GOLD STANDARD … DEBUNKED OR ANOTHER BUBBLE?

The financial liquidity crisis is in full swing around the world. It is no wonder that experts and novices alike seek ways and means to prevent a future recurrence. Many different solutions are enacted and proposed. All of them center on wealth and money or votes.

Questions regarding the reemerging push for a return to a gold standard and our discussions of earlier Austrian school of economic theories abound.

Such discussions especially flourish during major financial crises.

Certainly, gold has been viewed by civilizations for some five thousand years as stable and desirable. Why? Simple – man cannot easily destroy it, nor create it. It has been considered both wealth and money.

It certainly meets both ancient and modern economics’ criteria for wealth. To a lesser degree, it meets the definitions for money.

First, it is a medium of exchange. Almost everyone agrees to trade if gold is involved.

It serves as a store of value. In other words, gold cannot only serve as money, but it is actually a tangible representation of wealth.

It is a standard of value. People can agree that one ounce of gold is equal to a fixed amount of some other good or service.

Since it is rare instead of plentiful, that standard remains in tact as long as people agree. Richard Nixon unilaterally arranged for the United States to leave the gold standard in 1971 for political and economic interests. Gold prices “floated” against other currencies, and no country since then has remained on a gold standard.. Nonetheless, gold has been and can remain a basis for contracts, debts and other private or national obligations.

Finally, it is a unit of account. That simply permits us to set prices, costs, or profits. In short, any money, whether gold or silver or fiat (paper) money issued by a government, gold can fulfill that function.

Without too much difficulty, gold can also simply exist to guarantee the use of fiat money. That places a currency on the gold standard, and simply means that a government certifies that it has enough physical gold (as in Fort Knox or the IMF vaults in New York) for every dollar of fiat money it issues.

Your, or a country’s credit, is limited by the amount of gold owned.

Enter the problem.

It may be simplistic, but bears repeating. It is, after all, the reason why economics came into being in the first place. Supply and demand.

The fundamental law of economics assumes that mankind wants an almost limitless amount of goods or services. That includes everything from basic foods to intangible things like religion.

Those “wants” may have both positive and negative effects.

In a world where all physical goods are limited, if supplies are finite while wants are unlimited, we instantly see the basis for having to make choices. The choices can be resolved in civil manner by trade or, in the extreme, by war.

Therein lies the fundamental problem of gold as a backing for fiat money, or as a direct global currency.

There simply is not enough gold on the planet, existing above ground or yet to be mined, to back all the fiat currencies that have been created to accommodate the continually rising population in this world.

Better yet, if we applied simple supply and demand laws, the price of gold would reach enormous proportions compared to the universally accepted world standard of the equivalent US$700 per ounce at today’s values. Careful, please, the price may rapidly move or down from that level!

We know reasonably well how much gold there exists on the planet. We also know approximately who owns how much, both in physical gold and in reserves still to be mined. With the expected gold craze to continue, major exploration and mining companies are hoping to bring those underground reserves to daylight to join in the speculative fever of potentially recovering gold.

For example, Northgate Minerals Corporation (TSX: NGX, AMEX: NXG) announced September 8, 2008 that it found new mineral reserves at its Australian site, including some 140,000 ounces of gold. In their press release, the company stated that the find “will extend the current mine-life by an additional 18 months until the fourth quarter of 2011.” (biz.yahoo.com). (www.northgateminerals.com)

If you do simple math and use today’s value at $700/oz., that results in some $98 million. At a cost of some $20/oz, that results in a nice profit for the company and its shareholders.

However, that amount pales on a macroeconomic level.

It would make little difference on a world-wide basis for the United States, the International Monetary Fund, South Africa, Russia or Canada as countries. Russia, for example, recently announced continued progress in its Kamchatka gold discoveries.

Trans-Siberian Gold’s Asacha mine is estimated to process some 608,000 ounces of gold over the expected six and a half year life. It has not yet commenced drilling. The company is traded on the London stock exchange. (TSG-L)

In short, the supply of gold is reasonably fixed with only relatively small increases foreseen in the near future.

We can also reasonably predict general industrial and commercial uses for gold, such as electronics, medicine and personal jewelry.

With normal supply and demand predictable, the excess demand for speculation drives the price on the international gold market. It is a speculator’s and gambler’s heaven!

There are good and bad aspects to a national or world-wide gold standard.

Making gold convertible into a certain amount of dollars, yen, Euros or whatever would certainly restrict the amount of money each nation could spend. As such, it would artificially impose a certain financial prudence on the part of government issuance of fiat money. It would be likely to sharply curtail spending and investment.

It should certainly cause policymakers to think twice before wasting assets in such futile endeavors as wars not designed merely to defend a nation’s borders against intruders.

However, a return to the gold standard would impose a limit on growth, and thus on employment. History shows that unemployment was far more extensive under the gold standard than without it. Despite the speculation, irresponible credit use and eveb criminal activity, no one can challenge the tremendous growth in entrepreneurship worldwide sice the Reagan and Clinton administrations.

Whether it is the Federal Reserve or another central bank, interest rates would still have to be adjusted – even in a 100% gold-backed currency – to maintain that currency’s value relative to the arbitrary value agreed to and set upon an ounce of gold.

It all ultimately depends whether you want to put your trust in your fellow man (or woman) based on a shiny metal to back your country’s currency or on a piece of paper backed by the “full fait and credit” of the United States or any other country.

If you truly believe more in gold than in the ultimate productivity of the dollar, the yen or the countless others, by all means buy some gold directly through any one of dozens of legitimate gold currency dealers. Not issued by any bank, but backed directly by the gold you purchase, some of that gold is denominated in Dinars or Dirhams or Rials. Islam does not believe in interest or usury, but fixed fees. Remember, though: the value of your gold could rise or fall, depending on what the market dictates.

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43 comments to GOLD STANDARD … DEBUNKED OR ANOTHER BUBBLE?

