[Dave Birch] Now that I’ve taken to riding my new government-subsidised bicycle to work, I’ve got more time to listen to podcasts (through one earphone only, for safety reasons) and I’ve been getting through a fair few recently. One that blog readers might enjoy is the podcast of a presentation by Lawrence White at the
Foundation for Economic Education on the Gold Standard, which includes some speculation on how the United States might return to a Gold Standard. This is fascinating stuff for anyone who is genuinely interested in the way that money works, and how information and communication technologies might cause disruptive change in the future.
Lawrence is the F. A. Hayek Professor of Economic History at the University of Missouri–St. Louis and an adjunct scholar of the Cato Institute. He is the author of two of my favourite books,
Competition and Currency and
Free Banking in Britain, which I have open on the desk in front of me as I’m researching the “Scottish experiment” in monetary competition for a paper that I’m writing.
What I was wondering, while listening to the podcast, was whether gold would make the best commodity for the purpose of a monetary standard going forward. In the past, when people discovered new gold fields, that had a slightly inflationary impact. So when the California gold fields were discovered in 1849, they caused inflation of around 1-2% per annum for the next decade. That seems low by modern standards but was almost shocking at the time. But suppose someone discovers an asteroid full of gold in the future? That would cause a problem. Look at the historical case study of the devastating impact of the discovery of South American silver mines on the economy and economic development of Spain: The inflow of new silver simply led to inflation. Lawrence says in the podcast that he’s using “gold standard” as a shorthand, but other commodities would do just as well. Any suggestions?
These opinions are my own (I think) and presented solely in my capacity as an interested member of the general public [posted with ecto]
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The main advantage of gold is that it is already a monetary metal. Supplies of it are warehoused and traded primarily (though not exclusively) as a store of value. This is less so with other commodities. So long as there’s a mental or financial cost to translate between different forms of money, one will usually predominate. Gold has held that role in the past and really only the US dollar has been able to unseat it (post-Bretton Woods). There’s no guarantee it’ll hold that role in the future but it seems plausible. The asteroid scenario isn’t impossible, but nothing’s immune to such a situation. Certainly new reserves would have an inflationary impact, but it would be a constrained level of inflation that could be predicted by the market much more readily than that of an unbacked currency. If a golden asteroid had landed in California, and it had remained on the gold standard until the present day, its level of inflation would probably still not approach that of a Weimar or Zimbabwe.
“So long as there’s a mental or financial cost to translate between different forms of money”
This is one area where new technology may, in the long term, cause disruption because my mental transaction costs will fall to zero as my PC/mobile phone do the heavy lifting on currency conversion.
I’d suggest a currency backed by a basket of productive and non-productive assets (including commodities) instead of the current currency which is backed by debt.
Unfortunately the history of the real gold standard, which it is fair to say encompasses mainly the period from the Treaty of Vienna to WWI, is not a happy one. Not one to pined for in the world we live in today. Monetary authorities of that day, in their own historical context, were just as vulnerable to the political & economic winds as the current fiat-money based regimes are. Probably more so. To the extent that there was stability in this period, the high point of the British Empire and the long period of peace among the superpowers were more responsible than gold.
Looking at recent history, it seems to me that once Friedmanite monetarism infused the leaders of monetary authorities, particularly in the 1970s, we have mostly down alright by fiat money & inflation together. Despite deregulation that made the various M’s initially useful & later pretty much useless as a guidepost for what to do.
On the same subject, from the 8/23 edition of New Zealand’s nzcity.co.nz
How To Destroy Your Currency
A colleague of mine recently returned from Zimbabwe, where he had been assisting with monitoring of the election there. He showed me a bank note and I must admit it was impressive to hold something with a value of Z$50b (that’s Z$50,000,000,000!).
23 August 2008
Investment Research Group
Even more unusual was that the note carried an expiry date of December 2008. Thanks to runaway inflation of millions of per cent a year, that bank note would not even buy a loaf of bread in Zimbabwe.
This example got me thinking about why the Zimbabwe currency has devalued so much. The reason is that the central bank has been staving off the impact of a declining economy by printing unlimited quantities of bank notes and this ‘inflation’ of the currency led to rising prices (this is the true definition of inflation rather than the much quoted reference to the rise in consumer prices).
Then it occurred to me that all countries are doing the same thing to their currencies, only much slower than Zimbabwe. New Zealand increased the amount of money in circulation by around 10% in the past year and the purchasing power of that money fell by around 4%. In the past 20 years, a period when price inflation has been much lower than average, the purchasing power of our dollars has fallen by more than 40%.
While we can hope this trend does not escalate but that cannot be ruled out given that a dollar coin is only worth what someone else is prepared to swap for it.
This reminds me of what happened to the first attempt to offer currency that was not backed by gold or silver – so called ‘fiat’ currency. This was in the early 18th Century, when a British rogue by the name of John Law became involved with a French business called the Mississippi Company and later became Superintendent General of Finance for the French government.
That meant he had control of France’s finances as well as the company that was responsible for all of France’s foreign trade. To stimulate demand for the new-fangled paper money – an entirely new concept for most French people – Law announced that Banque Royale-issued notes were legal tender and it was illegal to hold large quantities of coins.
This was partly a reaction to increased demand by investors to redeem notes for coins. Such redemptions may have been a reaction to the increasing volumes of paper being issued. Some estimates put the increase value of currency in circulation during 1720 alone at around 200%.
Needless to say, extra money in circulation without a matching increase in goods and services soon resulted in higher prices. Inflation hit an annualised high in January 1720 of 276%. Eventually, confidence in the worth of the currency fell and more and more people tried to redeem them for coins.
When the coins ran out the company failed and many thousands of people were ruined. The final outcome of Law’s grand economic experiment was that France’s economy ended up virtually ruined, a far worst state than it had been a few years earlier.
We may laugh at the naivety of 18th Century folk but the principle has not changed. If for any reason people decided they don’t trust a currency then it is doomed. If that makes you nervous, why not hold a little gold? It is the only ‘true’ currency that you can be sure will always be accepted.