Questions on Mises VII: A Gold Standard by Any Other Name
Jason Kuznicki on Dec 14th 2006
Roughly a year and a half ago, the Positive Liberty commentariat and I discussed what a possible return to commodity money might look like.
For reasons unknown, these comments have since disappeared: I have a top-level post referencing the discussion in another post, but this second post has no comments at all.
Now, whenever a commenter writes something here, I tend strongly to remember it. And as much as a year and a half later, I may want to reference it. So whatever is going on is unacceptable. Can any more technically adept readers help me?
In any case, a commenter made the following arguments, which I am going to have to summarize from memory, as they are quite relevant to a discussion of Mises’ Theory of Money and Credit.
We can’t possibly go back to a gold standard. Here are the reasons why:
1. Serious difficulties would arise in industries requiring gold. These are not limited to jewelry, which would vanish, but also high-tech communications and electronics, which would likewise become too expensive for the average person’s budget.
2. The U.S. government could never afford to buy enough gold to cover every U.S. dollar now in circulation. Doing so would entirely wreck the American economy, to say nothing of the rest of the world.
3. There is so much economic activity, and so much economic value, that using gold to mediate all of our exchanges would make for prohibitively small currency units. Even at current gold prices — that is, before the multi-trillion dollar gold grab needed to return to a gold standard — one U.S. dollar would be less than 1/500th of a troy ounce.
Was he right? Personally, I find 1) unconvincing. I find 2) serious enough now, that it seems plain to me a government cannot be the entity to return us to a commodity money. I am inclined to find 3) a technicality; flakes of gold can easily be encased in a larger substrate that would make them the mechanical equivalent of coins. (Or could they even be integrated into paper money?)
Consider the following as you answer the above challenges:
A) We might easily pick another commodity to serve as our commodity currency; gold is by no means the only choice.
B) “We” in the above sentence should almost certainly not be the government; if a true commodity currency were to re-emerge, it could well be through a process of market selection among bartered goods, as Mises sketches in TM&C Part 1 chapter 2 section 2:
Now all goods are not equally marketable. While there is only a limited and occasional demand for certain goods, that for others is more general and constant. Consequently, those who bring goods of the first kind to market in order to exchange them for goods that they need themselves have as a rule a smaller prospect of success than those who offer goods of the second kind. If, however, they exchange their relatively unmarketable goods for such as are more marketable, they will get a step nearer to their goal and may hope to reach it more surely and economically than if they had restricted themselves to direct exchange.
It was in this way that those goods that were originally the most marketable became common media of exchange; that is, goods into which all sellers of other goods first converted their wares and which it paid every would-be buyer of any other commodity to acquire first. And as soon as those commodities that were relatively most marketable had become common media of exchange, there was an increase in the difference between their marketability and that of all other commodities, and this in its turn further strengthened and broadened their position as media of exchange.
Thus the requirements of the market have gradually led to the selection of certain commodities as common media of exchange. The group of commodities from which these were drawn was originally large, and differed from country to country; but it has more and more contracted. Whenever a direct exchange seemed out of the question, each of the parties to a transaction would naturally endeavor to exchange his superfluous commodities, not merely for more marketable commodities in general, but for the most marketable commodities; and among these again he would naturally prefer whichever particular commodity was the most marketable of all. The greater the marketability of the goods first acquired in indirect exchange, the greater would be the prospect of being able to reach the ultimate objective without further maneuvering. Thus there would be an inevitable tendency for the less marketable of the series of goods used as media of exchange to be one by one rejected until at last only a single commodity remained, which was universally employed as a medium of exchange; in a word, money.
What this one commodity might be today is anyone’s guess, although it is likely to still be a metallic element, and it might end up being gold after all. Metals are durable, divisible, uniform, portable, and impossible to counterfeit. Other suggestions are welcome, however.
C) This emergence of a new commodity currency could only take place if legal tender laws were abolished. I think this speaks for itself, and if not, the comments at Liberty and Power were quite decisive.
D) I can’t really link any of this to allergic reactions suffered after drinking Goldschlager. But they did turn up in some of my research queries, so here you go.
Now then… Commodity currency: Possible? Impossible? Worth the trouble? I know that this post is asking some questions that are well beyond my (and probably most others’) technical competence, so I promise that my next post will offer a dilemma that anyone can take a shot at — albeit a dilemma that seems central to the modern understanding of economics all the same.
[Crossposted at Liberty & Power.]
Filed in The Boardroom
1) is unconvincing, as marginal utility valuations would take over, and further, I have read (but don’t have the cite handy) that generally, even under a gold standard, no more than 20% of the gold stock was used as money - other uses can be more valuable than its value as money.
2) is nonsensical - you just set the value of each dollar based upon the current price of gold in $.