  • My thanks to Paleo Pat for being a loyal, intelligent reader. Further, his or her comment (www.politicalbyline.com) indirectly points out the differences between adherence to a philosophy and practical reality.

    The reader writes in response to my gold blog: “Egad, don’t tell that to the people that support Ron Paul, The Ludwig von Mises Institute or the people that are hawking gold on all the Conservative sites that run the ads for gold.”

    I will not argue pro or con the “purist” philosophies of Congressman Ron Paul or the famous Von Mises Institute. They, of course, are entitled to their respective opinion. Those “hawking gold” subscribe to only one philosophy: to maximize their profit on the gambling instincts of the public. That’s what makes a capitalistic system.

    In theory, the discipline to be instituted by a gold or other metal standard (platinum, palladium, etc.) might well be desirable. This is especially true in today’s financial debacle.

    Unfortunately, like so many philosophies, a return to a gold standard might be admirable in philosophical theory. In practicality, however, it flies in the face of reality of today’s increasingly global world.

    Apart from the empirical realities of supply and demand and free trade, the gold standard (and its adherents) is merely another method by which individuals or government intend to shape a society to its wishes. Not the ideal for a truly democratic world.

    As long as we enjoy the relative freedom of a capitalistic, pluralistic society, replete with its faults and errors and disagreements on philosophies, it’s best to stick with quantifiable facts, isn’t it?

  • Raymond

    Dr Z

    It’s harder to manipulate money backed by gold.

    The old “quantity of money” myth. The elasticity of money theory came from supporters of fiat money.

    If the money stock (gold or otherwise) remained relatively constant in a productive economy, the market will adjust moneys purchasing power — upwards. Money will buy more goods, which should naturally occur because of advances in production processes.
    Instead–
    We perversely accept its opposite, which is persistent loss of our moneys purchasing power from manipulation of the money supply. A truckdriver can understand this (I am).

    Rates or the price of borrowing money should be influenced by the supply of loanable funds from savings.
    Ample supply should produce lower rates and vice versa and this rate reflects consumers time preference ie saving now to spend later. The supply and demand for loanable funds dictates the price, or rate.

    We now (your grandchildren) face trillions in debt because of the current monetary system, with no end in sight. So yes, I do not trust government with the money.

    Let the market decide what money to be used, provided the federal government cannot manipulate it.

    Come to think of it, States finances may be in shambles but it at least reflects reality. They must tax or borrow to fund itself, and it has a limit.

  • Ray – I agree that IF the money stock (gold or otherwise) were held relatively constant, as Milton Friedman recommended in his works, any economy would run more effectively, capitalist or socialist or even communist..

    Unfortunately, whether the Fed or Bundesbank, PEOPLE make the decisions to increase/decrease money supplies at political or other will, not the theory!

    The theory works … the implementation doesn’t if the basics are not obeyed.

    A preset computer at, say, 4% money growth a year, would do a credible job.

    The key point re the gold standard is that it is impossible to have a countrywide (or worldwide) monetary system backed by gold today, since there simply is not enough physical gold in existence.

    Furthermore, how could the squawkings of more than 300 million be adequately addressed, each with their own set of needs, wants, and priorities?

    Again, the theory may be fine (although unemployment demonstrably increased during US and other countries’ gold standard times). Furthermore, currency devaluation had an equally disastrous effect as an excessive printing of fiat moneys.

    While supply/demand of loanable funds normally does dictate the price, the current crisis adds a factor: there is plenty of liquidity … but not enough desire or willingness to lend! A few rotten apple did spoil the barrel … and society became so used to government “solving” any small – let alone large – ailment that 9it would be hard to change U.S. human nature in less than another half a century or more!

  • Thanks, Dr Z. You said it so now I don’t have to.

  • Raymond

    The bust we are experiencing and the trillions in debt the country now face are the direct result of a “flexible” fiat monetary system—–controlled by the federal reserve system.

    It is what got us here.

    A scene from the ER:

    Nurse: But Dr Ben, you are prescribing the same medicine that got the patient violently sick!

    Dr Ben: Nonsense. Nurse, prepare to inject the patient with our new liquifying elixir TARP, pronto!

    :)

  • Raymond

    Friedman and Bernanke believe that the depression in the 1920s could have been sidestepped if only the central bank pumped enough liquidity. The problem then and today was bankers and consumers are not lending and borrowing, so their theory is wrong. The physical count of gold or whatever money chosen in circulation is not what is important . What is important is that it should not be manipulated. The market will adjust It’s purchasing power to serve the needs of commerce.

    The economic bust and trillions of dollars in debt the country now face was enabled by the current monetary system.
    Not just a few rotten apples.

  • Ray – You now no longer seem to be blaming the theory of monetary economics, but narrowed in on the institution of The Federal Reserve System.

    If, according to you and others, the Fed system is to blame for past and present economic ills, how would you explain the post-Civil War depressions and deflation that lasted roughly for most of the yearsl before a Fed was created?

    The U.S. switched from its bimetallic standard to a simple gold standard by 1873. The country was plunged into a severe, long-lasting deflationary period through roughly 1896!

    Who “manipulated” the currency? Gold? Did the government through its move to a gold standard? Or did Mssrs. Fisk and Gould and others, wishing to hoard gold?

    The “free market” ruled with little government interference, leading to the same argument as voiced today – the “rich” as opposed to the “poor.” By those standards, the rich really were rich, and the poor were really poor. All this inequality ultimately lead to the reform movements of early 20th century.

    Is it really the institution of the Fed you’re attacking?

    Or maybe you’re wishing for a free, unregulated market and hoping that the baisic nature of mankind is NOT pursuing self-interest and greed, but living in an idyllic environment?

    I do believe you might enjoy a more extensive, factual history of money or gold in the U.S. or elsewhere, and then make your assumptions about mankind, “free” markets, gold and credit, etc.

    Rothbard’s lengthy tome certainly provides lots of fine historical facts, but is underscored with his anathema towards government (in all forms?)

