In this thread about Ron Paul there was an interesting sidebar regarding the Gold Standard. I must admit I understand little about “money creation” through a fractional reserve system, the potential risks of fiat currency, the role of central banks, and the potential consequences in today’s world of a commodity based currency system such as the Gold Standard.
I have no position at this point but I am shocked to discover that the arguments for a gold standard do not actually sound so looney when I hear them out. I’m not convinced by them, mind you, but would love to read a good debate by those who understand these issues better than I.
The Gold Standard is not intrinsically a disaster, but it makes the monetary system less flexible and more tied to commodity markets. That can be rough, and I think virtually every nation on earth has abandoned it for those reasons.
Probably a good start to see exactly what a Gold Standard is. Found this article on about.com which is fairly good:
The short answer to your OP is that a Gold Standard is fairly inflexible, and it doesn’t work well in a rapidly changing environment. It doesn’t react very well to change, especially rapid change…and it’s very limiting on your economy for all those (and other) reasons. I think people look back on a Gold Standard the same way they look back on any perceived golden age (heh)…through rose colored glasses.
That’s only half of the story. Inflation is not solely determined by the rate of growth of the money supply. The rate of growth of the economy is another huge factor. If the growth rate of the economy outstrips the growth rate of the money supply – and the real price of gold has been rising steadily for decades now, which indicates that the growth rate of the supply of gold is indeed being outstripped by the rate of growth of the economy – then you get deflation, and all of the problems associated with that.
Inflation can also be spurred by real costs to the economy. In the 1970s, the U.S. had inflation because the price of imported oil went up – which, since all production/distribution/provision of goods and services in this country depended (and still depends :eek: ) ultimately on automotive transportation at one or several points along the line, indirectly raised the price of everything else. It had nothing to do with an expanding money supply, nor with real economic growth – in fact, that was the era when the term “stagflation” was coined.
Thanks, xtisme. That was very educational for being so concise.
While I can appreciate the idea of placing limitations on TPTB concerning the money supply as an inflation control, it seems to me that the gold standard steps away from the conceptual beauty of currency; that is, money is simply an abstract representation of value that provides a common unit of exchange for goods and services.
My economics knowledge is rather sparse, so I’d appreciate any input on the following. If the primary benefit of the gold standard is to control the money supply (i.e., one source of inflation), wouldn’t a comparable solution be to enact such a control through legistlation? That is, place caps on the [in|de]crease of the money supply in a given time frame, probably as some percentage of the GDP. Is that a stupid idea? If so, why?
On preview, I note Rysto’s point. But I think that caps tied to the GDP would take care of it. Also, now that I think about it, isn’t the amount of gold in the world fixed (not that there is no more to be mined, but that there are constraints imposed by having to retain a physical repository of any resource, be it mining more, securing it, transporting it, etc.)? Or is that easily solved by something I’m not seeing?
Pretty much, but the amount of gold on the market is not. Most of the world’s gold, I think, is in vaults such as Fort Knox where it just sits around being as auraceous as it can be – but from which it could be sold off at any time.
So, again I have to proclaim my economics ignorance and am looking for some education.
Wasn’t the solution to stagflation put in place by Volcker at the end of Carter’s administration? IIRC, it was to severely restrict the money supply, right? More to the point of this thread, would being on a gold standard have changed the situation in any appreciable way? (Or was your post simply a clarification/expansion concerning possible reasons for inflation?)
It’s not a stupid idea. This type of monetary policy is call “Monetary Targeting” and it was a popular idea among economists in the 1970’s. In the most part it ended up being a huge failure in practice. The exact reason for the failure is not known but there seemed to be some kind of feedback loop in the economy that was very difficult to predict. The US and UK missed their targets repeatedly against all known theory, and in Canada they hit their targets but inflation stayed out of control.
In my opinion, one of the problems with monetary targeting is that it confuses means with ends. Controlling the money supply should not be considered the goal – controlling inflation is the goal. Therefore, monetary targets should be thrown out the window and the Central Bank should instead focus on direct inflation targets.
In answer to BrainGlutton’s point, I should point out that when I’m discussing inflation I mean long-run inflation. In the long-run, people can substitute away from oil if the prices rise too much. Short-run inflation is a much more chaotic force in the economy and focusing on it tends to be counter-productive.
