"World Without Paper Money" by Nathan Lewis

[DriftWood]

Very good provocative article i found, that is directed at many of Ron Paul and Rothbards gold coin fans. It explains why such dreams can not work. We simply do not have enough gold (or silver or copper) in the world to make it work. What we need is paper money pegged to the price of gold. That way we don't actually need any gold at all.

(I think this guy is on the money all the time.. well most of the time.. do not care much about his survivalist rants)

http://www.newworldeconomics.com/



World Without Paper Money



June 2, 2008



There is a certain sort of gold-coin fundamentalist, who insists that we must not consider any sort of system that uses any sort of paper money, and only a metal-coin system will do. I'm sure you know the sort I'm talking about.

I often feel like I play economic psychologist, as it is interesting to think about why people are so devoted to these sorts of impractical niche ideas. I figure that one thing that has happened is that the gold standard advocates have become very aware of the general unpopularity of their ideas, and have compensated by offering ideas that are so extreme as to deserve unpopularity. Then, they are not so disappointed when people don't take them seriously, because they never expected to be taken seriously. It's the dissonance between a sensible idea and the ridicule it receives that causes psychological stress. If you offer a ridiculous idea, then you are not so surprised if it receives ridicule. Thus, gold standard advocates today tend toward extremist views which have no political chance of success, and, actually, no practical chance of success either, as we will show today.

Another reason for this phenomenon, it seems to me, is that most gold standard advocates today don't really have a sufficient understanding of monetary economics, in the sense that a mechanical engineer understands the machining of metal. Instead, they have a series of platitudes and vague principles, punctuated by periodic references to the Holy Mises. Platitudes and principles are fine, but they don't serve in the fundamental engineering-like process that creates a working monetary system. They are aware of their insufficiencies, in the same way that mainstream central banker types are also aware of their insufficiencies, which makes them cling to the existing interest-rate manipulation system rather than proposing sensible alternatives. The mainstream central banker types are equally impotent at creating a working monetary system, because they also lack the fundamental nuts-and-bolts understanding that would allow them to create functioning systems with any sort of features they desire.

The gold standard advocates have thus migrated somewhat toward the "let's all use gold coins" system, because it seems like there is nothing to manage. You just make coins out of gold --which, you have to admit, is a pretty simple rule, and doesn't require a paper-currency manager as would be required with a gold-linked paper money system.

The other favorite is the "let the free market figure it out" system, which means "I have no idea but maybe someone else does." In the 19th century, there was no government monopoly on currency production, and indeed many hundreds of private commercial banks distributed their own paper currencies, which were linked to gold. You can still see this system a little bit in Hong Kong today. However, all of these hundreds of private commercial banks had to have someone, on their staff, who understood the nuts-and-bolts of how to link a paper currency to gold, if they were going to be successful. So, the "let the free market figure it out" solution doesn't escape the need for a monetary engineer to make the system work.

As I've argued, the bullion coin system is not a particularly bad system, when used in a small area. Ecuador could probably adopt a bullion-coin system with no particular ill effects. However, it is not a system that is suitable for the world as a whole. Let's try to understand why, which is also the reason why paper monies were widely adopted during the industrial 19th century.

The fact of the matter is, there really isn't that much gold out there. Gold is hardly ever used up or thrown away, and as a result, about 85% of all the gold ever mined in all of history still exists in human possession. Over these many thousands of years of gold mining, humans have been able to extract about four billion ounces of gold. Historically, this amount has risen by about 2% per year due to mining, but recently, world gold production has been falling off rather dramatically despite recent economic incentives to produce more. It looks like we may have hit "Peak Gold," running into the physical limitations of availability in economic concentrations the Earth's crust.

So, four billion ounces is about all we're going to be able to work with. There are almost seven billion people in the world. So, if they all use gold coins, how many gold coins are they going to own?

A traditional problem with gold coins is that they are simply too valuable. A 1/10th oz. coin is about the smallest coin that is practical. There was a 1/20th oz. gold coin in the U.S., but it was really teeny and thus rather impractical and unpopular. A 1/10th oz. gold coin today would be worth about $100. When is the last time you saw a $100 bill? Although they are used commonly outside the U.S., particularly in illegal cash transactions, within the U.S. the $100 bill is very rare. The reason it is rare is not that the government refuses to make them -- the government is willing to trade a $100 bill for five $20 bills at any time -- but that people don't like to use them.

Traditionally, smaller transactions were carried out with silver and copper coins. This introduces new problems. The smallest practical silver coin is perhaps 0.05 (one twentieth) oz. The old silver dime of the 1950s had about 0.07 oz. of silver, and was 90% silver by weight. Using the traditional 15:1 silver:gold value ratio, at $1000/oz. gold, the value of the 1950s silver dime would be about $4.60 today. So, even the smallest silver coin is of rather high value, which necessitates the introduction of copper coins. Now, we've got a three-metal system, if you're going to make the coins have a bullion value equivalent to their face value. The actual market values of the metals drift over time, which introduces all kinds of new problems.

The point is, a "gold coin system" is really a silver-and-copper coin system. Today, there is about 1 billion oz. of silver in the world that could conceivably be made into coins. Remember, most small-scale transactions would be done with silver coins. You wouldn't see gold coins very often, but silver coins would be used every day, at the grocery store for example. How are seven billion people going to make a monetary system with one billion ounces of silver coins? Today, if we use the 15:1 silver ratio, that billion ounces of silver would be worth about $60 billion. There are about $800 billion of U.S. notes and coins in the world, not to mention the notes and coins of other governments. We can see that there isn't a whiff of a chance of making a silver coin system that would serve the world -- although maybe Ecuador could get away with it.

"Yes, but....," you say, "you could make the coins into token coins, and make them redeemable for gold on demand." This was the case for the silver coins in the U.S. after 1875 or so. Their contained silver value was less than the face value of the coin. The $1 silver coin had about $0.50 of silver in it. However, you could trade twenty $1 silver coins for a $20 gold coin with the government, which is why the coins maintained their value above their commodity value. You could even make a $1 silver coin with $0.001 of silver in it, really just silver plating over aluminum or something like that. This would work just fine as well. It's how coins work today. However, we can see that a $1 silver coin with $0.50 or $0.001 of silver in it is a token coin, which is functionally equivalent to paper money. A paper $1 bill is like a silver coin with no silver in it at all. So, once again, we have the need for a token coin/paper money manager, who manages the supply of coins/bills to maintain their value at the proper parity.

The bullion-coin advocates like to imagine that bullion coins cannot be devalued. Baloney. Governments were devaluing coins two thousand years before paper money was invented. Just take the $20 gold coin, containing an ounce of gold, and stamp it as a $1000 gold coin, containing an ounce of gold. This is what the Roman goverments did to their silver coins in the fourth century. It's what the colony of Massachusetts did in the 18th century. It is as common as water. "Yes, but...," you can hear the gold coin advocates argue already,"at least the coins you own already wouldn't be devalued." That's true. But, the government could just declare holding such pre-devaluation coins to be illegal. The U.S. government did this in 1933, which was the first permanent devaluation in the dollar in U.S. history. Gold coins stayed illegal until 1974.

Actually, you could have a $20 gold coin and a $1000 gold coin, both containing an ounce of gold, trade side-by-side. The $20 coin would have a commodity value of $20, and the $1000 coin would be a token coin with a commodity value of $20. "But, wouldn't everyone take the $20 coin instead, since they both have the same commodity value?" Well, the five-cent coin in the U.S. now has a commodity value of $0.07 or so. The $20 bill has no commodity value at all. But, they still trade side by side at their face values.

* * *

How much money do you own today? I mean real money -- base money -- notes, coins, and bank reserves. Probably no bank reserves unless you are both very, very wealthy and also very, very financially creative. So, notes and coins. Look in your wallet. I bet it is less than $500.

Most of what people think of as "money" is really a loan to someone else, like their banker. What happens when you buy something with a debit card, check or credit card? In this case, your banker pays the recipient (actually the recipient's bank) in real money, in this case a transfer of bank reserves through the bank clearinghouse at the Fed. All monetary transactions take place with base money, which is to say, real money. We must deal with the real world here, not some fantasy world in which people buy houses, or stocks and bonds, with a leather sack of doubloons. We've already talked about replacing token notes and coins with bullion. A bullion-based system could replace these bank reserves, which are now electronic, with bullion bars stored in the Fed's basement. The Fed already does this for central banks around the world. Instead, there would be a cage in the basement with Citibank's bank reserves in the form of gold, and the bars would shuffle around each day as banks made their payments. You could even make a pooled system, whereby the banks would have an unallocated claim on bullion stored at the Fed, and then you wouldn't even have to move the bars around.

The amount of bank reserves is really not very much -- about $80 billion in the U.S. -- and this could conceivably be replaced by bullion. You have to admit, it is a very efficient system, considering the volume of transactions in dollar terms and the very small amount of acutal money (bank reserves) used to make the transactions. Theoretically, if everyone made their transactions in this fashion, using debit cards and such, rather than in bullion coins, then a relatively small amount of bullion could serve. However, this also means that nobody really owns any bullion coins, and that all the bullion is owned by the large banks. In effect, we've substituted a paper dollar, linked to gold, with an electronic bank account linked to gold, which is not really any different. In reality, both would be necessary anyway.

What if all transactions were done with "electronic money" (actually bank accounts)? Then nobody would own any bullion coins, although the banks would make payments in bullion to each other. Thus, ironically, you could have an all-bullion system, which is really a no-bullion system. "M2" consists of notes and coins, demand deposits, savings accounts and money market funds, and small time deposits. In May 2008, U.S. M2 was $7.676 trillion. Theoretically, you could go to the bank and ask for your loan to the bank to be repaid in bullion coin. However, if everyone tried to do this, or even a small number of people tried this, the bank would shut its doors and say "sorry, no can do," for the simple reason that such a quantity of bullion does not exist on this planet.

* * *

I think we can see why an all-bullion system is impractical to the point of impossibility on any kind of large scale. Thus, we would need to have a currency manager, who knows how to manage supply to maintain a currency's value at its bullion parity. This is not really very hard to do, but you aren't going to escape that need by making silly claims about bullion coins or the "free market." The Holy Mises is not going to fly down from heaven and smite your enemies for suggesting that it's time to move beyond empty platitudes to real solutions.

I am actually a fan of Mises. He was without a doubt one of the 20th century's greatest economists. If you took all of Mises' self-proclaimed followers and heaped them in a pile today, it wouldn't even reach to Mises' knee. It's too bad that he's not around today to say: "You guys are a bunch of goofs." You could say the same of Jesus, Mohammed, the Buddha, etc.

Such people account for 99% of gold standard advocates today. The number of people who could set up and maintain a proper, functioning system -- the mechanical engineers of money -- are extremely rare. Actually, it's really not all that complicated. We're going to need some people who know how to play this game, or otherwise, the game will never be played.


Cheers

[Mini-Me]

His argument is fatally flawed on several counts:

Where did he come up with the notion that a significant number of gold money advocates desire a "strictly gold" system with absolutely no paper notes, where we only buy and sell goods using metal coins in our pockets? That's absurd. He spends half of the article arguing against it, when really, gold standard / commodity money advocates and competing currency advocates are talking about electronic and/or paper money backed by precious metals, with perhaps some coins thrown into the mix if they're practical.
He assumes that "we don't have enough gold in the world to support the $7+ trillion in M2, so if a whole bunch of people want to withdraw their gold, the system will collapse." He's falling into the fallacy of assuming that, under a gold standard, prices would remain the same. However, they absolutely wouldn't! Prices and values are determined based on supply and demand - gold is no different, and neither is money. Currently, there's only $80 billion or so of gold in the US, but that's because demand for gold is low. After all, why wouldn't it be? It's practically useless, and very few people recognize that it can be used as a shelter from inflation. If gold became legal tender, the demand for it would skyrocket precisely because of its scarcity and usefulness, and prices of other goods would plummet in relation to gold. Prices of all other goods and services in the market would naturally seek an equilibrium with the value of the aggregate gold supply. In today's dollars, I read somewhere that gold would fetch a price in the ballpark of $110,000/oz under this system. Sure, this would make gold engagement rings f'ing expensive, but...it WOULD work. There's plenty of gold in the world to support a gold standard - there's just not enough to support it at today's prices for other goods.
Finally, his argument for dismissing competing free market money is ridiculous and bordering on a straw man attack. Would there have to be paper backing and someone deciding how much gold (or platinum, etc.) each paper note is backed by? Of course, but ALL advocates of competing currency understand that! The difference between competing currencies and a single centralized currency is that the people in the market get to choose which "manager" they trust the most, and if one of the currencies being used goes sour, demand for it will decrease. In other words, market forces will seek out the best-managed currency.

[DriftWood]

His argument is fatally flawed on several counts:

Where did he come up with the notion that a significant number of gold money advocates desire a "strictly gold" system with absolutely no paper notes, where we only buy and sell goods using metal coins in our pockets? That's absurd. He spends half of the article arguing against it, when really, gold standard / commodity money advocates and competing currency advocates are talking about electronic and/or paper money backed by precious metals, with perhaps some coins thrown into the mix if they're practical.

He assumes that "we don't have enough gold in the world to support the $7+ trillion in M2, so if a whole bunch of people want to withdraw their gold, the system will collapse." He's falling into the fallacy of assuming that, under a gold standard, prices would remain the same. However, they absolutely wouldn't! Prices and values are determined based on supply and demand - gold is no different, and neither is money. Currently, there's only $80 billion or so of gold in the US, but that's because demand for gold is low. After all, why wouldn't it be? It's practically useless, and very few people recognize that it can be used as a shelter from inflation. If gold became legal tender, the demand for it would skyrocket precisely because of its scarcity and usefulness, and prices of other goods would plummet in relation to gold. Prices of all other goods and services in the market would naturally seek an equilibrium with the value of the aggregate gold supply. In today's dollars, I read somewhere that gold would fetch a price in the ballpark of $110,000/oz under this system. Sure, this would make gold engagement rings f'ing expensive, but...it WOULD work. There's plenty of gold in the world to support a gold standard - there's just not enough to support it at today's prices for other goods.
Finally, his argument for dismissing competing free market money is ridiculous and bordering on a straw man attack. Would there have to be paper backing and someone deciding how much gold (or platinum, etc.) each paper note is backed by? Of course, but ALL advocates of competing currency understand that! The difference between competing currencies and a single centralized currency is that the people in the market get to choose which "manager" they trust the most, and if one of the currencies being used goes sour, demand for it will decrease. In other words, market forces will seek out the best-managed currency.


If you agree with him that a pure gold coin system is a bad idea then you are already agreeing with him on the most important points. Who is suggesting such a system? None other than Ron Paul and Rothbard. Just check out Ron Paul's article at http://mises.org/story/2826 where he talks about getting gold coins into circulation, getting regular people to use it, and finally exchange the dollar with these gold coins.

A quick response that should hit at the heart of your points.

With gold coins, there simply is no gold coin small enough to buy small things. How much gold would a candy bar cost? A gram, A corn of gold? That amount is to small to handle as a coin. A gold coin system is simply impractical.

