“Thar’s Gold in Them Thar Hills!”

As reported by Politico and The Street, Ron Paul is in line to head the House Subcommittee on Domestic Monetary Policy and Technology on the House Financial Services Committee, the subcommittee that oversees the Federal Reserve, the U.S. Mint and the United States’ dealings with the World Bank, IMF, etc.. As The Street tersely reports:

Paul got some traction recently with legislation proposing to audit the notoriously secretive Fed. He also wants to re-establish the gold standard.

Auditing the Federal Reserve is a pretty good idea. The Fed is enormously powerful and should therefore be as transparent in its deliberations and decisions as possible. However, having any instrument or agency of the federal government auditing the Federal Reserve (including the Government Accountability Office which does not make government accountable and was more honestly named when it was the General Accounting Office) is a very bad idea. The Fed’s primary virtue is its nearly complete independence from the federal government. Having a committee drawn from all of the major accounting firms to perform the audit, on the other hand, might work.

A return to the gold standard, on the other hand, is simply nuts. As I recently wrote, I’d probably vote for Ron Paul if I bothered to vote and lived in his congressional district. Not that he’d need my vote, having garnered a 76% majority of the vote on Tuesday. And, mind you, if the gold standard (or, hell, the turnip standard) had the positive effects its advocates insist it would have without the negative effects they tend to discount if not ignore entirely, well and good. Here I must give the usual “I am not an economist or economic historian” disclaimer, but as I understand both the historical evidence (in, for example, the Great Depression) and the fundamental theoretical relationship between GDP and the money supply, the comparative dangers of inflation versus deflation, etc., the contemporary insistence on a return to the gold standard is tantamount to an irrational faith commitment.

On the other hand, it isn’t like bad economics is a rarity on Capitol Hill. And if we can’t have rational policy in Congress, shouldn’t we at least have entertaining programming on C-SPAN?

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This entry was posted in Economic Fallacies, Government Debt, Money Makes The World Go Round, Political Theory, Public Policy. Bookmark the permalink.

15 Responses to “Thar’s Gold in Them Thar Hills!”

  1. James K says:

    There are a few problems with the goldbugs’ position:

    The first problem is that they overstate the dangers of inflation. Hyperinflation is devastating to an economy, and highly variable inflation can be problematic even at more moderate levels. But modern (by which I mean post-’70s) monetary policy keeps inflation under sufficient control to make inflation a dead issue.

    The second problem is that goldbugs allege that tying money supply to a commodity prevents the government from screwing with the money supply. But debasement of the currency was pretty common. It’s true that it makes inflation harder, but not vastly harder.

    Third, if you do contain the money supply you end up containing it too much. To prevent inflation the money supply has to grow in line with real GDP growth. Less than that and you get deflation, and that can have perverse outcomes. I’ve read that the primary reason for the birth of the “company town” that paid in scrip was a deficient money supply. They couldn’t get the money, so they effectively bartered with their employees.

    Now, it’s possible that free banking has some potential, and I’d like to see some experiments in that direction. But commodity currency is a bad idea in economies that grow as quickly as Western economies grow.

  2. Murali says:

    Also, isn’t using gold to back your currency like fixing the price of Gold? And shouldn’t free-marketers be suspicious of price fixing?

  3. James K says:

    There’s that too. Of course modern monetary policy involves the government fixing interest rates, so it’s swings an roundabouts there.

  4. Kolohe says:

    Technically, it involves targeting a price for interest rates through open market operations – but as the proverbial 800 pound gorilla in the market, the Fed is able to, in normal times, make this a distinction without a difference. The issue, though, for the last nearly two years now is that it’s hit the nominal zero bound, and making it go negative requires a bit of trickery which even though I favor monetarism, not sure is entirely a good idea.

  5. ppnl says:

    I agree that a gold standard is nuts. One problem is that gold is essentially worthless. It has a few industrial applications but other than that its only value is in its limited supply.

    OTOH I wonder what would happen if you based a currency on a metal with a vast number of industrial applications. Aluminum for example. The “value” of aluminum then could not go very far beyond the cost of production else producers would literally mint new money. It’s value cannot fall very far below the cost of production as this would cause producers to stop producing and consumers to trade currency for metal and shrink the money supply. When currency loses its value this has the strange effect of stimulating the economy by providing a cheap source of an important material. The money supply then in a sense represents stored up industrial activity that can be released when needed.