    For considerably less biased accounts, consider reading the history of money and banking through the Library of Congress (http://www.loc.gov/rr/business/money) by Ellen Terrell (2005). You may find that there are many different sides to government’s role in the affairs of money and banking.

  • Raymond

    Sir:

    The 1813–1818 boom was a bubble from war finance ending in the panic of 1819. The Second Bank Of United States fueled the land speculation. I will look into your severe “deflationary”
    period that lasted trough 1896, to be fair. I think JD already covered both early attempts at establishing a central bank in the United States. ( I read other peoples posts). Both ended up in disasters for the country.

    Central banks and governments differ in approach and motives (the governments economic moves are guided by politics, whereas the Feds first priority is to bail out its creators, bankers). As far as theories, The results of Keynes and Friedmans theories have been playing out from 1913 until today.

    Can we say their their theories are sound?

    Both federal government and central bank have acted as economic planners directing our peoples prosperity.
    I believe they have failed miserably.

    The inflation, the boom and busts, the trillion dollar debt was not caused by a few bad apples.
    But despite of the mess,there is undying belief that if only managementtechniques were fine tuned, prosperity can be attained better than a self-serving free market.

    The discipline of gold prevented ancient Kings and modern governments from spending money it does not have. That is its only appeal to me.

    I want the Federal government to borrow or tax to fund itself, like the States, like its people.

    That is a wish from a taxpayer from main street with self interest in mind.

    With respect,

    Raymond

  • What the advocates of gold, or a gold standard, really want is STABLE MONEY. The best way to achieve global monetary stability will be to implement a Single Global Currency, managed by a Global Central Bank within a Global Monetary Union.
    The success of the euro shows that monetary union is the best way to ensure monetary stability. The primary problem with the euro and
    currencies of other monetary unions is the multi-currency system itself where currencies fluctuate in value against each other. If 16 countries can use the same currency, why not 192?
    In addition to eliminating currency risk, the use of a Single Global Currency would eliminate the current foreign exchange trading expense of $400 billion annually, eliminate current account imbalances, eliminate the need for foreign exchange reserves (now totaling more than $3 trillion), eliminate currency fluctuations; and bring other benefits worth trillions.
    The Single Global Currency Assn. promotes the implementation of a Single Global Currency by 2024, the 80th anniversary of the 1944 conference.
    That’s only 16 years away. The world is moving toward a Single Global Currency through the creation of monetary unions in Asia, North and South
    America, Africa and the Middle East (GCC) and the expansion of monetary unions in West Africa, the Caribbean and Europe.
    The Assn’s website is http://www.singleglobalcurrency.org. See the book, “The
    Single Global Currency – Common Cents for the World.”
    Morrison Bonpasse
    President
    Single Global Currency Assn.
    Newcastle, Maine, USA

  • Ray – If you continue to go back in history, your argument ultimately revolves around the Hamilton-Jefferson difference in philosophy, which ultimately resulted in the perspectives beteen states’ rights and a strong federalist position. That, in turn, goes right back the opinions of Locke-Hobbes in England – the nature of man. That opinion, of course, is endlessly debatable with neither side capable of “proof.”

    By the way, “the discipline of gold prevented ancient kings and modern governments from spendiing money it does not have” may be true in certain select instances but not in general. The option by European kings: to make war whenever felt desirable, appeal to unseen or unprovable ideals, and devalue their currencies when necessary! Hardly a responsible response to the “discipline” of a gold standard!

    Our next writer poses an interesting future option – global currency and monetary union with a global central bank!

    It would be interesting to hear what you and other supporters of the Austrian school might think about the philosophical AND realistic aspects of such an arrangement!

  • Dirk

    I’m happy someone gets it- that constraining global economic activity based on a single metal that doesn’t really correlate to economic activity makes no sense.

    Cleary, the gold standard is deflationary in absence of either major gold finds, or major negative economic shocks. More goods and services chasing a fixed money pool will create massive downward pressure on prices. And downward pressure on prices and assets equals lower incentives for investment, more difficulty paying off debt, and a negative wealth effect that creates real economic stagnation.

    Inflation, on the other hand, creates pressure to invest money- not hoard it. As long as a currency promises a future redemptive power, it will keep its value. Perhaps fixing currency values to a “total energy” metric- the sum of all oil, coal, gas, solar, nuclear, etc. reserves- would allow for both economic growth and a guarantee of some future redemptive power for something really useful.

  • Thank you, Dirk! Your concept behind an “energy-based” currency goes substantially beyond the various interests in the Middle East for a potential (crude) oil-based community.

    Your idea poyentially combines the elimination of the U.S. federal income tax, together with a solution to fund energy and other necessary global ecological necessities, while spurring, rater than restricting, investment and growth.

    It will take much convincing by well-placed visionaries against entrenched, self-serving political interests, however, it is potentially feasible.

  • Raymond

    We are in a deep economic mess and taxpayers are being forced to shoulder trillions in debt.

    Any clue how we got here?

  • Dirk

    Hey Raymond,

    Simple- the global economy has been on a tear. The late 90s were a period of explosive growth in technology, ideas, communication- with a whole additional universe called the internet to be monetized.

    So what does our Fed do? They jack up interest rates to head off “irrational exhuberance”, killing tech stock asset values and creating a major negative wealth effect. Add in 9/11, and we’re where we are today- except the President and media are behind talking up the economy and the Fed reduces interest rates and cheap foreign goods stimulate retail growth and capital gains cuts stimulate housing growth and our economy heats back up to 7% growth.

    So what does our Fed do? They jack up interest rates 18 times, causing millions of homeowners to consider selling their homes at the same time, and businesses to have to reduce expenses (read: employees) to cover increased debt service AND increase profits required to maintain their ratios (profits 2X debt service is typical). The Fed reduces rates, but, this time, the media and opposition are behind talking down the economy, oil speculation increases energy prices, and since confidence does not increase, millions of homes are still for sale, home asset values plunge, home loan collateral is in doubt, bank collateral is in question, insurance draws potentially exceed actuarial calculations, and in order to avoid a total collapse of our economic system, the government steps in.

