Hands of gold are always cold, but Bernanke’s hands are warm


James K

James is a government policy analyst, and lives in Wellington, New Zealand. His interests including wargaming, computer gaming (especially RPGs and strategy games), Dungeons & Dragons and scepticism. No part of any of his posts or comments should be construed as the position of any part of the New Zealand government, or indeed any agency he may be associated with.

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97 Responses

  1. Avatar Kolohe says:

    Good post, goldbuggery vexes me as well. #3 also sometimes gets lumped with fractional reserve banking as all that is wrong with the world.Report

  2. Avatar BlaiseP says:

    If only the Fed used Rules, you say. I write AI systems which use lots of different feedback mechanisms. The Taylor Rule is woefully simplistic, as was Greenspan’s system and Volcker’s before him. Every time the economy looked a little puny, friendly old Dr. Greenspan would give it yet another fortifying slug of hooch to perk it up. Medicinal, you know.

    It could not last. It is possible to be both drunk and hung over. Indeed, having conducted the experiment on myself in my youth, I can assure you it is true. Greenspan’s steady misapplication of the Fed Funds rate would lead to investors rushing into real estate in hopes of finding some security.

    The problem with the Taylor Rule is this: cutting interest rates to improve GDP only encourages more imprudent investing where such investments are possible. Consider China, playing games with its currency valuation, hoovering up US investment dollars.

    The answer to this seeming conundrum is exceedingly obvious: if you want money that means anything, you match your interest rate to a set of vector sums of GDP. I’d start with the two year GDP as neutral territory and put in a one year future projection for a target.Report

    • Avatar James K in reply to BlaiseP says:

      If only the Fed used Rules, you say.

      Actually I didn’t say that, I merely said it was an alternative worth exploring, I don’t actually have a view on whether rules would be better than the status quo.

      It could not last. It is possible to be both drunk and hung over. Indeed, having conducted the experiment on myself in my youth, I can assure you it is true. Greenspan’s steady misapplication of the Fed Funds rate would lead to investors rushing into real estate in hopes of finding some security.

      Taylor makes that exact criticism of Greenspan.

      The problem with the Taylor Rule is this: cutting interest rates to improve GDP only encourages more imprudent investing where such investments are possible. Consider China, playing games with its currency valuation, hoovering up US investment dollars.

      The purpose of the Taylor Rule is to promote price stability (i.e. keeping inflation low and as constant as is possible), not to promote GDP growth.Report

      • Avatar BlaiseP in reply to James K says:

        If we’re interested in price stability, inflation is a secondary concern. Inflation can be easily managed by tying the interest rate to GDP: as inflation appears, we increase the Fed funds rate to compensate.

        Something approximating the Taylor Rule is already in effect for a while. Here’s the fundamental problem with Taylor Rule: it focusses on short-term interest rates and not a year-over-year GDP. In an slow economy with huge amounts of slack, inflation won’t appear for a long time. Inflation is only a symptom. It is not a cause. While Greenspan was worrying about the bugbear of inflation, he was not responding to the root cause, rises and falls in GDP.

        At its core, the Taylor Rule is prescriptive of short term symptoms. It does nothing to address stability. If we want stability, monetary policy ought to take a longer term view, at least a two year view. The only important variable in Taylor Rule is GDP, the strength of the economy itself.Report

        • Avatar James Hanley in reply to BlaiseP says:

          Inflation is only a symptom. It is not a cause.

          A symptom of what?Report

          • Avatar BlaiseP in reply to James Hanley says:

            As with fevers, it could be any of a number of things.

            Let’s put aside the obvious causes such as printing too much money, or as with the British fighting in America, outright forgery.

            The Austrians would tell us it’s all a question of money supply. With the exceptions noted above, this viewpoint is complete bullshit. Astrology.

            In a thriving economy prices rise in consequence as a result of an increased demand for goods and services. Commodity prices rise as a result of increased demand. The stock market rises as investment demand increases. Workers get raises because the cost of their labour can be successfully passed along to consumers. All this is obvious enough. The Austrians go hugely astray when they try to it’s all about the money supply and they’re wrong. It’s about aggregate demand and supply, the gross domestic product. These Austrians don’t even listen to their own economists: Hayek tried to tell them money is only as useful as what it can buy. Problem is, it’s not what backs the currency that makes it valuable. It’s money’s ability to serve as a conduit of commerce that makes it valuable.

            Ron Paul should be locked up for his own good. Maybe put him on Haldol or some other powerful antipsychotic. He’s hearing voices. Yes, gold can be a measure of money — if you want to buy gold, that is. Want to keep inflation low? Hang onto your money, put under your damn mattress, grow your own food, build a bomb shelter and fill it with canned food like those Mormons and freaks out in Idaho. Don’t participate in the real world, where everyone has to add value to the proposition and get paid for his work.Report

            • Avatar James Hanley in reply to BlaiseP says:

              Austrians aren’t the only ones who would say inflation is all a question of money supply, though, right? And isn’t it the case that lots of economists, perhaps most, wouldn’t call a price increase in response to increased demand inflation?

              A price increase in response to increased demand will result in price increases for particular goods, whereas an increase in the money supply (if it outpaces the capacity to increase output) will result in a general price increase. These are different phenomena–is there wisdom in using the same term to describe different phenomena?Report

              • Avatar BlaiseP in reply to James Hanley says:

                I’ve already encompassed the case for mere money-printing, that’s the monetarists’ case in a nutshell. Milton Friedman made this case quite well. Though I don’t agree with much he says, even a blind pig can find an acorn from time to time. I am with Friedman: if we are to adjust the money supply, it ought to be on the basis of demand. GDP is a fine basis for measuring demand. Belay all this short term interest rate nonsense. Milton Friedman said insofar as we can derive meaningful demand numbers, that ought to guide monetary supply.

                See, as with science and scientists, we ought to study economists in the context of their times. This is especially true of Friedman and Keynes. A simplistic reading would say Friedman and Keynes were polar opposites. They weren’t. Look at when Volcker went hog wild in the 1970s: he damned near killed the economy with his deflationary schemes. Economies are great big ships. Takes a lot to get them moving and a lot to stop them. Volcker stopped the ship all right — by running it aground.

