There have been many economics questions in the past few months and so has sparked in me some questions.
One is:
How does a monetary system on the gold standard handle an increase in wealth creation?
Background: Assume, for simplicity, that the amount of gold is unchanging. Assume the monetary system uses a currency that is backed by gold - one can get their gold by turning in currency. You can also assume a central bank exists and that the currency is a national one.
I know the amount of currency in circulation can be much larger than the amount of gold in the reserves because the bank could notice that it could loan out $10 (for example) for each $1 of gold because noone redeems their currency for gold.
However, the amount of gold is fixed…and there seems to be a limit in how large a multiplier one could safely get away with…if not 10x gold reserves, then 50 or 100…but there seems to be a limit.
Now…people produce wealth…and lets assume the wealth is created faster over time than it is destroyed or consumed. Is that a reasonable assumption? If so, would currency on the gold standard slowly deflate over time?
Yes. And you have hit on the primary reason why major economies have abandoned the gold standard: the monetary policy can be much, much more expansive without such a standard.
And you don’t need a physical store of wealth to keep a currency valuable. You need to rely on the good faith/good knowledge of the powers that be instead of a physical medium, but really you always needed those people.
Slight WAG here, but I think the main idea behind the gold standard was that at any time, you could ask for your fiat money’s worth of gold. Banks could loan just as freely as they wanted expanding the wealth of the world, but at any given moment, everyone could come in and demand to get paid in real, solid gold however much they had in their account. Since there was a finite amount of gold, banks had to be a bit more careful of how far away from the dollar amount of all of the gold they had access to they would get.
With a stable amount of gold, I suspect that eventually the money market would cap. The issue isn’t really with individuals withdrawing their money as gold, but rather other nations. That makes it a real issue.
A nitpick, but the gold value of fiat money is zero - that’s the definition. Representative money is money that has a legal value equal to specified amount of gold. Then there’s commodity money in which the money is the gold itself (or whatever other commodity you use).
The dollar today isn’t fixed to a specific amount of gold. Back in the day you could take a dollar and get an ounce of gold (made up number) from a central bank. It didn’t matter if you did that October 4th 1853 or June 3rd 1875. Your dollar would get you one ounce of gold. There is no such gauranatee today.
Yes, that’s the essence of it. And the people would have to suffer all the problems and volatility that a deflating currency would carry with it.
This is the relevant equation of exchange based on the quantity theory of money: M * V = Y * P,
where M is the money supply, fixed in this case, V is the velocity of money (how fast the average dollar changes hands; often assumed to be fixed for convenience), Y is the real output level, and P is the general price level (the change of which is the inflation rate). If the left hand side of the equation is fixed, then any increase in real output must correspond to a decrease in prices. Bad news, there. There are plenty of prices that are sticky and don’t want to deflate. There’s not many people out there would actually accept a pay decrease on the assumption that their salary is going to be worth more next year because of a general decrease in prices. And that’s not even covering the benefits of a small touch of inflation due to standard monetary policy based on a central bank’s open market operations.
The problem is that if you’re stuck in a hyperinflationary cycle, your reichsmark or your pengo isn’t going to buy you very much gold.
A dollar that’s worth a gram of gold will always be worth a gram a gold. The problem that gold bugs ignore is that it’ll never be worth more than a gram of gold. You’re better off with a currency that can rise with the general wealth of a society rather than have a currency that’s tied into one fixed commodity. If you do that your economic growth is stagnated by a artificial shortage of capital.
I’m not an economist. I can’t be that mysterious. However, some of you are missing a very basic fact. The amount of available gold changes. It is not stable. There are enterprises known as gold mines.
The money supply with a gold standard isn’t actually constant, no, but the change is so small as to be negligible. We simply do not mine enough gold to keep up with changes in our output level. And supposing we found a magical new source of gold, some super mine in space or whatever, the resulting expansion of our money supply would quickly outstrip our output level and we’d be left with horrendous inflation.
We simply can’t control the output of mines as reliably as we can the output of our printing presses. This control is a good thing. It allows us to expand or shrink our money supply as the situation changes. Expansion is exactly what the Fed has been doing the last year, and this is the primary reason why our recession is likely to end this year. Compare that to the situation during the Great Depression, where they stuck by the gold standard for 3 years as the economy tumbled further and further down, until FDR was finally elected and we dropped the fixed standard, devalued the currency, and began the process to recovery.
It depends on whether the economy grows faster than miners can dig coal out of the ground. During most of the Nineteenth Century, when the American economy was growing very rapidly, prices did in fact trend downward.
Even under the gold standard, the Fed had tools (reserve requirements and the discount rate) with which to massage the money supply–tools which it spectacularly failed to use between 1929 and 1933. If they had controlled the base money supply as well, there is little reason to think they would have done any better.
Actually, there is. The sooner countries abandoned the gold standard, the sooner their recovery started. That’s not to discount the other tools available, but there’s simply no comparison between the comparative effects.
Romer, the current chair Obama’s council of economic advisers, did some influential work on this. Her research also indicates the overwhelming importance of dropping the gold standard, the single biggest factor in the recovery.
Since the Gold Standard was dropped, the overall stability of the market has improved significantly. It was still prone to dramatic rises and falls, but the average rate of growth over multi-year spans locked in to about 3% a year and has remained so until modern day.
The problem with a gold standard is that it makes money a scarce commodity. Which does keep the value of money high but does nothing for the overall economy. Money doesn’t create anything just by existing. Money creates wealth by circulating.
Imagine three people, each of whom have a good business idea. In an economy with “loose” money, each of them will probably be able to find investors who will loan them money to start their businesses. They’re good ideas so each of their businesses succeed. They hire people and develop and build products and repay their loans. The economy grows larger.
Now imagine the same three people in a gold standard economy. Investors may recognize that their ideas are all theoretically good but money is scarce. There simply isn’t enough money out there to invest in every good business idea. So at best only one of these people gets a loan and is able to start his business. The result is fewer new jobs and fewer new products. This gold standard economy grows only a third as much as the previous one.
I’ll accept that. The definition of “recoverable” changes a bit with the price of gold. For example, a few decades ago, a big spike in the price made some unprofitable projects look good. At that time, an old friend of mine got his geology degree. He was hired by an adventurous company with a mountaintop mine in Montana*. The ore had to be helicoptered out. Just a few months before, with a lower gold price, the scheme would have been wildly unprofitable.
*Yes, a certain song was played many times at the farewell party.
Just an academic question 