    So what should our Fed do now (and if you’re worrried about government fiscal policy, you’re worried about how to slice the pie, not how to make the pie bigger). Massive quantitative easing. OK, so oil goes back to $100 and gold goes to $1200- so what? Garage sale t-shirts go to $1 and cell phones cost $75- so what? Home values go back to 90% of what they were- so what? The problem is fixed, that’s what.

    And when that happens, the investments our Treasury has made with deflated dollars will turn out just fine.

  • Wow so much muddled thinking in one place. It is amazing that my browser didn’t pop up a warning.

    1) Any stock of money sufficient to be accepted by the public as a money and selected as the medium of exchange is capable of serving as money. There is no need to grow the stock of money. Despite this false criticism, the gold stock does grow at a predictable (by mining engineers) and low rate between 1% and 3% per year.

    2) The purchasing power of a money is related to the stock of money and the demand for money. Its purchasing power is also related to the supply and demand for all other goods in society for which it is exchanged. Thus as productivity increases, the purchasing power of a stable or slowly increasing money will increase. This has the effect of making daily expenses of those with debts easier to bear.

    The only time a debt would become harder to pay off would be if the debtor was in a field of employment where his pay decreased in line with the increase in purchasing power of money. This might be a possibility, but at the same time that human actors today judge their debt burdens based on future expectations of income, those operating under a regime of increasing purchasing power of money would be capable of determining their expected future debt load capabilities. Those who guess wrong in such a situation are no different than those who bite off more debt than they can chew under our inflationary regime.

    The biggest improvement that increasing purchasing power has is for savers and those on fixed incomes. Savers would earn interest + the difference in purchasing power between when they started saving and when they start consuming. This is the opposite of today where the difference in purchasing power subtracts from the interest and reduces the incentive to save. This will have the effect of greatly encouraging saving and the stock of loanable funds, driving interest rates to natural and sustainable low levels. This will benefit the saver/consumer in the future as well as the entrepreneur and the durable good consumer in the present.

    Inflation on the other hand encourages debt based financing. It favors instant gratification, but since there are fewer savers since debt is the preferred method of financing, the purchases of today are not sustainable. The increase in consumption fueled by new money is not fully offset by the preferences of a ever shrinking class of savers who abstain from present consumption. This results in a business cycle like we see continuously under a system of bank credit expansion (ex nihlo). Inflation encourages capital consumption and not investment as Dirk claims. Empirical evidence of this is present in the dilapidated factories and rotting machinery of the American Rust Belt.

    3) All business cycles (as in repeated and not caused by something like war or famine) are the result of fractional reserve banking and its concomitant ex nihlo credit expansion. There can be no stable and sustained economic growth under a fractional reserve banking regime. There will always be over-expansion combined with malinvestment, and and then retrenchment as the bad investments are liquidated. Attempting to tie a money to a commodity standard while maintaining a fractional reserve banking system is unsustainable. There will inevitably be calls for the creation of a central bank and lender of last resort as the bust causes bank runs.

    The only viable solution is to realize that fractional reserve banking on demand deposit money is clearly a case of conflicting views of a contract and thus an untenable and invalid contract. How can a depositor demand a physical object which the banker (rightly?) assumes is lent to him for his purposes. A physical object must have a clear owner and can not be subject to control simultaneously by two parties of differing opinion under which direction to place the object. Thus demand deposits must be maintained in a warehouse fashion with 100% reserve maintained at all time. This eliminates the possibility of a bank run (in the historical sense and in the practical sense of potential damage to the depositor). Furthermore by limiting bank loans to funds deposited in time accounts (i.e. true saving) there will cease to be a business cycle.

    4) The idea of a world central bank is superfluous with a free monetary system and 100% reserve banking. The main purposes of the central bank are to ease governmental expansion and to act as a lender of last resort. A world central bank will only lead to world bureaucracy. If banking is on a firm economic and legal foundation, there is no need for a lender of last resort. A world central bank is only an excuse for the establishment of world government. It can not prevent world wide business cycles while maintaining a fractional reserve banking system. Furthermore, if it maintained a 100% reserve banking system, it would still be subject to political considerations in open market operation and would still cause misallocations of resources, though not of the intertemporal kind as explained by the business cycle theory. The misallocations would result in privileged borrowers being able to bid resources from those who obtain the increase in the money supply last.

    5) The myth that a gold standard would limit growth is preposterous. One of the greatest periods of economic (and population) expansion was obtained under a gold standard and under a period of increasing purchasing power of money (Cf. the 19th century). There is no theoretical nor physical restriction on the growth of economy based on a sound monetary system besides the subjective actions of individuals to save which allows for the implementation of longer and more productive production techniques.

    The claim that unemployment is higher under a gold standard is also ridiculous. All non voluntary unemployment is the result of artificial restrictions on the movement of labor or its price. One must be careful not to make the mistake of comparing the unemployment rates of a central bank and fractional reserve banking boom period to an average or bust phase unemployment rate under the fractional reserve banking system which has persisted in the United States prior to its inception. Under a free market, all labor wishing to be employed will be. All state intervention attempting to reduce the ranks of the unemployed can only be obtained by reducing the well being of other actors in the economy. As such interventionist attempts to reduce unemployment, though they may increase productivity (doubtful), will not be optimal as compared ex ante in terms of the satisfaction of wants of all economic actors. On utilitarian and natural rights grounds, state intervention in the labor market is counterproductive, misguided, and should be avoided.

    6) The idea that there is not enough gold to back all of the fiat currencies of the world is the most foolish statement of all. Logically one can take the stock of gold available and divide it by the weighted sum (by exchange rate) of the currencies of the world. This could provide backing for every single dollar, ruble, yen, etc. However, this is a bad policy, for the market should be left free to choose its own money, it should not be instituted from on high via state decree or central bank policy.

