Bryan Caplan  

Austrian Challenge: What Would the Macroeconomy on the 100% Gold Standard Look Like?

PRINT
Ross Douthat on Liberaltariani... We Coulda Had a Payroll Tax Ho...
Arnold mentions that:
The Washington Post reviews The Lords of Finance, focusing on the role of the gold standard as a policy blunder contributing to the Great Depression. As I've said, a great swath of economists (starting with Milton Friedman and moving left) takes this view.
Meanwhile, when asked, "If you could change just one thing about economic policy in the US, what would it be and why?," Walter Block answers: "Get rid of the Fed, and go on the 100% gold standard instead."

Setting aside the moral debate on 100% reserves, I've got to wonder, "Why that?"   I presume (though I'm open to correction) that Walter gave this response because he thinks that his preferred monetary regime would almost certainly have much better economic consequences than the status quo.  This thought inspires me to poll our readers:
What do you think the long-run consequences of Block's proposal would be for the average values and standard deviations of inflation, output growth, and employment?
When you respond in the comments, feel free to label yourself an Austrian or non-Austrian if you like. 

Extra credit: What would the immediate adoption of the 100% gold standard (as proposed here) do to the economy over the next two years?


Comments and Sharing





COMMENTS (74 to date)
Oz Andrew writes:

What is the current value of all the worlds gold in U.S. dollars, and what is the current quantity of money in the world in U.S. dollars? Is there enough gold to replace fiat money? If we're just talking the United States, does that country have sufficient gold stocks to run a gold standard?

Maybe a silver standard would be more practical. Or perhaps we just do a once off divide by 10 on all prices. Now there's deflation for you!

For other macro affects, it would depend on the reserve ratio(s). Current ratios are wildly excessive. 100% is too strict. I prefer the old Bank of England standard of 2:1. That is, two units loaned out for every unit in the vaults - the optimal ratio?

Matt writes:

I'm fairly convinced by what I take to be the Austrian view that a 100% Gold Standard would in the long term lead to a mild negative rate of inflation (and that such deflation would not be a bad thing) with a relatively lower standard deviation; a higher average real growth rate (though perhaps not reflected in current claimed measures of GDP) with lower standard deviation and a lower average rate of true unemployment with lower standard deviation.

I wouldn't put predicted values to any of these though because I have little faith in the conventional measures of inflation, growth or unemployment as accurate, unbiased or particularly meaningful measures of the quantities they purport to represent.

Larry Peoples, Sr. writes:

Refried beans would be a much better world monetary standard than gold. At least after consumption there would be a better end product.

Jacob Oost writes:

Like Friedman, I believe that such a system could only be practical or desirable with a restrained government whose size was less than 10% of GDP was was generally laissez faire and non-interventionist.

But the question doesn't assume that, so I'll assume we still have the Jabba the Government we have now, only with a "100% gold standard."

In which case it's simply impossible to tell. How will other nations react? What would it mean for international trade? In a laissez faire situation, it's easier to say "in the long run unemployment and inflation and growth will all be better," but there's just no way to tell from here. You can't predict that well, with so many variables. Hayek, and whatnot.

And I'm non-Austrian.

Oh, and nobody asked me but I'll say anyway: if I could change just one thing about US economic policy, it would be to limit the size of all government expenditures to no more than ten percent of GDP.

Grant writes:

As someone who leans rather strongly towards Hayek and Mises, I have no idea why some Austrians still push for gold. I know the Rothbardian moral argument for 100% reserves (and think its just plain wrong), but I really don't understand why a group of people who think money must originate in the market want to have the government create a new currency out of a shiny yellow metal.

What do you think the long-run consequences of Block's proposal would be for the average values and standard deviations of inflation, output growth, and employment?
I can say what I think would happen if we went from the status quo to free banking:

Cycles like the one we are currently experiencing would be lessened significantly or eliminated. The entrepreneurs unable to forecast future economic conditions and interest rates would not have access to as much capital as they did under continuous credit expansion, so fewer unsustainable business projects would be undertaken. Other businesses would then no longer have nearly as great of incentives to "keep up" with institutions who had embarked on doomed projects which produce short-term gains, but long-term losses. Credit markets would show better selection of prudent, credit-worthy borrowers, and the incentives to lower lending standards (via lobbying or however) in order to execute projects viable only in the short-term would not exist. Innovation would still take time for markets to price, possibly causing bubbles in the process, but the magnitude of duration of these bubbles would be reduced. Without as significant of asset bubbles, cyclical changes in aggregate demand (which is often based off of perceived wealth; e.g. the value of one's home or stock portfolio) would lessen.

We'd experience greater long-term growth. Prices would gradually deflate, though wages (on the whole) would not. In the beginning there would likely be a few bank failures. Both banks and depositors would become much more conservative and thoughtful in what they did with their money.

Tiddy writes:

^^^ Too right! ^^^

Go Grant!

andy writes:

No mandatory standard, gold, silver or ketchup, would be stable or would last long without abuse.

Competing currencies and the abolition of legal tender laws (and of taxes on alternative currencies) is the way to go.

Would many (most?) opt for precious metals? -undoubtedly.

Would 100% backed currencies trade at a premium to partially backed ones?... for sure

Would government be forced by competition to be more honest with money?...perhaps, in time

Johnson writes:

Cycles like the one we are currently experiencing would be lessened significantly or eliminated.
>>>>>>>Nope, they would be even bigger and have bigger collapses. Your dead wrong hear

The entrepreneurs unable to forecast future economic conditions and interest rates would not have access to as much capital as they did under continuous credit expansion
>>>>>>>Again, wrong. The same "continuous credit expansion" would happen and it would be worse


, so fewer unsustainable business projects would be undertaken. Other businesses would then no longer have nearly as great of incentives to "keep up" with institutions who had embarked on doomed projects which produce short-term gains, but long-term losses.

>>>>>>>>>Wrong again

Credit markets would show better selection of prudent, credit-worthy borrowers, and the incentives to lower lending standards (via lobbying or however) in order to execute projects viable only in the short-term would not exist. Innovation would still take time for markets to price, possibly causing bubbles in the process, but the magnitude of duration of these bubbles would be reduced.
>>>>>>>>>>Wrong, those bubbles would be bigger

Without as significant of asset bubbles, cyclical changes in aggregate demand (which is often based off of perceived wealth; e.g. the value of one's home or stock portfolio) would lessen

>>>>>>>>Wrong, those bubbles would be bigger.