3) I actually think is a partially valid argument. Face it, gold is most useful as money in higher value transactions. Doesn’t mean gold can’t be money. Rather, and I’ve made this point a few times elsewhere, it means that gold shouldn’t be the ONLY money. Free markets would likely (and have, if you read about the Aztec market the Spaniards found) create multiple, independently valued monies to circulate, some more useful for high value transactions (i.e. gold) and some for low value (i.e. shells). This is the argument that most minarchist “gold-bugs” don’t address: while a state-enforced gold standard is better than what we currently have, it still is far from perfect or even “free-market”.
Having multiple independently valued monies serves other purposes as well, such as protecting the economy at large from an inflation like the one Europe suffered after Spain “found” all that new world gold. It makes so much sense to me that I can’t imagine that a truly free market would ever not develop in that direction.
My comments to the three problems posed:
1. Serious difficulties would arise in industries requiring gold. These are not limited to jewelry, which would vanish, but also high-tech communications and electronics, which would likewise become too expensive for the average person’s budget.
Prices would certainly rise, but there’s no reason to believe that any particular use for gold would “vanish.” The commenter does (tangentially) bring up a good point about the one advantage of a fiat currency: it allows us to put all commodities to use in production and consumption, rather than locking some of them up in vaults to back a medium of exchange. Kuznicki has the best reply to this argument, though: why pick gold? Why not silver or copper or even lead?
2. The U.S. government could never afford to buy enough gold to cover every U.S. dollar now in circulation. Doing so would entirely wreck the American economy, to say nothing of the rest of the world.
Rubbish. Perhaps it could not buy a sufficient quantity of gold while continuing to profligately spend in all manner of ways, but if it kept its non-gold expenditures to a reasonable level there’s no reason why it couldn’t accumulate a sufficient quantity of gold. And how would purchasing gold entirely wreck the American economy any more than purchasing public schooling, or milk subsidies, or any of the other million or so items on the Federal Budget?
3. There is so much economic activity, and so much economic value, that using gold to mediate all of our exchanges would make for prohibitively small currency units. Even at current gold prices — that is, before the multi-trillion dollar gold grab needed to return to a gold standard — one U.S. dollar would be less than 1/500th of a troy ounce.
So far as I can tell, this just means there would be deflation, and if so, what of it?
Quasibill brings up an interesting point regarding competing currencies within a society, and it may have implications for returning to a commodity currency (even via government, rather than the market). Suppose rather than backing the existing stock of dollars, the U.S. government simply issued parallel commodity currencies. People would be free to use the fiat currency if they wished, but they could also buy and sell with dollars backed by gold, silver, and/or other precious metals. The government outlays to procure the commodities could be substantially smaller, because they would not have to issue enormous quantities of the backed currency.
This would probably result in smaller daily transactions taking place with the fiat currency (or a lower-value backed currency, like the copper dollar), with larger transactions carried out with the high-priced commodity dollars.
It would also most likely have the tendency to keep the Fed in closer check, because devaluation of the fiat dollar would tend to push people to the commodity dollars.
As far as #2, it is the strongest reason why. The Gold Standard is incompatible with Welfare-state deficit spending. Ala Greenspan:
Of course much later, as Fed Chair, he changed tune a bit:
But as I’ve testified here before to a similar question, central bankers began to realize in the late 1970s how deleterious a factor the inflation was. And, indeed, since the late ’70s, central bankers generally have behaved as though we were on the gold standard. And, indeed, the extent of liquidity contraction that has occurred as a consequence of the various different efforts on the part of monetary authorities is a clear indication that we recognize that excessive creation of liquidity creates inflation which, in turn, undermines economic growth…
…So that the question is: Would there be any advantage, at this particular stage, in going back to the gold standard? And the answer is: I don’t think so, because we’re acting as though we were there.
Well, I don’t know about you, but I trust the “monetary authorities” about as much as my weatherman.
The gold standard is also quite abhorrent to the warfare state, which is the first use the Fed was put to enabling. But then again, the welfare state = the warfare state. Can’t have one without the other. Bread and circuses and all such things.
But that doesn’t change the fact that it *could* be done, just means that our current masters will never willingly do it.
Won’t the price of gold skyrocket, causing industry to be denuded of gold, if gold becomes the standard currency?
Quasibill opined that this was unconvincing because…
marginal utility valuations would take over, and further, I have read (but don’t have the cite handy) that generally, even under a gold standard, no more than 20% of the gold stock was used as money - other uses can be more valuable than its value as money.
I am doubtful here, as I still suspect that the price of gold would increase tremendously. Mises noted that when England abandoned silver money, the price of silver collapsed:
We could expect the same to happen in reverse if any commodity were widely adopted as money in the modern world. Some other commodity, valuable yet not so valuable as to be unable to take the transition to money, will likely serve best.
Admittedly I am unsure if any commodity has ever been generally adopted, as opposed to being abandoned, during the course of recorded history. Ancient societies were mostly already using gold and silver commodity monies when they learned how to write. And the modern introduction in a new geographical area of commodity money in gold or silver did not have a significant effect on its price, not because the price would never significantly change on the general adoption of a commodity money, but because any “new” geographical area for the gold or silver commodity money had a minuscule effect on the gold or silver markets, which even in the age of colonialism were already globalized, and because the colonies’ economies were generally scant (they also consisted largely of slave labor and raw materials extraction, neither of which requires much gold). These introductions werre a drop in the global bucket.