    All that needs to be done is to eliminate legal tender laws and taxes on market selected monies. Since we have several thousand years of history showing that Gold and Silver are typically selected as money, we should start by eliminating taxes on them. If there is a push for a different medium of exchange, it should be treated in the same fashion. At the same time, all fractional reserve demand deposit banking must be subjected to traditional legal principles regarding property rights.

    This means a reversion to 100% reserve banking. From these two changes, the market will perform the transition to a sound money with the minimum disruption and transfer cost. A state imposed system can only result in higher costs, as well as a retention of particular privileges for the state, most commonly in the form of a central bank, liable to interfere in the money supply through open market operations and subject to the political whims of demagogues.

    In conclusion, I highly recommend Huerta de Soto’s book Money Bank Credit and Economic Cycles, http://mises.org/books/desoto.pdf, for a thorough review of the history and evolution of banking and money and a solution to the recurring nemesis of the business cycle.

  • Raymond

    You are basing your entire argument on a flawed notion that the money supply must expand with a growing economy.
    From there it cascades to absolute nonsense. (Trillions in debt as investment?)

    If the economy s output of goods is expanding and the unit count of money remains steady,

    it is moneys buying power that will expand and there is no limit to this. Can you grasp this at all.

    From there you portray saving as hoarding because it doesn’t fit neatly in your Keynesian infected “economic”
    concepts.

    Spending or saving are personal choices and this is reflected in the pool of savings. Absent the Feds intervention, ample supply of savings will naturally lower the price of borrowing. A basic economic law of supply and demand. Ever heard of it?

    This price signal convey consumer preference with their money. Hoarding? You will abstain from using your money too if you don’t trust the current environment. Otherwise people save money to spend later.

    This where the Feds activities( of artificially lowering and raising of the price of borrowing money) produce the job creating booms and the inevitable job destroying bust.

    The price signal from the supply of consumer savings is ignored by the central bank with disastrous results.
    It is acting like a cat chasing its own tail, reacting to the effects of its previous move.

    The Fed induced bank credit encourages unsustainable production and demand that begins to unwind with the next
    upward rate move—–this time to “prevent” inflation but of course.

    Recessions is how the economy adjust to the excesses made during the boom phase—-by liquidation. As it always has in previous times.

    This is where we are today. And you want to administer the same medicine that got the patient violently sick.

    Your very original sales pitch of unbridled money printing
    (now called “liquidity” injections) has its parallel in history.

    Operation Bernhard was a secret Nazi counterfeiting operation in World War 2.

    The goal was to flood England with counterfeit pounds, with the goal of destroying her economy.

    By your “economic” logic the Nazis were instead hell bent in promoting economic growth in England.

  • The intent of this discussion was to focus on why a scarce commodity. i.e.,gold (or platinum, palladium, etc.) was ill-suited in this ever-expanding global world for simple supply-demand reasons, was it not?

    Immediately, the focus shifted away from the basic question of gold to the “ills” of the Federal Reserve (and other central bank) systems, ignoring the myriads of debates the subject has previously engendered.

    It finally appears to have reached the ultimate conclusion (by some readers) that fiat money, in general, along with a fractional reserve system in particular are incompatible with the modern world.

    The latter, of course, belies a basic, proven “truth” – fractional reserves have been empirically studied and analyzed since the Middle Ages! That economic law, like basic supply and demand, has passed the test of time and logic.

    I prefer – as do the majority of professionals in the field – to test hypothetical theories with results in empirical, factual evidence, not mere normative “could,” or “should” political statements. They may sway the emotion-seeking electorate but do little to solve the extant crisis.

    That, of course, is greatly lacking here. Where are the facts and feasibility of application, with a short and long-term perspective?

    Even the underlying assumptions concerning the “nature of man” in re Locke-Hobbes, Jefferson-Hamilton, etc. remain unaddressed.

    I think that assumption is as crucial to a discussion of the Austrian school, as it is to understanding the motivations of Karl Marx or Milton Friedman or Paul Krugman.

    Do the adherents of Von Mises somehow simply assume an innate “goodnes” for mankind that they resent any role for government? If so, why not state it? Even better, prove it empirically.

    Could the United States have easily extricated itself from the ravages of the 1930’s Great Depression? Could it do so in 2008/9? At what cost to whom? To whose benefit? The questions are substantial.

    I venture to suspect that such an ideal as a true, unregulated market would quickly become just as onerous as did the communist model. It, however, was enacted for most of the last century around the world.

    Maybe rational logic is easier to replace by visceral normative arguments? Of course it is. While it may place blame at individuals or institutions, it does nothing to rectify proven errors and mistakes.

    Certainly the Fed during the last half a century has been and can be blamed for miscalling various intended economic results by not following the proven, empiral guidelines of Milton Friedman.

    Certainly the actions by the U.S. Congress following 9/11 resulted from blind fear, fueled by a herd instinct and a war based on flimsy political excuses resulted partially in todays’ financial difficulties.

    Certainly, the actions from Main Street to Wall Street can each be blamed for a share of the global financial crisis. Worse. it harbors the escalation of a new populism that hardly augurs well in the global society, the Austrian adherents notwithstanding.

    Perhaps the fact that the Austrian school of economics delights the Libertarian, often anti-statist, and at worst, neo-anarchist elements of American society is borne out by the fact that it is hardly mentioned, let alone studied, in the majority of American graduate programs?

    Underlying all is the perspective of the nature of man. Is it realistic, borne out by centuries of discussions and writings, or merely a thin veil of normative frustration, voiced at an intangible, the government?

  • How can a discussion of money (specie backed, or fiat) not eventually bring up the most pernicious aspects of our current system? Namely the fractional reserve banking system and the central bank, and the havoc that their privileges and policies wreak upon the capital structure as evidenced in the business cycle.

    Obviously, fiat money and fractional reserve banking work by some definitions of the word work. Are they optimal? No, from a liberty perspective. Clearly any money which fundamentally is plagued by recurrent business cycles should be considered as poor when there are alternatives which would eliminate this terrible misallocation of resources. Perhaps if scarcity were no longer a problem, a money supply that endogenously creates economic miscalculation would be acceptable, then again, human actors wouldn’t need money in that world.