Grant, "Austrian" economics is a fraud. Not just intellectually, but spiritually. You worship the international to such a extent, I would charge you with treason.

The same things that happened today, would happen under your "dream" system. Corruption, massive credit creation, massive unemployment, underemployment during downturns and probably a hire crime rate with the modern tendency towards violence.


Fr. re writes:

I have a somewhat (non Austrian) provocking answer : in my opinion a 100% gold standard system is unsustainable without a strong, quasi-authoritarian, government to enforce it. The problem is that gold standard is probably not an evolutionary stable strategy ; banks and customers will always be better by agreeing on some other non-100% system. One of the reason of the development of fractionary reserve banking is that it satisfies everyone, at least in the short and mid-run : government of course, but also customers and financial intermediaries.

Therefore, while it is possible that at the beginning 100% gold standard eliminates inflation and softens business cycles, we have to take into account the political economy aspect of the problem. My guess is that in the long run 100% gold standard will need a strong enforcement by the government, not only at the national level but also probably at the international one. The consequences in terms of output growth and employment are impredictable. Pure free banking has some other drawbacks, but at least it is more realistically implementable.

Félix writes:

.....average values and standard deviations of inflation, output growth, and employment?

No need to pose the theoretical question, there is plenty of empirical evidence from the 19th and 20th cent.... remember that CHF was backed by gold up to 1999....


-Inflation: much lower average, much lower SD (this more because of 100% reserves than gold)

-Output: higher long term as savings and accumulated capital work their compound interest magic. Lower SD.

-Irrelevant. Monetary effects on employment are an illusion. Depends much more on legal structure...incentives, flexibility.


(I lean austrian...evidently)

rogers writes:

F.A Hayek -The Denationalisation of Money
Selgin- Good Money

Theory... and history.

Vasile writes:

Competing currencies and the abolition of legal tender laws (and of taxes on alternative currencies) is the way to go.

While I agree that competing currencies is the way to go, I don't think it is the way it will stay.

Say you have only fringos, but I really really want is chingos. Well, I can accept your money at a discount and then go to a currency broker. Clumsy. Not funny. Ineffective.

After all we already have a world of competing (national) currencies, at least, whenever we have cross-border trade. And we all know that the dollar (almost) became the currency.

Would 100% backed currencies trade at a premium to partially backed ones?... for sure

Do you see the problem here? At a premium relative to what?

Anthony writes:

What does it mean to "go on the 100% gold standard" if you abolish the Fed? Who would enforce "the 100% gold standard"?

I can imagine "going on the 100% gold standard" without abolishing the Fed, and it'd be disasterous. I can also imagine abolishing the Fed without "going on the 100% gold standard", and it'd be wonderful.

There isn't enough gold in the whole world to support the monetary needs of the United States. I can't imagine such an exercise ever being carried out, but if it were we'd have an immediate collapse of the economy which perhaps would eventually work itself out after decades of mining for gold, or, if the Fed allowed, when people in the US abandoned the dollar for a currency which wasn't so damn expensive.

Bill Woolsey writes:

You cannot answer the question of what would happen if you went to 100% gold reserves unless you say, "at what price of gold?"

If the price of gold is "too high" the the result would be inflation. Too low (which apparently is the usual assumption) then it is deflationary. And with just the right price...just the right level of nominal income.

The impact for real growth, variance, and the like, all depends on "100%" of what, exactly. Currency? Checkable deposits? What about overnight commercial paper? What about money market mutual funds? I predict that if there were 100% gold reserves for some narrow measure of money, then that measure of money would have a relatively low demand. The other financial instruments that people would hold instead of money would generate everything that fractional reserve banking once generated.

I think the result would be moderately worse than free banking.

Joan writes:

Johnson, any argument for you claims?

fundamentalist writes:

Dr. George Reisman has several articles at mises.org on how to the US could quickly go gold, and his book “Capitalism” has excellent chapters on it. But not all Austrians favor a gold standard. Hayek didn’t.

The boom/bust cycle issues from the high leverage inherent in fractional reserve banking. A gold standard with fractional banking will experience the same business cycles that we have experienced for the past 400 years. As far as I can tell, based on my reading of Braudel, fractional banking began long before paper money in the middles ages in Venice and it began with gold dealers.

Hayek points out that it will be impossible to get rid of fractional banking. We have had it for centuries and the debate over it is just a long. And as De Soto points out in his book on money and banking, life insurance companies, mutual funds and many other types of businesses engage in fractional banking. One of the biggest bubbles and subsequent collapses in the 18th century happened not because of fractional banking but by a proliferation of bills of exchange according to Braudel.

Free banking might help, but we had something similar to free banking in the US throughout the 19th century and still had disastrous bubbles and depressions. For an example, check out Rothbard’s book on the panic of 1819.

My suggestion as an Austrian would be to return to Alan Greenspan’s early strategy of targeting the price of gold. I don’t know why he abandoned that strategy because I thought it worked pretty well.

Meanwhile, Austrians shouldn’t cry too much about the elastic money supply. It’s a wonderful opportunity to make a lot of money by timing the market according to the Austrian business cycle theory. Don’t worry! Be happy, and make a lot of money from the ignorance of mainstream economics!

Dave Smith writes:

Inflation would go down, become less variable

Output would go down, become more variable

Employment averages would not change, but employment would become more variable

I'm a quasi-Austrian

Eli writes:

Non-Austrian.

Business cycles would be longer and deeper, and recessions more frequent. The MC of gold would fall during booms, making booms boomier. The MC of gold would rise during busts, making busts bustier.

Extra credit: the big problem for the next two years would be where to set the peg for the transition. This is not remotely trivial. The current dollar price of gold provides no guide to the general equilibrium dollar price of gold after a switch to the gold standard. If the price is wrong (as it surely would be), then there would be a large inflation or deflation. Our current financial crisis would not ameliorate in any case, because it has very little to do with the "soundness" of the currency.