No, they can’t – not without completely rebuilding our national transportation infrastructure, demolishing all the sprawlburbs and rebuilding everything more compact and walkable – a process which itself would consume a lot of oil and is probably politically and economically impossible anyway. (Hint: There isn’t going to be any “hydrogen economy.”)
Most people would agree that the primary criterion by which a currency scheme should be judged is price stability. Price stability facilitates borrowing, lending, and long-term contracts, all of which conduce to a thriving economy.
It isn’t obvious whether specie or fiat money wins based on this criterion. Consider changes in the Consumer Price Index and its predecessors since 1800.
In the short run, specie prices can be very unstable–up 3.7% in 1847, for example, and then down 7.1% in 1848. Not so hot if you’re trying to figure out a fair return for a 12-month CD.
In the long run, however, specie is just swell, and fiat money is awful. The CPI was 51 in 1800, 41 in 1932 . . . and 618 in 2007. Not so hot if you’re trying to figure out a fair rate for a 30-year mortgage.
However, in all honesty, I don’t see us ever going back to a system in which prices might go up 4% next year, or down 8%, depending on how much the economy grows and how much gold is mined. People won’t accept it. People prefer the chronic but relatively predictable (at least since 1982) inflation of fiat money.
BG plenty of other alternatives that use much less oil. Buying smaller cars, switching to the new diesels, hybrids, PHEVs, soon to be available Extended Range EVs (EREVs), BEVs, heck even biking more in nice weather!
Can I have some explanation of the risks and benefits of fractional reserves and how it expands the money supply, effectively creating money that isn’t really there?
Thanks for the quote; seems about right to me (particularly the bit about Reagan…I was a wee lad in the early '70s). However, isn’t part of “Along came President Jimmy Carter” what Volcker did? According to Wikipedia:
So, while I can’t confirm which is more correct (since it’s not really an either/or), it’s nice to see that my memory isn’t totally off.
Thanks for the vote of confidence. What you describe isn’t quite what I was thinking, however. From what I gather, what was implemented was more like a central planning office or an algorithmic control of the money supply. I was thinking more along the lines of keeping the Fed as it is now, but with caps on what they can do. Granted, so long as the chairman is monetarily conservative, such caps shouldn’t ever be invoked, but much like presidents, there’s no telling what future policies (or chairmen) will be.
Of course, such legislation also assumes that current understanding of economics will be applicable; if stagflation was “new” at the time, there are surely other situations that are currently undreamed of. I can see where it would be bad to tie the hands of the institution entrusted to enact monetary policy in the first place.
Fractional reserve banking arises out of a mismatch between the needs of lenders and borrowers. Borrowers want to borrow money with a fixed payback period–you want to know when you have to pay back a loan. Some lenders are willing to loan fur a fixed term, but many more aren’t–people will loan (put in the bank) a great deal more money if they know they can get it back whenever they want.
Fractional reserve banking finesses this mismatch by pooling and lending most of the money from a large pool of small depositors, knowing that some will want it back every day, but by the law of large numbers they won’t all want it back at once.
You can probably see the advantages and disadvantages of this without me even pointing them out. The advantage is that society mobilizes a huge pool of additional capital which would otherwise be unavailable to finance investment, which spurs economic growth. The disadvantage is that sometimes everybody will want their money at once–panic is contagious–and when that happens both the depositors and the bank are SOL.
Fractional reserve banking complicates monetary policy, because “demand deposits” (backed only by fractional reserves) are so closely equivalent to currency that they must be classified as money. From the standpoint of this thread, however, note that fractional banking can and has operated alongside both specie and fiat currency.
Well, it’s important to note that the system can’t create an infinite amount of money; in the Wikipedia example, the most money that can ever be in the system due to the original $1000 is $5000.
The difference between specie currency and fiat currency isn’t that there’s all of a sudden 5x as much money in the system. The difference is where that original $1000 comes from. In a specie system, there’s $1000 of gold sitting somewhere in the Fed’s vaults. In the fiat system, there’s a piece of paper saying the US government owes the Fed $1000.
No, they can’t – not without completely rebuilding our national transportation infrastructure, demolishing all the sprawlburbs and rebuilding everything more compact and walkable – a process which itself would consume a lot of oil and is probably politically and economically impossible anyway. (Hint: There isn’t going to be any “hydrogen economy.”)