Yes, you do have a point that in a gold standard system where paper was backed by 100% gold, it would cause a massive deflation of prices. However this is not a good thing.. and even once we got over the initial deflation in introducing the system. Any economic growth would mean more deflation. As the supply of gold could not be increased (as paper in circulation would still be backed to 100% by gold locked into vaults). So if someone invented something amazing like the tractor, causing 100 times as many potatoes to exist as previously. Prices of everything, not just potatoes would shrink. The low price of potatoes would cause demand to increase. The increased demanded would not be accompanies by an increase in the money supply. So now there was more things in the world, but the same amount of money. The prices of everything, not just potatoes, would have to shrink to reflect this fact. This kind of gold standard would mean constant deflation. Deflation is as bad as inflation (probably worse). I will not go into why deflation is bad, unless you ask me to.

The money supply has to grow in step with economic growth for the value of the currency (and stable commodities) to stay level. Economic growth basically means that the quantity of stuff that people want has increased. More stuff that people want, means more things will be traded, which means there will be an increased demand for money (to work as the middle man between all those trades).

What we need is a money whose value is stable, which means the supply has to be able to increase in step with economic growth. Gold coins cant do that, paper/plastic backed by 100% gold cant do that. Paper/plastic pegged to the price of gold can. In such a system no gold is actually needed. No hoarding and burying of gold in vaults never to be seen again is needed in such a system. All you need is to print more paper money when the price of gold goes up and unprint it when it goes down. Always keeping it level.

(the details for such a peg is described in his book.. its real simple and the change could be done overnight at the fed.. without anyone noticing it. all the fed would have to do is scrap its interest rate peg for a gold price peg. A computer or a monkey could run the fed. In this article Lewis explains it abit http://www.dailyreckoning.com/Issues/2008/DR050608.html#essay)

Cheers

[Kraig]

All you need is to print more paper money when the price of gold goes up and unprint it when it goes down.

Who the hell would you take it from when you "unprint" it? Someone would have to lose out.

[davver]

If you agree with him that a pure gold coin system is a bad idea then you are already agreeing with him on the most important points. Who is suggesting such a system? None other than Ron Paul and Rothbard. Just check out Ron Paul's article at http://mises.org/story/2826 where he talks about getting gold coins into circulation, getting regular people to use it, and finally exchange the dollar with these gold coins.

A quick response that should hit at the heart of your points.

With gold coins, there simply is no gold coin small enough to buy small things. How much gold would a candy bar cost? A gram, A corn of gold? That amount is to small to handle as a coin. A gold coin system is simply impractical.

Yes, you do have a point that in a gold standard system where paper was backed by 100% gold, it would cause a massive deflation of prices. However this is not a good thing.. and even once we got over the initial deflation in introducing the system. Any economic growth would mean more deflation. As the supply of gold could not be increased (as paper in circulation would still be backed to 100% by gold locked into vaults). So if someone invented something amazing like the tractor, causing 100 times as many potatoes to exist as previously. Prices of everything, not just potatoes would shrink. The low price of potatoes would cause demand to increase. The increased demanded would not be accompanies by an increase in the money supply. So now there was more things in the world, but the same amount of money. The prices of everything, not just potatoes, would have to shrink to reflect this fact. This kind of gold standard would mean constant deflation. Deflation is as bad as inflation (probably worse). I will not go into why deflation is bad, unless you ask me to.

The money supply has to grow in step with economic growth for the value of the currency (and stable commodities) to stay level. Economic growth basically means that the quantity of stuff that people want has increased. More stuff that people want, means more things will be traded, which means there will be an increased demand for money (to work as the middle man between all those trades).

What we need is a money whose value is stable, which means the supply has to be able to increase in step with economic growth. Gold coins cant do that, paper/plastic backed by 100% gold cant do that. Paper/plastic pegged to the price of gold can. In such a system no gold is actually needed. No hoarding and burying of gold in vaults never to be seen again is needed in such a system. All you need is to print more paper money when the price of gold goes up and unprint it when it goes down. Always keeping it level.

(the details for such a peg is described in his book.. its real simple and the change could be done overnight at the fed.. without anyone noticing it. all the fed would have to do is scrap its interest rate peg for a gold price peg. A computer or a monkey could run the fed. In this article Lewis explains it abit http://www.dailyreckoning.com/Issues/2008/DR050608.html#essay)

Cheers

Your contention that we must maintain price stability by increasing the money supply in proportion to increases in productivity flies directely in the face of the fundamental facets of Austrian economics (it is also the mistaken idea that cause the great depression). Price deflation is a normal thing and should be welcomed.

Also, the author doesn't seem to understand the Austrian view on fractional reserve banking either. To be honest, his article is littered with misconceptions and fallacies.

[DriftWood]

double post..

[DriftWood]

Who the hell would you take it from when you "unprint" it? Someone would have to lose out.

The central bank can increase the money into circulation by buying assets off the open market. It just prints the money and uses it to buy the bond.

The central bank can decrease the money in circulation by selling assets on the open market. The money it gets back like this it will just bury in some vault and throw away the key.. or just burn the money in a big pile.

Theoretically the central bank will have enough assets to buy back the whole money supply (as when they created the money they got assets for free)

If somehow the central bank lost all those assets along the way..

The govt can help out by not spending the money it gets thru taxes. That way the money supply in circulation is decreased.

There is a final way, even if the fed has no assets and the govt gets no tax money.. I think this is the most common way. The fed can issue and sell bonds. It basically says to the open market, give me 100 million now and ill give you back 125 million 50 years from now. The money supply will be reduced until 50 years from now.. and by that time the economy will probably have grown enough to need the extra supply of money.

Cheers

[DriftWood]

Your contention that we must maintain price stability by increasing the money supply in proportion to increases in productivity flies directely in the face of the fundamental facets of Austrian economics (it is also the mistaken idea that cause the great depression). Price deflation is a normal thing and should be welcomed.

Also, the author doesn't seem to understand the Austrian view on fractional reserve banking either. To be honest, his article is littered with misconceptions and fallacies.

Yes, when it comes to economic schools..

Just like Keynesianism is flawed because it only focuses on demand side of money.. the monetarist economics is flawed because it only focus on the supply side of money.

The author of that article follows another economic school, i think its called modern classical economics.. it has classical economics in common with the Austrain school. But instead of the flawed monetarist approach popular with the Austrain school. It instead incorporates "supply side economics".

(modern classical economics has nothing in common with neo-Keynesiansim. The keneysians dont even believe in classical economics.)

I got convinced that Nathan Lewis, and his brand of economics really works better than Keynesianism and monetarism after reading his book.. "Gold: the once and future money". If you ask me its right up there with the classics.. like "economics in one lesson", "wealth of nations", "freedom and capitalism".. well maybe not up there, but its a real eye opener (half the book is the facts and history, the other half is the theory). I recommend it to everyone.

Volker by the way was a monetarist.. and he did just as much damage by deflation to the economy as the inflationist before and after him did

Edit:

The author understands fractional reserve banking.. I also used to think it was evil. Now i see that banking, without fractional reserve banking makes no sense. the whole point of banks is to get lenders and borrowers together. A bank is not supposed to have any reserves. A bank is not a warehouse. (Anyways.. some of the Austrian economics fans (Rothbards fans) puts me off as it sometimes seems more like a religion than science. All this talk about banks being evil.. even the central bank can be a good thing as long as it does not inflate or deflate the value of the currency.)

Monetarists and Austrian economists as i understand it count deposits as money. I think that is bad.. there will be lots of double count of money as the money in banks are lent out, and the borrowers themselves lend put it into banks and lend out to others. If only base money is treated as money (no credits or deposits) then no double counting happens. Then banks do not create money and fed is solely responsible for inflation.. I think much monetary policy and inflation/deflation becomes much clearer with this narrower definition.

Cheers

[Paulitician]

the flawed monetarist approach popular with the Austrain school
What do you mean?


Volker by the way was a monetarist.. and he did just as much damage by deflation to the economy as the inflationist before and after him did
I don't think there should be any undue inflation or deflation. In fact, with money pegged to say gold, there would be no deflation (with full banking) and neglible inflation after gold is mined.


the whole point of banks is to get lenders and borrowers together
How is this not possible with "warehouse" banking?


A bank is not supposed to have any reserves.
I should start one up then. That way I get and can lend out "free" money too.


A bank is not a warehouse.
There is no reason it can't be.


even the central bank can be a good thing as long as it does not inflate or deflate the value of the currency.
When has this ever been the case? Not to mention, you said you no longer find fractional reserve banking "evil", but by its very nature it does inflate and deflate the currency (well actually, I think it just inflates, while the market deflates).

But no one is arguing for deflation here (unless you're talking about price decreases which is a subject all unto itself). However, if we were ever going to go on a gold standard, especially 100% gold reserve standard, obviously it would entail deflation in the transition. Such a thing ever happening is long shot, no doubt. I don't think anyone is arguing that. The problem some of us have with fractional reserve banking/central banking is not so much the things themselves (although I do find them unethical and yes, it is philosophical/political but so what?), but what government is able to do with them.

[davver]

Yes, when it comes to economic schools..

Just like Keynesianism is flawed because it only focuses on demand side of money.. the monetarist economics is flawed because it only focus on the supply side of money.

The author of that article follows another economic school, i think its called modern classical economics.. it has classical economics in common with the Austrain school. But instead of the flawed monetarist approach popular with the Austrain school. It instead incorporates "supply side economics".

(modern classical economics has nothing in common with neo-Keynesiansim. The keneysians dont even believe in classical economics.)

I got convinced that Nathan Lewis, and his brand of economics really works better than Keynesianism and monetarism after reading his book.. "Gold: the once and future money". If you ask me its right up there with the classics.. like "economics in one lesson", "wealth of nations", "freedom and capitalism".. well maybe not up there, but its a real eye opener (half the book is the facts and history, the other half is the theory). I recommend it to everyone.

Volker by the way was a monetarist.. and he did just as much damage by deflation to the economy as the inflationist before and after him did

Edit:

The author understands fractional reserve banking.. I also used to think it was evil. Now i see that banking, without fractional reserve banking makes no sense. the whole point of banks is to get lenders and borrowers together. A bank is not supposed to have any reserves. A bank is not a warehouse. (Anyways.. some of the Austrian economics fans (Rothbards fans) puts me off as it sometimes seems more like a religion than science. All this talk about banks being evil.. even the central bank can be a good thing as long as it does not inflate or deflate the value of the currency.)

Monetarists and Austrian economists as i understand it count deposits as money. I think that is bad.. there will be lots of double count of money as the money in banks are lent out, and the borrowers themselves lend put it into banks and lend out to others. If only base money is treated as money (no credits or deposits) then no double counting happens. Then banks do not create money and fed is solely responsible for inflation.. I think much monetary policy and inflation/deflation becomes much clearer with this narrower definition.

Cheers

Volcker didn't deflate anything. All he did was hold M1 constant. He was a brave and respectable man for what he did.

Banks can match borrowers and lenders without fractional reserve. This was done forever. You deposit you money at the bank. If you want to you can purchase a CD which pays interest. The bank will take the money in your CD and lend it out to someone. That person repays the loan at interest, and the bank repays you at interest, pocketing a small fee for the work and risk involved. The difference is that the money being loaned out represents genuine savings, not fake counterfieted savings.

What is money? That's a harder question. In a fractional reserve system does base money even count as money? In fact, I'm not so sure "money" exists within a fractional reserve framework, at least the Austrian sense of money.

A central bank by nature always leads to inflation and deflation. Human beings are as incapable of choosing the correct price for money as they are for choosing the correct price of milk. Central banking becomes just another failed attempt at price controls, except in this case they are trying to control the price of money and credit.

Alternatively, the central bank could avoid trying to influence the price of money, but then why even have one.

[Mini-Me]

LONG post...I have a couple things to respond to at length.



Monetarists and Austrian economists as i understand it count deposits as money. I think that is bad.. there will be lots of double count of money as the money in banks are lent out, and the borrowers themselves lend put it into banks and lend out to others. If only base money is treated as money (no credits or deposits) then no double counting happens. Then banks do not create money and fed is solely responsible for inflation.. I think much monetary policy and inflation/deflation becomes much clearer with this narrower definition.
Cheers

I was thinking about this a few days ago, and I think I agree. State-enforced fractional reserve banking with all of its safety nets is just a disaster waiting to happen, and it's immoral because the safety nets bought through inflation and taxpayer money encourage poor decisions. However, even under a gold standard, fractional reserve banking can occur under the umbrella of free banking (unless a full 100% reserve requirement is enforced for on-demand deposits...which probably means that rather than getting interest, you'll have to pay the bank to guard your money, since they cannot loan it). Under the current system, credit is created in a much more literal sense than under free banking, but the end results of the money multiplier effect are the same in both cases. In other words, the view that fractional reserve banking "creates" more money by itself is really just based upon the false assumption (encouraged by government) that your bank deposits are still money that you own.

The biggest problem with fractional reserve banking is exactly that: Especially considering FDIC protection and whatnot, everyone considers their on-demand bank deposits to be "safety deposits" of some sort, and they count them as money they can always rely upon. People don't understand that once they deposit their money, it's no longer theirs: They loaned it to the bank, and that's why they're paid interest. Things can go sour when that bank is irresponsible, yet people ignore this. Because of the money multiplier effect, up to 9 people think they hold claim to each dollar in existence, and they base their financial decisions off of this false assumption. Were it not for safety nets like the FDIC and bank bailouts obfuscating all of this, banks would be forced to make wise lending decisions, and consumers would learn to better understand the true nature of their deposits and pick their bank based on its record of responsibility (versus the interest rate paid). In other words, the biggest problem with fractional reserve banking is that the banks are in bed with the government and consumers are completely unaware of what they're getting into.

If we understood on-demand deposits as just deposits and not as actual money, we'd only have real inflation when the Fed itself creates money out of thin air (either to fund the government or to "lend" to banks). That practice HAS to stop (and so does the concept of "money as debt"), but if fractional reserve banking were not officially protected by the government, perhaps the only fraud surrounding it would be the way consumers are misled about their deposits.

It'd be interesting to get AceNZ's perspective on this, if he's still around...



A central bank by nature always leads to inflation and deflation. Human beings are as incapable of choosing the correct price for money as they are for choosing the correct price of milk. Central banking becomes just another failed attempt at price controls, except in this case they are trying to control the price of money and credit.

Alternatively, the central bank could avoid trying to influence the price of money, but then why even have one.

davver hit the nail on the head - deflation isn't the "best" thing in the world, but it's not the worst either, and you have to measure it against the far greater evil of giving anyone centralized control over the entire money supply. Centralized control over the entire money supply will always be screwed up by ineptitude (simply due to the fact that no human can possibly do the job perfectly, a shortcoming shared by human-written computer programs), likely causing worse and more drastic inflation/deflation than natural increases/decreases in the economy's size, and it will often be abused by either special interests or the government itself. Our money supply today is supposedly regulated via Keynesian economics, but it's not! Instead, Congress views the Fed as an endless wishing well of money, and the Fed is happy to comply. Were money supply manipulations performed strictly according to Keynesian (or new Keynesian) theory, we probably wouldn't be even close to the mess we're in today. We'd have more swings than we would with noninterventionist schools like the Austrian school, but we wouldn't be facing catastrophe. The biggest problem with interventionist schools has less to do with poor economic theory and much more to do with subjectivity, slippery slopes, and potential for abuse.