Floccina writes:

I guess the idea is that if deflation increases more people would go into gold mining and if inflation increases people would stop mining so much gold, so in theory the system is self regulating and so it might be very stable. Draw backs would be more effort going into gold mining, danger of large gold finds and that it might cause less risk taking and this slower though more even growth (if you believe people are naturally risk averse). In net it might work out well. After hearing George Selgin I have begun to think that free banking might be better but the banking system that we have seems unstable enough that we should consider changes. Some liberals also do not like fractional reserve banking because they think that it increases income disparity.

I am a semi-Austrian.

Floccina writes:

An alternative to radical change (let's face it barring complete economic collapse radical change will not happen) would be make 4 separate competing FDICs and attempt properly incentivize them (even though they would still be Fed Gov. backed) and have them act like private insurers and threaten to drop insurance on banks that take too much risk. Any bank that could not get insurance would be liquidated.

Joe writes:

If the US alone would adopt the gold standard, our economy and society would be under non-stop speculative attack from other traders. Never mind the fact that if China is able to suddenly "find" lots of gold in them thar hills, we are suddenly not so rich of a nation.

Also, private surrency sounds great, but i am far too reminded of Madoff/ other scams. Private currency just encourages thefy due to information assymetries inherent/short term incetives that woudl be inherent in the system; and obviously laws do not prevent people from lying and cheating. The push to a private currency would cause numerous bank failures..ala Madoff.

Anthony writes:

"What would the immediate adoption of the 100% gold standard (as proposed here) do to the economy over the next two years?"

Rothbard does not present a "detailed blueprint" in this paper. In particular, he leaves out the price per dollar of gold, leaving it up in the air if it would be $35/ounce, "enough to make the gold stock 100 percent of the present supply of dollars", or somewhere in between.

$35/ounce would cause nearly every mortgage in the country would fail. It's hard to imagine the government allowing that to happen, and it's hard to imagine what steps would be taken to mitigate such a crisis.

For the second measure, let's say $8 trillion, which is M2 and seems to be a relatively recent estimate of all dollars "held in the U.S. branches of all FDIC member banks" divided by 8,000 tons of "official US gold reserves" gets us over $30,000/ounce. At that price, the gold in my wedding band is worth about $5600. The tiny amount of gold in my broken cell phone is worth about $35. I can't help but think this is going to be disruptive to the economy and have negative effects over the short term (2 years).

"Somewhere in between" would probably be the most fair way to go. Let's say $1000/ounce, since that's roughly equal to the current market price and so nice and round. That said, I can't estimate the effect on the economy, because there are too many unanswered questions. If most depositors demanded full payment in gold immediately following the switch to that price, the FDIC would likely find itself bankrupt. One way they might be able to avoid massive bank defaults would be to replace bank notes with IOUs, perhaps treasury bonds, but this would be a big drain on the economy in the future while the US Government engages in massive taxation to pay off this debt. Alternatively, the FDIC could simply be allowed to default.

Whatever the path, it would be quite painful to make the switch, but ultimately it is something we're going to be forced to do eventually anyway, if not by an explicit move to the gold standard, then via a hyperinflationary collapse of the dollar.

I'm not an economist, and I came up with this off the top of my head. I'd love to hear whether or not my analysis is accurate, and in particular I'd love to hear a more well-thought out description of the effects by someone more knowledgeable than myself.

MHodak writes:

The answers are,

Standard deviations of inflation: much lower
Output growth: higher over time (but far more dependent on other policies)
Employment: not statistically different over time

The net result would probably be just as many boom-bust cycles, but marginally higher overall growth over time (which does accumulate nicely). The fact that we already have ready access to competing currencies in a global market, however, I think gives us most of the disciplining benefits of a gold standard.

I think we have more to gain by not prohibiting courts from enforcing private contracts written on a gold standard. This would create a little more and better credit (especially when inflation comes back), and discipline on the dollar over time (which might reduce the likelihood of inflation coming back, or at least make it less destructive of our credit markets).

MHodak writes:

Oh, re average value of inflation: close to zero on products of established technology.

A nice suit costs the same ounce of gold today as it did in Medieval times. Don't see any reason for that to change on most products. New technology would continue to show rapid price depreciation, as it does now, with no untoward "deflationary" effects.

Vasile writes:

You cannot answer the question of what would happen if you went to 100% gold reserves unless you say, "at what price of gold?"

Well I have no way to know what will the price of a suit will be under a hypothetical 100% gold standard, but I happen to know what the price of one ounce of gold will be. One ounce of gold. As for other prices... I'll let the supply and demand do their usual trick.

So I suppose you were not thinking about a world where gold is money, simple and easy, but about one with paper money exchanged for gold at a fixed ratio.

I may be wrong, but I don't think this is the question our host was asking, and I'm quite sure that is not what W. Block was referring to.

Vasile writes:

Never mind the fact that if China is able to suddenly "find" lots of gold in them thar hills, we are suddenly not so rich of a nation.

Well, I'm glad you asked. Currently the reserve of extracted gold is something like 150 000 tons of gold. To put things in perspective the annual production of gold is 2 500 tons, which is a 1/60 of the currents reserves.

So, are you still afraid of Chines gold-miners? Or will you rather fear that the China will accidentally the whole treasuries market?

Yancey Ward writes:

There is a mighty big assumption being made when asking/answering this question- namely, the government sits back and does not interfere other than to enforce contracts for the 100% standard. There is absolutely no basis on which to make this assumption since we already know what will happen-just look to the period 1913-1933 and up to 1971.

Credit inflation is an inherent feature of our trade- has been since the dawn of time. Where we have gone wrong, in my humble opinion, is that we have now tied every human on the planet into the failure of a single system of finance, and all such systems fail eventually. Only difference this time is that there will be no areas of financial rectitude on which to restructure and rebuild.

Completely free banking is the only way to go, and you have to draw your lines of defense to keep governments from playing favorites. Not an easy task, but there are no easy answers to prevent catastrophes like the one we are rushing headlong into at ever increasing velocity.

Jeremy, Alabama writes:

It's not that gold standard is good. It's that the absence of standard is so thoroughly abused by the political class.