    If you would like to see the empirical evidence backing the Austrian business cycle theory, see the following:
    http://mises.org/journals/qjae/pdf/qjae9_2_4.pdf
    http://www.mises.org/journals/scholar/Sechrest8.pdf
    However all economists would be wise to read and heed the warnings of F.A. Hayek in his Nobel acceptance lecture, The Pretence of Knowledge.

    It is true that should statements move from the realm of value free economics to political value statements. This is a movement to the realm properly governed by ethics. At the same time, the immutable laws of economics can tell an inquiring mind what the likely effects of a particular policy will be. If this individual values liberty and individual choice and autonomy highly, then economic laws can go from descriptive to prescriptive. If the individual values the free market and classical liberalism as the highest goal, then economics can indicate guide action toward that goal, including which monies will be most compatible. For a little background that ties the previous paragraphs together nicely see http://mises.org/rothbard/extreme.pdf

    Since we are now discussing the world view and ethics of Misesians, they are basically split into two camps. Those who like Mises himself ascribe to utilitarianism as the basis of their ethical system are typically minarchist and lean toward the classical liberal position. Those who follow Rothbard and Hoppe ascribe to a natural rights, or logically deduced ethic which leads to the anarcho-capitalist stance and the rejection of the monopoly state.

    I don’t want to go much further off track here, but let me state that Austrian economics is comprehensive and rigorous. Its foundations in a priori deductive reasoning from self evident postulates leads to a very distinct methodology as compared to the Neo-Classical and Keynesian schools of economics, namely the emphasis on theory and the elucidation of economic truth as compared to the fitting of empirical data to ad hoc models (or as is often the case, vice versa).

    Perhaps it is the paucity of equations and mathematics required to gain a working knowledge of Austrian Economics which attracts many of its armchair adherents. At the same time, its leading intellectual proponents’ forays into political value statements and ethics in defense of limited government and market anarchy call strongly to the libertarian minded. Were it not for the unfortunate effect that Keynes General Theory had on the economics taxonomy and the resulting separation of macro and micro due to his self confessed ignorance of capital and its structure, Austrian Economics, with its robust capital theory would be the mainstream.

    If we are delving into alternate realities, should Keynes not have worked his regressive influence in economic thought, perhaps Krugman would not call for ridiculous absurdities like governmental stimulus, justified by Keynesian confusion. Logical tests refute the wisdom of many of the policies which deepened the Great Depression and which our court economists seem ready to prescribe again. E.g. if it is good for the government to stimulate, why not the local counterfeiter? or why stop at only $600BN? If a minimum wage is good for the poor, why not raise it to $100/hour?

    Where is the recourse to empiricism? If policy failed miserably then, what suggests that the same answers will result differently now? Oh, I forgot that empirical economics means that we try banging our head into the wall in many different ways, because that is the only way we can prove or disprove if a particular variable contributes to our resulting headache. Theory and reason indicate a way out of our present predicament as much as they would suggest not banging one’s head if one wanted to avoid a headache. Theory and sound economics indicate a way to avoid business cycles.

    But lets try empiricism one more time. Perhaps if we account for or throw out a particular variable, we can show that employment will increase with a raise in the minimum wage or some other such nonsense. Perhaps a replay of the Hoover-Roosevelt play-book will not result in 15 years of depression this time around, just consider the variable of the savings rate which was much higher then.

    I again implore the reader to reconsider the advice of Hayek in The Pretence of Knowledge. For a background on the question of whether or not economics is an empirical science, listen to the following. http://mises.org/HSCAE/mp3/5-Hoppe.mp3

  • Vikinger

    So what is the explanation for the London quoted Trans Siberian Gold mining co. share value dropping week after week and now being quoted at only 13p (20c)?
    The Russians and South Africans appear to own 85% of the company, and they still need to raise $40m (I think) to see them through to refining the ore they’ve already stockpiled. The two major stockholders could do a deal and take control so as to force private buyers out at a nominal cost. On the other hand, there could be a major boost in the share price once the outstanding funding is resolved. The market seems to think that this is a gamble too far???

  • Vikinger – I can only recommend the company’s website, http://www.trans-siberiangold.com/r

    It contains all the company data, as well as contact numbers for the company’s investor relations staff, should you wish to follow up on the stock.

  • Inquisitor

    It is incredible that some people have such blind faith in the thoroughly debunked “empiricist” (it isn’t) hypothetico-deductive model. It works, to an extent, in the natural sciences (some argue it was never even how science proceeded to begin with, see Kuhn, Feyerabend etc) but wreaks havoc when applied to social sciences which do not deal with strictly deterministic things, but acting man. For crying out loud, even the mainstream of philosophers has consigned positivst garbage to the dustbin of history. Why do economists insist on clinging to it in a science that is most ill-suited for it? Read Mises, read Hoppe, read Martin Hollis, read Barry Smith, read Roderick Long, read Geoffrey Plauche. Read any of them on methodology and have your silly, atavistic prejudices (which Hollis likens to astrology) debunked through and through.

    As for gold, ignore the crank who authored this and read works by Rothbard and Mises for a proper understanding of the topic.

  • Inquisitor

    All Austrian econ is, btw, is deductive inferences from highly well grounded empirical (in the original Aristotelian sense) facts. Mises would phrase this differently due to his Kantian leanings. If you do not know the philosophy behind it, please refrain from expressing an opinion and educate yourself (pretty much the opposite of what most people seem to do.) Long’s article on the types of abstraction (precisive vs non-precisive) and Plauche’s article on Aristotelian renditions of praxeology shed some light on this often neglected fact. So please, before ranting about “empirical” sciences and the like make the effort of getting an education.

  • Raymond

    Vikinger

    For clues, research how the price of gold and and gold mining companies fared when it was still used as backing for paper money.

    Don’t you think that is a huge factor that affects it’s price that is not present today ?

  • Dirk

    Wow, some complex terminology in this thread now.