  6. James K says:

    ppnl:
    Actually, gold’s lack of industrial applications is what makes it so useful as a commodity currency. What would rather have the world’s aluminium doing, sitting around doing nothing as coins or actually making useful goods?

    The most critical mistake goldbugs make (though they’re not alone in this) is that things have value, they don’t. Objects don’t have value, people value objects. You can’t put currency on a “firm” basis by swapping paper for gold, because there’s no such thing as a firm value. The only exceptions are goods that are perishable and essential for human life (like water or staple crops), but these make terrible currencies.

  7. ppnl says:

    James K,

    As I see it the value of any currency depends on its rarity.

    In the case of paper money the rarity is caused by a government’s commitment to only print so much along with a promise to accept it as payment for any debt. In that sense all paper money is a creation of government.

    With gold backed money the rarity is enforced by the rarity of gold. Governments no longer have the power to make more money at will and it is far less of a creation of government. The price is set only by the market. I think that is why some libertarians like it.

    The problem with both is that the rarity is artificial. In the case of paper money it is obvious and there is always the risk that government will act to devalue their currency. In the case of gold it is less obvious but the very choice of gold rather than sand creates that rarity. But since there are hard limits on the quantity of gold the money supply cannot change very much. This can cause its value to fluctuate wildly without active intervention of people who have stockpiles of the stuff. That probably means governments.

    Aluminum is not rare as it is like the third most abundant element in the earths crust. It is however difficult to produce in a pure form. In order to produce it you must feed and house large numbers of people. The people who use it also must feed and house large numbers of people. The relationship between the two sets the price that everyone trades on.

    I agree that things do not have intrinsic values. But that’s exactly why you should back your currency on something whose value in a given economy cannot vary overly much and yet the potential supply is effectively limitless.

    I’m not sure why you think it is inefficient to stockpile massive amounts of industrially important aluminum yet it is ok to spend large amounts guarding massive stockpiles of an essentially useless substance. With either gold or aluminum you must feed and house people in order to produce it. In that sense they are equal. The difference is that one is useful and the other is just pretty.

    Put another way you can never eat gold but in a sense you can eat iron, copper and aluminum because these are what you need to produce food efficiently. If most of the gold in the world disappeared very little would change except for the immediate collapse of some markets. Do away with most of the iron, copper and aluminum and most of the world would starve.

  8. James K says:

    I’m not sure why you think it is inefficient to stockpile massive amounts of industrially important aluminum yet it is ok to spend large amounts guarding massive stockpiles of an essentially useless substance.

    Because if that stockpile of aluminium is sitting in a vault, it’s not being used to make wire or cars or whatever else one uses aluminium for. Not that I think wasting money guarding gold is a good idea either, I’m just fine with fiat currencies.

  9. ppnl says:

    Yes but a fiat currency is always a creation of government and its value depends on the strength and power of that government. Government must be given the power to manipulate that currency in order to protect it. The value of an objective standard for the value of currency is that it potentially allows government to get out of the business of currency manipulation.

    Yes stockpiled aluminum is not being used but it also isn’t hording an irreplaceable commodity as any amount needed can be produced. Stockpiles simply represent stored industrial activity that can be released to stimulate the economy. Unlike a fiat currency, releasing aluminum cannot be inflationary beyond a point because the cost of producing more aluminum is relatively fixed.

    How much is stored and when it is released is determined by the free market demand for currency. The only problem I see is that I’m not sure it is practical to store enough aluminum to cover the demand for currency.

  10. James Hanley says:

    ppnl,

    I would say all currencies are human creations, and so the value depends on the strength and power of the institution backing it.

    I’m open to persuasion, but I’ve yet to see an argument that leads me to think fiat money is intrinsically different, although it may make manipulation simpler. If we go to the gold standard (or aluminum standard, or frozen Beluga caviar standard), there will remain the political and financial incentive to manipulate the supply, even if that means actually changing the standard. I.e., one of the gold bugs’ errors is to think that if we returned to the gold standard there would be some way to ensure that we would remain there.

    I think the more important is how well the determiner of the money supply are insulated from both personal interest in the money supply and political pressure on it. That’s why I remain a cautiously enthusiastic supporter of the Federal Reserve System, while recognizing that we are, of course, dealing with nearly infinitely fallible humans.