Going gold would certainly have a contractive effect at least at first. But how otherwise do we control the profligacy of Washington?

Grant Austin writes:

I have no economic background. I'm a computer scientist/programmer.

The economy is a set of abstractions and money is the key abstraction upon which most of the other abstractions in that set are based upon. Other economic abstractions are very dependent on the properties of the particular money abstraction they are based on.

The power of an abstraction is proportional to its flexibility. If we tie money to some fixed resource we remove a lot of the flexibility from what we can do with our set of economic abstractions.

This means that human aspirations and achievements are not limited by our willingness to cooperate or compete. Instead we are limited by a fixed quantity of metal and the market's perception of its value. That's no good.

Brian Shelley writes:

Austrian leaner

If going to a gold standard dampens economic cycles, I would think that the theory of the Austrian business cycle would predict lower long term unemployment on a gold standard. If the reason for cycles is misallocation of labor and capital, then eliminating these misallocations would lead to better determination of their uses.

Say Susie became a web developer in 1998 because of the boom, then struggled for work until 2004 when she became a real estate agent. Lost her job in 2007, and now looking for another new line of work. If she hadn't been deceived by inflation cycles she could have picked a sustainable career where she could have developedd some expertise by now, but instead she's starting over. Her human capital is much less now because of the misallocation of her faculties.

Greg Ransom writes:

I thought the Austrian position was free banking.

Zdeno writes:

In my view, the gold standard is merely a means to an end - removing any the option of fiddling with the money supply from the toolbelt of governments. The gold standard could achieve this, as could completely free, unregulated currencies. I would also have no problem with a fiat currency that was credibly constrained to remain fixed in eternity, or grow in lockstep with population growth.

The primary benefit of Block's proposal would be that Washington would be forced to be honest in their confiscatory policies. Most Americans think that the Obama administration is doing some fancy-shmancy financial maneuvering to "fix" the economy; they don't see the coming decade of 15% inflation as the massive tax increase it is. The gold standard would also decrease uncertainty for investors, homebuyers etc.

fundamentalist writes:

eli: "Business cycles would be longer and deeper, and recessions more frequent."

That contradicts the history of the US under a gold standard in the 19th century.

fundamentalist writes:

Greg, free banking seems to have been the position of Mises and Hayek. It seesm that Rothbard revived gold.

Grant writes:

Johnson,

Since this is the only economic claim you made about my comment, I'll address it:

Again, wrong. The same "continuous credit expansion" would happen and it would be worse
Do you have any evidence for this claim? Free bankers tend to believe that competition among bank notes (currencies) tends to provide an upward pressure on interest rates that does not seem to be present in our current system. Credit expansion by any issuing bank would result in a devaluation of its currency. I believe emperical studies of the world's few instances of free banking support this.

Some people point out that we operate under an international free banking system. I don't totally disagree with this, and believe this is one reason the world's financial system works as well as it does. However, central banks (being granted a geographic monopoly) do not operate under the same incentives as free banks do. As John Taylor recently showed, they can operate in tandem, decreasing interest rate across the board. In contrast, free banks with profit motives can rarely achieve anything like this for very long, given the prisoner's dilemma and freer entry into their market. I believe the feedback mechanisms of free banking more quickly correct for miss-priced interest rates than under our current system (e.g., how long did it take a majority of us to realize that interest rates were kept too low for too long under Greenspan?).

Greg Ransom, I think Bryan seems to equate "Austrian" with the more Rothbardian flavor of Austrian economics, while he sees Hayek as more neoclassical. Sometimes Mises.org seems like it should be renamed Rothbard.org.

Greg Ransom writes:

Is there one economists out of 50,000 who could explain to you the institutional operation of the gold standard, or even two different types of a gold regime.

I.e. are ANY of these economists intellectually competent to comment on the gold standard?

I'd say we have here something similar to botanists or genome researchers giving us their "scientific" judgment on global warming.

ThomasL writes:

Austrian

I favor some form of hard standard for a simple reason (the same one as most proponents, I think): with a standard the government cannot easily manipulate the currency value for political reasons.

There is no compelling reason the standard needs to be gold. Anything with fundamental restraints on production would do.

Devil's Advocate writes:

(Austrian-leaning but not an economist)

It seems that one of the primary concerns driving the debate is the profligacy of the Federal Government and the resulting incentive to inflate the money supply to meet the Government's expanded obligations. It seems that there are really only two ways to limit the expansion of the Federal Government: Constitutional and financial.

The Constitution was intended to provide a check on the scope of the Federal Government by establishing a limited number of areas in which it was granted power from the States. The interpretation of the Constitution has changed over time, however, to the point at which there seem to be few areas of government involvement that would actually be deemed unconstitutional.

With the Constitution no longer impeding the expansion of the Federal Government, limiting the ability of the government to finance its operations may be the only effective check on its size. With that in mind, I am very much in favor of some kind of limitation on the ability of the government to inflate the money supply.

I am in favor of free banking, which ideally would prevent the Government from being able to unilaterally inflate the money supply to its own benefit. At the very least I believe that the Fed should be abolished. Rather than mandating a specific reserve, whether 100% gold or otherwise, the banks should be free to maintain the level and type of reserves that their customers will tolerate. I think that the transition to such a system (if possible at all without a collapse making it a necessity) might be painful in the short run, but will lead to greater stability in inflation and employment. The overall growth in output may not be affected in the aggregate as much as it might be smoothed through decreased volatility.

Joe writes:

My comment about China suddenly finding "gold" in the ground is an abstraction that relates to putting our economic future into the hands of potential miners/others. Although the current production of gold is small compared to all currently mined reserves, the past performance is no guarantee of future success. So, if any country suddenly finds a huge gold vein, then we have a new world superpower....

Also, there is a psychological basis for going against the gold standard. Peope to not think in relative terms, they think in nominal terms. Most people do not care that their salary just keeps pace with inflation, they just want to see that they have MORE this year than last year. That is the problem with deflation, as opposed to inflation. Humans has a natural bias to want to collect more, not less as time goes on, even though if deflation were the norm, less would be more.

Graeme Bird writes:

It would be no problem going over to a multi-commodity standard just so long as no fractional reserve were tolerated anywhere. This would be a costless exercise. In fact it would shore up the situation by keeping our extraction industries ahead of the game.

