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DollarMeUp's picture
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politeia's picture
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It would not shrink the economy in the least. It would benefit the economy and it would end the ability the government has to create its own debt by printing money out of thin air. If you like deficit spending with a dollar that decreases in value, the gold standard may not be for you. If you like spending limited to what the federal government brings in through taxes and from borrowing (like how local and state governments work), and you want a balanced budget and a dollar that maintains its value, the gold standard may be for you.

To make it happen, what you do is take into consideration the amount of gold the U.S. government has in reserve and calculate a rate based on the number of fiat dollars currently in circulation. I have no idea exactly what that would come out to, but it could, say, make a dollar worth 1/1000 of an ounce of gold. This means you could take $1,000 to the bank and receive a one ounce gold coin. Banks would have to have one ounce of gold in reserve for every $1,000 in circulation if this were the proper calculation based on the number of fiat dollars in circulation in a 100% reserve gold standard.

The other way to go about it that would make anybody holding gold very happy would be to let the market determine the price of gold necessary to back the number of fiat dollars in circulation. Gold would then appreciate in value dramatically to make that scenario come to fruition.

However, I don’t advocate switching directly to a gold standard. While interest rates are way too low right now in my mind, a switch right over to a gold standard would cause a massive overnight increase in interest rates.

I’d like to go the route Nobel Laureate F.A. Hayek proposed - competing currencies where you allow a dollar backed by gold to compete directly with our fiat dollar. Let the market decide, and if it picks the gold backed dollar, the transition would be smooth.

Most economists would probably say that a gold standard is not only fine, but optimal when the economy is running along smoothly.

It is when we have an economic meltdown that economists disagree on the gold standard. Those in favor of a fiat currency believe we need a lender of last resort in the Federal Reserve to “stimulate” the economy by printing money out of thin air to provide easy credit and economic growth during downturns.

Those in favor of the gold standard don’t believe this is necessary and that downturns should be allowed to run their course. Banks should be allowed to fail, which would create newer banks with better business models and market discipline where they won't make the bad loans or take the excessive risk out of greed that creates the asset bubbles that bust into these terrible recessions. A 100% reserve gold standard in itself would make it very hard for reckless banks to create dangerous asset bubbles due to the limits a 100% reserve gold standard puts on the money supply. Keeping the money supply in check provides futher benefit as long-term increases in the money supply cause inflation, which decreases your buying power. A gold standard maintains your buying power.

A gold standard thus benefits the poor and middle class as it maintains their buying power. Under our current Federal Reserve banking system the rich and politically connected benefit the most as they get their hands on the money the Fed prints out of thin air first and thus benefit from the full value of that fiat money, but by the time it trickles down to the poor and middle class, those fiat dollars have decreased in value due to inflation and the buying power of the poor and middle class is decreased relative to the rich and in regards to the full buying power they would have under a gold standard.

I have posted before that I believe a free market with a 100% reserve gold standard is the most equitable economic system for all in society, and this helps explain why. There are other reasons why this would benefit the needy, but I don't want to get too long winded or technical.

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Brotherhood of Thieves

~ As we must account for every idle word, so must we account for every idle silence.

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dmuth's picture
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What he said.

Politeia: When I get around to upgrading these forums, you're getting a "resident economist" forum badge. Smiling

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Hi all,

I have not had a chance to catch up on the last thread "real life" (holy moly, it is a lot of comments) but just wanted to chime in here quickly. I think Politeia drastically diminishes the danger of using gold to back currency and both the depression of 1893 and the Great Depression are textbook cases where gold backing failed our economy and it was one of the major factors that plunged the country into depression. Here is a simply analogy to understand why this is:

In a system where gold is backing the dollor, I can go to the bank and turn in my currency(1 dollar) for, lets say 1/1000 of an ounce as described above. I think the first question one has to ask themselves is, why anyone would be motivated to do this? In a stable economy, using the currency (dollars) is what is accepted as legal tender to buy gas, groceries, to pay the mortgage, you name it. Of course, some folks will convert various percentages of currency into gold (you can do this today and it is advertised on the TV/radio daily) as savings, a reserve, a safety net, a long term investment. Try showing up at the Sunoco, SuperFresh, or your mortgage lender with gold coins or bars and ask them to accept this as payment. Let me know how that goes over? Even in a system that backs currency with gold it is just not that simple to use gold in a transaction.

