation sets in. there is no avoiding the consequences, unless the authorities intervene and this sets up the next, bigger bubble.

as regards the mises quotes i proffered, they don’t need to be qualified, they’re perfectly self-explanatory, they’re on the public record, and he wasn’t one to be idly mouthing whatever came into his head. also tmc was an early work, and later views are as valid (if not more so, if you grant that age brings wisdom). whether there exists a gold exchange standard or not makes no difference to the definition of inflation or deflation.

in earlier posts, you cited falling oil prices as a sign of deflation (greenspan the deflationist!), then gold (a non-money, these days), and now foreign fiat currencies and gold. will the real deflation please stand up! unless you define the term in some concrete way, as inquisitor asks, you’ll be struggling to understand whether we’re experiencing inflation or deflation.

Don’t be fooled by the 100% gold reserve crowd. If the dollar were as good as gold you would not need any gold to back it. That sounds flippant but it is true. Once you return the dollar to a sound footing relative to gold very few people will want gold.

Why? Consider your own transactions. Would you rather carry around a pocket filled with gold coins or a wallet with a few pieces of paper and cloth of different denomonations of dollars backed by gold? Those who believe we would need massive amounts gold reserves to return to a gold standard don’t understand a real gold standard currency and why it evolved in the market place.

If it takes 100 trillion to run the world economy, and you back that with gold, then the gold will be worth 100 trillion. You could back it with 10 randomly picked rocks stored in a vault someplace and they would be worth 100 trillion. Its irrelevant. The point is your economy is then taking its first steps towards sound money and market conditions improve thereafter.

The value of the commodity (or ies) does (do) dramatically increase at the time of decision. Everything else is redeemable in proportion so there is no hyperinflation. (Maybe 1 oz gold = $60k old dollar = $1 new greenback. You have $60k in the bank… redeem for $1 greenback and you can go buy a nice car with it.)

This is my present understanding and it seems logical (comes from here: http://mises.org/books/goldpeace.pdf pgs 49 -50).

-r

Do not take Mises out of context. What I mean is, go back in the chapter you quote from and look at his foundation for his statement. In section 3. Demand for Money and Supply of Money he discusses the quantity theory:

Modern monetary theory takes up the thread of the traditional quantity theory as far as it starts from the cognition that changes in the purchasing power of money must be dealt with according to the principles applied to all other market phenomena and that there exists a connection between the changes in the demand for and supply of money on the one hand and those of purchasing power on the other. In this sense one may call the modern theory of money an improved variety of the quantity theory.

It is important to look at the theory rather than simply proof texting. Most of the time Mises was writing we were on a gold standard and that changes his analysis significantly. Today on a floating currency things are different. Mises was dealing with parity and so changes in quantity were reflected in gold flows.

Today it is critical to analyze changes in quantity in context to demand. For example the FED has pumped in massive amounts of money but the value of the dollar is declining relative to gold and other currencies. This can only be understood if you consider demand for money.

Mises is correct that in the past inflation and deflation were defined as increases or decreases in the money supply. Today inflation and deflation are defined as changes in prices. Both definitions are imprecise and lead to bad policy. Inflation and deflation must be viewed from the perspective of The Theory of Money and Credit, the exchange value of the currency based on the interaction of supply and demand.

Superficial writing such as Polleit’s compounds the confusion. There is much more to inflation and deflation than just supply. This is why Mises over and over was careful when using the terms. (See Inquisitor’s January 7, 2009 12:12 PM comment above)

Malinvestments do not need deflation to unwind. Read the entire section on inflation and deflation and then what Mises recommends as the way to return to sound money out of an inflation.

“Inflation, as the term was always used everywhere and especially in this country, means increasing the quantity of money and bank notes in circulation and the quantity of bank deposits subject to check…But people today use the term ‘inflation’ to refer to the phenomenon that is an inevitable consequence of inflation, that is the tendency of all prices and wage rates to rise.” (Economic Freedom and Intervention: An Anthology of Articles and Essays by Ludwig von Mises, 1990, p 99.)

“What many people today call inflation or deflation is no longer the great increase or decrease in the supply of money, but its inexorable consequences, the general tendency toward a rise or a fall in commodity prices and wage rates” (Human Action p. 423). the italics are mine.

if you’re against deflation, then you must be cheering the fed’s (largely successful) anti-deflation interventions.

The crash in the prices of real estate, stocks etc is “nature’s way” of destroying the excess paper currency. When you sell your house, stocks or other asset that has fallen in price in dollars, you transfer the government’s folly into your personal loss. The purchaser of the asset gets a market price that is closer to the intrinsic value of the asset.

Instead, hold on and wait a few years. Prices of real estate, gold, stocks, oil and everything else will soar again with the dollars being printed.

All we can do is pay off our personal debts and control our personal spending. In 2010, we can try to elect better politicians.