I just wrote a post a few days ago arguing that deflation concerns under a gold standard are exaggerated...I'll repost it here, since the discussion in that thread is pretty much dead and nobody commented on it:




Good video, I agree with much of what Paul said. However, I disagree with his desire for a fixed money supply because it will only lead to deflation assuming the economy continues to grow.

How would you like the dollars you use to pay your fixed monthly mortgage payment, for example, to rise in purchasing power? If you're paying $1000/month right now, and deflation doubles the purchasing power of the dollar, you'll be paying twice as much even though the dollar amount of your payment hasn't changed. The same thing happens to businesses in a deflationary period, and they have to lay off workers as a result.

The money supply needs to be expandable for the economy to function best, but there should be much more oversight than there is now.
I think you're not considering all of the factors here. I'm not an expert on economics and there are probably a few things I'm missing as well, but there are several blind spots in your argument:

First of all, you're considering a very sharp and drastic deflationary scenario in which the purchasing power of the dollar increases twofold very quickly and thus puts undue pressure on debtors. In reality, it would only increase by 3 or 4% annually, meaning people would adjust a lot better to slowly declining prices - which in and of themselves are good things!
When price deflation occurs because of an increase in economic productivity, that means more wealth is being created in the economy and more/better goods/services are being circulated. Let's assume the demand exists for this increased supply - after all, if it didn't, the increase in productivity wouldn't last long enough to create a deflationary trend in the first place. In that case, although companies are selling their goods for cheaper, they will be selling more of them, meaning their nominal revenue wouldn't decrease (on average). That means they won't have problems paying off fixed-dollar loans. Furthermore, their operating costs will decrease, since they're buying materials for less and, depending on the scenario, possibly paying lower nominal wages.
I mentioned that nominal wages might go down. This depends on a few factors, but as far as I can tell, a critical one is population growth. Is the population increasing as quickly as the economy is expanding, or quicker? If so, wages might fall as much as (or even more than) prices - after all, the pie isn't growing as fast as the number of people taking a piece. In that case, ordinary people would have the same amount of trouble paying for most items as they would if the monetary supply was increasing, but I do agree they'd be feeling a bit more of a pinch from mortgages and the like.
Otherwise, if the population isn't growing as fast as the economy, prices will probably fall faster than wages, meaning the cost of living would decrease faster than people's means, offsetting the extra squeeze from repaying fixed-dollar loans like mortgages.
You're stuck in the mindset of our modern economy, rife with easy money, excessive borrowing, and rampant inflation. Our current economic culture discourages saving encourages people to borrow money (since they'll pay it back cheaper) and spend it as quickly as possible. However, an economy with slow and gradual deflation would encourage people to save money, since every dollar they save will be worth more tomorrow. As such, borrowing money would not be as much of a necessity as it is today. People would already know going into a loan that they'll be repaying the money in slightly more valuable dollars - the market would factor in that knowledge to adjust interest rates accordingly.
Furthermore, under a fiat monetary system, you need to look at money like stock. It's kind of like owning stock in a company, except instead, you own stock in the economy as a whole. The number of dollars you own represents your share of the money in the economy, and you can "sell the shares back" for any good or service in the economy. The key point to take away is this: When a company becomes more and more valuable, it oftentimes does a stock split. When that happens, the value of every share decreases by a certain ratio, but each and every shareholder is compensated accordingly by being given more shares, proportional to the number they already owned. However, when the economy becomes more valuable and the money masters decide to do a split, it does not happen with such fairness - instead of the shares being distributed proportionally, pretty much ALL of the new shares are given to the largest shareholders, diluting everyone else's current stake in the economy. This is part of the reason why inflation is theft (and the other part is something I won't get into, but it has to do with prices typically rising faster than wages under inflation). Whenever you DO increase the monetary supply, regardless of whether it's to maintain price stability or to compensate for fiscal irresponsibility (which causes inflation), you're unfairly redistributing wealth.


Finally, you actually forgot an argument that would aid your case: Price stickiness. Under deflationary pressure, especially in a culture otherwise accustomed to inflation, psychological and other factors tend to make prices "sticky" on the way down. This means that, for a constant amount of money in the economy, deflationary conditions would result in prices remaining too high at their previous values, which could reverse the economic upturn that caused increased productivity in the first place. I'm not sure exactly how to argue against this one except in two ways:
1.) I can downplay it and say that with slow, gradual deflation, it wouldn't be a huge problem. After all, it didn't really cause many problems when we were on a gold standard in the 1800's (although there were some economic troubles caused by other things).
2.) I can merely argue that the alternative danger of giving some group control over the money supply (like the Federal Reserve) is far worse anyway. After all, we're seeing today why money masters cannot be trusted to be responsible (and government also cannot be trusted to spend responsibly when it knows it essentially has an unlimited money supply).

Then again, the point is probably moot, because if we were on a gold standard or if we had competing currencies and gold emerged as a preference...the gold supply ironically tends to expand at approximately the same rate of the economy anyway.

*There are other ways to create money under a fiat monetary system that would avoid this though, if you're really in the mood for some government meddling: Instead of creating money as debt through loans, the money masters could keep track of the number of dollars in existence on each date. When they increase the number of dollars in existence, everyone's bank account can be electronically augmented accordingly, thereby distributing the new money evenly and fairly. What about people with paper dollars? Well, those dollars have a year on them - so when you deposit a 2020 dollar in a bank in 2022, your account would be updated by the real dollar amount adjusted for inflation, not the nominal amount. This would be the optimal fiat money solution if we could trust government, but just like ALL fiat money solutions (and even more so in this case), it's just begging to be exploited by tyrants.

[DriftWood]

Volcker didn't deflate anything. All he did was hold M1 constant. He was a brave and respectable man for what he did.


He kept M1 stable. And that caused a big deflation of the price of gold. Remember gold is real money. Its price should not change. A currency that doers not keep pegged to the value of gold is a bad currency.

Volker should have scrapped the idea of keeping the money supply constant. He also should have scrapped the idea that M1 is money. Bank deposits (or Certificate of deposit) is not money (I'll explain why further down). Base money is money, its the stuff that the FED creates (notes and coins and electronic bank reserves). He should have put more base money into circulation when when the price of gold goes down, and he should have taken more base money out of circulation when the value of gold goes up. The price of gold is an indicator not so much about changes in the demand and supply of gold, as it is an indicator of a change of demand and supply of everything else. Its an indicator wheret the economy is growing or shrinking. The money supply needs to expand or shrink in tandem with the economy (the demand for money) for the value of the money to stay stable.



Banks can match borrowers and lenders without fractional reserve. This was done forever. You deposit you money at the bank. If you want to you can purchase a CD which pays interest. The bank will take the money in your CD and lend it out to someone. That person repays the loan at interest, and the bank repays you at interest, pocketing a small fee for the work and risk involved. The difference is that the money being loaned out represents genuine savings, not fake counterfieted savings.


That's how banks work already. All the money you deposit, is lent out. The lender pays you an interest. The bank is only the middle man, that connects borrowers with lenders. No counterfeit money is created by a bank. The bank does not create money, it only creates debt and credit. This whole idea about banks creating money comes from the bad definition that deposits are money. I'll describe why deposits are not money below..



What is money? That's a harder question. In a fractional reserve system does base money even count as money? In fact, I'm not so sure "money" exists within a fractional reserve framework, at least the Austrian sense of money.


Deposits are not money.. because if they the same money would be co8unted many times. If you lend money to a friend, no new money is created. The only thing that is created is deposit and credit. You no longer have the money, but you have a little piece of deposit paper that says "Thanks man, I'll pay you back the money tomorrow, and a little extra for your trouble. Promise.". Your friend has your money, and a little credit note that's says "Here you go man. You pay me back tomorrow." Your friend spends your money, and throws away the piece of paper. The next day, even if he remembers noting about last night.. you have the piece of deposit paper that he wrote.. you show it to him.. and he says ooh yeah.. and he pays you back the money. You throw away your piece of paper.. and do whatever you want with the money.

Whats this got to do with anything? Well it shows you that no new money was created. It would have been wrong to count the deposit as money. That would have meant that both your friend and you had the same money at the same time. And it would have meant that when your friend spent your money, you would still have that money. It makes no sense to count deposits as money.

The same goes for banks. When you put money in the bank deposit account. That money is lent out the back door to some borrower. Your no longer have any money in the bank, what you have is a little piece of paper that says "Thanks man, i'll pay you back later. and a bit for your trouble". That piece of paper is not money, your money is being spent somewhere else. You cant buy anything with that piece of paper. When you close down your account or withdraw money.. you are basically saying. "Hey, man. Remember that money i lent you.. Well i need it back now". And the bank says "Oh, yeah.. almost forgot.. here you go.". The bank gets the money from saying to its borrowers "you know that money i lent you.. well i need a little of that money back now."

You see, there is no counterfeiting of money going on here. No money is created. All that is created is small notes where borrower promises to pay back lenders, and a little extra for the trouble.



A central bank by nature always leads to inflation and deflation. Human beings are as incapable of choosing the correct price for money as they are for choosing the correct price of milk. Central banking becomes just another failed attempt at price controls, except in this case they are trying to control the price of money and credit.

Alternatively, the central bank could avoid trying to influence the price of money, but then why even have one.

No, a central bank is not evil by nature. Its just that they are doing the wrong job. What they should do is keep the currency pegged to the price of gold (this is not the same as every paper be backed by 100% gold). If the price of gold is increasing or decreasing then the central bank is not going its job. Volker the deflationist let the value of the currency increase relative to gold, and the greenspan and bernanke the inflationists let the value of the currency fall relatibe to the value of gold.

I have explained why fractional reserve banking is not evil in this forums so many times now that i don't feel like doing it again. In short fractional reserve banking has nothing to do with fiat money or central banks. Even without a central bank under a gold coin system fractional reserve banks would still exists. Fractional reserve banking is how banks connect borrowers and lenders. Its how they connect short term lenders, with long term borrowers. They can connect the short term with the long term, like this because they always have so many short term lenders that as a whole they act as one big long term lender. It is not a scam, its just the best method of lending that the lender prefers. You as a lender prefer to lend on short term instead of on long term. And because there are so many other short term lenders who rarely demand all their money out at once.. the bank can lend this money out on long term. Its not a scam, its science, its the way many short time lenders, together behave as one big long time lender.

Cheers

[buffalokid777]

If we ONLY used Gold, there would not be enough currency for the world.....

But why couldn't we use silver for currency? What about platinum? Palladium?

We need to get away from talking about a gold standard for currency.....instead commodity currency is the answer.....now all commodities are NOT suitable for currency......only the non perishable commodities are suitable as money.....

But many are....that hold the same properties as gold....these include.....Platinum, Rhodium, Palladium, Silver, Copper, Titanium, Steel, Nickel, Aluminum, Tin....etc....there are more than enough commodities to have a vibrant hard currency based on all commodities that have the same properties as gold as money........in that they are non perishible and have intristic value like gold......

[DriftWood]

LONG post...I have a couple things to respond to at length.


I agree with most of what you say. Except for the part about deflation being acceptable, under a system where the money supply can not increase to stay level with demand. A slow deflation of 3%, is bad for the much the same reason that a slow inflation of 3% is also bad. In a long term it will have big effects.

Imagine this.. if a slow deflation is not bad for the economy.. then it would not be bad if at the end of the year a couple percentages of the US money was burned in big bonfires, in some weird pagan ritual. Such a deflationary event could not be distinguished from deflation caused by economy growth.

During deflation, businesses would have a hard time finding money to pay their employees. Eventually, the employees would get a lower wage. But they would themselves find it harder to pay yesterdays bills with today's money. Eventually, the they would renegotiate the bills, to something they could afford. However if they had some long term contract or bill they could not renegotiate then they would be screwed. They would have to continue paying last decades high prices in today's low price/wage world.

There is kind of a drag effect.. or a water ripple effect when inflation and deflation effects works its way thru the economy. Where prices and wages change from what they where last year to what they are today. Eventually everyone will be at the new lower prices and wages. But lots of damage happens to get there, and some people get there quicker than others.. this sets the seed for "unfairness" and unpredictability. People with big fixed rate mortgages.. will not be able pay back the loans in an deflation world. Companies will not be able to pay employees the contracted agreed upon wages in an inflated.

The problem with inflation and deflation is that it makes contracts and business relationships between people less predictable. It means a big group of people having to get from point A to point B while holding hands and not letting go. This gets harder as some people start walking sooner and some later. Lots of business relationships will be broken for no other reason that they could not hold on thru the transition. These people might have worked hard to make that relationship in the first place.

Much like.. relationships are more predictable in calm waters.. bridges are safer on stable ground.

Cheers

[Mini-Me]

No, a central bank is not evil by nature. Its just that they are doing the wrong job. What they should do is keep the currency pegged to the price of gold (this is not the same as every paper be backed by 100% gold). If the price of gold is increasing or decreasing then the central bank is not going its job. Volker the deflationist let the value of the currency increase relative to gold, and the greenspan and bernanke the inflationists let the value of the currency fall relatibe to the value of gold.


HERE'S MY INITIAL POST, BUT I REALIZED LATER THAT I TOTALLY MISUNDERSTOOD YOU:
From my understanding, this would be a complete disaster:
If you peg the dollar to a certain weight in gold, you won't be able to use the price of gold in dollars as an indicator to determine inflation, precisely because it's pegged and can't fluctuate like it does under fiat currency. By definition, a dollar would be worth a certain weight in gold. However, you also won't have a full gold standard with dollars backed by gold, so prices would not adjust themselves based on the supply of gold (based on the supply and demand for money vs. the supply and demand for other goods). In other words, you essentially have a fiat currency just like before, except the price of gold is explicitly distorted in a way that you can no longer use it to judge inflation. Furthermore, the market will become confused as to how it should price goods in dollars: Should goods be priced based on the number of dollars in circulation, as in fiat currency, or should they be priced based on their relative exchange rate with gold? In other words, when gold is not in and of itself money but a dollar is pegged to a weight in gold, prices based on the supply and demand of gold will be completely different from prices based on the supply and demand of paper currency. It would be a miracle to get these even close, and any growth or shrinking in the economy would upset this balance. In terms of regulating the supply of currency, you'd be totally shooting in the dark based on whether there's a shortage or abundance of people willing to sell gold.

Ultimately, the problem here is that by pegging the dollar to a weight in gold without the dollar actually being backed by gold*, all you're actually doing is price-fixing gold.

*(And when the dollar is actually fully backed by gold, it follows that the total amount of gold backing the money must be equal to the total face value of all paper money backed by said gold.)