    But I think economics is much simpler. Creation of goods and services and distribution. And our Constitution gives the responsibility for the creation of money to our Federal government. This doesn’t keep someone from creating their own means of exchange- bartered services, chickens, empty promises- but Federal regulations generally apply to Federal dollars, and humans have shown a preference for transactions supported by the rule of law. And the US rule of law has shown superior to a large part of the world.

    The “debt explosion” of the last 30 years has accompanied a “standard of living” explosion, both globally and in the US. Do a little simple research- calculate the number of hours a minimum wage worker of 1978 has to work to buy one month rent, a cell phone, a video player, a pair of shoes, jeans, shirt, months worth of milk, monthse worth of steak, RT airfare Chicago to New York, month’s worth of AIDS medication, and a month’s worth of gasoline- vs. today. You’ll see it’s less than half as many hours today as 30 years ago. All this “debt” and “money” has created a boom in productivity, has brought more people into the global economy, has yielded larger, nicer, and more efficient, houses, nicer, more reliable, and more efficient cars.

    Nothing improves productivity like scale and technology, both of which require more economic activity, not less. And price stability has been found to be key to both stable growth and improved living conditions for the poor (no less than Obama’s chair of National Economic Advisors has published this)- NOT reducing prices.

    But at this point, it looks like we’ll get to see the effects of the ideas I’ve been touting as the Fed has begun to pursue them the last 3-6 months. We’ve already seen what happened when the Fed increased rates and constrained the money supply from 2004-2007…

  • Raymond

    Dirk,

    Which complex terminologies did you not understand?

  • Raymond

    Dirk,

    Economics In One Lesson
    by Henry Hazlitt.

    It’s for beginners who knows absolutely nothing about how the economy works with no complex terminologies.

  • Dirk

    Raymond,

    I’m apparently not as well read in philosopher’s works as some, so the term Kantian doesn’t mean much to me (and I’m guessing that, like those guys you hear call on talk radio debating what a coach or politician was probably thinking when they made a decision, there are different interpretations to be had anyway).

    Atavistic, minarchist, and even normative as used above are out of my daily lexicon as well.

    But, as I said, I think price stability and expectation of future value of money is more important than either buying into the old Austrian school of thought (which I think was more credible in years past when the king dictated economic activity- oh wait…) or letting the market solve problems for itself that the government created (by constraining money).

    Do you subscribe to this equation:

    Money x velocity = goods x price? And if velocity drops due to lower confidence, what then?

    Now, if you don’t want more goods (maybe you’re a scarcity paradigmer who thinks we’re running out of oil, land, water, etc. and that we need to ration goods) then I suppose you don’t create more money, or hope people can get used to deflation (and the deflation of the late 1800s was created via the industrial revolution- no wonder living standards increased, even though we got the stereotype of the mustache-twirling banker throwing widows and farmers out from that period).

    But given the Obama economic team values price stability and economic growth, it’s no wonder you see- and will continue to see- significant liquidity/debt monetization from the Fed.

    The question I have is this- unlike 2004-2006, will they let growth stay high this time? Because 7% GDP growth means it take 10 years for an economy to double, and the 3 billion folks living on $2.50/day probably would like to get to $5/day sooner than that…

  • Raymond

    Prices naturally fluctuate to reflect the underlying supply and demand for goods. And it now takes $22.10 of todays money what it took $1 to buy in 1913.

    (1) Could you explain how you define Price Stability?

    Assets minus Liabilities = Net Worth

    (2) What equation do you use to arrive at net worth?

  • Raymond

    Dirk,

    As of Nov 26, 2008 the American taxpayers debt stands at

    $10.6 Trillion (govt borrows it on behalf of taxpayers).

    Not sure if the figure includes interest payments.
    Do we have to pay this back?

    Dirk, the best question for last —

    How can the US economy create jobs without adding to this enormous debt?

  • The national debt ultimately comes down to the will of the people.through Congress. The U.S., unlike so many countries, has never defaulted on a single cent of its debt. Yet, only once in American history has the total national debt been reduced to virtually zero!

    That is why the good faith and credit of the U.S. has been unparalleled.

    American Congressional policy – and thus, the will of the people – however has created uncertainty in the minds of American debt holders, including foreign governments.

    The questions are serious enough.

    Waging yet another war while demanding more and services from the federal government instead of assuming personal responsibility accounts for the escalation of American debt.

    Whether the U.S. chooses to further escalate the debt is the people’s choice in a democracy.

    President Clinton oversaw annual budget surpluses resulting from a thriving economy, and proceeded to pay down the federal debt in three years by some $355 billion by 2000.

    Shortly thereafter, Congress, on behalf of the American people, gave the Bush administration a virtual blank check to wage the Iraqi war.

    Congress and the people it represents simultaneously insisted on maintaining and increasing social service expenditures.

    From Main Street to Wall Street, it is now time to pay the piper. The present financial crisis may provide the necessary respite to rethink the overall way of life of American society.

    That rethinking, more than any prevailing beliefs, must deal with reality and fact, not wistful wishes.

  • Raymond

    Job creation without adding to the national debt, increasing taxes or inflation.

    How can the US economy achieve this?

    Trough production with savings.

  • Norbert Haag

    As you can imagine, I hold some distinctive views on the topic of your article.

    What puzzles me is the use of some terms and its definitions. So, let me ask some question to get a clarification here.

    (1) What is your definition for a money?

    My humble proposal would go along these lines:

    “A money is the most marketable good in the market”

    Because this definition includes any of the other defintions that where given, of which most are an outcome of this one.

    Money is a medium of exchange, because it is the name for the most marketable good.

    Money is a measure of account, because you can measure the cost of goods by comparing them to there money value rather than to compare them to thousands of other goods.

    Because money is nothing that is brought into existence by an authority but by the market, a money can not be implemented by mere will but only by the market – no question, once a good is accepted as money a lot of fiddeling can be done with it like coin clipping and counterfitting.