                You ask if price increases in response to increased demand inflation. Not of necessity. Lots of factors go into such increased demand and increasing prices. Most commodities, take oil futures as an example, might move up on the basis of the latest uncertainty with Iran. People want to take positions at market to ensure future delivery: the speculators anticipate this and make profits. Is this inflation? I don’t see it as inflation. It’s a market responding to increased demand. The value of other markets won’t be affected.

                In fact, there are people I’ve worked for who had me build a model. Here’s how it works:* take the ten largest futures markets, sum the total value of current contracts (gets pretty big!), and watch the total value move in relation to the dollar. You can bet with this index, in which case you’ve created a hedge against deflation, or against it as a hedge against inflation.

                * it’s considerably more complex than just summing the values: the firm has to take positions in the market, sell winners and buy losers to keep the index balanced, and that’s just the start.Report

            • Avatar Nickleby in reply to BlaiseP says:

              Just for the record, Paul is in favor of denationalizing the currency. Big difference. He wants competition in currency and then the market would decide which type is preferable. That was hayek’s stance as well.Report

              • Avatar BlaiseP in reply to Nickleby says:

                Ron Paul has been peddling his Fear Schtick for long enough. He has to go. He might know something about deliverin’ babies but he’s a completely incompetent economist.

                Hayek could never have contemplated a world where currency arbitrage could first create the Eurodollar, then the Euro outright. Hayek was on the right track though, theoretically. Currency arbitrageurs have given us the mechanisms for the market to decide which currency is preferable.Report

              • Avatar M.A. in reply to Nickleby says:

                We tried that for over a decade.

                It didn’t end well. In fact, it was one of the principal reasons we convened this little thing called the “Constitutional Convention” in 1787. We had 13 states issuing their own paper currency, we had a national currency that a large number of merchants in the states wouldn’t take or argued over the exchange rates for. We had promissory notes issued for grain and tobacco and other produce being exchanged willy-nilly in lieu of currency. We had foreign coinage being used all over the place.

                It was a complete fishing mess and I’m inclined to agree with BlaiseP, Ron Paul should be locked up in a nursing home and medicated for senility, since his mind’s gotten rhapsodic for the days of his teen years when that many currencies were in circulation and he was fighting the Redcoats alongside George Washington.Report

  3. Avatar Jason Kuznicki says:

    The fact is that plenty of people use gold as money today. What is one of the chief purposes of money? It is to serve as a lasting store of value. Worldwide holdings of gold are inexplicable via any other purpose.

    I’m going to have to write a post on the theory of money soon, but the basic point will be this: Money is not “the thing created by central banks and/or governments.” It’s also not gold or any other commodity. Money is a way of using and treating stuff. It’s a game that we all know how to play.

    Virtually all of us play the money game with the U.S. dollar. It’s convenient and the game has lots of fringe benefits when we play it with dollars.

    Many of us also play the game with gold, some possibly in the hopes that lots of others will join in and the gold side of the money game will be where the real action eventually migrates (not me, however; I don’t consider gold a particularly good store of value at the moment). Bitcoin represents an attempt to play the game with some very new stuff.

    But it is ultimately the same old game, and the same rules tend to apply. Most of the important rules aren’t the ones set up by issuing authorities or market players; they are rules that emerge from the existence of lots of folks simultaneously attempting to play the game. They come into force as a function of more and more people actually doing so, and they are very difficult to legislate around.Report

    • Avatar DensityDuck in reply to Jason Kuznicki says:

      Indeed, up until the latter half of the Twentieth Century, gold wasn’t even much use! At least, from a practical industrial viewpoint. It had some application to dentistry and to electroplating, but the electronics industry that would find its conductive qualities useful didn’t exist yet.

      I suspect that this was why so much mid-century SF talks about “uranium dollars”, with uranium (an eminently useful element) replacing gold.

      “Most of the important rules aren’t the ones set up by issuing authorities or market players; they are rules that emerge from the existence of lots of folks simultaneously attempting to play the game. ”

      Which, probably, is the primary reason why libertarians are so distrustful of the notion of market regulation. Their attitude is that the market regulates itself, in an emergent fashion, the same way that a bunch of fibers contracting in response to electrical impulses can create the gross physical distortions of flesh and bone that enable me to type this message.Report

      • Avatar Jason Kuznicki in reply to DensityDuck says:

        The existence of emergent rules in a general sense is not a guarantee that the rules that emerge in a particular instantiation will be a full or desirable set. Nor is the full set — which will emerge, given the right underlying gamepieces and supporting structures of law — a guarantee that nothing bad will happen.

        It’s fascinating to re-examine Ludwig von Mises’ Theory of Money and Credit in this context. It’s become one of the ur-texts of the goldbugs, but Mises’ claims about the credit cycle are remarkably modest. Credit cycles will exist in any economy that has credit, he argues. The tendency for governments is to make things worse, not better, but the cycles themselves just are not the government’s doing. Gold is (circa 1912) the best available weapon to fight inflation, and the state should avoid manipulating credit markets. But that’s about it. Fairly tame stuff, actually.Report

        • Avatar BlaiseP in reply to Jason Kuznicki says:

          Oh dear. The Credit Cycle. Economic astrology. Any currency trader will gladly concur with Mises’ beliefs about trading paper money for a coffee and a newspaper, receiving metal coins in exchange, of no special value except what he can trade them for.

          Thereafter, Mises has no valid explanation for either booms or busts. I am truly amazed that educated people can go on believing he has an answer for anything after 2008, when the so-called Free Market blew itself to pieces and it was only the ability of government to manipulate credit markets which saved us.Report

          • Avatar Jason Kuznicki in reply to BlaiseP says:

            Well. Who wrote these words, then?

            Every time the economy looked a little puny, friendly old Dr. Greenspan would give it yet another fortifying slug of hooch to perk it up. Medicinal, you know.

            It could not last. It is possible to be both drunk and hung over. Indeed, having conducted the experiment on myself in my youth, I can assure you it is true. Greenspan’s steady misapplication of the Fed Funds rate would lead to investors rushing into real estate in hopes of finding some security.

            Like it or not, this is exactly what Mises warned about. This is an Austrian business cycle.

            Was the Austrian remedy — liquidate failing banks, tighten credit — appropriate? That’s a different question, and I don’t think time has been too kind to the Austrians here. But the idea that artificially low interest rates would lead to a systematic misallocation of capital is just Austrian business cycle theory in a nutshell, no more and no less.