IMPORTANT EDIT: It's come to my attention that I might have misunderstood the entire premise: Perhaps you're not advocating price-fixing gold? Upon closer examination, it seems that what you're advocating is to keep fiat money, except, depending on whether the market price of gold deviates from some "target" (say $1000/oz as an easy mark, since that's around where it is today), you print more money or extinguish more money accordingly. Technically speaking, this actually would work, if sole your aim is to keep price stability. However, there are several concerns:
1.) Short-term pricing trends for gold can be influenced by speculation, and because of that, you'd have to use long-term trends, which are indeed historically stable. More importantly, since gold itself is not worth a significant portion of the economy when it's not actually considered money, powerful banks and special interests can sell a lot of gold between themselves at whatever price they want and purposely distort the price when the resulting government monetary reaction would be favorable to them. Such price suppression happens even now, and that's just to keep people from noticing inflation. Imagine how much it would be done if banks knew that government would give them more money to lend if they made the gold price seem super-low! This would be a constant danger, and it would break price stability of other goods and services.
2.) Depending on how you create and extinguish money, there will probably be some socialist-style wealth redistribution going on just like there is with today's inflationary system (where the wealth is redistributed upwards, I might add).
3.) I still disagree that price stability needs to be an absolute aim; rather, I'm taking the Austrians' side and arguing that money supply stability should. :p More precisely, it's unreasonable to expect that a single fiat currency will successfully achieve the aim of price stability. One reason for this is that it's very easy for fiat money to be abused by the issuer and others (as I've already argued before). Without competition in currency, we the people have no way to place a foolproof check on this. However, if we DID have commodity-backed competition, people would obviously choose to hold gradually deflationary currency rather than the government-issued currency whose supply and value will fluctuate to maintain price stability. In other words, absolute price stability is only the goal if there's a monopoly on money, but in that case, especially if it's fiat money, such price stability will be less probable than if we had competing commodity-backed currencies that simply don't try to play games with their supply.

[buffalokid777]

Ultimately, the problem here is that by pegging the dollar to a weight in gold without the dollar actually being backed by gold*, all you're actually doing is price-fixing gold.

*(And when the dollar is actually fully backed by gold, it follows that the total amount of gold backing the money must be equal to the total face value of all paper money backed by said gold.)

That's why commodity currency is the answer to hard currency and rather than just using gold and silver as commodity currency.....a basket of suitable commodity currencies is what is needed to make it work........for a commodity currency to be suitable it must be 1.) have some intristic value 2.) Be non perishable 3.) Be easy to transport....by going this route we would have actual hard currency......

[Mini-Me]

If we ONLY used Gold, there would not be enough currency for the world.....

But why couldn't we use silver for currency? What about platinum? Palladium?

We need to get away from talking about a gold standard for currency.....instead commodity currency is the answer.....now all commodities are NOT suitable for currency......only the non perishable commodities are suitable as money.....

But many are....that hold the same properties as gold....these include.....Platinum, Rhodium, Palladium, Silver, Copper, Titanium, Steel, Nickel, Aluminum, Tin....etc....there are more than enough commodities to have a vibrant hard currency based on all commodities that have the same properties as gold as money........in that they are non perishible and have intristic value like gold......

First of all, I agree with one thing: Commodity currency doesn't just have to be gold. Any metal that is sufficiently rare, that has a sufficiently stable supply, and that is sufficiently chemically and physically stable will work perfectly fine as currency, and they can even coexist as competing private currencies (where people decide which ones they want to use based on how confident they are that the paper notes aren't being debased beyond their backing).

However, I want to argue against your opening comments:

I addressed this in another post above, but actually, if were entirely on a gold standard without any other kind of competing money, there WOULD still be enough currency in the world. Putting aside discussion on exactly how money should be issued, you can technically issue any number of dollars you want, as long as you make each dollar redeemable for the total weight of gold in store divided by the total number of dollars in circulation.

Now, you're probably thinking, "But the total value of ALL THE GOLD IN THE WORLD can't POSSIBLY be worth the entire money supply?!? All of the other goods and services would surely outweigh the value of gold alone!" Here's where it gets interesting...ask yourself this: Under fiat money, can the total value of all greenback paper bills be worth the entire money supply? ;)

The intrinsic value of paper versus other commodities is pretty low. Why is this? Well, because paper in and of itself is abundant! Supply and demand favor a low price. Now consider paper money: If fiat money were not actually legal tender, it would be worth practically nothing. However, once it is considered money, it is considered so useful that demand for it skyrockets, and all of a sudden, one stupid green piece of paper is worth an entire cheeseburger (and it used to be worth more ;)). How do you explain this? It's because, no matter what is used as the money supply or how many pieces it's divided into, prices of all other goods and services will adjust accordingly. Notice: Right now, we essentially consider about 1 trillion slips of paper to be worth everything else in the rest of the economy. By virtue of being the money supply, it inherently IS worth everything else in the rest of the economy.

Similarly, right now, gold has an intrinsic value of "only" $1000, based on the current number of dollars in existence. Its "intrinsic" value is higher than paper and it fetches a higher price solely because of its rarity, not its usefulness. In fact, it's useful for very few industrial purposes! Like everything else, the value of gold is determined by supply and demand. If gold became usable as money (via a gold standard), it would immediately become MUCH more useful and its demand would skyrocket. Assuming no competing standard exists, when gold is used as money, the total value of gold automatically and inherently becomes worth the value of the money supply, which means that other prices adjust to it - just like under fiat money!

The only real differences with gold are this:
1.) It has a relatively constant supply and it can't be counterfeited or printed on a whim. (That said, the issuers of paper receipts CAN cheat and issue more notes than have actual backing, like the US did under its "quasi-gold standard. This is why it's best to have competing currencies backed by commodities - not just gold, but whatever floats your boat ;))
2.) There are some small side effects, because gold really does have a few industrial and cultural purposes, and we're considering all gold to be equal (unlike paper money, where only paper printed a certain way is considered money - all other paper is cheap). For instance, the high demand for gold would make your wedding ring worth a shitload of money in melt value, and only Hollywood stars would continue to buy gold rings. ;)



Now, depending on some factors, there are some other "side effects." Driftwood doesn't like the idea of a constant money supply because of slight deflationary trends as the economy grows - I disagree with him here.

Furthermore, if you were to issue a gold standard today (or start a private gold-backed or platinum-backed etc. paper currency, but this particular decision is more relevant to a FRN to gold standard conversion), you'd have to make a choice: Do you want to break up the supply into a LOT of cheap notes, or fewer more valuable notes? Consider two scenarios:

If you wanted to retain price continuity, you'd want to do the former. After all, there are around a trillion FRN notes circulating IIRC, and prices of goods and services are based on the fact that there are about a trillion dollars available in real currency. In this case, each dollar would be worth about 1/110,000th of an oz of gold or so (based on something I heard - the number could be off, though). Prices of most goods and services would remain about the same, give or take, but the price of gold (now that it's considered money) would be about $110,000/oz.
On the other hand, if you wanted to maintain gold at around $1000/oz, you'd have to issue far fewer notes (one 110th as many). However, prices of all other goods and services would suffer SEVERE price deflation (they'd divide by 110 or so). This would be a pretty big adjustment for the market to deal with on a psychological level. If you were to do this, you probably wouldn't want to call the new currency "dollars" as well, because that would greatly confuse old ladies. ;)

In either case, gold would become worth WAY more than it is now relative to other goods and services, precisely because of its usefulness as money.

[Mini-Me]

That's why commodity currency is the answer to hard currency and rather than just using gold and silver as commodity currency.....a basket of suitable commodity currencies is what is needed to make it work........for a commodity currency to be suitable it must be 1.) have some intristic value 2.) Be non perishable 3.) Be easy to transport....by going this route we would have actual hard currency......

Hehe...we're going to get our posts crossed here, but I'll address #1: Intrinsic value is not fixed. The value of absolutely everything is based on supply and demand, which is why a gold standard would work, a platinum standard would work, competing currencies would work, etc. You don't need a basket, and actually, it starts to not work if you try to equate the same paper receipt to weights of two or more different metals at once (since the values of those metals can fluctuate relative to each other, especially if there are other competing currencies around).

[buffalokid777]

Hehe...we're going to get our posts crossed here, but I'll address #1: Intrinsic value is not fixed. The value of absolutely everything is based on supply and demand, which is why a gold standard would work, a platinum standard would work, competing currencies would work, etc. You don't need a basket, and actually, it starts to not work if you try to equate the same paper receipt to weights of two or more different metals at once (since the values of those metals can fluctuate relative to each other, especially if there are other competing currencies around).

I see what you are getting at, I'm not trying to fix intristic value.....I am simply saying the metals should be coins since they have intristic value and that should be money and they should be meltable by law to allow redistribution as their values fluctuate........if one of the metals begins to become more in demand for other uses than currency.....such as platinum......retailers will offer a premium for that commodity currency through discount......thus each of the metals commodity currency would be a competing currency.......but I think it is very important that all currency have intristic value that is my main point....we need to take baby steps first by getting rid of paper currency that has no intristic value....(well other than toilet paper, post it notes, or fire kindling)....that is why I support commodity currency....because it has intristic value....it need not be fixed......to allow for fluctuations in supply in demand....but it also should not be pegged to paper as that allows the dishonest to game the system......

[Mini-Me]

I see what you are getting at, I'm not trying to fix intristic value.....I am simply saying the metals should be coins since they have intristic value and that should be money and they should be meltable by law to allow redistribution as their values fluctuate........if one of the metals begins to become more in demand for other uses than currency.....such as platinum......retailers will offer a premium for that commodity currency through discount......thus each of the metals commodity currency would be a competing currency.......but it I think it is very important that all currency have intristic value that is my main point....

Well, I think the truly important thing is that currency needs to have intrinsic scarcity, otherwise its value can be debased by creating more of it, e.g. printed paper. If this is what you mean by intrinsic value, I agree. I also agree that coins might become useful as money in under a freely competing currency system, but I do think that paper notes (with commodity backing) and/or electronic money (with commodity backing) would be the market's overall choice. It's just inconvenient to literally carry around precious metals in your pocket all the time (and in the case of a few like gold, just a tiny bit would be worth too much to ask for change back ;)). Ultimately, market forces would determine how much of the metals are used as coins and how much are stored in vaults to back paper/electronic receipts.

[scooter]

Volker by the way was a monetarist.. and he did just as much damage by deflation to the economy as the inflationist before and after him did

I think you're missing the boat on Paul Volcker's efforts of the 80s. Had he not done what he did, you may have already had a huge collapse in the dollar long before now. Sure, the dollar strengthening caused a pretty deap recession, but it was a necessary one. From 1980-1982 we had a tough recession while the interest rates were held very high, but what happened after that? Only one of the largest and longest bull markets in the history of the country.

I haven't read through all of the very long posts, but I did notice another thing I disagree with. I don't think that slow and steady (less than 3%) inflation or deflation are necessarily bad things. You are underestimating the market's ability to adapt and manage such situations. For example, even if inflation was 10%, but it was a constant 10% annually and never changed, I don't think it would be too big of a problem. Wages would adapt, prices would adapt, and the overall outcome would be that not much really changed.

Now, large swings of inflation or deflation that are unpredictable and in such amounts that the market can't recover... those are the bad ones.

Remember that money right now just serves the purpose of an exchange mechanism. It is no longer and never really was a store of value in the modern credit systems. If inflation or deflation are slow and manageable to such a degree that people have enough time to convert their excess money into fixed assets that CAN be considered stores of value, then there is nothing wrong at all with either phenominon.

[buffalokid777]

Well, I think the truly important thing is that currency needs to have intrinsic scarcity, otherwise its value can be debased by creating more of it, e.g. printed paper. If this is what you mean by intrinsic value, I agree. I also agree that coins might become useful as money in under a freely competing currency system, but I do think that paper notes (with commodity backing) and/or electronic money (with commodity backing) would be the market's overall choice. It's just inconvenient to literally carry around precious metals in your pocket all the time (and in the case of a few like gold, just a tiny bit would be worth too much to ask for change back ;)). Ultimately, market forces would determine how much of the metals are used as coins and how much are stored in vaults to back paper/electronic receipts.

The way I see it paper redemption for currency allows for Fractional reserve banking.....the bank may have 10 Tonnes of Gold.....but print up redemption certificates for 100 tonnes of gold......because they know most won't redeem their certificates......which would lead to a run on the bank if the bank succumbs to corruption.....

By requiring all currency to be commodity.....we stop this from happening......

An ounce of rhodium is $9000+ you could carry millions easily.....

Platinum $2,000 an ounce......you could carry hundreds of thousands easily.....

Substituting Paper for commodity is where fractional reserve banking was born from and from where most of the problems we have now come from.....

That is why I am so sure commodity must be currency.........because the dishonest cannot easily replicate it.......commodity currency is honest hard money.......

And your argument that gold is too expensive for small transaction....silver, steel, tin, etc arent....using all stable metals would produce the commodity currency we need at all levels of transactions.....

[Mini-Me]

The way I see it paper redemption for currency allows for Fractional reserve banking.....the bank may have 10 Tonnes of Gold.....but print up redemption certificates for 100 tonnes of gold......because they know most won't redeem their certificates......

By requiring all currency to be commodity.....we stop this from happening......

An ounce of rhodium is $9000+ you could carry millions easily.....

Platinum $2,000K an ounce......you could carry hundreds of thousands easily.....

Substituting Paper for commodity is where fractional reservee banking was born from and from where most of the problems we have now come from.....

That is why I am so sure commodity must be currency.........

This would require a coercive government mandate disallowing people from using paper or electronic money, which would be unworkably inconvenient for anything but the simplest retail transactions...and if you disallow fractional reserve banking, you're disallowing any lending whatsoever, at least with regard to on-demand deposits.

Lending is crucial to the funding of new capital, and although you can do it without banks lending out on-demand deposits (which results in fractional reserves), I don't see why people should be disallowed from lending their money to banks or anyone else for short-term loans, as long as they understand the risks. That is, that's assuming they're not fraudulently led into believing their deposited money is still theirs, like they are today - people never seem to question the implications of why banks pay interest on deposits. Whenever you lend money to anyone, there's a chance that they're going to default - the only way to prevent this is just to forbid people from lending their money (or to use bailouts, which is even worse than bank runs, since it encourages unaccountability and irresponsible lending practices). As Driftwood pointed out, and as I elaborated on in my brainstorm about this, the real problem with fractional reserve banking is that the government's safety nets and bailout programs (FDIC, etc.) encourage banking irresponsibility, yet they also give people the impression that their deposits count as money they own, when they're really loans they gave to the bank. In other words, the real problem here is that the government's promises and involvement totally obfuscate the actual nature of these transactions. (Obviously, we have another huge problem in that the Fed keeps expanding the base currency to bail out banks, lend to banks, and fund the obscene deficit spending of the government.) If we had non-inflationary base currency (such as commodity-backed money) and a free banking system where banks were able to rise and fall of their own accord, people would have choice. They would suffer no losses to inflation from keeping their money under their mattress (whereas today, they HAVE to put it in a bank, since it's worth less every day and the interest helps alleviate that). Alternatively, they could choose a bank to deposit their money in based on the bank's track record for keeping high reserves, lending responsibly, etc. versus how attractive their interest rates are.

Anyway, the most important point is that it the inconvenience of forcing people to carry around metal and only metal would be a crushing burden on the economy.

[buffalokid777]

This would require a coercive government mandate disallowing people from using paper or electronic money, which would be unworkably inconvenient for anything but the simplest retail transactions...and if you disallow fractional reserve banking, you're disallowing any lending whatsoever (at least with regard to on-demand deposits).