    (OT, it suddenly strikes me that the gold bugs, particularly those who screech about our money supply being controlled by private interests, and many of whom style themselves libertarians, and the “get the gov’t out of the money supply and let banks issue their own money” libertarians are irreparably at odds with each other, no?)

  11. ppnl says:

    My concern with fiat currency is that it lacks economic mass. It is true that it can be easily manipulated but it’s also true that it is absolutely necessary to manipulate it and nearly impossible to manipulate it effectively. Even the top economists have fundamental disagreements on how to manipulate it and even disagree after the fact on the effects of a given manipulation.

    A currency based on a commodity has economic mass in that the underlying commodity has utility no matter what. Except for gold which has very little underlying utility and so is a cosmically poor choice.

    I have no particular problem with the fed nor am I driven by any particular political motive. My interest comes from watching the economy in online games. Here money is something that falls off monsters. Not very realistic. But what would it take to create a more realistic economy? A fiat currency would require some kind of controlling fed. Since even the best economists can’t agree on how to make that work I can’t see how it can be implemented in a game. But a commodity based currency might basically run itself.

    Maybe you could have a game in which each of the schools of economic thought founded a city based on their ideas. Have them compete and see who wins. The saltwater union vs the freshwater republic maybe?

  12. James K says:

    ppnl:

    As I see it there are three possible problems that can occur with money supply:
    1) Hyperinflation – the money supply grows out of control. This doesn’t happen by accident, it takes an epic fail to achieve.
    2) Unstable inflation – constant tinkering with money supply causes unpredictable inflation. This can happen, and the major virtue of commodity currency or a commodity standard is that it stops this happening.
    3) Money shortage – There isn’t enough money to efficiently transact, forcing a larger number of barter transactions. This is the problem with commodity currencies or a commodity standard, the commodity you’re using almost certainly won’t be mined fast enough to keep up with growth in a modern society.

    With modern monetary policy, I see the risk of 3 being a bigger problem than the risk of 2, so I favour fiat currency. I don’t see how changing one commodity for another changes anything, expect that whatever you use ends up standing idle, either as coins or as bars in a vault. It’s true that fiat currency needs more management (though not as much more than you think, someone would need to do the Open Market Operations to maintain the peg or arrange for periodic re-coinage), but there are low-management options with fiat currency too, for instance you could simply mandate money supply increase by a fixed amount each year.

  13. ppnl says:

    Yes I see your point about money shortage. It would take really high production rates to expand the money supply as needed. But I’m not sure what you mean by “do the Open Market Operations to maintain the peg or arrange for periodic re-coinage”. My idea was to peg the currency to a given weight of metal and make it easy to redeem metal for currency. Metal producers are essentially coining currency and metal consumers are shrinking the money supply. The open market thing is happening all the time.

    You are probably right that a fiat currency works better in real life. But a commodity system may still work better in the limited context of a game.

  14. Scott S. says:

    I follow and agree with criticisms of the gold standard. But, I want to refute the claim that gold has no actual usefulness other than as a proxy for money.

    Gold is extremely valuable as jewelry and decoration. Gold has intrinsic value to people because it is beautiful and is relatively easy to repurpose efficiently because it has a low melting point and does not degrade over time. This last trait also makes it a fantastic material for electronics. The reason it isn’t used more is because it is often more valued by the market as a thing to buy whose value to others will not decrease much over time, either in the form of jewelry or as gold ingots.

    So, gold is a commodity like any other. It is valued by people proportionally to its usefulness as a stable conductor, an attractive craftswork material, and a remarkable ability to be repurposed with very little loss. The reason people like the idea of a gold standard is that people have been storing their wealth in the value of gold for millenia, so it doesn’t seem strange. Fortunately, our modern economies don’t need (and would probably be harmed by) a commodity currency anymore.

  15. James K says:

    ppnl:
    I simply meant that there would be some admin associated with a gold standard. Even in the low-admin scenario you posed, you’d have to have someone maintaining the gold stockpile the government would need.

    In any case I suspect you’re right that it would be better to use commodity currency for a game, at least if you were serious about having a coherent economy. Hmm, now I’m curious as to how Eve Online runs it’s monetary policy.

    Scott S, Point taken. I still think gold would be better than aluminium (fewer markets affected and aluminium is too abundant), but it’s a pointless argument since the best option is to use neither, as you say.

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