Now imagine an economic crisis is occurring, inflation is occurring(the dollar is dropping in value) and everyone is converting dollars to gold coins/bars because everyone deems the gold as more valuable than the dollar. This is the assumption of the masses. US history bears this out, that inflation can happen, under the gold standard. Now imagine everyone is trying to make all their transactions based, not in US dollar currency, but in real, tangible gold. The simple process of depositing a pay check into your bank, with-drawling cash for gas and groceries, and writing checks out for the mortgage, which happen instantaneously (well, almost) are now contingent upon the movement of all this gold from one place to another. You have to ask yourself is this an efficient system of transacting? The vast majority of economists don't think it is.

The initial post was, "If dollar is to be tied to hard gold, wouldn't that considerably shrink the economy, making every person's life miserable?" Your correct, gold as a currency backer is not liquid enough to keep pace with modern post industrial society and their economic systems and it would have the effect of shrinking economies or not allowing them to grow as fast as they would under a system that backs currency against other currency. It (gold backed currency) played a significant role in bringing about the depressions 1893 and 1929 and is in part why not many economist, of any school of thought, take what F.A. Hayek has to say on this subject seriously.

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politeia's picture
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Well, if you look at the depression of 1893 and the Great depression, you will note we had fractional reserve banking. Per my first post in this thread and as I explained in the link in the previous sentence the key point is to have 100% reserve banking.

Current Fed Chair Ben Bernanke has even blamed the Fed for the Great Depression as the Fed began raising the Fed Funds rate in the spring of 1928, and kept raising it through a recession that began in August 1929. This led to the stock market crash in October 1929. Speculators began selling dollars for gold in September 1931, so the Fed raised interest rates futher which caused a run on the dollar. Note this was not until two years after the market crashed and the speculative bubble burst. The Fed then raised interest rates even further to preserve the value of the dollar. This further restricted the availability of money for businesses, causing more bankruptcies than occurred when the market crashed. At this point Bernanke claims the Fed failed again when it did not increase the supply of money to combat deflation. As investors withdrew all their dollars from banks, the banks failed, causing more panic. The Fed ignored the plight of banks per Bernanke, thus destroying any remaining consumer confidence in banks. Most people withdrew their cash and put it under the mattress, which further decreased the money supply.

During the Great Depression people did not convert many dollars to gold as you seem to indicate, but what actually occurred was run on the dollar due to the Fed setting artifically high interest rates. Thus you can certainly have bank runs on dollars and since banks usually lend out about ten times as many dollars as they take in from depositors in fractional reserve banking, it does not take too many people withdrawaling dollars to make a bank insolvent. Remember, under our current fiat fractional/Federal Reserve banking system all money is created from debt. If all loans were called in there would be no money (which is backed by nothing except debt) circulating in the economy.

A key point that Ludwig von Mises made (as well as F.A. Hayek and Murray Rothbard) that I absolutely agree with is that the deflation of the money supply is valid if this deflationary process is the result of people withdrawaling their bank funds through the conversion of these funds into currency (dollars or gold) which is not fractionally reserved. A bank run is the People's negative sanction that provides them with their sovereignty over their own property -- their money, and it keeps banks in check in the long run as banks become more responsible due to bank runs, and assuming they are not bailed out by the government, which allows them to remain irresponsible in their lending practices if they know the government will save them at the expense of taxpayers (see how that works in detail by Clicking Here).

As Ludwig von Mises stated in The Return to Sound Money:

The eminence of the gold standard consists in the fact that it makes the determination of the monetary unit's purchasing power independent of the measures of governments. It wrests from the hands of the "economic tsars" their most redoubtable instrument. It makes it impossible for them to inflate. This is why the gold standard is furiously attacked by all those who expect that they will be benefited by bounties from the seemingly inexhaustible government purse. What is needed first of all is to force the rulers to spend only what, by virtue of duly promulgated laws, they have collected as taxes. Whether governments should borrow from the public at all and, if so, to what extent are questions that are irrelevant to the treatment of monetary problems. The main thing is that the government should no longer be in a position to increase the quantity of money in circulation and the amount of checkbook money not fully – that is, 100 percent – covered by deposits paid in by the public. No backdoor must be left open where inflation can slip in. No emergency can justify a return to inflation. Inflation can provide neither the weapons a nation needs to defend its independence nor the capital goods required for any project. It does not cure unsatisfactory conditions. It merely helps the rulers whose policies brought about the catastrophe to exculpate themselves. One of the goals of the reform suggested is to explode and to kill forever the superstitious belief that governments and banks have the power to make the nation or individual citizens richer, out of nothing and without making anybody poorer. The short-sighted observer sees only the things the government has accomplished by spending the newly created money. He does not see the things the non-performance of which provided the means for the government's success. He fails to realize that inflation does not create additional goods but merely shifts wealth and income from some groups of people to others. He neglects, moreover, to take notice of the secondary effects of inflation: malinvestment and decumulation of capital (pp. 438-39).