Lending is crucial to the funding of new capital, and although you can do it without banks lending out on-demand deposits (which results in fractional reserves), I don't see why people should be disallowed from lending their money to banks or anyone else for short-term loans, as long as they understand the risks. That is, that's assuming they're not fraudulently led into believing their deposited money is still theirs, like they are today - people never seem to question the implications of why banks pay interest on deposits. Whenever you lend money to anyone, there's a chance that they're going to default - the only way to prevent this is just to forbid people from lending their money (or to use bailouts, which is even worse than bank runs, since it encourages unaccountability and irresponsible lending practices). As Driftwood pointed out, and as I elaborated on in my brainstorm about this, the real problem with fractional reserve banking is that the government's safety nets and bailout programs (FDIC, etc.) encourage banking irresponsibility, yet they also give people the impression that their deposits count as money they own, when they're really loans they gave to the bank. In other words, the real problem here is that the government's promises and involvement totally obfuscate the actual nature of these transactions.

Anyway, the most important point is that it the inconvenience of forcing people to carry around metal and only metal would be a crushing burden on the economy.

But lending still could occur.....the loanee would simply receive commodity currency.....as long as the bank had the currency to lend for interest......lending must be from reserves that were saved....not from money created out of air.....

When paper currency is introduced, it allows banks to lend money they don't have......the fed banks can get paper from the fed......but if the fed didn't have commodity currency to lend, the bank who wanted the loan would be SOOL.....under the current system if the member bank wants a loan.....the fed can print up what the member bank needs....(loaning resources they don't have)
Commodity currency keeps all members in the banking system honest......not allowing any participant to live beyond their means.......or as I like to say....you can't loan that which you don't own.........

[Mini-Me]

But lending still could occur.....the loanee would simply receive commodity currency.....as long as the bank had the currency to lend for interest......

When paper currency is introduced, it allows banks to lend money they don't have......the fed banks can get paper from the fed......but if the fed didn't have commodity currency to lend, the bank who wanted the loan would be SOOL.....under the current system if the member bank wants a loan.....the fed can print up what the member bank needs....(loaning resources they don't have)
Commodity currency keeps all members in the banking system honest......not allowing any participant to live beyond their means.......

It's not that banks are lending money they don't have - they DO have the money (and when they don't, that's fraud - then again, under today's system with government-sanctioned and protected fractional reserve banking, this fraud is sometimes permitted even if their reserves are negative). Rather, depositers believe the money is still theirs, but they lent it to the bank. That's the difference. The money isn't ACTUALLY being multiplied, or at least it wouldn't be under "free" fractional reserve banking. Rather, multiple depositers mistakenly believe they hold claim to the same dollar that someone else is using, when really, all they hold claim to is the bank's promise to pay them back. When the bank screws up and makes a bad loan, that impairs their ability to pay back their depositers. When the bank REALLY screws up and makes tons of bad loans, that destroys their reserves so much that it can cause a bank run. However, the point is that if it wasn't for government and Fed obfuscating when bank deposits really are (by means of bailouts for everybody involved, funded through inflation), people would simply understand that this is a risk they must be willing to take if they want the interest they get for lending their money to a bank via deposits.

I agree that the Fed should be abolished, and when it prints more base currency to lend to banks, it actually IS creating more money out of thin air. This wouldn't happen under commodity-backed currency, or if it did, it wouldn't actually be "legal" like it is today. The manager who tried to pull it would be guilty of fraud. However, that's why competing currencies are desirable - you can choose to use and accept only the ones that you know aren't being toyed with by thieves.

Furthermore, fractional reserve banking IS possible without paper money! You lend a bank a hunk of gold as a deposit, in return for a promise of that money back and interest (on demand). They lend it out to someone else, who spends it, and the next person also deposits it, and it's loaned out again, etc. That's the same exact "money multiplier effect" you have today. The only difference is that there's no central bank to create precious metals out of thin air for use as reserves. However, if that specific practice was made illegal like it should be with regard to paper receipts (because it's counterfeit and fraud), there wouldn't be a problem, especially in the face of fierce competition.

The point is this:
Ultimately, it should be up to the market, not the government, to decide what is used as money. If people are happy with using ONLY metals, no paper currency will evolve. If people want a more convenient way of doing things, companies will spring up issuing redemptive notes. You'll put the money you have in their possession, they'll guard it for a fee (and it will still be absolutely YOURS as long as you can present the redemptive note - i.e. it's not a loan), and you're giving redemptive paper receipts so you can more conveniently spend money. This will only work if there's a large demand for it, because people will only accept those receipts if they have faith in the company guarding the real money behind them, yada yada. :)

[buffalokid777]

It's not that banks are lending money they don't have - they DO have the money (and when they don't, that's fraud - then again, under today's system with government-sanctioned and protected fractional reserve banking, this fraud is sometimes permitted even if their reserves are negative). Rather, depositers believe the money is still theirs, but they lent it to the bank. That's the difference. The money isn't ACTUALLY being multiplied, or it least it wouldn't be under "free" fractional reserve banking. Rather, multiple depositers mistakenly believe they hold claim to the same dollar that someone else is using, when really, all they hold claim to is the bank's promise to pay them back. When the bank screws up and makes a bad loan, that impairs their ability to pay back their depositers. When the bank REALLY screws up and makes tons of bad loans, that destroys their reserves so much that it can cause a bank run. However, the point is that if it wasn't for government and Fed obfuscating when bank deposits really are (by means of bailouts for everybody involved, funded through inflation), people would simply understand that this is a risk they must be willing to take if they want the interest they get for lending their money to a bank via deposits.

I agree that the Fed should be abolished, and when it prints more base currency to lend to banks, it actually IS creating more money out of thin air. This wouldn't happen under commodity-backed currency, or if it did, it wouldn't actually be "legal" like it is today. The manager who tried to pull it would be guilty of fraud. However, that's why competing currencies are desirable - you can choose to use and accept only the ones that you know aren't being toyed with by thieves.

With commodity currency.....a bank could only make as many bad loans as it had currency......could there still be bank runs? Of course....there will be people who deposit their commodity currency in the bank to be reloaned for interest.....and if the bank is unable to pay.....they would lose their deposits.....

But commodity currency would also stop the fed from printing money from thin air.....it is the collar the Fed needs.......the fed currently can counterfeit money at will as they are not restrained by commodity currency.......would commodity currency stop all the problems with our financial system? Of course not.....the people willing to deposit their commodity currency in banks could feed the problem.

But commodity currency would be a huge restraint of corruption.....it wouldn't eliminate it.....but it would restrain it much more than our current system.....

people would still make mistakes by depositing their commodity currency in dishonest banks....and they might lose....but by using commodity currency we could restrain alot of the dishonesty in banking.......while we couldn't restrain all dishonesty in banking.....I have no doubt the result would be better than the current banking system......

[Mini-Me]

Eeergh...I edited my post, so you might want to reread it.
Anyway, the point is that competition is also a check on corruption, and ultimately, the government should have no say as to what people have to use as money. People should be able to exchange goods and services using whatever they want. If they want to use twisty-ties as a medium of exchange, that's up to them, but I doubt many would.

If we didn't have legal tender laws and other currencies were legal (which is difficult to do when they're an income tax as well obviously, but...), the Fed would be powerless, because people simply would have ditched the dollar for commodity-backed currency long ago. The Fed is only so powerful because we HAVE to use their money, and because what they're doing is not even considered illegal when it should be (both of which would be fixed under freely competing currencies).

Anyway...bedtime....argh. Tired.

[buffalokid777]

Eeergh...I edited my post, so you might want to reread it.
Anyway, the point is that competition is also a check on corruption, and ultimately, the government should have no say as to what people have to use as money. People should be able to exchange goods and services using whatever they want. If they want to use twisty-ties as a medium of exchange, that's up to them, but I doubt many would.

If we didn't have legal tender laws and other currencies were legal (which is difficult to do when they're an income tax as well obviously, but...), the Fed would be powerless, because people simply would have ditched the dollar for commodity-backed currency long ago. The Fed is only so powerful because we HAVE to use their money, and because what they're doing is not even considered illegal when it should be (both of which would be fixed under freely competing currencies).

Anyway...bedtime....argh. Tired.

I agree....competition is a check on corruption.....If an individual bank is corrupt and screws their customers and another is not and pays interest.....the bank customers will gravitate towards the honest bank....


Unfortunately the fed IS a monopoly.....they have no competition in creating US currency.....so I think commodity currency is the perfect way to restrain the fed......

[Mini-Me]

I agree....competition is a check on corruption.....If an individual bank is corrupt and screws their customers and another is not and pays interest.....the bank customers will gravitate towards the honest bank....


Unfortunately the fed IS a monopoly.....they have no competition in creating US currency.....so I think commodity currency is the perfect way to restrain the fed......

I know I said I'd go to sleep, but I lied. I will now though, after I mention:
In today's climate, commodity currency is indeed a great way to restrain the Fed while it still exists and while legal tender laws still exist. Since freely competing currencies are of questionable legality (depending on how you look at it) and because the income tax severely complicates things, there are some practical obstacles today...but I agree that at least trying might be a good start, especially in smaller communities.

However, in the rest of my posts, I was talking about a hypothetical bright future without legal tender laws in the first place, meaning the Fed would be entirely irrelevant. :p

[buffalokid777]

meaning the Fed would be entirely irrelevant. :p

That would be so sweet :)

But I don't think that will happen until the masses make it happen by dragging them out kicking and screaming......

My views are more of a way to get to that point, or at very least restrain the fed where they can't do no additional damage thru fractional reserve banking :)

[davver]

He kept M1 stable. And that caused a big deflation of the price of gold. Remember gold is real money. Its price should not change. A currency that doers not keep pegged to the value of gold is a bad currency.

Volker should have scrapped the idea of keeping the money supply constant. He also should have scrapped the idea that M1 is money. Bank deposits (or Certificate of deposit) is not money (I'll explain why further down). Base money is money, its the stuff that the FED creates (notes and coins and electronic bank reserves). He should have put more base money into circulation when when the price of gold goes down, and he should have taken more base money out of circulation when the value of gold goes up. The price of gold is an indicator not so much about changes in the demand and supply of gold, as it is an indicator of a change of demand and supply of everything else. Its an indicator wheret the economy is growing or shrinking. The money supply needs to expand or shrink in tandem with the economy (the demand for money) for the value of the money to stay stable.

No, your really misunderstanding what money and gold is. Money is whatever people decide money is. Gold, paper, beans, whatever the market demands. The value of money is determined by supply and demand just like everything else. In the US there is a monopoly on money because of restrictive government laws. As a result most people use FRNs.

In the early 1980s the value of the FRN was depreciating rapidly. It was no longer a store of value, so demand for its competitor, gold, went up in spite of the laws penalizing it. For a brief period gold re-monetized, its price reflected not only demand for things like jewelry, but also demand as aform of money. It is pretty telling that at its peak the price of gold times ounces in circulation was equal to M1.

When Volcker stabilized the growth of M1 the FRN once again became a store of value, so gold de-monitized and became just another commodity. At no point did Volcker reduce the montary base or any other money aggregate (deflate).

Second, the different monetary aggregates all represent different kinds of money. Money is whatever people will accept for transactions. If someone will accept an M3 component as payment, then M3 is money. If someone will only accept physical cash, then only physical cash is money. The local newstand that just opened only accepts debits or credits, no cash. So to them the monetary base is worth less then M2.

During the great depression the monetary base expanded, but it was a period of great deflation. That is because monetary aggregates that people used to accept as money (M1, M2, etc.) de-monetized because people demanded cash versus those aggregates. As a result the overall level of money in the economy contracted, even as cash in circulation increased.

As long as M2 and M3 are accepted in transactions just as MB is, there is effectively no difference between them. They are all money. Demand determines that is money and what isn't.


The rest I will address when I have more time.

[Mini-Me]

No, your really misunderstanding what money and gold is. Money is whatever people decide money is. Gold, paper, beans, whatever the market demands. The value of money is determined by supply and demand just like everything else. In the US there is a monopoly on money because of restrictive government laws. As a result most people use FRNs.

In the early 1980s the value of the FRN was depreciating rapidly. It was no longer a store of value, so demand for its competitor, gold, went up in spite of the laws penalizing it. For a brief period gold re-monetized, its price reflected not only demand for things like jewelry, but also demand as aform of money. It is pretty telling that at its peak the price of gold times ounces in circulation was equal to M1.

When Volcker stabilized the growth of M1 the FRN once again became a store of value, so gold de-monitized and became just another commodity. At no point did Volcker reduce the montary base or any other money aggregate (deflate).

Second, the different monetary aggregates all represent different kinds of money. Money is whatever people will accept for transactions. If someone will accept an M3 component as payment, then M3 is money. If someone will only accept physical cash, then only physical cash is money. The local newstand that just opened only accepts debits or credits, no cash. So to them the monetary base is worth less then M2.

During the great depression the monetary base expanded, but it was a period of great deflation. That is because monetary aggregates that people used to accept as money (M1, M2, etc.) de-monetized because people demanded cash versus those aggregates. As a result the overall level of money in the economy contracted, even as cash in circulation increased.

As long as M2 and M3 are accepted in transactions just as MB is, there is effectively no difference between them. They are all money. Demand determines that is money and what isn't.


The rest I will address when I have more time.

This is a very good post, davver. However, even when people exchange bank deposits and such for goods as money, they should realize that those bank deposits could disappear at any time. Despite the fact that they're money because people are using them as such, they're also just loans at the base level. Essentially, people are trading IOU's from banks as money, and that's fine as long as they understand the inherent instability of their choice of money. The problem with this system in our country is that people don't understand what their preferred exchange medium really is (an IOU that can disappear anytime a bank does something stupid), which is in my opinion due to all of the federal safety nets and guarantees. Essentially, systemic obfuscation of their other nature as loans/IOU's distorts the market and causes people to make stupid decisions based on a confidence they should not have in their preferred money (bank deposits). Because of all of the guarantees (which encourage poor decision-making and wealth redistribution when things go bad), people are given misplaced confidence in these IOU's from their government. Under a free market, they would not be so misled, and bank deposits most likely would not be nearly in such high demand as money.

In other words, people are free to use Oreo cookies as money, but they need to understand that Oreos can go rancid at any time, and if they're holding a bunch of Oreos when they do, they're f'ed. ;)

[davver]

This is a very good post, davver. However, even when people exchange bank deposits and such for goods as money, they should realize that those bank deposits could disappear at any time. Despite the fact that they're money because people are using them as such, they're also just loans at the base level. Essentially, people are trading IOU's from banks as money, and that's fine as long as they understand the inherent instability of their choice of money. The problem with this system in our country is that people don't understand what their preferred exchange medium really is (an IOU that can disappear anytime a bank does something stupid), which is in my opinion due to all of the federal safety nets and guarantees. Essentially, systemic obfuscation of their other nature as loans/IOU's distorts the market and causes people to make stupid decisions based on a confidence they should not have in their preferred money (bank deposits). Because of all of the guarantees (which encourage poor decision-making and wealth redistribution when things go bad), people are given misplaced confidence in these IOU's from their government. Under a free market, they would not be so misled, and bank deposits most likely would not be nearly in such high demand as money.