    (2) Why would it be that there is not enough gold to run our economy?

    I think this is one of the first arguments being brought against a gold standard. and it is therefor debunked many times.

    Gold as a money is a commodity. Its value as a money lies in its acceptance as a medium of exchange. Like any other solid commodity gold is measured by weight. The term dollar in a gold standard market would not be a unique entity, nobody could explain, but rather a measure of weight, say 1/4 ounce of gold.
    So, now we could refer to a quantity of gold by saying 10 1/4 ounces or … much easier… 10 dollars.

    As the monetary unit is nothing more than a unit to measure weight, it is the same than a meter, a mile, a bushel, a pint or what have you. Did we had to inflate the mile only because we encountered that the sun was millions of miles away? Did any shortage of inches ever appear in the know history? Not as far as I know.

    There can never be a reason to have more of a measurment. In fact, the more fixed a stock of a money is, the better. This is the reason why a money usually has rarity as an attribute (beside others).

    Because it is rare, it is stable. Wealth stems not from the generation of a money but the production of useful goods.

    How useful a good is, is shown in its money equivalent when an transaction occurs. If i can trade my produced good for 10 units of a money, than these 10 units are the measure of its utility or usefulness for others. If the cost to produce the good was less than those 10 units, wealth grew. If it was more, wealth has been destroyed.

    Whether the expression of the 10 units is 1 $ or 100000 $ doesn’t make any difference at all. If it would, we could just, by decree, start calling 1 buck a million bucks and be all millionairs at once.

    Bottomline, economies do not need more money to grow, they need the production of more useful goods.

    The price of those goods are expressed in terms of money, e.g. how many units of the commodity used as a money is needed to buy this good.

    If a good is sought after and gets scarcer, the price will rise. If a good gets more plentyful, the price will fall. No need to fiddle with the money at all.

  • I interviewed a gold-mining portfolio manager on my radio show on 11/30 where we talked about the investment ramifications of foreign dollars owners dumping their holdings and the impact on gold.

    That plus the inflation outlook based the Fed’s monetary policy actions lead many to believe that skyrocketing gold prices are in our future.

  • Dirk

    Raymond,

    Price stability means prices of goods and resources are stable year to year.

    Stable does not mean constant- ask any airline pilot.

    While the price of some goods has increased greatly- women’s bras, buggy whips, bottle of coke- you also realize that many goods weren’t around in 1913- AIDs meds, cell phones, PCs, video players. As the economy has grown, these new goods and services have required monetization to come into existence. The bottom line is that the cost in hours worked to get these goods is WAY WAY less than in 1913.

    I define net worth as do you, but there are accounting issues- what is Yellowstone Park valued at on the balance sheet? Not to mention US government deficit of $10.6T vs. (per Fed in June) appx. $55T citizen net worth.

    But the ultimate source of wealth for our country, like most people, is our earning power. The ability to convert raw materials (sunlight, rain, metals, etc.) into goods and services. And it just seems obvious to me that if you want new laborors, entrepreneurs, and investors to do this, they have to be incented to produce- not watch wealth hoarded and passively increase in value as not enough money is created to support the creative ability of our economy.

    And gold can’t increase fast enough, nor does it correlate all that well with economic activity.

  • RM – Your radio guest reflects accurately on previous speculations in gold whenever people worry about the future of the investment climate, whether economic or political or through natural disaster..

    Gold, as a speculative hedge against perceived perversity, rises and falls with the normal behavior of supply and demand.

    The previous high of $850 in 1980 resulted from speculation as much as the new record nearing $1,000 an ounce did this year. This followed more than two decades of trading of gold within a reasonable trading range.

    The Middle Eastern conflicts, natural disasters, perceived economic disarray – not to mention a declining, easily available supply of gold, naturally heightened speculation, driving up the price.

    Just like the stock market – gold rises because there are more buyers than sellers!

  • Raymond

    Dirk,

    Your model for production and jobs can only be achieved with added national debt, added taxes or inflation.

    And efficient production processes in the market does not rely on debt, taxes or inflation. That is a silly assertion.

    Production With Savings is a better way.

    The period 1866 — 1897 a time of secular deflation was perhaps the greatest ever experienced by the US economy during a period of comparable length. Real GDP grew more more than 4 percent per year, on average, not withstanding the persistent deflation.

    Mainstream economists believe constant debasement of money, deficit financing and taxation is the only way to prosperity.

    R. Higgs wrote about the bogeyman deflation 37 years ago
    The Transformation Of The American Economy, 1865-1914

    Robert Higgs is a Senior Fellow of Political Economy for the Independent Institute. He is the 2007 recipient of the Gary G. Schlarbaum Prize for Lifetime Achievement in the cause of Liberty.

    Enjoy,

    Ray

  • Raymond

    Dirk,

    A little humor with your pilot analogy.

    The pilot feverishly works the controls to stabilize the aircraft. Yet one look at the instrument panel indicates the plane has damaged engines ( from using JMK brand jet fuel) on it’s long descent into the ocean.

    Pilot talks to the passenger and says ” ladies and gentlemen please remain calm. Our new TARP jet fuel will give us the lift we need, so fasten seat belts , close all windows and focus on my voice!”

  • Jim Knuckset

    This may seem absurd, but after eight years of reactionary rule Obama will look good in 2020. Nixon lost in 1960 returned in 1968!

  • Nixon lost, but not necessarily because of Eisenhower’s record. JFK basically stole that election, according to some, but there is no way Obama looks good in 2020, since he’s at the helm of this disastrous administration….People have long memories…No one will look back at 2009-2012 with nostalgia….

  • gold trader

    Gold is now at 1500. Looks like the masses are going with Gold as the new global currency.

  • You might be right. As long as China pegs their currency to the dollar, and every mature economy is buried in debt, fiat currencies are risky.

  • Does the price of gold and silver these days reflect natural supply and demand, or merely unbridled greed and the desire to profitably second-guess the speculators???

    How much better than to fearfully go long or short the previous metal?

    Your thoughts are invited!

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