A 100% reserve gold standard without government intervention would not restrain economic growth in the least. Rather, economic growth would cause deflation under the gold standard as opposed to the inflation we see with the increase in the money supply under our fiat monetary system, and this increase in purchasing power via deflation would spur ongoing economic growth.

Now Keynesians have trained everybody that deflation is a bad thing, but the Austrian School has a different view. In the view of the Austrians, the Fed does the exact opposite of what it should do.

Instead of allowing for the market to correct itself through the beneficial effects falling prices have due to deflation, with the falling prices allowing for more purchasing power to fuel the economy with more consumer spending, the Fed is flooding the economy with even more money it prints out of thin air and with even more easy credit (exactly what caused this crisis in the first place). To the extent that these efforts are successful, and prices are prevented from falling, the effect is to prevent economic recovery. It prevents economic recovery by preventing the reduced level of spending that deflation represents from buying the larger quantity of goods and services that it would have been able to buy at lower prices - and thus fuel our economy, of which 70% is based on consumer spending and consumption.

Just as falling prices are a result of deflation, rising prices are not inflation itself, but rather a consequence of inflation. Inflation is an increase in the money supply (usually when the Fed prints too much money out of thin air or makes credit too easy with artificially low interest rates). During the boom (the recent real estate bubble), inflation and credit expansion increase the supply of money and at the same time reduces the perceived need to save money. Then, in the subsequent bust phase of the business cycle (what we are going through now), the demand for money for savings rises and the supply of money falls (deflation). Both of these factors make for a decline in total spending in the economy and thus the need for a correspondingly lower level of prices to achieve economic recovery.

From this perspective, bailouts, low interest rates and credit expansion (what the Fed is doing now) are the exact opposite of what our benevolent government should be doing, and in doing so, the government is setting us up for stagflation followed down the road by high inflation with its inflationary actions (increasing the money supply and availability of credit) that prevent the falling prices of deflation from solving our problem by naturally giving people more purchasing power with their existing incomes because prices are falling, which in turn would stimulate the economy - and without spending trillions of dollars of taxpayer money on bailouts and jobs that are never created.

Under a gold standard deflation increases the value of your dollars and the increased buying power grows the economy. I personally would much rather have the dollars in my pocket give me more buying power which grows the economy as I spend them, as opposed to the current fiat monetary system where the government prints money out of thin air to grow the economy, and when it does this the dollars in my pocket decrease in value due to inflation.

And why is our current system so popular? What government would not want a system that allows it to print money out of thin air? It's all about power and control. As for most economists supporting our current economic system, they are educated in colleges and universities that support this system because the government gives those colleges and universities so much money. It's all about being part of the status quo and not rocking the boat to enhance your career as an economist.

Your Keynesian view, Willey, is certainly the accepted norm and I respect that fact - not that I agree with that norm and its conventional "wisdom". My contrarian view is not one that is easily dismissed or I would not have it.

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Brotherhood of Thieves

~ As we must account for every idle word, so must we account for every idle silence.

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DollarMeUp's picture
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politeia, does my following idea make sense?
If there was systematic deflation, people would not want to invest in new businesses, banks would not have as much money to lend and this would end up choking all technological progress and productivity?

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politeia's picture
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That's what the Keynesians say. Under our current fiat fractional/Federal Reserve monetary system, systemic deflation is a bad thing and would generally cause what you mention because our current system as a whole relies on increasing the money supply with dollars printed our of thin air (inflation) to grow the economy. When fiat money deflates or decreases in value across the economy, this hinders the inflationary attempts of the Fed to "stimulate" the economy. So yes, under our current fiat monetary system deflation is generally not good, though you can note exceptions within the economy that have very little government intervention where lower prices have benefited both consumers and manufacturers - particularly in anything that is innovative or high tech like computers and anything involving electronics. I would add, the less the government interferes and the more free the market is, the more innovative it becomes.

With a 100% gold reserve monetary standard, deflation is not a bad thing at all as it increases your buying power and helps stimulate the economy.

Here is a Simplistic View and here is a more Technical View on how deflation is good ("benign" as mentioned in the second link is a good thing) in a free market with sound money and no government intervention in the monetary system.

=================

Brotherhood of Thieves

~ As we must account for every idle word, so must we account for every idle silence.

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