Our Austrians at Mises.org grossly understate their case on this matter. There are only two industries that need to stay ahead of the game to avoid a general civilisational collapse. And thats the food industry and the energy/extraction industries taken as a whole.

The medical industry could disappear tomorrow and that would be tragic for many individuals. But if the energy, extraction, or food industries were to tank we would run the risk of a energy-capital-vortex developing. Where we don't have the energy to get the capital and the capital to get the energy and so forth.

The difference in my view, is not to try to go to gold all at once. In transition we want to nuance matters so we have maybe half a dozen fully backed moneys... and fully anticipating that perhaps in 100 years or 200 years gold may have taken over entirely.

But actually so long as we can be assured that even the smell of fractional reserve is not present, then it ought to be the case that four or more monies ought to be able to keep off the ground. It would be fortunate if we had a stored commodity that was digitized that represented an explicitly energy-based commodity. Like liquified-coal or something of that nature.

But the thing is we will lose all hope for anything to compete with gold and silver so long as even the smell of fractional reserve is with us. We can have a digitized money that doesn't have all the portability of pre-information-age-money and it still could be feasible. But this is an idle speculation unless there is absolute zero-tolerance against fractional-reserve.

We can learn from a 1000 years of banking you know. We ought to be able to learn from this history and retain the knowledge. We can learn that fractional reserve must always mean bank/government collusion and there is no getting around that.

Niccolo writes:

Well... Initially... Massive deflation that would probably motivate people to go straight back to the fed - or worse.

After that...


Massive deflation that would probably motivate people to go straight back to the fed - or worse.


It certainly would result in an awfully big boon for the mining industry though.

------------

To Joe,


I don't see the problem with multiple currencies and it obviously isn't so that one currency will ever once and for all be the only currency - never has been, never will, some currencies might get really successful, but creative destruction wins out in the end.

Also, I get sick of all this Madoff stuff. Fact is, many investments are ponzi schemes, governments too! Just because he wasn't particularly successful in it/didn't manage it well enough/had crappy kids who sold him down the river doesn't mean that you're ever going to get rid of ponzi schemes or that every scheme is going to go down in flames like his.

---------------------


Greg Ransom,


Mises and Hayek believed in monetary equilibrium. The modern "Austrians," however, are really just Rothbard occultists and believe in gold as if it were the feces of the LORD.

-------------


Fundamentalist,


Yeah, I don't know about the free banking thing in the US, but I don't think anyone should fool themselves into thinking that even if you had a perfect monetary system that fluctuated quickly and never fell into trouble that you'd get rid of booms and busts. The market isn't always so steady; it's generally the best thing we have, but it's not God.

Graeme Bird writes:

There is absolutely no need for massive deflation if you start off going after half a dozen FULLY-BACKED commodity monies in the phase-out.

You see the first thing is you have to be phasing out fractional-reserve even before you are phasing out fiat money. But by the time you are at a 50% reserve asset ratio for the compulsion-cash you can start transitioning over to these various commodity monies.

Ironically the first step to phasing out the fiat-cash is to print more of it because your first step is to reduce the ponzi-money. As the reserve asset ratio for the fiat-cash starts inching above 50% the other monies will be able to compete.

The thing is it costs a lot of RESOURCES (it costs a lot of money) to keep this paper-money going. The fundamental costs for paper money are much higher then they are for coins.

Well those charges ought to be passed on to the consumer. And if there is no efficient way to do this then all you need to do is make interest earnings on 100%-backed commodity money or even on hybrid loans non-taxable.

Then you have a push-factor for the paper-money to be phased out. And once fractional reserve is halfway to being phased out then it will be the case that these other monies can start getting some traction.

I recommend a straight tax advantage for commodity money as a stress-free way to see it edging out the compulsion cash.

But there is not way to do it seamlessly without first charting the course to edging out the ponzi-money.

Graeme Bird writes:

One more thing before I get a reply. I don't think this matter can be resolved without a sort of consciousness towards all the realities of the extraction industries. You cannot contemplate this matter sensibly without keeping the dynamics of the extraction industries in mind.

If ever you start selling, lending or trading ponzi-commodities rather than the real thing you are not saving any resources as the fractional-reservists wrongly contend. Rather you are imposing costs on the extraction industries.

But the costs of having half a dozen monetary commodities are basically nil. Because you think about it. You go looking for a needle in a haystack.... well you will find a lot of four-leaf clovers prior to finding the needle.

The way these small-cap extraction companies work they have their exploration costs. They have their flyovers where they measure some gravity-field or something and make inferences on that basis. They put down drills and they map stuff out. And if you are doing that for gold, silver, copper, platinum, and liquified coal you are amortizing the costs of bringing up just about everything else. So this idea that 100% backing is costly is just wrong. It is a misunderstanding of how the extraction industries work.

This I think is the best tip I can give the mises.org people. There ought to be some communication between the monetary theorists and the people running these small-cap exploration companies to get the full reality of the situation. Because while a sudden change to gold alone may well cost a lot of resources to the community as a whole..... if instead we started with maybe half a dozen monetary commodities it wouldn't cost a thing. In fact it would be an act of civilisational insurance and any premium price on the monetary commodities would be amortized on all the other gear these adventurers were bringing up.

Lord writes:

Non-austrian.
A gold standard is deflationary so we would have an asset that would return a real interest rate with no investment necessary and an especially high rate during recessions. There would be periods of growth with the introduction of new technologies, optimism, and credit, interspersed by lengthy recessions during which gold would be hoarded. Growth would be lower overall as it was in the 19th century and more sporadic as only investments with a higher rate of return than gold would be profitable. Inflation would be negative its variance would increase over recent history as the economy switched from growth to recession. Growth would slow and variability increase. Employment would suffer from this increased volatility and the minimum wage would be a disaster since wages would have to fall with prices over the long term. Wars would become extremely expensive and without devaluation after them would be inevitably followed by depressions to reset the price level, at least until it was abandoned as it would be.

Graeme Bird writes:

Its absolutely no good making these speculations without first describing your transition strategy.