            (I’d add that there may be other types of business cycles, too, and that the existence of some specifically Austrian cycles does not preclude the existence of other, non-Austrian phenomena that look superficially similar but that stem from different causes.)Report

            • Avatar BlaiseP in reply to Jason Kuznicki says:

              I did. And if there is a relationship to Austrian Economics, the problem began when the Free Marketeers (who had successfully pushed for Austrian-style deregulation) began to make secret and highly irregular bets upon that capital flight. There’s your Austrian Business Cycle.Report

              • Avatar Jason Kuznicki in reply to BlaiseP says:

                If you’ve spent any time at all with the Austrians, you’d know that they were no fans of Greenspan or his monetary policy. To lay the blame at the feet of the Chicago School is possibly more justified, but it takes some arguing about financial regulations as the real cause of the crash — a difficult claim, to my mind, with “easy credit” making such a strong case all the while. This though is the very opposite of what Austrian theory would have urged in the years just before 2008, so again, the crash can’t be blamed on them.Report

              • Avatar BlaiseP in reply to Jason Kuznicki says:

                I have spent time with Austrians. I did some consulting for an outfit name of Rand Financial. Yes. Named for Ayn Rand. Boy howdy do I know Austrians.

                Credit is risk. I say risk must be regulated and placed in open markets. You and the Austrians seem to believe this is all a misallocation of capital. No, Jason. It’s a misallocation of information. If the Libertarians were the least bit serious about Booms and Busts, they would be screaming for more regulation of risk markets.

                Since they are not, we can go on Teaching the Controversy for as long as you like. I blame 2008 on Greenspan, a self-described Austrian whose nose was at last rubbed in his own shit like a disobedient puppy and was forced to admit he had no idea the investment banks would operate so stupidly.Report

              • Avatar M.A. in reply to BlaiseP says:

                Trusting in the banks to self-regulate was letting the fox guard the henhouse.

                Trusting in the banks to self-regulate while simultaneously letting them dump savings accounts in the stock market was handing the fox a ketchup bottle.

                Trusting in the banks to self-regulate while simultaneously letting them dump savings accounts in the stock market and bundle home loans into “securities” that those savings accounts were then invested in in the stock market? Now that was asking the fox to guard the henhouse while handing him a Smoky Joe, a 20lb bag of charcoal, a 12oz can of lighter fluid, and a fully equipped spice and sauce rack.Report

              • Avatar BlaiseP in reply to M.A. says:

                You should have seen what I was made to do at Citigroup. I literally pulled their loan rules application in half. Where once mortgages and car loans and credit card applications were routinely denied, I was asked to route those denials from No and Hell No and Fuck No into ever-higher interest rate loan offers.Report

              • Avatar Jason Kuznicki in reply to BlaiseP says:

                The fact remains, unrebutted: What you described was an Austrian business cycle. And I agreed with your previous comment. (Do you?)

                Greenspan spent some time with Ayn Rand, sure. But there’s absolutely nothing in his academic pedigree or his actions in office to suggest that Greenspan was an Austrian. Sort of the opposite, rather — his Ph.D. advisor nixed Murray Rothbard’s thesis. Even if Greenspan were an Austrian, he would be the most heterodox Austrian ever, one who very clearly repudiated the school’s teachings about a central bank’s ability to foment a credit boom.Report

              • Avatar BlaiseP in reply to Jason Kuznicki says:

                Astrology also makes predictions and explanations. Some of them come true. But it’s an ex-post-facto explanation, featuring tortured reasoning.

                Why did 2008 happen, in your estimation? The Austrian Business Cycle is a perfect explanation for 2008 but not because credit was misallocated. Information was misallocated. Mises was absolutely right about how these things manifest. He was utterly and completely wrong about why they happen. Greenspan was to blame for 2008, believing the private capital markets would behave intelligently. They did not. Therefore, it seems to me you ought to explain why the private capital markets did not adequately cope with unregulated risk. Unless and until you can do so, I remain genially of the opinion the Austrians have the cart before the horse.Report

              • Avatar James Hanley in reply to Jason Kuznicki says:

                but not because credit was misallocated. Information was misallocated.

                Is there a relationship between the two? Can the former happen without the latter?Report

              • Avatar BlaiseP in reply to Jason Kuznicki says:

                Simple answer, James: No. It’s like that old joke flowchart: Did you fuck it up? Yes? Can you hide it? Yes? Problem solved.Report

              • Avatar James Hanley in reply to Jason Kuznicki says:

                There’s actually more than one question in there.

                1. Does information misallocation necessarily cause resource misallocation?

                2. Is information misallocation the only cause of resource misallocation?

                The answers to the two questions may or may not be independent of each other.Report

              • Avatar BlaiseP in reply to Jason Kuznicki says:

                Begged questions in both forms.

                1. Does information misallocation necessarily cause resource misallocation?

                Fano’s Inequality. Information allocation may be imperfect but it certainly improves when you understand how much you can rely on it.

                2. Is information misallocation the only cause of resource misallocation?

                Pretty much nonsense. We’re talking about risk, not resource allocation. If you knew a billion dollars worth of diamonds were buried under your house and nobody else did, would you rent a bulldozer and start digging?Report

              • Avatar James Hanley in reply to Jason Kuznicki says:

                It’s logically impossible for a question to beg the question.

                However it’s quite possible to dodge the question.Report

              • Avatar BlaiseP in reply to Jason Kuznicki says:

                Look, you can’t call risk a resource. That’s the begged part of your question. Logically impossible.

                Information theory starts taking over here. Risk can be quantified but only to the extent information is available. If any of the Wall Street investment banks were aware of how their policies of putting off risk onto each other was only creating a spider web which would take them all down at once, they would not have been playing the CDS game. They would have stuck with the underlying revenue streams from those mortgages, paying closer attention to the strips thus generated. They weren’t aware. Lack of information. They went from strips to swaps, selling insurance to each other without the Actual Resources, that is to say, the Kash Moneh to pay.

                When the Fed marched into Bear Stearns and realised what was going on, they started checking all its counterparties and found they were all up to their necks in risk exposure.

                So, if you insist, very generally information misallocation does necessarily cause “resource” misallocation, but only if we play this stupid game of calling risk exposure a resource.