Matt,
Yes, us average Joes want to know what to do now, what are the immediate individual strategies to weather this fiasco. Unfortunately, such predictions and advice are all but impossible, for the very reasons described in this article, that the continued and rapidly escalating massive govt manipulations cause such disequilibrium, making it impossible to predict accurately what the immediate consequences may be. The past five months have demonstrated that our “leaders” in Washington (and their Wall Street puppetmasters) will go to unprecedented lengths to manipulate the money supply and economy to their advantage. Austrian theory can predict what the ultimate outcome of such inflationary manipulations may be, but it can not predict what the next “rescue” interventions will be over the next few months, because nobody can predict what Obama, Bernanke, Paulson or his successor, or other interventionists will do next. Witness W and cronies bailing out Detroit, despite the strong public objection and congress’s refusal to do so. With this sort of uncertainty driven by such massive interventions, we can only vaguely guess what is coming next, even if our theories permit us to make good predictions of the longer-term consequences of the recent interventions.

redshirt,
Setting a gold standard would not be the cause of hyperinflation, per se, if the currency had not been recently so massively inflated by the Fed (and ditto for other countries and their central banks). Our govt only holds so many tons of gold in Ft. Knox, and if they have recently doubled or tripled the money supply, without increasing the gold holdings to match, then any attempt to return to a gold standard at this moment in history would result in effective hyperinflation. If gold were pegged at the $800-900/ounce range it is trading today, then a dollar bill would be worth about 1/900th ounce of gold. If there are about 8 or 9 trillion dollars of “money” in circulation (see http://mises.org/markets.asp#monetary), then the Fed would need about 10 million ounces of gold in its vaults to back the currency at that price, or over 3 thousand tons of gold. As nobody can get an accurate accounting from the govt of just how much bullion is actually stashed away, and some believe that it may be considerably less than this, despite the “official” figure of 4,603 tons (http://en.wikipedia.org/wiki/United_States_Bullion_Depository), it is likely that the Fed would not be able to match that price. If other countries, such as China, and private holders of US currency suddenly demanded redemption in gold for the currency they are holding, what would happen? The govt would have to set the dollar-to-gold ratio much higher than $900/oz to avoid such a catastrophe, which would mean, in effect, massively devaluing the dollar, or “hyperinflation” in terms of the true purchasing power of dollars. Instead of a dollar buying 1/900 oz of gold, or equivalent value in other commodities, say it would only buy 1/10,000 oz of gold. I would guess that there is not enough bullion in the world for every country to revert back to a gold standard at today’s gold prices, so they would all have to either “devalue” their existing supply of money to match their actual supply of bullion, or they would have to destroy part of the existing paper currency (and unbacked bank deposits) to match its supply with the gold supply. This will never happen, for obvious political reasons.

And while I am ranting, I again want folks to consider what they mean by “deflation.” I have pointed out in other discussions on this blog that we need to be clear about whether we mean “price deflation,” which is falling prices, or “monetary deflation,” which is a contraction in the supply of currency/credit. They are not the same thing, especially in a manipulated monetary system. Too often falling prices are mistakenly referred to as deflation, even when their has not been an actual contraction in the money supply. We have come to equate rising prices with “inflation” in our everyday language, because, by and large over the last century, price increases have been a direct result of inflationary monetary policy. So we also call falling prices “deflation,” even if they are not due to a decrease of money supply. As one poster pointed out, prices may drop gradually because of improved efficiency of production, which would be a good thing, even if it is “deflation” of the price, as it means more value for the consumer, without meaning a loss of profit or production for the producer. But monetary deflation, or a sudden contraction of the money supply, induced by manipulative govt policies, can be harmfully disruptive to the economy, as Fox and Pinchak point out.

At the moment, we actually have a dramatically expanding money supply, which is inflationary, not deflationary, thanks to Bernanke, because of the fear of “deflation” and “frozen credit markets.” While at the same time, prices are falling because of the business cycle downturn, as consumers realize they should save more and spend less now that the boom party is over, which can be called “price deflation,” even as we are getting monetary inflation. Prices are dropping because of a drop in consumer demand, not because of a drop in the supply of money to purchase things. The money supply magicians seem to hope that throwing more dollars into circulation will somehow magically prop up the falling prices, which they are inaccurately calling “deflation,” thus getting the boom party going again, and staving off “deflation.” But prices are falling because consumers are afraid to go on borrowing and spending as extravagantly as they have been for the past decade or two. So this strategy is not likely to work very well.

The risk of this strategy is that once the downturn levels out and the cycle swings upward again, all this injected money and artificial credit (not based on real savings) will rapidly drive prices up further, causing massive “price inflation” tomorrow, next year, or whenever, as a consequence of the monetary inflation occurring today. Then the Fed will have to raise interest rates and backpedal frantically to rein in the money supply again, to stop the skyrocketing price inflation. It is this monetary yoyo-ing that is the cause of our problems, but how do we get the govt to stop it?

If Polleit means what he says in the quote I posted above he is a deflationist. If he does not he is a poor writer. I choose to assume that he is saying what he meant.

Rothbard’s opinions are at times based on retribution rather than economics. This is a case in point. If you deflate to prevent the bankers from gaining how are you going to ensure that an innocent party is not harmed by your deflation?

In The Theory of Money and Credit Mises in essense says that we should determine the current equilibrium between supply and demand after an inflation and set a new parity at that level (this is essentially where Polleit finally ends up in his article after praising deflation). Any other actions brings unintended consequences and “punishment” of some who were not offenders. I will stand with Mises over Rothbard any day.

The Theory Of Money and Credit
PART TWO: THE VALUE OF MONEY
CHAPTER 13—MONETARY POLICY
4. Restrictionism or Deflationism (p. 231)

When the value of money is increased, then those are enriched who at the time possess credit money or claims to credit money. Their enrichment must be paid for by debtors, among them the state (that is, the taxpayers). Yet those who are enriched by the increase in the value of money are not the same as those who were injured by the depreciation of money in the course of the inflation; and those who must bear the cost of the policy of raising the value of money are not the same as those who benefited by its depreciation. To carry out a deflationary policy is not to do away with the consequences of inflation. You cannot make good an old breach of the law by committing a new one. And as far as debtors are concerned, restriction is a breach of the law.

If it is desired to make good the injury which has been suffered by creditors during the inflation, this can certainly not be done by restriction.

There is also the question of why any libertarian would prohibit a bank and its customers from openly operating on fractional reserve principles, if that is what they want to do.