You see I'd want to shoot holes in what you are saying but cannot do so for lack of a transition strategy.

But we can say this for sure. Once transitional matters were all overcome there would never and could not be monetary deflation under 100% backed gold.

Mencius writes:

Restoring sound money - from a paper currency, or even from a paper-inflated gold standard - is a lot like landing an airliner in a river. If you see it done wrong once, it looks like a recipe for disaster. But it only has to be done right once, too.

Rothbard's landing plan, for example, is a bad one. It sets the gold/paper exchange rate way too low. Instant bust-up. The same can be said of the gold-exchange standard attempted after WWI. The correct answer, which would have averted the first Great Depression, was a level of devaluation against gold which struck the gutless parliaments of the '20s as politically unacceptable. The pound had always been inflated with paper, but this time the goose was overstuffed.

Your goal in the transition is to set the gold/paper ratio so that it minimizes the disruption to your present economy, which, while basically fscked after a century of subsidized credit, is at least somewhat functional. In other words: activity which is economically rational before the transition should remain rational after it. Economies do not heal instantaneously.

(Also, there is basically no way to solve the problem without making present holders of gold very, very rich - although this can be attacked via one-time taxes, ie, confiscation. Otherwise, they are simply doing well by being right. What could be more American?)

Your goals are to (a) replace all paper money and paper-denominated financial instruments with allocated gold; (b) leave everyone with the same relative purchasing power as before the transition; (c) terminate in a stable system, which does not use accounting tricks to expand the amount of apparently available present gold (ie, MT/FRB).

There are many ways to do this, but here is one. Nationalize the entire dollar financial system, converting market-traded assets to dollars at current market price. Add as many dollars are needed to render USG itself solvent, considering all liabilities and entitlements. Convert these dollars into notes against your gold reserve. The gold/paper ratio ("gold price") is then a matter of division.

This yields a gold/paper ratio much higher than the present market figure, of course. Thus any proactive conversion requires decisive, effective action on the part of USG - for this reason, among others. I believe this is the main obstacle to any return to sound money - not any matter of economic principle.

Besides, frankly - the very question is impertinent. It's the professional paperhangers who need to explain why we should construct another house of cards to replace the one that just collapsed.

Precious metals were the basis of human monetary systems throughout Greek, Roman, and European history. Paper money was universally regarded as the department of the monetary crank. And indeed, it is the patent-medicine econasters of the 20th century who, were there any justice at all, would be prostrating themselves and whining for mercy before the jury of the past. I'd like to see Professor Caplan explain to, say, George Bancroft, why the printing press is an essential feature of modern civilization.

Graeme Bird writes:

For that part of the problem where you want to get rid of fractional reserve its a simple matter of restricting the central bank to two measures.

When they wish to restrain demand they must never sell bonds. Rather they must instead increase the reserve asset ratio. Quite quickly they must get rid of any loans to the bank and other subsidies to these welfare queens.

When they want to increase demand then its a straight cash injection. Either through the normal spending of the treasury. Or by retiring debt.

Since they have only two measures and they are not allowed to increase debt you will be at 100% backing in no time. And its up to the central bank to make sure its handled smoothly.

John Turner writes:

Mencius,

Bancroft starts off by saying that “[g]ood money must have an intrinsic value.” I’m sorry, but nothing has any intrinsic value, gold included. If you accept his initial argument then there is no such thing as good money.

Graeme Bird writes:

Thats not right. Gold, Silver, Copper and Platinum are marvelous metals for industrial processes. Where I am I use platinum for testing salt. And platinum so far is an essential part of catalytic converters. Golds industrial applications are legion and Copper as well. If Silver were more plentiful a silver alloy would be the closest thing we have to a super-conductor.

So no. What you are saying is not right.

Graeme Bird writes:

"Austrian Challenge: What Would the Macroeconomy on the 100% Gold Standard Look Like?"

Its almost the wrong way of looking at it right there. LIFE IS BETA. Thats the way to look at it. A free market 100% backed monetary system will always be in transition if its done right. To understand the whole thing one needs to think of the money supply industry, as always evolving and being in transition like any other industry.

But the main thing is to get rid of fractional reserve for all time and then let the evolution of the money-supply-industry begin.

Mencius writes:

John,

Bancroft was a historian, not an economist. I'm not suggesting that his reasoning is precisely correct - just that the conclusion he arrives at is the most reasonable choice for a null hypothesis.

Lord writes:

There would be price deflation, which is what most people consider deflation, since the amount of goods increases while the amount of gold does not (almost), but growth would likely decline to the level of gold increase, stabilizing prices and leaving gold with no real return.

Jeff writes:

Milton Friedman was an extremely smart, creative, well-read and well-trained economist who devoted a lifetime to thinking about these issues. Yet it appears that many of the people commenting on this post and others like it actually think they know better than Friedman did. Unbelievable.

Chris Lemens writes:

Fr. re writes:

> in my opinion a 100% gold standard system is
> unsustainable without a strong, quasi-
> authoritarian, government to enforce it. The
> problem is that gold standard is probably not
> an evolutionary stable strategy ; banks and
> customers will always be better by agreeing
> on some other non-100% system.

I think that the government would still have to decide what it would accept in payment of taxes. If the government specified that taxes had to be paid in gold -- or always and promptly swapped any notes for gold -- would you still hold the same opinion? (This is not a rhetorical question.)

Chris

Mark B. writes:

Fundamentalist: "That contradicts the history of the US under a gold standard in the 19th century"

The question before us is relative to the proposed conversion to a 100% gold standard, i.e. 100% reserve ratio for demand deposits in accordance with traditional legal standards. No fractional reserve banking.

US banks in the 19th century did not maintain a 100% reserve ratio, and that is one of the reasons why they were susceptible to periodic financial crises. Indeed from an Austrian point of view, fractional reserve banking causes endemic crises due to the malinvestment and misallocation of resources caused by unnatural, excessive, and misplaced credit expansion unbacked by voluntary savings.

A much better historical example is the Bank of Amsterdam from about 1609 to 1780, which did in fact maintain a 100% reserve ratio and survived under conditions such as imminent threat of foreign invasion that caused many of their Dutch peers to fail.

