David R. Henderson  

Gibson on Gold

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San Jose State University economist Warren Gibson has an excellent article, "Gold and Money," in the latest Freeman. He lists a number of claims about gold, both positive and negative, and proceeds to do a "True, False, Uncertain, with explanation" treatment of each. In the process, he lays out a concise history of monetary policy in the United States, pointing out one of the most harmful government interventions that "helped" put the "Great" in Great Depression: the ban on branch banking.

I had known most of what was in there but I've never seen it so nicely done in such a short space. His article would be an excellent reading in a Money and Banking or American Economic History course.

Two things I learned:
1. "All the gold ever mined would only fill one large swimming pool."
2. There's gold in that 'thar fort:

It has been 40 years since the last indirect link between the dollar and gold was severed, and yet the government continues to hold some 8,000 metric tons of gold bullion--the world's largest single stash. Oddly enough it is valued at $42 per ounce, the last official price before it was set free to be established in free trading. At today's market price of around $1,300 per ounce, the hoard would be valued in the hundreds of billions of dollars.

Only one thing missing, assuming my memory is correct. When he discusses the inflation of the 1890s and into the 20th century due to the increase in the supply of gold, Warren doesn't mention the introduction of the cyanide process for extracting gold. If I remember a Ben Klein lecture in Monetary Theory at UCLA from 1974, this was a big deal. I think Ben said that it put the kibosh on William Jennings Bryan's presidential run in 1896.


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COMMENTS (12 to date)
Tim Worstall writes:

I'm not wholly sure that it was the cyanide process. It's about the right time: but then so was the discovery of the S African deep mines. The Witwatersrand gold rush was 1886 I think.

Be interesting to know which did have the larger effect really.

But it's certainly true that the gold supply increased significantly in the 1805 ish to 1910 time span.

Just as the European (most especially Spanish) gold and silver supply did after the discovery and plunder of S America.

I would and do argue that these two episodes mean that gold and or silver....indeed, any other commodity which we might find a new source of, or a new method of extracting, cannot therefore be used as a forever stable measure of value.

Could certainly be better than politicians, but still not perfect.

Curt writes:

The folks who are obsessed with gold typically make this point (as does the article): "Under the Fed’s watch the dollar has lost more than 95 percent of its purchasing power and the economy".

My question is why should we care about this factoid? Doesn't the average income buy a whole lot more now than in 1913? The standard of living has risen greatly despite this whine about the value of the dollar. Just why should I care what a dollar is 'worth' as long as I can earn enough of them to buy things I want/need?

It would be nice to see some explanation of just why anyone would think we'd have benefited from having a dollar that is (in some way) 'worth' exactly what it was worth before the Fed came along.

Yancey Ward writes:

Curt wrote:

My question is why should we care about this factoid? Doesn't the average income buy a whole lot more now than in 1913? The standard of living has risen greatly despite this whine about the value of the dollar. Just why should I care what a dollar is 'worth' as long as I can earn enough of them to buy things I want/need?

Let's suppose you had a bank account, and 20% of it's value disappeared one day. Why should you care if you still earn enough dollars to buy the things you want/need?

Mr. Econotarian writes:

I think the issue is whether mild inflation of government-controlled and/or fiat currency is a Pareto improvement.

It certainly seems to a lot of bright people that deflation was a leading cause of the negative effects of the Great Depression, and that "gold clauses" in contracts amplified this.

It could very well be that mild inflation of the major currency allows for an economy to grow faster than one that faces the risk of volatile inflation/deflation due to changing supply/demand of a commodity.

Now whether you trust a government not to inflate beyond levels that most people would agree is not Pareto-improving is another question.

But today (in the US) there are no limitations on holding gold if you prefer it to the government-operated fiat currency.

fundamentalist writes:

Curt, don't confuse what is with what could have been. Could we have done better without the price inflation caused by devaluing money?

And don't assume that our standard of living is higher because we left the gold standard. That would be the post hoc fallacy. It could be higher in spite of leaving the gold standard.

In order to know the answer to those questions you have to understand sound monetary theory.

And price inflation is the least of the disasters that monetary inflation inflicts upon us. The worst is the boom and bust business cycle. But even simple price inflation transfers wealth from workers and senior citizens to the financial services industry and the government.