In other words, people are free to use Oreo cookies as money, but they need to understand that Oreos can go rancid at any time, and if they're holding a bunch of Oreos when they do, they're f'ed. ;)

A government monopoly enforced by a system of penalties and propaganda. We all know what legal tender laws are all about. At the end of the day no matter what you do to erect a government monopoly, if you abuse your currency enough people will stop using it in spite of the barriers. That's why gold is up, you can't keep a good competitor down.

[DriftWood]

Here is my response to the second half of your reply..



IMPORTANT EDIT: It's come to my attention that I might have misunderstood the entire premise: Perhaps you're not advocating price-fixing gold? Upon closer examination, it seems that what you're advocating is to keep fiat money, except, depending on whether the market price of gold deviates from some "target" (say $1000/oz as an easy mark, since that's around where it is today), you print more money or extinguish more money accordingly. Technically speaking, this actually would work, if sole your aim is to keep price stability. However, there are several concerns:


Yes, calling it price-fixing to gold, is a technically a correct description. When a govt fixes the price of one product by printing or unprinting money they are peggeing the currency to that product. The value of that product is then the reference point of value, that all other things are valued relative to. There is nothing practically problems doing this. Govt would only get into trouble if they used more than one reference point of value, if they tried to price fix / peg the currency to more than one product. If they one day printed money because gold the price of gold was high, and the next day printed money because the price of food was high.. Having more than one peg is practically impossible. (Thats why the historic bimetallic gold-silver standard failed. Gold and Silvers values are not the same, they fluctuate relative to each other. Say someone yesterday took out a loan to buy a house in silver-gold pegged dollars. If today the silver value has gone down relative to gold, then people will pay their mortgage back in silver instead of gold dollars, and vice versa. Such a system will break down because the currency has two values, not one.)



1.) Short-term pricing trends for gold can be influenced by speculation, and because of that, you'd have to use long-term trends, which are indeed historically stable. More importantly, since gold itself is not worth a significant portion of the economy when it's not actually considered money, powerful banks and special interests can sell a lot of gold between themselves at whatever price they want and purposely distort the price when the resulting government monetary reaction would be favorable to them. Such price suppression happens even now, and that's just to keep people from noticing inflation. Imagine how much it would be done if banks knew that government would give them more money to lend if they made the gold price seem super-low! This would be a constant danger, and it would break price stability of other goods and services.


Yes, gold is not perfect.. its just historically more stable than any other alternative. The problem with speculators changing the value of gold, would still exist with a gold coin system. Speculators could still buy up or sell raw gold to change the value of the gold coin.

However i don't speculators, big banks or anyone else could control the value of gold (more than temporarily).

If someone would like to cause the currency to loose value.. he could sell his wast reserves of of gold. Temporarily the price of gold would go down. Eventually all that gold that he had would just have moved place.. from his safe to some other safes. Its not like he somehow got to keep his own gold when he sold it.. so the amount of gold in the world had not increased. The supply of gold had not changed, and neither had the demand. (Well technically the demand had gone down a little, if the person in question never wants to hold gold again. But he obviously likes collecting gold, because of the fact that he had so big reserves to begin with. His demand has not changed more than temporarily)

So any price decrease in gold.. because of people dumping all their gold is only temporary and it will come right back up again. all that has happened with that gold is that it has moved from one safe to another. It does not really matter if that gold was moved from the vaults of the biggest bank in America, to some vaults of rich billionaires in the middle east. Its still available on the same international gold market.



2.) Depending on how you create and extinguish money, there will probably be some socialist-style wealth redistribution going on just like there is with today's inflationary system (where the wealth is redistributed upwards, I might add).


The creating of money would be done by the central bank selling loans (issuing bonds) at a slightly lower price (interest rate) than the private market. That extra money would become part of the overall money supply in circulation. The FED would make a profit from this money creation scheme, it could buy assets with the profits it makes from the interest rate, when the borrower pays back the money.

The uncreating of money would be done by the central bank buying loans from the private market. The money would be taken out and kept out of circulation. The FED would make a loss from this scheme, in that it would have to pay back not just the loaned money also the interest.

This is just another way to say that the central banks creates money by buying assets with newly printed money. And the central bank un-creates money selling these assets (the money it gets it burys in a vault and throws away the key. Deleted from circulation.).

If the central bank loss was somehow bigger than the profits.. then the the govt could help out by not spending the money it made in taxes or that it made some other way. Put that money in a vault and throw away the key. Delete from circulation.



3.) I still disagree that price stability needs to be an absolute aim; rather, I'm taking the Austrians' side and arguing that money supply stability should. :p More precisely, it's unreasonable to expect that a single fiat currency will successfully achieve the aim of price stability. One reason for this is that it's very easy for fiat money to be abused by the issuer and others (as I've already argued before). Without competition in currency, we the people have no way to place a foolproof check on this. However, if we DID have commodity-backed competition, people would obviously choose to hold gradually deflationary currency rather than the government-issued currency whose supply and value will fluctuate to maintain price stability. In other words, absolute price stability is only the goal if there's a monopoly on money, but in that case, especially if it's fiat money, such price stability will be less probable than if we had competing commodity-backed currencies that simply don't try to play games with their supply.

I guess what it comes down to.. a pure gold system changes the demand for gold. So you change the value of the very thing you want to use as a reference point. A paper money pegged to the price of gold is much like a pure gold system except that the value of gold does not change, the reference point does not move. We want the value of gold to stay the same, not change it. The reason why gold is treated like a thing with supernatural powers, is that its value is so stable (relative to all other things). We want gold to keep being stable, we don't want to destroy this stability in value.

I'm all for competing currencies.. the scheme that I'm talking about does not have to be done by the govt, it can just as well be a private bank. It does not really matter who does the work of keeping the value of the currency stable.

Imagine.. a system with 3 private currencies.
One bank creates deflating paper money.
One bank creates inflating paper money.
One bank creates stable paper money.

(deflating, inflating or stable compared to the economy as a whole.. which can be best seen comparing the money compared to gold)

Anyone borrowing money would prefer the inflating money. Anyone paying bills would prefer the inflating currency. Anytime someone could consume something now and pay for it a little later would prefer the inflating currency. Employers would prefer the inflating currency, because they pay workers for the work they produced last month. Consumers would prefer prices to be priced in inflated currency, that way the fixed sticker price on a candy bar would make sure that its cheaper today than it was yesterday.

Anyone with savings, or anyone lending, would prefer deflating currency. Workers would prefer to be payed in the deflating currency. Anyone getting payed for stuff they did yesterday would prefer the deflating currency. All those with bills outstanding would like it.

The middle way is the stable currency.. neither the lenders or borrowers would like it best, neither workers or employers would like it best. But it is the best middle ground, its the best compromise between the different people. On the whole, noone is just one role, most people are both borrower and savers, people are both employees and consumers. Many people are both employees and employers. The stable currency is the best compromise. Both parties of most business deal or contracts would not agree to use one of the other currencies. I think that in a free market.. with these 3 competing currencies. The stable one would be used most for this very reason.

Money in itself is a way that lets us, consume something before we produce something to pay for it. In a barter economy something is always paid for at once. With money the trade is not competed until, you spend the money that you earned. All that money floating around the world will eventually come back, and be traded for some asset of real value. Money is like lots of outstanding debt, (and debt is a killer during deflation), i think this is the reason why deflation is so destructive to the economy.

Cheers

[DriftWood]

No, your really misunderstanding what money and gold is. Money is whatever people decide money is. Gold, paper, beans, whatever the market demands. The value of money is determined by supply and demand just like everything else. In the US there is a monopoly on money because of restrictive government laws. As a result most people use FRNs.

In the early 1980s the value of the FRN was depreciating rapidly. It was no longer a store of value, so demand for its competitor, gold, went up in spite of the laws penalizing it. For a brief period gold re-monetized, its price reflected not only demand for things like jewelry, but also demand as aform of money. It is pretty telling that at its peak the price of gold times ounces in circulation was equal to M1.

When Volcker stabilized the growth of M1 the FRN once again became a store of value, so gold de-monitized and became just another commodity. At no point did Volcker reduce the montary base or any other money aggregate (deflate).

Second, the different monetary aggregates all represent different kinds of money. Money is whatever people will accept for transactions. If someone will accept an M3 component as payment, then M3 is money. If someone will only accept physical cash, then only physical cash is money. The local newstand that just opened only accepts debits or credits, no cash. So to them the monetary base is worth less then M2.

During the great depression the monetary base expanded, but it was a period of great deflation. That is because monetary aggregates that people used to accept as money (M1, M2, etc.) de-monetized because people demanded cash versus those aggregates. As a result the overall level of money in the economy contracted, even as cash in circulation increased.

As long as M2 and M3 are accepted in transactions just as MB is, there is effectively no difference between them. They are all money. Demand determines that is money and what isn't.


The rest I will address when I have more time.

Yes you are correct, money is what people allow it to be. But that does not mean that people, as a whole, will not prefer one type of money over others. There is inflating money, deflating money, and stable money (compared to the value of all the things in the world if you summed them all up (aka the economy)).

In my previous post.. i argued that some people will not accept deflating money, other will not accept inflating money, stable money is the compromise that these different people will find when interacting with echother.

Cheers

[DriftWood]

I think you're missing the boat on Paul Volcker's efforts of the 80s. Had he not done what he did, you may have already had a huge collapse in the dollar long before now. Sure, the dollar strengthening caused a pretty deap recession, but it was a necessary one. From 1980-1982 we had a tough recession while the interest rates were held very high, but what happened after that? Only one of the largest and longest bull markets in the history of the country.

I haven't read through all of the very long posts, but I did notice another thing I disagree with. I don't think that slow and steady (less than 3%) inflation or deflation are necessarily bad things. You are underestimating the market's ability to adapt and manage such situations. For example, even if inflation was 10%, but it was a constant 10% annually and never changed, I don't think it would be too big of a problem. Wages would adapt, prices would adapt, and the overall outcome would be that not much really changed.

Now, large swings of inflation or deflation that are unpredictable and in such amounts that the market can't recover... those are the bad ones.

Remember that money right now just serves the purpose of an exchange mechanism. It is no longer and never really was a store of value in the modern credit systems. If inflation or deflation are slow and manageable to such a degree that people have enough time to convert their excess money into fixed assets that CAN be considered stores of value, then there is nothing wrong at all with either phenominon.

I agree with most of that. What Volker did was necessary, he just over did it. He not only stopped inflation, he reversed it. Causing deflation (compared to the value of gold, and to the value of most other things like candy-bars, cars and movie tickets.. etc).

A small amount of deflation/inflation is better than a large amount, for sure. What would be even better is even less, or no deflation/inflation. If there is a way, a money, with less inflation/deflation then it has my vote. And i think there is (paper/plastic pegged to the price of gold).

Cheers

[davver]

I agree with most of that. What Volker did was necessary, he just over did it. He not only stopped inflation, he reversed it. Causing deflation (compared to the value of gold, and to the value of most other things like candy-bars, cars and movie tickets.. etc).

A small amount of deflation/inflation is better than a large amount, for sure. What would be even better is even less, or no deflation/inflation. If there is a way, a money, with less inflation/deflation then it has my vote. And i think there is (paper/plastic pegged to the price of gold).

Cheers

Sigh, you learned nothing from my post.

The price of gold in dollars is not the determinate of inflation or deflation. The change in the supply of dollars determines if you have inflation or deflation. Gold is only money is people see it as money. In normal times, when people trust the FRN, gold is demonetized. Its price mainly reflects its demand as jewelry. In times of extreme financial stress gold re-monetizes, as it did in the early 1980s. When gold spiked from $200 to $800 in less then a year that didn't mean we had 400% inflation. It merely meant that gold was re-monetizing as a competitor to the FRN. The subsequent price drop didn't represent 80% deflation either. When Volcker restored confidence in the FRN gold de-monetized. The price of gold is only a reflection of inflation when people value it as money over long periods of time. Most of the price movements in gold today reflect increased or decreased monetization of gold.

Volcker never caused deflation. None of the monetary aggregates fell, and the CPI never dropped (tertiary, but related to your candy bar statement).

People have historically chosen gold because it never deflates (it is fairly indestructible, so its supply never decreases) and it tends to inflate at a very slow rate (it gets mined out of the ground around 2%/year).

[davver]

Yes you are correct, money is what people allow it to be. But that does not mean that people, as a whole, will not prefer one type of money over others. There is inflating money, deflating money, and stable money (compared to the value of all the things in the world if you summed them all up (aka the economy)).

In my previous post.. i argued that some people will not accept deflating money, other will not accept inflating money, stable money is the compromise that these different people will find when interacting with echother.

Cheers

Which is why they love gold. Gold never deflates, and its rate of inflation is pretty low 2%/year or less.

[DriftWood]

The way I see it paper redemption for currency allows for Fractional reserve banking.....the bank may have 10 Tonnes of Gold.....but print up redemption certificates for 100 tonnes of gold......because they know most won't redeem their certificates......which would lead to a run on the bank if the bank succumbs to corruption.....

By requiring all currency to be commodity.....we stop this from happening......

An ounce of rhodium is $9000+ you could carry millions easily.....

Platinum $2,000 an ounce......you could carry hundreds of thousands easily.....

Substituting Paper for commodity is where fractional reserve banking was born from and from where most of the problems we have now come from.....

That is why I am so sure commodity must be currency.........because the dishonest cannot easily replicate it.......commodity currency is honest hard money.......

And your argument that gold is too expensive for small transaction....silver, steel, tin, etc arent....using all stable metals would produce the commodity currency we need at all levels of transactions.....

There really is no alternatiuves to gold. There is a reason many civilizations independently started using gold instead of other precious things, as money. Its not that gold is precious or scarce that makes it so good as money. It is the fact that its value stays the same. Thats another way of saying that its supply does not change much, and its demand does not change much. Or rather that its supply and demand increases slowly, pretty much in sync. Value equals demand divided by supply. The value of gold has stayed remarkably stable thruout history. On the supply side.. 95% of all the gold that has ever been found is stil in circulattion, only a couple of percentages have been consumed (in things like fake teeth and conductors.. or lost at sea.). This means that the small amount of gold that is dug up every year make very little change top the overall supply. When it come to demand gold has changed little aswell.. there is little use for gold.. most of the gold that is consumed jas been put into teeth and electronics.. however there are better less precious materials for these purposes so there is very little practical use fort gold. The value of gold is remarkably stable because it is remarkably useless.

Other precious metals like silver.. have a less stable supply and demand.. silver has lots of industrial use.. so its demand is high and changing. Its value is therfore less stable. The same goes for other.. metals. They might be precious, even more precious now than gold, but that does not make them good as money. Their value is less stable.

Imagine if begining today we made a monetary system based on coins.. We called it metal money. We would use platinum for big denominations, gold for intermediate ones, silver for small ones, copper for even smaller etc. Every coin would have a stamp on it, its face value, that its worth X amount of metal money. We would stamp the coins with their face value they hold today. A gold coin would have a "100" stamp. A platinum coiun would have a "1000" stamp. A silver would have "10". A copper a "1". Correponding to their relative value to eachother they have today. You see what im getting at? Well on the first day they everything would work fine, and a platinum coind would be worth 10 as much as a gold one, and a 100 times a silver one, and 1000 a copper one. Anyone would be willing to trade you 1000 copper coins for one platinum coin. One year later this system would be in disarray. Somneone mining company made a big copper find, driving down the value of copper. Some other company found out a good use for platinum in making heavy duty drills. Driving up the value of platinum. Now you would not find anyone who would be willing to trade 1000 copper coins for one platinum coin, despite the face value on the coins still being the same.