                Now let’s address your second concern, though it’s only a rephrasing of the first. Is information misallocation the only cause of resource misallocation? In the case of risk, absolutely.Report

              • Avatar James Hanley in reply to Jason Kuznicki says:

                Look, you can’t call risk a resource. That’s the begged part of your question.

                Great, except I never did any such thing. Perhaps you could answer without resorting to wild distortions of what I wrote?

                And the second question absolutely is not a rephrasing of the first. Either can be true without implicating the truth of the other.

                1. Does X necessarily cause Y?

                2. Is X the only cause of Y?

                Look at them carefully. They’re logically independent of each other. Definitely not the same question at all.Report

              • Avatar BlaiseP in reply to Jason Kuznicki says:

                Have it your way, James. The answers are Yes and Yes.Report

              • Avatar James Hanley in reply to Jason Kuznicki says:

                I think that’s probably right. Certainly I can’t see how bad or missing information couldn’t cause suboptimal investment decisions. As to the second, I was tempted to suggest that pumping too much money into the economy could itself cause bad investment decisions, but I think if information was perfect people would recognize what’s going on and respond appropriately–I think the harm must come from at least some people being fooled by the increase in the money supply (and others banking on some people being fooled).

                It’s not my area of expertise, though, and I don’t pretend it is.Report

      • Avatar Kimmi in reply to DensityDuck says:

        oh, you did not just go there. I’m sorry, but the electrochemical neurology is absolutely not the metaphor you want. Try homeostasis next time?Report

  4. Avatar James Hanley says:

    Very nice post, James. I remember Jack Kemp pushing the gold standard when he ran for prez–it was all a bit horrifying.

    Frankly I think the Fed has mostly done a pretty good job. Considering we’re dealing with humans, our starting assumption should be that any institutions we devise are going to be imperfect, so of course the Fed is, too. But setting up an agency where the political temptations are minimized is a pretty good idea for this sort of thing–far better than leaving control of the money supply to the Treasury, which in itself is far better than leaving control of the money supply to the legislature.

    Perhaps a fixed rule would be better most of the time, but because humans lack the ability to define rules that apply to every situation, a fixed rule has dangers as well. Perhaps the fixed rule with the capacity to not follow it at times, with required explanation to Congress, might be the best way. That’s assuming, of course, that we can get the experts to agree on the rule.Report

  5. Avatar Jaybird says:

    One thing to keep in mind while wondering about the crazy folks out there, there may be a reason that they’re crazy. There have, in fact, been a number of countries that tried to solve a number of problems through printing money. From the wheelbarrow stories of Germany from a hundred years ago to Zimbabwe, there are stories of stacks of cash being worth nothing at all. (One of my friends has one of those Zimbabwe notes worth “billions” decorating his cubicle, for example. If it were a $20, I’d think that he might have to worry about someone (from another department entirely, or the weekend cleaning crew, or the night watch) lifting it. As it is, it’s only a billion Zimbabwe dollars. He’s got it pinned to his wall.

    You say “After all, Greece, Spain and Italy can’t print their own currencies and that hasn’t stopped them.” which is an interesting point because, I suspect, we’re going to see an interesting thing or three happen with the Drachma when Greek exits the Euro… and here is the question I want you to think about: how will the Greeks who bought gold be doing compared to the Greeks who bought Greek bonds?

    I’m not a Goldbug myself (to meet that definition I think you’d at least have to buy gold in your free time and I don’t) but I do think that it’s more likely that we will see more opportunities for Goldbugs to say “I told you so” in the near future than we will for monetarists.Report

  6. Avatar M.A. says:

    Short and sweet responses:

    1. Boom-bust cycles predate Central Banking practices, and the worst of them in recent memory – the Great Depression – happened despite a monetary policy tying money to a tangible metal in storage.

    2. Governments can print their own currency, sure. The problem isn’t that. The problem is that nobody can agree on making taxation rates nominally equal to what the public has decided needs to be paid for in government services.

    Everybody wants something for nothing. Especially the rich, who give (as a percentage basis) far less than the middle class.

    3. Currency with a “real value” is itself a lie. The US government at one point pegged 1 dollar to a certain number of ounces of gold, and then held a static exchange silver-to-gold rate. This massively inflated the “value” of gold over time, and caused a couple of massive gold rushes and eventually boom-and-bust ghost towns when people decided that there must be massive gold veins to be mined in California and Alaska. What was the eventual response? Reduce the dollar-to-gold ratio, and adjust the silver-to-gold exchange rate.

    The best alternative I have heard is the drive for rules based macro policy, driven by John Taylor. Taylor argues that rather than leaving interest rates entirely up to the judgement of the Fed, the Fed should instead be required to specify a rule they will use to set interest rates, and if they deviate from the rule they have to explain to Congress why. You could even go further and mandate a particular rule by law, removing Fed discretion entirely.

    As much as I hate to stand up for the Fed, trying to set interest rates by algorithm is just going to encourage people to try to play the algorithm. There’ll have to be constant adjustments to it as people find new loopholes or sectors that the algorithm doesn’t take into account.

    Also, adjusting interest rates by the Fed isn’t the main cause of the current economic issues. The current issues are a result of fiscally un-sound deregulations in the repeal of Glass-Steagall combined with the effects of foreign governments like China practicing currency manipulation and product-dumping on the world markets along with ill-conceived “free trade” policies that benefit nobody but corrupt middlemen and cost jobs.Report

    • Avatar DensityDuck in reply to M.A. says:

      It is good to point out that commodity currency is entirely dependent on the limited supply. Not just the USA, but 1500s-era Spain experienced massive devaulation when large new sources of its chosen commodity were discovered.Report

    • Avatar James K in reply to M.A. says:

      I agree with everything you said there, barring the last paragraph.Report

    • Avatar Simon K in reply to M.A. says:

      There’s lots of problems with the Taylor rule, or as you say with any algorithmic approach. I like the relatively new market monetarist approach that says you avoid this (and several other problems) by targeting the market forecast of the required amount of money. That way any attempt to manipulate the Fed’s target results in the Fed adjusting its target.Report

  7. Avatar Michael Cain says:

    According to the numbers at Wikipedia, and assuming minimum-sized Olympic pools — 50x25x2 meters — then it would take right at 3.4 pools to hold all of the gold ever mined and refined.Report