Curt writes:

I understand that those of us with big hoards of money would like that money to retain value (i.e. be risk-free). But most people don't have hoards of money, and I think the the wealthy can fend for themselves - rather than just sitting on piles of risk-free money they have to make choices on investing it (some will win, some will lose, that's all to the good).

The factoid seems to imply that we are much worse off because of the devaluation of dollars - that in some sense we have only 1/20th of the assets we had back in 1913. But that's obviously not true.

We don't have counter examples of how much better the world would be under the gold standard - since the world is largely on fiat currency. So I think the folks proposing gold need to explain just how fixing the price of gold will change our situation, not just in terms of the price of gold, but in the impact on the average person's standard of living, GDP growth, etc.

Note: I'm not saying there aren't problems with inflation, boom/bust, etc. - I'd just like a better explanation of why folks think something that no modern country is doing is going to put us all on a better trajectory.

fundamentalist writes:

Curt, if you know good monetary theory, you don't have to have a controlled experiment to understand the damage that inflation does. You don't think transferring wealth from workers and retirees to the financial services industry and the state is a bad thing?

Most of the decline of median wages from 1973 to 1992 happened because price inflation eroded wages. And the booms that monetary inflation causes destroy huge amounts of wealth.

That said, a gold standard does not and cannot prevent monetary inflation that causes price inflation. Most monetary expansion comes from credit expansion that results from fractional reserve banking. Even with a hard core gold standard, credit expansion is very easy. I happened many times in the past.

What's needed is better monetary theory on the part of the Fed, not a gold standard. With good monetary theory gold is unecessary.

Curt writes:

I agree that the credit expansion from fractional reserve banking is a key issue, and can obviously be overdone a la the 2008 crisis. But I think there are benefits from a certain level of credit expansion, and that a certain amount of inflation is actually necessary to help maintain the cycle of repayment of credit (yes, this hurts the creditors some and helps the debtors).

I think there is still an evident amount of confusion about measurements of inflation and its effects. In an economy where a fairly small portion of our expenditures are on food, then some inflation in the food sector is not too worrisome. On the other hand, it may have devastating effects in places where people spend a large portion on food.

In other areas like technology, the amount we get per dollar has increased far faster than the value of the dollar has dropped, thus on net we continue to make gains.

So I think it's a little too simple to say inflation = bad! (All else being equal, maybe so, but when is all else ever equal?)

Philo writes:

Why does the U.S. government hoard gold? (And why are some other governments, such as the Indian, accumulating gold?) Is this due to magical thinking of some sort?

The government could raise some of its funds for operations by selling assets, and buried gold is so obviously useless that it should be at the top of the priority list. (It has been proposed that the government sell off some of its hoarded petroleum, but this is not usually presented as a measure to raise revenue. I would like to see it sell not just its gold but also most of its land and buildings. What is the objection to this proposal--particularly with regard to gold--and why does it not figure in public discussed?)

8 writes:

People like to use the 1913 date, but in reality, pure fiat currency has only been in effect since 1973.

If the Fed held inflation to say 2% per year, every year, then there's a case that central bank isn't creating a lot of harm. I've seen the asymptote when you get out into time, but people will live in the middle and never experience that drop. Just like we don't sit around today worrying about a 95% loss in the dollar because we haven't experienced it.

I think to a large extent, people want easy money. Sound money will only exist in a country that has limited voting rights, or no democracy. That said, once every three generations, sound money will rear its head and reset the currency system. (Assuming no structural reset such as a Jubilee.)

Mike Rulle writes:

I am not buying the "large swimming pool" fact assertion. "Large" does leave wiggle room, but still not buying it. Sounds like one of those urban myth stats----if true, however, it is interesting.

John writes:

I just finished watching a video, "Money as Debt" by Paul Grignon. The video explains that money is created not by the Mint but by banks that issue loans based on the Fractional Reserve Requirement. Since the banks create only the principal and not the interest required to pay back the loan, the only way to sustain the system is through ever increasing debt. Such a system can hardly survive. The video advocates a nationalized banking system. Just wondering what your views were. I doubt it is in favor of having the government run the whole system. The video suggests that governments should avoid paying interest to private lenders by creating their own money (not sure how though, maybe just printing more money). Would this work? There would likely be inflation, but is this preferrable to the current system?

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