Bill writes:

I think this is the wrong question to ask, because it assumes that government would continue to hold a monopoly on money creation.

Free banking should be the objective. For all I care the government could continue to print toilet paper if they would give ME the opportunity to opt out. Unfortunately, if I am smart and keep my "money" commodity backed instruments, I am ultimately taxed on its appreciation relative to the toilet paper they pass off as federal reserve notes.

Remove the tax implications of holding commodity money and the Fed would eventually disappear on its own. But of course, so would the influence and power of the federal government, so we know that it is fantasy to think it could happen.

What disappoints me most is that there are "economists" who still believe the central governments should hold a monopoly on money creation. They should be ashamed of themselves. It is immoral, coercive, and economically destructive.

functionality writes:

Money is, among other things, an unit of measurement.... just imagine trying to design and build a bridge with meters that changed in length according to government policy. Or trying to cook without a stable unit of temperature?

That is what accounting and finance has to contend with when it uses fiat money as a reference. Even econ statistics become meaningless over time and destroy the scientific value of many data series.

1gram of gold has been 1 gram of gold for hundreds of years.... 1 dollar? I don't even know what it will be next year.

fallacious writes:

Jeff
"Yet it appears that many of the people commenting on this post and others like it actually think they know better than Friedman did. Unbelievable."

...yes Jeff, human beings are possessed of individual brains. That's why arguments from authority only sway those that can't think for themselves.

I've read most of what Friedman wrote on the subject and was not convinced, despite admiring the man and agreeing with him on many things.

In fact he changed his mind on the subject in his late years...

Graeme Bird writes:

"There would be price deflation, which is what most people consider deflation, since the amount of goods increases while the amount of gold does not (almost), but growth would likely decline to the level of gold increase, stabilizing prices and leaving gold with no real return."

Most people consider that deflation in error. So most people ought to get their act together on that score. And the amount of gold can increase quickly if there is the demand for it to increase. We have dozens of small-cap gold companies looking for the stuff and they can expand the current supply upwards of 7% per year if the demand for gold is high enough.

You absolutely cannot make these claims without specifying your transitional strategy. Currently we only have monetary deflation or the prospect of it because of fractional reserve. "When gold comes into existence it stays in existence." Whereas bank-ponzi-money can disappear at any time. So in fact monetary deflation is really quite impossible if transitional arrangements are overcome.

100% backing is a way to avoid both inflation and monetary-deflation.


Graeme Bird writes:

"Yet it appears that many of the people commenting on this post and others like it actually think they know better than Friedman did. Unbelievable."

Friedman was a great freedom fighter but he's not the ultimate authority on money. And you have to learn to think for yourself.

Friedman also was subject to the incredible pro-fractional reserve religious impulse. Not necessarily in himself but he would have been subject to the astonishing peer pressure in this regard. And he had at first advocated 100% backing then backed away from that. Perhaps if he hadn't of backed away from it he may have been sent into obscurity. So strong is the tendency towards macromancy.

Graeme Bird writes:

You don't need a strong authoritarian government to stop fractional reserve banking any more than the banks need a private army to stop their own people embezzling cash from the till.

If its illegal and all employees have a legal obligation to not practice it then it won't be practiced if there is a minimum of local auditing. The reason is because if you are a teller and your till doesn't balance.... then you have to dob in whose fault it is because you may quickly be blamed yourself. The same goes for the wider crime. Once its phased out and illegal it won't take a great deal of effort to stop a breakout in its practice.

The pull of fractional reserve religiosity is so powerful that you get people grasping at any straw to justify it and this excuse comes up a great deal.

fundamentalist writes:

Mark B.: “US banks in the 19th century did not maintain a 100% reserve ratio, and that is one of the reasons why they were susceptible to periodic financial crises.”

I was responding to Eli’s statement that under a gold standard depressions would be deeper and longer than under fiat money. Yes, it was fractional reserves and paper money that caused the depressions of the 19th century.

Jeff: "Yet it appears that many of the people commenting on this post and others like it actually think they know better than Friedman did. Unbelievable."

As Mises and Hayek pointed out, Friedman’s monetary theory was simplistic. Friedman wasn’t the only intelligent person who ever lived and wrote about economics. Many other people were better economists than Friedman, such as Mises and Hayek, as great as Friedman was. Friedman had lashed himself to Keynes and could not escape the consequences.

Joe writes:

Quasi Austrian/Behavioral
Under a 100% fractional reserve system, what would prevent banks/bankers from extending credit to increase their margins? They know that only a small % of deposits are ever requested at one point in time, and if individuals in the organization have incentives to make money they will. The idea that there will be no regulatory capture/rogue behavior in a 100% reserve system does not seem to square with reality or real behavior. Organizations want to be around for the long term, and so tend to care about reputation, but the changing workplace dynamic, where workers are dispensable free agents has changed the individuals view of their relationship with the organization, and are much less concerned with the long run. Any banking system is flawed, because the people who constitute the system are inherently flawed.

Jeff writes:

Joe (immediately above) is absolutely right. The essential insight of Burkean conservatism is that institutions evolved to their current state for good reasons. Proposing fundamental changes to something as essential to civilization as the monetary system without an appreciation of what's right with the current system is both radical and stupid.

spencer writes:

As a practical gold analyst it depends on the price of gold.

At anywhere near current market clearing prices the non-monetary demand for gold exceeds the supply.

Consequently, private demand would buy the monetary authorities gold holdings -- this is one of the things that happened in the 1960s --and the monetary authorities would be forced to raise the price they are willing to pay for gold to own sufficient gold supply to conduct monetary policy.
Otherwise, the monetary authorities would be faced with a contracting supply of monetary gold and a constant deflationary economic environment.

For a gold based monetary system to work the monetary authorities must set the price at which they will buy all gold tended to it at a level higher than any foreseeable market clearing price.
That is what the Bank of England did in the 1800s system that the gold bug want to emulate. Moreover, there is nothing to prevent the monetary authorities from raising the price at which the offer to buy all gold tendered to it as FDR did in 1935.

Consequently, the initial establishment of a gold base monetary system will be accompanied by a multi-year burst of inflation.

Any of the above theorist speculating on what a gold base system who do not specify what the price would be is useless analysis that has no basis reality or even of theory.