  8. Avatar DensityDuck says:

    I think the idea behind “real value” is that people who hoard cash want to believe that it will always be worth something. If money is tied to a commodity, these people think, then inflation won’t exist because there won’t be any possible way for it to occur, and the dollar I put in a cigar box in the closet today will always be worth a dollar.Report

    • Avatar Simon K in reply to DensityDuck says:

      Its very common to see the von Mises crowd argue exactly that. It doesn’t work, though – money put in the cigar box does represent savings somewhere, but nothing ensures those savings weren’t wasted. Malinvestment doesn’t require inflation, even if inflation causes it.Report

  9. Nob Akimoto Nob Akimoto says:

    I think the biggest thing goldbugs don’t seem to realize is this:
    The US operates in a global economy, and unless you’re going to force everyone else (at the point of a gun? Nuclear weapons? Who knows….) to convert to a gold standard, the move would be entirely meaningless and lead to the very same thing that happened in the 60s with gold pooling and all sorts of scary trade restrictions trying to spring up to keep gold hoarding at a minimum.

    Let’s not even go into what the practical effects of converting would be. You’d think the two words “Specie Circular” would make people swear off goldbuggery forever.Report

    • Avatar Jaybird in reply to Nob Akimoto says:

      The US operates in a global economy, and unless you’re going to force everyone else (at the point of a gun? Nuclear weapons? Who knows….) to convert to a gold standard, the move would be entirely meaningless and lead to the very same thing that happened in the 60s with gold pooling and all sorts of scary trade restrictions trying to spring up to keep gold hoarding at a minimum.

      This misapprehends why Goldbugs are Goldbugs. They’d argue that everyone else *ALREADY* sees gold as something that has great inherent value. China, India, Egypt, Niger, Greece, France, England, Canada, Mexico, Argentina, Australia, Japan.

      Gold is useful there Romeo Foxtrot November.

      If guns are being pointed, it’s to keep people away from using gold the way that people already see it.Report

      • Nob Akimoto Nob Akimoto in reply to Jaybird says:

        You’re missing my point. It’s not that others don’t view specie as valuable, it’s that exchange rate parity and monetary policy don’t care about that value except that it provides a mechanism of arbitrage. If the US went back to gold convertability at a fixed rate, it would quickly find itself hit by countries who don’t care to disarm unilaterally.Report

  10. Avatar Katherine says:

    I’d appreciate further explanation of the reasoning behind advocating the gold standard, because to me (based solely on first-year economics) it seems ridiculous for a couple reasons:

    1) In the modern world, the government no longer controls the size of the money supply. Things like purchasing goods on credit, which everyone does these days, actually increase the amount of money in the economy. Or that was the gist of what I got from econ class.
    2) Gold seems arbitrary. Yes, we choose it because it’s rare, but even that’s been occasionally fallible (the Spanish Empire went bankrupt partially due to inflation from all the gold they brought back from the Americas). In contrast, when money isn’t based on the gold standard, its value is based on the amount of faith everyone else has in the government’s ability to survive and repay its debts. Hence, America’s first two attempts at non-gold-backed money – the Revolutionary War and Civil War – went terribly because America’s survival as a country was doubtful in both cases. These days, though, having the value of money based on perceived creditworthiness rather than an arbitrary mineral seems to make more sense for a stable and well-off nation.Report

    • Avatar James K in reply to Katherine says:

      I didn’t advocate the gold standard.Report

    • Avatar Simon K in reply to Katherine says:

      I don’t advocate the gold standard either, but you can make a decent argument in terms of modern economics something like this:

      1. Changes in the money supply only affect the economy insofar as they haven’t already been predicted. If you doubt this, consider what would happen if the Federal Reserve announced it was going to double the supply of dollars in a week. Prices would double now, nothing would happen in a week.
      2. The economy can adapt to almost any trend in the money supply, even a decline, provided it is known about well in advance. If you knew money doubled in value every year, would you worry about your pay being cut by a quarter annually? That would be a 25% pay rise, right?
      3. Its almost impossible for the Fed to commit itself reliably to a stable path of money supply growth. Powerful constituencies will almost always demand either more or less money, causing either inflation or deflation.
      4. The amount of gold in existence is very stable and grows only slowly. Gold isn’t unique it this. There’s an alternative currency called BitCoin that uses the solutions to difficult mathematical problems. You could use anything provided its in stable supply (not leaves) is hard to destroy (no paper or tea) and is portable (no ningies or giant stone wheels)
      5. The Fed (or other monetary authority) can commit itself very strongly to stable money supply growth by guaranteeing covertability to something like gold that’s in very predictable supply.

      The problems with this are:

      1. The supply of gold may be stable, but demand for money is not. If gold is money, the supply of gold people actually want to trade is not stable. Under the gold standard, entire countries (France) hoarded gold. Obviously gold someone is hoarding cannot be traded.
      2. The velocity of money is not stable. You sort-of capture this in your point about credit (although saying credit is a subsitute for money is a way to make economists roll their eyes at you). During some periods (say 2004-2007) it takes relatively little actual money to secure a fairly large amount of trade, because people accept promises to pay later and most of those eventually cancel out without money having to change hands. During other periods (now) people demand cash in hand or collateral on deposit.Report

      • Nob Akimoto Nob Akimoto in reply to Simon K says:

        Re: Problem 1 – You’d essentially wind up with a global Gresham’s Law effect, where everyone hoards gold and tries to use dollars to convert into gold. Or perhaps you might see dollar hoarding as after the end of Bretton Woods. Either way, you’d have a serious incentive for the central bankers to jump off the metal wagon, because you’d see an enormous deflationary spiral of epic proportions.

        I’m thinking of doing a post on the Crash of 1837, because that was an interesting case of bimetallism in Mexico combining with a sudden contraction of money supply in the US leading to an enormous economic meltdown.Report

        • Avatar Simon K in reply to Nob Akimoto says:

          That depends on there being an incentive to hoard money, I think. People (and countries) only hoarded gold under the gold standard if they perceived some risk their currency’s gold peg would move. That, of course, reduced the supply of gold in circulation and increases the risk of devaluation. That in turn could happen because the 19th century gold standard wasn’t full gold backing – it was James’s more sophisticated option of merely promising to redeem paper money for gold on demand. Plus, private bank notes and other safe assets were considered equivalent and redeemed for gold by the Fed, effectively meaning that commodity and credit money got comingled with one another. A 100% gold standard with a clear distinction between credit and actual money would not suffer from this particular incentive, since no-one would have cause to worry about the value of their money assets.