The only way such a system could work is if you.. instead of stamping the coins with their value.. you printed them with their weights. Their weights do not change after all, even if their value changes. Now however, all products being sold in the country would have to be priced in each of the different currencies, and the products would have to get a new sticker price every day to reflect the changes in value since yesterday. If they did not recalculate, then a candy bar would be cheaper if you payed for it in copper instead of in platinum etc.. This constant recalculation of prices to keep the value of the product to be the same in all currencies is clerly very impractical.. so it would probably mean that products would only be sold in a single currency. That way the sticker price would not have to be recalculated from day to day. Some stores might just accept gold, others platinum, other copper. For the same reson a company would only do business in a single currency, it would buy stuff and sell stuff and pay wages in a signle currency to avoid the problem with recalculating and set new wages and prices every day to keep the relative value between the currencies the same. In the end most companies and people would prefer gold.. as its value was most stable.

Gold really is amazing.. not because its precious, not only because its supply does not change much, but also because its deamand does not change much (its stays useless to industry).

Cheers

[DriftWood]

Sigh, you learned nothing from my post.

The price of gold in dollars is not the determinate of inflation or deflation. The change in the supply of dollars determines if you have inflation or deflation. Gold is only money is people see it as money. In normal times, when people trust the FRN, gold is demonetized. Its price mainly reflects its demand as jewelry. In times of extreme financial stress gold re-monetizes, as it did in the early 1980s. When gold spiked from $200 to $800 in less then a year that didn't mean we had 400% inflation. It merely meant that gold was re-monetizing as a competitor to the FRN. The subsequent price drop didn't represent 80% deflation either. When Volcker restored confidence in the FRN gold de-monetized. The price of gold is only a reflection of inflation when people value it as money over long periods of time. Most of the price movements in gold today reflect increased or decreased monetization of gold.

Volcker never caused deflation. None of the monetary aggregates fell, and the CPI never dropped (tertiary, but related to your candy bar statement).

People have historically chosen gold because it never deflates (it is fairly indestructible, so its supply never decreases) and it tends to inflate at a very slow rate (it gets mined out of the ground around 2%/year).

I see what you are saying, i just dont agree with it.

You have a different definition of deflation and inflation than me. You simply say that inflation is increase of money supply (you are a monetarist). I say that inflation is a decrease in the value of gold.

Yes, when the dollar was inflated in the 70s.. people bailed on the dollar and put their wealth into gold because they saw that the dollar was not good as gold. It kept loosing value relative to gold. Then Volker came along and stopped the money press completely, people saw that the dollar started falling slower aganist the value of gold, to the point where its stopped falling, people saw that once again the dollar was as good as gold. They saw they no longer needed the real thing, the started holding more dollars and less gold, this sent the value of gold down relative to the dollar.. and this continued to happen, the money press still stood still. People noticed that dollar was better then gold. The value of the dollar continued to climb and the value of gold kept falling. At this point there was little reason to hold anything but dollars. Gold, candy, food, cattle.. everything fell against the value of the dollar. Owning anything but the paper dollar was a foolsih investment. The economy and investement came to a screething hault. The ressession was not nessessary. What im saying is that it could have been avoided if Volker had started the printinting press again, when he noticed that people started selling their gold for dollars. If gold is loosing value against the dollar, you can bet that most things, aka the whole economy is loosing value against the dollar.

Our disagreement comes from what money is or what it should be. The monetarist argument is that money should not increase in supply, because money should be a safehouse for wealth. If gold and everything looses value compared to money then thats a good thing because people with savings gain purchasing power.

My argument is that a deflating money (compared to gold and most other things) is very destructive. Money is not just used for savings. Money is used as the denomination for contracts. People make relationships and assumtions about the purchasing power of their money to more or less stay level. If i lend my friend money i dont want to have to predict how fast that money is going to gain or loose purchasing power. If i could assume that one dollar today is worth one dollar a year from now (that the purchaisning power stays level) , i would be less likley to make a bad decision. When a shop owner puts prices on his product, he should not have to predict how fast the customers purchasimng power will decrese or increase. It would be better if he could assume that cusomers have the same purchasing power today as they did yesterday, that way he would be less likley to make a bad decision. The same goes for the wages that a employer agrees to pay his employees, he has to predict the amount inflation/deflation (comparted to gold and things in general) in the future.

People should not have to be market experts to make business decisions. If i borrowed you money today without interest, and the market had changed by the time you payed back. I would eighter have made a loss or a profit. If i made a loss, you yould have made a profit and vice versa. A big or small profit or loss depending on how much the market had changed the purchasing power of the money. If someone had invented the next big thing, like the tractor and the market now was flooded with potatoes. Then there would be more things of value (potatoes) in the world being traded. This extra trading would increse the demand for money. There would now be less money, per thing of value, in the world. Prices of everything (not just potatoes) would decrease. You would have made a loss loaning that money. You would have to pay back the money youy spent last year, in money with a larger purchasing power. Your wage might already have been decreased. And now you had no way to make back the money you loaned. A year ago, you bet that economy would not have grow this much. It was a gamble and you lost out.

It would be better if regular people did not have to predict the future or be a market experts just to agree on future prices, it would be better and easier for all if people could assume that a dollar bought much the same things a year from now as today. That way it deals like this would be less of a gamble.

A money manager can make this assumtion be true. He can keep the prices on average stable. He does this by using the price of gold as the guiding star. Becuse it's value stays more stable than anything else. He can use its as the reference point, agaisnt wich he judges the value of all other things. If the value of a currency grows relative to gold he can be pretty sure (because gold is the most stable value ther is) that its not the value of gold that has decreased so much as its the the value of the currency that has decreased. If the supply of the currency has not changed then there must have been a increase in the demand for the currency. Thats another way of saying that the demand for real things has increased, or the supply of real things has decreased. Eihter way the purchasing power of the currency has increased. People that where assuming that the purchasing power would stay the same will be either be happy or disappointed with this change. The winners will be the lenders, savers, employees. The losers will be borrowers, employers, anyone who has to pay a bill.

I think the best money is money that holds purchasing power stable. That way people can do business without having to predict the future of the economy as a whole. No matter if there is a resession or a bull market, most things will cost about the same. The best way to get price stability and predictability like this is by pegging the currency to the price of gold.. Obviously some things would still get more expensive and some would get cheaper, but on the whole prices would stay the same.

Cheers

[davver]

I see what you are saying, i just dont agree with it.

You have a different definition of deflation and inflation than me. You simply say that inflation is increase of money supply (you are a monetarist). I say that inflation is a decrease in the value of gold.

Yes, when the dollar was inflated in the 70s.. people bailed on the dollar and put their wealth into gold because they saw that the dollar was not good as gold. It kept loosing value relative to gold. Then Volker came along and stopped the money press completely, people saw that the dollar started falling slower aganist the value of gold, to the point where its stopped falling, people saw that once again the dollar was as good as gold. They saw they no longer needed the real thing, the started holding more dollars and less gold, this sent the value of gold down relative to the dollar.. and this continued to happen, the money press still stood still. People noticed that dollar was better then gold. The value of the dollar continued to climb and the value of gold kept falling. At this point there was little reason to hold anything but dollars. Gold, candy, food, cattle.. everything fell against the value of the dollar. Owning anything but the paper dollar was a foolsih investment. The economy and investement came to a screething hault. The ressession was not nessessary. What im saying is that it could have been avoided if Volker had started the printinting press again, when he noticed that people started selling their gold for dollars. If gold is loosing value against the dollar, you can bet that most things, aka the whole economy is loosing value against the dollar.

Our disagreement comes from what money is or what it should be. The monetarist argument is that money should not increase in supply, because money should be a safehouse for wealth. If gold and everything looses value compared to money then thats a good thing because people with savings gain purchasing power.

My argument is that a deflating money (compared to gold and most other things) is very destructive. Money is not just used for savings. Money is used as the denomination for contracts. People make relationships and assumtions about the purchasing power of their money to more or less stay level. If i lend my friend money i dont want to have to predict how fast that money is going to gain or loose purchasing power. If i could assume that one dollar today is worth one dollar a year from now (that the purchaisning power stays level) , i would be less likley to make a bad decision. When a shop owner puts prices on his product, he should not have to predict how fast the customers purchasimng power will decrese or increase. It would be better if he could assume that cusomers have the same purchasing power today as they did yesterday, that way he would be less likley to make a bad decision. The same goes for the wages that a employer agrees to pay his employees, he has to predict the amount inflation/deflation (comparted to gold and things in general) in the future.

People should not have to be market experts to make business decisions. If i borrowed you money today without interest, and the market had changed by the time you payed back. I would eighter have made a loss or a profit. If i made a loss, you yould have made a profit and vice versa. A big or small profit or loss depending on how much the market had changed the purchasing power of the money. If someone had invented the next big thing, like the tractor and the market now was flooded with potatoes. Then there would be more things of value (potatoes) in the world being traded. This extra trading would increse the demand for money. There would now be less money, per thing of value, in the world. Prices of everything (not just potatoes) would decrease. You would have made a loss loaning that money. You would have to pay back the money youy spent last year, in money with a larger purchasing power. Your wage might already have been decreased. And now you had no way to make back the money you loaned. A year ago, you bet that economy would not have grow this much. It was a gamble and you lost out.

It would be better if regular people did not have to predict the future or be a market experts just to agree on future prices, it would be better and easier for all if people could assume that a dollar bought much the same things a year from now as today. That way it deals like this would be less of a gamble.

A money manager can make this assumtion be true. He can keep the prices on average stable. He does this by using the price of gold as the guiding star. Becuse it's value stays more stable than anything else. He can use its as the reference point, agaisnt wich he judges the value of all other things. If the value of a currency grows relative to gold he can be pretty sure (because gold is the most stable value ther is) that its not the value of gold that has decreased so much as its the the value of the currency that has decreased. If the supply of the currency has not changed then there must have been a increase in the demand for the currency. Thats another way of saying that the demand for real things has increased, or the supply of real things has decreased. Eihter way the purchasing power of the currency has increased. People that where assuming that the purchasing power would stay the same will be either be happy or disappointed with this change. The winners will be the lenders, savers, employees. The losers will be borrowers, employers, anyone who has to pay a bill.

I think the best money is money that holds purchasing power stable. That way people can do business without having to predict the future of the economy as a whole. No matter if there is a resession or a bull market, most things will cost about the same. The best way to get price stability and predictability like this is by pegging the currency to the price of gold.. Obviously some things would still get more expensive and some would get cheaper, but on the whole prices would stay the same.

Cheers

Stable prices are not the result of stable money supply. In an ordinary economy, where there are increases in productivity, a constant money supply leads to price deflation. Only an inflationary monetary policy can lead to price stability.

When prices decrease this is not deflation. One of your statements in particular I found very misguided:


Then there would be more things of value (potatoes) in the world being traded. This extra trading would increase the demand for money. There would now be less money, per thing of value, in the world.
The quantity of money doesn't change just because more potatoes are being produced. The quantity of money remains the same. The denominator of price, potatoes, has increased. So the price ($/potatoes) decreases. No deflation has occurred. There has been no reduction in the money supply.

If falling prices are the result of productivity growth then price deflation is NOT the result of an increase in the value of currency. Falling prices are the result of a decrease in the cost of goods. The value of the currency never changes if its supply is kept constant and its demand remains the same.

When you change the supply of money you are changing its value. It is no different then when large new supplies were found in the new world. This increased the supply of gold (silver especially) and caused them to lose value.

The theory of stable prices was touted throughout the 1920s. It was argued that the Feds inflationary policies weren't in fact inflationary because consumer prices held constant throughout the period. The error of price stability was exposed in the following great depression. Most of the counterfeit money had gone into capital investment because of the low interest rates it created. Eventually that capital investment was revealed to be malinvestment, as expected savings that business leaders thought would be used to purchase the goods produced by that capital was actually an illusion created by artificial savings. Price based inflation definitions were a huge culprit in the great depression.

As for Volcker the CPI never decreased during his tenure. Not to surprising considered he never deflated. Only the price of gold really deflated, and that had to do with its de-monetization. The recession resulting from Volcker's actions was entirely necessary as it liquidated the malinvestment caused by the previous inflationary policy. Had he not done what he did we might not even have a dollar today.

[DriftWood]

Stable prices are not the result of stable money supply. In an ordinary economy, where there are increases in productivity, a constant money supply leads to price deflation. Only an inflationary monetary policy can lead to price stability.

When prices decrease this is not deflation.

One of your statements in particular I found very misguided:

The quantity of money doesn't change just because more potatoes are being produced. The quantity of money remains the same. The denominator of price, potatoes, has increased. So the price ($/potatoes) decreases. No deflation has occurred. There has been no reduction in the money supply.



I'm not saying the quantity of money was changed, I'm saying its value was changed because of an increase in the demand. Let me explain.

Again you are disagreeing because you use a different definition of inflation and deflation than i use. You say that inflation simply is an increase in money supply. You say that the value of money is simply the quantity of money supply.

I say that inflation is the increase of prices in general and the increase in of gold in particular. I say that the value of money is not just set by the supply, it is equally set by the demand. So if the supply stays the same, the value of the money can still change if the demand changes. The demand for money changes when the economy grows, when there are more things people want in the world. The value of a money can be seen in its purchasing power in general an in the price of gold in particular.



If falling prices are the result of productivity growth then price deflation is NOT the result of an increase in the value of currency. Falling prices are the result of a decrease in the cost of goods. The value of the currency never changes if its supply is kept constant and its demand remains the same.


Its correct, its not that the value of the money has increased, its that the value of everything else that has decreased. The extra productivity means the supply of the things can be increased. Imagine a world where suddenly there are two things where there used to be one thing. The money has not increased, and neither has the prices of the things, yet. The reason the price is forced down is simply because there are more things per money now. More things are competing for the same money, the demand for the limited money has increased. The prices can not stay the same because, there would not be enough money in circulation to buy up all those things at their current prices. The price of everything will go down to reflect the available supply of money. This is just another way of saying that increase in productivity has increased the supply of things, which has forced down prices, which has increased the purchasing power of money. The value of money is its purchasing power. This increase of purchasing power should also be seen in the price of gold going down (remember when there are more things in the world but the same amount of money, the price of everything goes down).

To keep the value aka the purchasing power aka the price of gold the same you need to increase the supply of money.



When you change the supply of money you are changing its value. It is no different then when large new supplies were found in the new world. This increased the supply of gold (silver especially) and caused them to lose value.


Yes



The theory of stable prices was touted throughout the 1920s. It was argued that the Feds inflationary policies weren't in fact inflationary because consumer prices held constant throughout the period. The error of price stability was exposed in the following great depression. Most of the counterfeit money had gone into capital investment because of the low interest rates it created. Eventually that capital investment was revealed to be malinvestment, as expected savings that business leaders thought would be used to purchase the goods produced by that capital was actually an illusion created by artificial savings. Price based inflation definitions were a huge culprit in the great depression.