Josh writes:

(Austrian leaning)

Why not just abolish the FDIC?

Isn't that the real problem? People would reign in the banks a lot quicker that way, like they used to.

alex writes:

Gold standard is good. 100% gold standard is insane and unnecessary. It would destroy banking and lending.

Hayekian competitive currencies anyone? With that we could actually figure out which type of money is preferred by the market instead of imposing a cumbersome centrally planned monetary system like a 100% gold standard.

Graeme Bird writes:

"Under a 100% fractional reserve system, what would prevent banks/bankers from extending credit to increase their margins?"

Fines and jail and the loss of all their equity? How does that sound? If its illegal and you break the law you get fined or jailed. What is so hard to conceive about that.

The creation of bank-cash-pyramided money requires collusion between two or more banks in most cases. So if one bank doesn't want to go under for breaking the law he won't be an enabler of another bank that wants to flout the law and sell or loan non-existent assets. Which is always fraud.

On another note the key advantage to 100% commodity banking is finally we will have stability of spending. Stability of the volume of spending. Stable growth not just as a national aggregate, but regionally as well.

The advantages are really about correcting all the deficiencies of fractional fiat. Which causes gyrations in spending all over the shop. Since when the new bank-ponzi-money is created it starts changing hands and starts the process of erratic spending patterns.

Fractional fiat has many costs associated with it. But one big one is that it amounts to a full frontal attack on the price-and-spending-volume system for the allocation of resources when it comes to business spending. It throws a wrench in our price(and spending volume) system.

Less Antman writes:

I'm swimming in the Atlantic Ocean midway between Vienna and Chicago.

I don't know what would happen under a 100% reserve gold standard: I'm an anarchist because I don't think central planners can ever know. But a government-enforced gold standard that operated honestly strikes me as hopelessly utopian and would, upon failing, just be seized on to further discredit free market supporters. Monetary expansion tools might simply be defined as money substitutes instead of money so that government inflation could continue. Indeed, as an advocate of free banking, I believe that is the correct interpretation, although I tremble at granting any flexibility to central planners.

I'd abolish legal tender laws so that competing currencies could be tried. My guess, and nothing more, is that we would end up with fractional reserve gold as the market choice, and that inflation would occur until the price of gold notes was driven down to the pure commodity value of gold, then stabilize.

Graeme Bird writes:

Some people seem to think that their ideals change the nature of reality in the strangest ways. Your anarchism doesn't change the nature of monetary-economics. Being for anarchism and then claiming that 100% backing is utopian is pretty bizare right there. But in fact fractional reserve would destabilize any functioning anarchic system and can pass no market test.

Under any functioning anarchism you need profit-making enforcement agencies. To make a profit they would need to avoid enforcing contracts that are expensive to enforce or that cannot be enforced. A fractional reserve contract is such a contract. The most important fellow in the enforcement-agency would be the fellow who helped any two parties alter a contract so that it would be cheap to enforce. Since the way to be profitable is to basically just take your fee and not have to use up valuable resources enforcing dud contracts. Once ponzi-money is out in the system it no longer becomes possible to decide who owns what.

Sooner or later a market anarchy system would have to learn that it must not tolerate fractional reserve. Even if the lesson was painful and took them a 1000 years to learn. But we have a 1000 years record of banking to draw from and we ought to have learned that lesson by now.

Your transition strategy is moronic since it runs the risk of a monetary collapse, followed by a collapse in the velocity of circulation, which could destroy the economy with it, and discredit commodity money for a century to come.

Ideals do not overcome technical facts as some sort of utopian crazies imagine. I'm a pessimistic anarchist and a hopeful minarchist but I'd have to say that I get a bunch more pessimistic when I see people blithely dismissing the realities of monetary-economics in this way. All anarchists must come to grips with the reality that if they are serious, then an anarchistic society would have to take a zero tolerance approach towards fractional reserve.

Graeme Bird writes:

"Joe (immediately above) is absolutely right. The essential insight of Burkean conservatism is that institutions evolved to their current state for good reasons."

Well this institution evolved for very good reasons. A counterfeiting racket shared between government and banks. A fait accompli foisted on people after the fact.

We see the process of how this evolves even now, where share brokers are pyramiding on shares and issuing IOU's when they cannot deliver. This issuing of IOU's is a fait accompli foisted on the market after the fact of rampant embezzlement. Its an attack on market share pricing.

Likewise in the gold market. People just basically inventing ponzi-gold and trading it so the price of gold falls even as the waiting times to take delivery grow longer. All such bad habits get locked in the system if you let it and its very hard to navigate back to normalcy in property rights once these practices begin. And yet all such practices are an attack on the price system and something that is foisted on customers by the initial embezzlement of their property.

The Burkian argument is incredibly weak here. So much so as to be not be worth worrying about.

Once banks (brokers, gold suppliers) are allowed to embezzle property in this way the costs of setting things right is prohibitive. Thats the very good reason that this system evolved, but thats no reason to keep it when its an idiotic system.

scineram writes:

Alwasy nice to see libertardians throwing out freedom of contract when it becomes uncomfortable.

Graeme Bird writes:

But its not a freedom of contract issue. Its a fraud issue. A ponzi-scheme issue.

You see freedom of contract relates where it is to do with ones own property. But if you loan out gold that you yourself do not own and don't even have rightful possession of thats fraud.

So now people are passing off ponzi gold and silver. They are pyramiding on shares and passing this off and crashing share prices with rabid shorting. This is all fraud. Nothing to do with freedom of contract. Which is a secondary libertarian matter in any case. The key libertarian matter is clarity and strength of property titles.

No fractional reserve contract can be enforced. So its not appropriate to smuggle in this idiotic monetary superstition and macromancy under that banner. I mean its just a bizare excuse for a priviledged and subsidised counterfeiting racket that swallows up so much of our resources and is monetary-economics lunacy.

Graeme Bird writes:

Fractional reserve contracts cannot be enforced. And freedom of contract is only to do with your own property. Not with scamming people by lending or trading items that you are not in lawful possession of. Bank cash pyramiding is a case of straight fraud.

Comments for this entry have been closed
Return to top