          Of course, there might be other reasons to hoard gold – eg. if there’s a dearth of safe assets and a lack of confidence in future growth, as arguably we have right now, people may choose to hold gold in the same way they’re currently choosing to hold assets that have negative real returns.Report

          • Nob Akimoto Nob Akimoto in reply to Simon K says:

            Even with a 100% gold standard in the US, you’d still essentially be turning the currency exchange system into a giant commodity market if others remain on fiat or reserve backed currencies. Moreover, given the flexibility and strength that monetary policy provides for export oriented economies, it’s not plausible that you’d ever see a situation where one country unilaterally goes on the gold standard and then this is met by reciprocation through out the world economy.

            In this case I have a hard time believing that you wouldn’t see one of the following: 1. hoarding by foreign banks as they use it as a hedge against their own currency’s eventual inflation, or 2. asset accumulation as a result of balance of payments. If country A’s entire treasury is gold backed currency then every time it trades abroad, it’s losing bits of specie reserve and thus effectively removing its own money supply if it trades with foreign countries.

            Now if it were to demand autarky as a result of this, I suppose it might work, but I thought the goldbugs were also simultaneously for “free trade and peace” or whatever neoisolationist nonsense they’re peddling these days.Report

    • Avatar M.A. in reply to Katherine says:

      Things like purchasing goods on credit, which everyone does these days, actually increase the amount of money in the economy. Or that was the gist of what I got from econ class.

      That’s the general Econ 101 view, but it’s actually more complicated. There’s constructive and destructive forces on the money supply.

      Issue a lot of credit and you technically – for a while – increase the theoretical money supply. But eventually that comes back down. Anytime a person or business goes bankrupt or defaults on a loan, that’s a decrease in the money supply as the issued credit at least partially “vanishes” on failed risk. The more bankruptcies happen, the worse it gets. And that’s not even accounting for the fake money of anything resembling a Ponzi Scheme, the definition of which many have argued applies to “financial vehicles” such as credit default swaps.

      The short version is: yes, when you issue credit, you appear to increase the money supply – but at least part of that increase is only an illusion.

      Hence, America’s first two attempts at non-gold-backed money – the Revolutionary War and Civil War – went terribly because America’s survival as a country was doubtful in both cases.

      One of the things that really annoys me about the goldbuggery crowd is that they occasionally slip over into their other talking point, the “competing currencies” idea. The short version of it is that any coin from any nation, anything issued by any bank, should all be “legal tender.”

      Theoretically we have a little of this already. The government can’t stop you from negotiating to barter if both parties really want to. But the madness of having over a dozen different competing currencies (commodity “money”, specie from at least 5 nations, paper money issued individually by all 13 colonies as well as the continental government, promissory notes from warehouses for a certain amount of grain or tobacco or other produce) was one big reason that the Constitutional Convention decided they’d had enough and gave the federal government the sole power “[t]o coin Money, regulate the Value thereof, and of foreign Coin…”

      Competing currencies? This way lies madness. That was one of the reasons the Euros attempted to standardize. Setting aside some of the other silliness in crafting a “unified government” structure that was actually less powerful than the US’s Articles of Confederation, the retiring of too many individual state currencies and standardization on the Euro was – or should have been, absent other disasters – a smart move by the European nations.Report

      • Avatar Kimmi in reply to M.A. says:

        you’re allowed to issue currencies in America. you just still need to pay your dang taxes. Someplace up in connecticut did it (using it to help get people to go to local stores), another restaurant issued “money for X’s Cafe”, where they would allow you to buy discounted tickets good for a meal (the meal to be provided after a certain date, when the shop had moved to its new location). essentially getting a loan from people.Report

        • Avatar M.A. in reply to Kimmi says:

          You’re allowed to issue play money and exchange it for real money or real goods or real services provided that everyone agrees to the transaction. Disney Dollars come to mind.

          another restaurant issued “money for X’s Cafe”, where they would allow you to buy discounted tickets good for a meal (the meal to be provided after a certain date, when the shop had moved to its new location). essentially getting a loan from people.

          That’s called a “gift certificate.”

          But Disney Dollars and gift certificates aren’t official currency. No business is required to take them; all businesses in the USA are required by law to accept the official minted currency of the USA, and only the US Government is allowed to issue legal tender.

          Everything else you have described is either a loan, or a form of barter. Not official currency, not legal tender.Report

      • Avatar Simon K in reply to M.A. says:

        MA – That’s not any Econ 101 I can remember. It may seem obvious that credit works like money, but to economists it is not. The standard view is that when you buy something on credit, someone is actually lending you pre-existing money. Money is not being created.

        In order for extension of credit to actually create money, we would need to be living in a credit money economy. Credit money is when I can buy something for 5 bucks by saying “this says Bob owes me 5 bucks” and they’ll take it. Clearly people do not normally do this unless maybe if Bob is a bank. Even if Bob is a bank, isn’t he just lending me pre-existing money? Its possible to understand our economy as a credit money economy if you think bank checking accounts are mostly backed by debt rather than by reserves of “real money”, and “real money” is mostly irrelevant. This is a heterodox view – there’s a current version of it called “Modern Monetary Theory”, but historically it was called Chartalism or ne0-Chartalism on the basis that it reduces money to chartals or state issued debt token. The key idea is that bank loans indirectly create sufficient deposits for the lending bank to claim these as reserves, so in practice the need to hold reserves against outstanding loans places no real constraint on bank lending. Most MMT advocates are auto-didacts and they’re nearly as annoying as Austrians, with whom they have more in common than they think.

        The standard econ 101 view is that money is an actual thing (albeit these days just bits in a computer or pieces of paper) that exists in some fixed supply. Thus when banks lend out deposits, the need to hold sufficient reserves does impose a real constraint on them. The total amount of bank lending is constrained by the total volume of reserves available. This view does acknowledge that banks create money, but not by extending credit – they do it by keeping in reserve only a fraction of what they take in deposits. Thus there are multiple claims on any given dollar of reserves, but these claims themselves are used as money (that’s what your checking account is). So in the standard view, there are multiple different kinds of money – bank checking accounts are “less real” than bank reserves or cash, but at the same time more real than CDs or money market accounts.Report

  11. Avatar b-psycho says:

    Though I think rather lowly of central banking, I’m no fan of the gold standard either.