As far as i know the great depression was caused by tariffs. And later they started inflating and taxing to fix the economy, which just made everything worse.



As for Volcker the CPI never decreased during his tenure. Not to surprising considered he never deflated. Only the price of gold really deflated, and that had to do with its de-monetization. The recession resulting from Volcker's actions was entirely necessary as it liquidated the malinvestment caused by the previous inflationary policy. Had he not done what he did we might not even have a dollar today.

I find that hard to believe, that CPI never changed. During the the 70s Gold, Commodities and CPI shot threw the roof. When Volcker got into office he took those down (80s). Deflation/inflation will first be seen in the price of gold, then in other commodities, then in commodity intensive product, and finally in services and wages.

Cheers

[davver]

The value of money doesn't change when the prices of goods change. Increased purchasing power doesn't make money any more valuable then it was yesterday if the supply is constant. Tomorrows goods are not equivalent to todays goods.

Your charge that demand for money increases as goods increase doesn't make sense. The price of the goods will adjust to the new ratio of $/goods. Demand for money will only increase if there is a change in the desire for money, it has nothing to do with goods.

You can call changing prices whatever you want. It doesn't matter what you call increasing or decreasing the money supply, the concept itself is the only thing that is important, not the label. Focusing on prices is a fools errand, but perhaps you need to read some more in-depth works to understand.

I recommend Murray Rothbard's: America's Great Depression. It is one of the best books I've ever read.

CPI never contracted under Volcker:
http://en.wikipedia.org/wiki/Image:US_Consumer_Price_Index_Graph.svg

[DriftWood]

The value of money doesn't change when the prices of goods change. Increased purchasing power doesn't make money any more valuable then it was yesterday if the supply is constant. Tomorrows goods are not equivalent to todays goods.


Look, we disagree on the definitions. The definition of inflation/deflation, money and the value of money is not set in stone, its something that can be debated. You are just deciding that your definition is right, and my definition is wrong. You need to explain what makes your definitions better, not just keep repeating the definitions over and over.

You are a follower of the monetarist Rothbards definitions.. thats fine. I'm not, I think Nathan Lewis definitions are better. Why?

Because i think using these definitions in monetary policy, will be the least damaging to the economy and to regular people.

Purchasing power matters. A money that has no correlation with purchasing power is utterly useless. Imagine if the money in your wallet bought you one hamburger today, 1000 tomorrow, and half a hamburger the day after, and so on. Having such money would useless, as you would not know how much to pay for anything, and you would not know how much to charge for anything.

A money that keeps the purchasing power the same.. say you want a hamburger.. you work 15 minutes and make enough money to buy one hamburger, piece of cake. You forget about the hamburger and watch some TV. The money falls in between the sofa. You find the money 10 years later, and it still buys you a hamburger. The purchasing power has stayed the same, instead of increased. I think thats fair, considering that the work you did was only worth one hamburger, you only did it for the burger. Imagine if instead the purchasing power of the money had increased, and that you could buy 10 hamburgers with that work you did, that was only worth one hamburger. I don't think that fair. I don't think money in itself should be an investment, as money left under the sofa is not put into productive use, its just there doing nothing, its purchasing power should not change. If that money had been invested instead in a burger factory or something.. then the money would have been put into productive use. And you could have made a profit so that your purchasing power had increased enough to buy 10 hamburgers. I think that is more fair.




Your charge that demand for money increases as goods increase doesn't make sense. The price of the goods will adjust to the new ratio of $/goods. Demand for money will only increase if there is a change in the desire for money, it has nothing to do with goods.


Think about it. What is demand for money? In a world with nothing to buy, no one needs or wants any money. There is no demand. With more things in the world that people want, they need money to buy those things. There now is demand for money. Imagine a world where there are lots of things people can buy, every thing costs one dollar, but there is only one dollar bill in circulation. Everyone want that one dollar so that they can buy a thing. The demand for that one dollar is sky high. They might even get violent to get it. Demand for money increases as there are more thing that people want in the world. For every trade that is made, people need money to work as the middle man. If there is not enough money, for all these trades, the prices of the product being traded has to be adjusted downward to reflect the fact that demand for money is higher than the supply.



You can call changing prices whatever you want. It doesn't matter what you call increasing or decreasing the money supply, the concept itself is the only thing that is important, not the label. Focusing on prices is a fools errand, but perhaps you need to read some more in-depth works to understand.


Yes, its the concepts that matter. But we need to put a names to the concepts. And explain what concepts we mean when we use those names. Saying that we disagree on the definitions is saying we disagree on the concepts.




I recommend Murray Rothbard's: America's Great Depression. It is one of the best books I've ever read.



I'll admit I'm no fan of Rothbard's.. I would not mind reading that book though. But i suspect it would be more of the same monetarist arguments i heard before.

I suggest you read the book "Gold: the once and future money." Thats where i got many of my definitions about money and inflation. Its one of the better books i read.




CPI never contracted under Volcker:
http://en.wikipedia.org/wiki/Image:US_Consumer_Price_Index_Graph.svg

Yeah, looking at the diagram it looks like you are correct. In nominal terms the CPI has gone up ever since the 50s, and Volker just slowed it down close to 0%.

However if you compare commodity prices to the price of gold for the same period you will see that commodities not only stayed level with gold, but decreased in value during the 80s. Check out the commodity charts (the June 6, 2008 post) at http://www.newworldeconomics.com/

This makes me very suspiciously of how CPI is calculated.. and reading wikipedia..

"Two basic types of data are needed to construct the CPI: price data and weighting data. [...]. The weighting data are estimates of the shares of the different types of expenditure as fractions of the total expenditure covered by the index."

That sounds like they have removed the cost of the commodities and raw materials that make up the product, from its price.. If this is the case then its not surprising commodity price increases or decreases do not show up in the CPI graph. I think most people have heard about the commodity boom that happened in the 70s, and that it went away in the 80s. It was much the same as todays commodity boom. If Volcker was running FED today, he could bring the prices of commodities down much like he did in the 80s.

Cheers

[davver]

You're definition is wrong because you don't understand purchasing power. You're saying that if a dollar can purchase the same amount of goods tomorrow as today then it is just as valuable. This assumption implies that goods today are equivalent to goods tomorrow. This isn't true. People have time preference, so the an amount of goods today is worth more then the same amount of goods tomorrow. Therefore, if a dollar can only purchase the same amount of goods tomorrow as today then it has lost value.

Let us take the example of electronics. Every year the price of electronics declines dramatically while the quality increases substantially. In the past this has resulted in very high levels of price deflation in electronics. So why does anyone ever purchase a big screen or a computer? After all, if they just save their dollar it will be dramatically more valuable next year, and the year after that. The answer is time preference. The dollar next year it not more valuable then the dollar this year. At some point someone goes out and buys a new computer because they would prefer to have a computer now. Today's dollar is worth more then next years dollar.


Think about it. What is demand for money? In a world with nothing to buy, no one needs or wants any money. There is no demand. With more things in the world that people want, they need money to buy those things. There now is demand for money. Imagine a world where there are lots of things people can buy, every thing costs one dollar, but there is only one dollar bill in circulation. Everyone want that one dollar so that they can buy a thing. The demand for that one dollar is sky high. They might even get violent to get it. Demand for money increases as there are more thing that people want in the world. For every trade that is made, people need money to work as the middle man. If there is not enough money, for all these trades, the prices of the product being traded has to be adjusted downward to reflect the fact that demand for money is higher than the supply.

The price of good will adjust to the available money, not the other way around. If there is only one dollar in existence and 1000 goods then the price per good will be 1/1000 dollars. This is a digital age, there is no reason why that dollar couldn't be divided into smaller units rather then printing another dollar. If you use something like gold money they will just divide an ounce into grams, they won't conjur 10 more ounces out of thin air.

Price stabilization targeting was the goal of the Fed in the 1920s. They inflated massively to offset productivity gains. It ended in the great depression. The book is a good read.

The CPI is a consumer goods prices. If those consumer goods contain commodities, which they all do, then it is included in the CPI.

The commodity boom of the 70s was based both on reckless monetary policy and legitimate resource shortages. Monetary policy alone doesn't determine the price of oil. Due to those resource shortages large investments where made in the development of new resources, leading to an oversupply throughout the 80s and 90s. This wasn't the result of deflationary monetary policy (inflation was high) but rather a whole new supply/demand equation for commodities.

[Paul.Bearer.of.Injustice]

Food and [fresh]water are and probably always will be the only thing with intrinsic value to every human on the planet. If the money supply were to be pegged to any resource, it should be these. The importance of these prices remaining stable makes more sense to me than gold.
The West having an abundance of food and water is how the current global economic system is sustained and has been sustained for the last 4000 years through the exploitation of 3rd world nations, who sell us all their assets for these things.
Rothschild once said "Give me control of the money supply and I care not who makes the laws."
Well, give me control of the food supply I care not who controls the money.

True advancement of an economic system would be a totally different system than the price/wage system we have today which is just an evolution from human slavery to wage slavery. Softening hearts didn't free slaves, technology did. And technology can propel us into a perfect energy accounting system that is truly fair where everyone can survive based on their needs(if survival is a basic human right), and desires are achieved only through effort.
The problem with our modern(actually ancient Babylonian) economics is that desires(things over and above basic survival) can be gained my cheating the system and remaining idle (I again invoke compound interest and frac-reserve banking).

By using compound interest, you are assuming assets will increase exponentially over time to match this magical interest equation. The deceitful people who know this is impossible (the ones who invented it) game the system with debt creation knowing it can never be paid back and they will live like kings until the system inevitably collapses, and when it does, they still control all the assets and start over as kings... and on and on and on again...

[SeanEdwards]

I think the concept of money as a reliable store of value is very important, and I don't see how any scheme of pure fiat money can ever meet that requirement. I tend to favor the idea of baskets of commodities backing the value of paper money. So one dollar becomes a bill of ownership for some quantity of real tangible goods that has lasting value. Gold and silver have been historical favorites, but they don't have to remain the only option. I could see other less precious metals being usable as stores of value, or even energy sources being used. But the main thing is that money should have a connection to something real, something more real than declarations of "trust me" from bankers.

[DriftWood]

You're definition is wrong because you don't understand purchasing power. You're saying that if a dollar can purchase the same amount of goods tomorrow as today then it is just as valuable. This assumption implies that goods today are equivalent to goods tomorrow. This isn't true. People have time preference, so the an amount of goods today is worth more then the same amount of goods tomorrow. Therefore, if a dollar can only purchase the same amount of goods tomorrow as today then it has lost value.


Yes, no goods are exactly the same today as tomorrow. However the future and the things that will exist then, are not completely relative, and un-comparable to todays the things that exist today. Its correct, in such a world there concept of an increase in purchasing power would not make any sense, because no thing could be said to be much the same as some past thing. In the real world however, many things do stay the same. Oil pumped up today is much like oil the oil pumped up yesterday, it might be cheaper or more expensive but its still pretty much the same stuff. Hamburgers might change a bit over time, but its still a hamburger. (And if you look for it you can probably find a hamburger that is much the same as hamburgers where 50 years ago, it would probably be a bit bigger, and the meat would be more organically grown.)

Time preference.. You would rather have a hamburger today than have to wait until tomorrow, that is true. I don't think this justifies an increasing purchasing power of money not invested (say money stored under a mattress). However, If you invest the money (profitably) or save it with a bank (the bank will invest the money for you by lending it out) your purchasing power could grow enough to offset the time preference.



Let us take the example of electronics. Every year the price of electronics declines dramatically while the quality increases substantially. In the past this has resulted in very high levels of price deflation in electronics. So why does anyone ever purchase a big screen or a computer? After all, if they just save their dollar it will be dramatically more valuable next year, and the year after that. The answer is time preference. The dollar next year it not more valuable then the dollar this year. At some point someone goes out and buys a new computer because they would prefer to have a computer now. Today's dollar is worth more then next years dollar.


Yes, electronics probably are the things that change the most. However you could argue that a high end TV of last year, should not be compared to that TV today, but to the high end TV of today's. If you accept that, then your purchasing power will not have increased much when it comes to TVs.




The price of good will adjust to the available money, not the other way around. If there is only one dollar in existence and 1000 goods then the price per good will be 1/1000 dollars. This is a digital age, there is no reason why that dollar couldn't be divided into smaller units rather then printing another dollar. If you use something like gold money they will just divide an ounce into grams, they won't conjur 10 more ounces out of thin air.



Yes, prices of goods change to reflect the available money, and the reason it does that is because there is more demand for the available money, which is caused by an increase in the supply of things we want. So first comes the increase in the supply of things we want, that causes a increasing demand for money, that causes the value (the purchasing power) of the money to go up, that causes the price of the products to go down.

The prices would not go down, if the value (threw the demand) of money had not gone up. If the value of the money had been kept the same, by an increasing in the money supply. Prices would have stayed the same.

You may, as you do, disagree that increasing the money supply, to offset the increase in the demand for money, is a good idea. But we should not, and i don't think we do, disagree on the mechanics of why and how prices decrease.




Price stabilization targeting was the goal of the Fed in the 1920s. They inflated massively to offset productivity gains. It ended in the great depression. The book is a good read.


They where still under a gold standard. In a world where paper money is exchangeable for gold, you need to keep the value of the the paper money the same as that of the gold. If the demand for gold has not increased, but the demand for paper money has increased, you need increase the supply of paper money to keep the paper money from getting more valuable than gold.

The beauty of paper money exchangeable in gold is that this this increase in the supply of paper money (to keep the value of gold and paper money the same) is automatic and relatively decentralized.

When the demand for paper money increases, paper money will get more valuable than gold. More people will exchange gold for paper money, the banks that issue the paper money will simply print it. This increase in the supply of paper money will drive down its value. This will continue until again, the value of gold and paper money is the same. If the supply is increased to much, people will increasingly exchange the paper money for gold.. decreasing the supply of paper money, wich will increase its value until its the same as of gold.

I don't think the great depression was caused by monetary reasons, but by fiscal. Even under a gold standard you can kill the economy, with high taxes and tariffs.




The CPI is a consumer goods prices. If those consumer goods contain commodities, which they all do, then it is included in the CPI.

The commodity boom of the 70s was based both on reckless monetary policy and legitimate resource shortages. Monetary policy alone doesn't determine the price of oil. Due to those resource shortages large investments where made in the development of new resources, leading to an oversupply throughout the 80s and 90s. This wasn't the result of deflationary monetary policy (inflation was high) but rather a whole new supply/demand equation for commodities.

The fact that both the commodity boom of the 70s and its collapse in the 80s, did not cause any noticeable change in CPI, suggest that CPI figures are not reliable. (The CPI kept increasing at much the same rate as it had since the 50s.)

Commodity booms and busts will occur regardless of monetary policy, simply because of periodic demand and supply cycles. But monetary policy sure can make things worse than it has to be. If the price of all commodities (and gold) are going threw the roof, maybe its time to make the currency stronger. If all commodity prices (and gold) is falling threw the floor maybe its time to make the currency weaker. This way prices in general get less volatile.

Cheers