The U.S. government could never afford to buy enough gold to cover every U.S. dollar now in circulation. Doing so would entirely wreck the American economy, to say nothing of the rest of the world.
Quasibill opined that this was “nonsensical” because
you just set the value of each dollar based upon the current price of gold in $.
But this would be a far cry from an actual gold standard: No gold coins would issue, and no notes would exist that were payable in gold on demand. Without a full reserve for every dollar of paper money issued, there is no genuine gold standard.
If we followed this recommendation, and simply pegged the dollar to the value of gold, then immediately there would spring up a black market that would trade dollars for gold at a rate other than the pegged rate: This would happen because, without the government operating a gold window — which itself requires a substantial reserve of gold — a difference would inevitably arise between the market estimates of the relative worths of these items, dollars and gold. The government rate would be a figure traced in the air and nothing more.
As to the question of which present-day commodity might be the most serviceable money, Quasibill opts for multiple standards and multiple monies. He writes,
All of this strikes me as reasonable, yet the argument that Mises lays out, by which an invisible hand process converges upon a single commodity currency, still seems powerful as well.
I think AMW errs, too, by likening the amount of gold that would be necessary to fully back the dollar with the amount of money the government now spends on the welfare state. The former is vastly larger, as the welfare state is only a fraction of the total dollar-denominated economy.
Mostly as an aside, I might add that households in the developed world generally do not keep the larger part of their wealth in money anyway. For instance, our household’s greatest single economic asset is a plot of land with a house on it. Its second greatest single asset is our stock portfolio (these ranks might reverse if we could access those parts of the portfolio that cannot be touched without penalty until retirement). Our third asset, and only on the days shortly after payday, is our checking account. Only the latter consists of money. The same is likely true of most American homeowners, I would think. All of which means that AMW is quite right when he notes that the deflation would be a temporary and not an unbearable burden for us. I suspect that the same would be true for most, though certainly not for all.
[...] Thanks: Discussion continues on Question VII; commenters AMW and Quasibill — both clearly know their economics — have been tremendously helpful in particular, and I thought I would take the opportunity to thank the many commenters who have contributed so far. Without you, I’d be talking to myself. [...]
think AMW errs, too, by likening the amount of gold that would be necessary to fully back the dollar with the amount of money the government now spends on the welfare state.
In a single year, I will agree with you that the government could not fully back the dollar. Over a decade or so? I’m not so sure.
Remember also that the job is made more difficult by the Fed’s policy of open market transactions, which annually increases the number of fiat dollars floating around. So perhaps a state rate of monetary contraction (fully revealed to the public well in advance) would be of help here.
In any event, this seems to argue more strongly for my solution of introducing multiple commodity currencies alongside the fiat dollar.
AMW is quite right when he notes that the deflation would be a temporary and not an unbearable burden for us.
Deflation is a burden for the entrepreneur, but a boon the salaried employee (in the short run) and the fixed-income individual (in perpetuity). Moreover, if the deflation were well known ahead of time, there is little reason to expect that deflation would be a significant burden on anyone.
I still think that pegging it at a certain value will solve the majority of the problem - since most people today are used to the fact that their dollars aren’t convertible, I don’t see most of them running to the “window” to trade them in. It would take a “crash” - and, yes, I fear this is likely in the near future regardless, but it’s somewhat beside the point here - to start such a run. Otherwise, people will keep on trading their coupons blithely, and no black market would be necessary. Meanwhile, similar to AMW, I think the government could acquire the gold it needs to back the coupons in circulation.
It’s all an exercise in imagination, ’cause as I said above, the beneficiaries of the current system are not going to voluntarily end it. Someone, or some circumstance, is going to have to force the end.
As far as the size of the welfare state, well, that depends on the definition. If all you’re talking about is true welfare, like AFDC, that takes up a truly miniscule amount of the yearly budget. Meanwhile, adding future liabilities like Medicaid and SS creates a majority, but the point about that is, we can end those liabilities tomorrow (by simply rescinding the enabling legislation) and we’d still have a massive budget with a massive deficit - especially when you add in the “off budget” costs of social engineering the middle east. This is always the problem with those who obsess about the “welfare” state - it’s the least of our problems right now, behind the warfare and regulatory states.
I still think that pegging it at a certain value will solve the majority of the problem
Essentially that is fractional reserve banking. Most likely you are right: few people would try to cash in and get the gold (/silver/platinum) unless there was a sudden crash.
[...] The developer is pleased. And the search for a commodity of exchange — a money — would be on. Mises himself explained, in a passage I have quoted, how this search would likely unfold. [...]
[...] As longtime readers may know, I’ve been quite interested in the gold standard. In particular, some months ago, I discussed it with two people whose identities are unknown to me, but who seem to know their stuff. [...]