    What gets me lately though is the association of it with laissez-faire: Saying a dollar is worth X amount of gold is to say that gold is worth X amount of dollars per ounce, which sounds like price-fixing to me.Report

    • Avatar James K in reply to b-psycho says:

      Pretty much any monetary policy involves fixing at least one price. Now free banking, that’s laissez faire.Report

      • Nob Akimoto Nob Akimoto in reply to James K says:

        And utterly insane in a global economy.Report

        • Avatar James K in reply to Nob Akimoto says:

          Oh, I’m not saying I think its a good idea.Report

        • Avatar b-psycho in reply to Nob Akimoto says:

          Considering the blatant deep corruption in the system we have now, I wouldn’t be so quick to consider the status quo particularly sane…

          If it were possible to design an ideal monetary system, my first request of it would be a larger role in determining value for labor. My 2nd request? Any conceivable route for concentration for the speculative advantage of a few squashed, permanently.Report

          • Nob Akimoto Nob Akimoto in reply to b-psycho says:

            The status quo is in fact, quite insane, but trying to force free banking into it would just make things work.

            As for an “ideal” monetary system…

            Well, give me a world government first, then I’ll design one.Report

            • Avatar b-psycho in reply to Nob Akimoto says:

              That was intended to clarify what I see as the key problems with the one we have. I’m under no illusion that a deliberate design can actually work.Report

              • Nob Akimoto Nob Akimoto in reply to b-psycho says:

                One of my greatest problems with the current global economy is that capital moves much more freely than labor, making it easier to have extreme disparity in labor value. Plus the concentration of financial advantage and leveraging that allow for substantial bets to be made on the backs of the many by a handful for the good of just the handful.Report

          • Avatar James K in reply to b-psycho says:

            I’m not sure what you mean by this, the very last thing a monetary system should do is try and control the pries of specific commodities.Report

  12. Avatar MaxL says:

    I have to agree with everything you just mentioned. I think there is also the nagging problem of exchanging currency manipulation (where currency is treated as a commodity) for straight up commodity price manipulation in the gold market. It seems to me like a lot of effort just to make South Africa fabulously wealthy.

    And then there is the problem of the transition: transferring all that wealth, and demand, to South Africa would be a huge drag on our economy for years, I am fairly sure.

    For what it’s worth, after years of living overseas, I have found that there is always a large, die hard group of goldbugs in every group of “expats.” To your opening question, goldbugs truly are the libertarians many of us meet in the everyday world. I think the topic comes up within a minute or two of anyone mentioning the economy and is one of those things that serves as a good reminder that, although lefties like me and libertarians share some ground along the lines of individual liberty, we are much less in agreement and share less perspective in common than it appears at first.Report

  13. Avatar Matty says:

    Pre-Industrial Revolution, economies didn’t grow so the necessary money supply was constant.

    Is this true? granted the industrial revolution was a major change but given the amount of social and political change that occurred before the revolution the idea that economies were fixed doesn’t sound right to me. Then you have the claims that inflation helped damage the Roman empire which again doesn’t seem to me to fit with a constant money supply.Report

    • Avatar MaxL in reply to Matty says:

      The Romans started minting impure coins in the 3rd century AD, and lots of them. That led to brutal inflation and widespread distrust of the currency. To make matters worse (and this was an honest mistake since they didn’t know much Econ or monetary theory), when they realized that that was the cause of the problem and went back to minting pure coins, they didn’t pull the bad currency out of the market quickly enough and they only minted coins in very large denominations, so 90% of the people had no access to usable currency at all.

      Um, hat tip to the History of Rome podcast.Report

    • Avatar Kolohe in reply to Matty says:

      ‘The money supply was constant’ is not correct (the Romans did famously debase their money from time to time) but what I think he mean is that the money supply didn’t need to be variable, as industrial (and post industrial) economies have swings that agricultural economies lack. (that is, the cyclical nature of industrial economies is inherent, and caused by (the sum total of) human behavior, vice an ag economy that would go in the tank at a natural disaster, and do well (for some) in a bumper crop)

      And economies prior the Industrial Revolution were in a Malthusian trap, basically only growing as fast as the population did. I can’t find de Long’s graph on GDP from the dawn of time to today (this is close, but not it http://delong.typepad.com/sdj/2008/03/delong-econ-210.html ) but it basically shows that we only had ‘real’ economic growth, (and exponential growth) after we figured out how to use steam (and coal) to get off the man-beast energy limit treadmill.Report

    • Avatar James K in reply to Matty says:

      The necessary money supply (money demand, if you will) didn’t change much, the actual money supply could.Report

  14. Avatar wardsmith says:

    James, thank you for this article. I wanted to post comments here but am so far behind I can only read. Was saving this for an OP I was thinking of writing but the subject is a bit too complex unless we take only a simple viewpoint and ignore much of the rest. Currency Wars is an excellent book, highly recommended, but his testimony given before Congress is almost as good and a reasonable synopsis of much that was in the book.Report

  15. Avatar Nickleby says:

    The comment about a growing economy needing more money to support that had never made sense to me. Don’t the rules of supply and demand apply to money as well? If the amount of goods went up so would the demand for money which would increase its value (deflation?). It would still work. They couldn’t use their same monetary policies that is a true but I think many see this as a good thing. Friedman even toyed around with the idea towards the end of his career of a fixed monetary policy.Report

    • Avatar Simon K in reply to Nickleby says:

      The laws of supply and demand do apply, but are not magical. Prices do not adjust instantaneously, so if there’s a shortage of money, some transactions that would otherwise be possible won’t occur. This is true for anything of course – if there’s a shortage of peanuts, someone won’t be able to buy peanuts and the price “should have been” higher. So what?

      Money is special because 2/3 of the transactions money is involved in are either the sale or purchase of debt. Consider – I work and get paid, I don’t need all that money so I put it in the bank. That’s a purchase of debt, since the banks owes me the money back. The bank lends most of the money to someone else. Thats similarly a purchase of debt. They use it to buy something. The person they buy it from doesn’t need the money right now …. So you have 2 debt transaction for every one “real” transaction, both via banks. Actually its usually more than that since banks lend deposits to one another …

      Now consider what happens if I want my money back. The bank lent it to someone else, so they can’t just fetch it from the vault. Instead they use money they keep in reserve for just this occasion. But what happens if too many people want their money back relative to the amount the bank has? The bank has to borrow from another bank. This happens all the time and isn’t a big deal, normally. But what happens if there’s a shortage of money because prices are taking time to adjust, say because of unexpected growth? All the banks want to hold onto their money and won’t lend to one another. And now you have a financial crisis ….

      Under the gold standard this used to happen all the time, every 10 years or so. All it took was a rumor of a delayed gold shipment or a weak bank and kaplooey. Like Lehman brothers every 10 years, Now consider that in the modern economy ….Report

  16. Avatar wardsmith says:

    Everything Simon said with the additional wrinkle that banks operate under a bizarre reserves system that no business could ever get away with. Therefore when you “loan” $1000 to a bank, it gets to turn around and ‘borrow’ $20,000 keeping it in compliance with a reserves requirement of 5% (and MANY banks are far far lower than this). Add in hedge funds and other players to this mix, and we get a massive inflation of imaginary money based on “holdings” that are illusory at best. When /that/ house of cards falls (and it will, again and with a vengeance) – well consider that roughly 97% of ALL the “money” in circulation isn’t even money, it is just numbers on a computer screen. That “money” is the air beneath the wings that hold up our bloated bureaucracies, take away 90+ percent of it and those beasts will come crashing to the earth, Greece times 150. Gold won’t really help then, nor diamonds, food might until the system has a chance to recover – over time.Report

    • Avatar Simon K in reply to wardsmith says:

      That’s not quite a correct description of reserves, ward. If I lend the bank $1000, it gets to lend $20,000, not borrow it. But that depends on the bank already having $20000 in lendable reserves, which it won’t, so its more realistic to say the bank gets to lend $950 of every $1000 deposited. If I deposit $1000 it actually inhibits the bank’s ability to borrow, because it impacts their capitalization ratio, deposits coming above everything else in the capital hierarchy.

      I assume its just a slip-up on your part, since your diatribe on the evils of fractional reserve banking doesn’t work unless lending enables more lending. This point gets vastly exaggerated both by post-Keynesians and by Austrians (I assume you’re the latter … correct me if I’m wrong 🙂 Even if we take it as given that banks face no real constraint on their lending from the need to repay depositors, they do still face other constraints, which concern them a great deal more. In this model, banks are basically credit clearing houses, bundling debts together to create safer assets to sell to depositors. Similarly, in this model there is no true “safe asset”, money is just a unit of account and dollar bills are just tokens of bank credit. If we take these assumptions, the name of the financial game is to match assets to liabilities so the risk & return of the assets is a little higher than the risk & return of the liabilities, the difference being the banks profits.

      This is basically how bankers see their business, so far so good, and its at least as plausible as the standard monetary model. But this is where we part company – there’s nothing inherently fraudulent or illusory about any of this. Banks still face a constraint on their lending based on the need to match assets and liabilities, and that constraint is based, ultimately on the performance of the underlying loans, which are based on the performance of some real capital somewhere. They cannot expand their balance sheet indefinitely, but only where sufficient real assets exist to justify it. Isn’t this, actually, what you want?

      I suspect that what you will say in response is that the gross balance sheets of financial institutions consist mostly of gambling debts, having nothing to do with real capital. That is true. However, this doesn’t have a monetary impact. The debt that gets used as money is for the most part very safe – T-bills, investment grade corporate bonds, bank deposits, etc. What happened in 2006 was that some clever dick found a way to pass off dodgy mortgages as debt safe enough to use as money, and then some other clever dick found a way to pass of bets on dodgy mortgages as dodgy mortgages that could be passed off as money. This sort of thing actually is quite rare – most real enterprises, after all, did not go bust.Report

      • Avatar wardsmith in reply to Simon K says:

        Trust me Simon, the bank “borrows” the $20K immediately before it loans it out. The bad news is if there were only a couple of banks this wouldn’t work, the good news is there are scads of banks and they can and do loan and borrow from each other, dozens of times per day. The freeze up of the financial system in 2008 was because the banks didn’t trust each other’s dodgy balance sheets because they knew damn good and well that their own balance sheets were shit. That was “fixed” by them all having access to the Federal Reserve’s discount window including allowing for non commercial banks’ access. New money is continually being created. Once a bank has enough “money” on deposit they can appear to be solvent. Not enough? Borrow and pretend it is a deposit. They both belong on the same liabilities side of the balance sheet if properly accounted for.

        You are right that, “the gross balance sheets of financial institutions consist mostly of gambling debts, having nothing to do with real capital”. Not only are they gambling that loans will be repaid, but they are further gambling on anything and everything they can find with a dollar sign (or pound sign) attached that has the potential of being legitimate. “Mark to market” accounting rules undid AIG, Lehman Brothers and then multiple other entities who were deemed to be “too big to fail” and therefore we didn’t get to watch their denouement.

        In the US, the cash we carry around in our pockets says, “Federal Reserve Note”. The “Federal Reserve” has about as much to do with the U.S. government as Federal Express does. It is a consortium of ~2000 commercial banks. Periodically, the Fed asks the Treasury to print up some more money. Are you fully familiar with “Quantitative Easing”? The Fed is creating money out of thin air and using it to purchase Treasury notes. That is what banks do, they pull cash from an uncertain future to be able to use it today. Once they loan that cash out, they treat the (debt) as an asset, with slight reserves to account for non-repayment of debt. They are indeed inflating their balance sheets and we get to find out who has been skinny dipping only when the tide goes out.

        The house of cards is completely real, I’ve had these discussions with bank presidents. It is plausibly better than when the US had 20,000 different bank notes in circulation backed by multiple different institutions of varying quality. The bad news is more and more “dodgy” debt is receiving the implicit guarantee of repayment from the world reserve currency, the US. We know what happened to Britain’s status as reserve currency and how that affected the country. In the case of the US, who is next in line to carry the torch? Who can be trusted and who has the heft? If there is a vacuum (hint, there is a BIG vacuum) the proverbial brown stuff will hit the fan.Report

  17. Avatar Scott says:

    This date in history, June 5, 1933, the United States went off the gold standard.Report