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  • The Midas Touch

    Posted by James R. Rummel on July 21st, 2009 (All posts by )

    Some months ago, back when it seemed that he might actually matter in some small way, I was talking to a Ron Paul supporter. He angrily demanded to know why I was amused that anyone would take Dr. Paul seriously.

    I said that one of the many, many crazy plans Dr. Paul had for this country was to move us back to the gold standard, and I pointed out that China mined more gold every year than the US. While the US was in the top three, Russia was not that far behind. Did anyone in their right mind want to simply hand that kind of power to Russia and China? What happened if they cut back on production, and the gold supply dried up?

    Since that conversation, China has moved into first place so far as gold production. I never thought Dr. Paul had even the ghost of a chance, but it is certainly a good thing he didn’t.

    But remember how I said that the reason why it was a bad idea was because China and Russia might collude to squeeze off the gold supply? Looks like Obama’s policies might be doing something similar.

    Follow that last link and read how a gold investor thinks that confiscation is now possible. Hey, it happened under FDR!

     

    18 Responses to “The Midas Touch”

    1. ElamBend Says:

      Not to mention that going back on the gold standard would require the mother of all deflations.

    2. Craig Says:

      “What happened if they cut back on production, and the gold supply dried up?”

      Why would the gold supply “dry up” simply because China cut back on production. Virtually all the gold ever mined still exists; that’s one of the “features” of a gold standard. China couldn’t change that. For those of you who can’t envision anything but a constantly-fluctuating money supply, courtesy of the Fed, I suppose it’s a big leap to think that, were prices and wages allowed to adjust to the money supply, its size wouldn’t matter.

      What we care about is the purchasing power of money; not its quantity.

      I was certainly no Ron Paul supporter in the last election, but his views on the gold standard weren’t the reason.

    3. mishu Says:

      For those wanting to go back to the gold standard, check Britain’s history early last century. It wasn’t pretty.

    4. TMLutas Says:

      I view the PRC’s gold producer role as a natural ‘catchup’ consequence of it ceasing to be communist in an economic rules sense. When Mao was around, all that territory was off limits for modern exploitation by outside parties that had the capital to do it (while the PRC itself was busy wasting its physical and human capital in great ideological circle jerks like the cultural revolution). During that period, physical mines in the rest of the world were exploited leaving a differential between the quality of gold mining opportunities inside the free world and in the PRC.

      Now that the country is available for investment, that differential is being wiped out and of course the PRC’s gold production is rising as a natural consequence. Yes, the PRC government could return us to the bad old days of maoist economic idiocy but that’s more a threat to themselves than a threat to us.

      A further meditation, supplies do not ‘dry up’ forever. There are always potential supplies that become real reserves as prices rise. The ultimate expression of this is the cost to manufacture the resource. You can’t drive the long term price of oil above the cost to manufacture it via Fischer-Tropsch or other processes. As the market price approaches the ceiling this becomes relevant. So what’s the ceiling price of gold? I suspect there’s still a great deal of space between market price and that ceiling price but how much exactly?

    5. Jay Manifold Says:

      ElamBend nailed it, and I would add that the mother of all deflations would be followed by endless and hopelessly uncontrollable inflation. Extraction of gold from soil via genetically engineered plants, followed by extraction of gold from seawater via nanomachinery, followed by asteroid mining — there would be orders of magnitude more gold brought into circulation. We would be fortunate if the value of the currency dropped to a thousandth of its initial level; I would expect something more like this.

    6. Marty Says:

      I’m not a big fan of the gold standard, but why would it necessarily be deflationary? Wouldn’t that depend on the parity rate set for gold vs. currency, and the reserve ratio for gold-backing vs. outstanding loans? Once a parity is set, it might be gradually deflationary if economic growth was faster than new gold entering the money supply, but deflation of that sort is not necessarily a bad thing, we had it from 1870 to 1913. The deflation in the Depression was completely different.

    7. Steph Houghton Says:

      “Not to mention that going back on the gold standard would require the mother of all deflations.”

      Proveably not true. This the oldest canard of the paper bugs. At what price is the question that must be asked at some prices going on the gold standard would cause inflation, at other prices deflation, at some it would causse stability.

      As for Jay’s vew that the higher price for gold would cause a masive increase in gold production and thus inflation, I doubt it. One of the resons comdity moneies are preferable is becuase their is a non monitary use for the comodity that an excess of the monitary commodity will flow in to.

      “I’m not a big fan of the gold standard, but why would it necessarily be deflationary? Wouldn’t that depend on the parity rate set for gold vs. currency, and the reserve ratio for gold-backing vs. outstanding loans? Once a parity is set, it might be gradually deflationary if economic growth was faster than new gold entering the money supply, but deflation of that sort is not necessarily a bad thing, we had it from 1870 to 1913. The deflation in the Depression was completely different.”

      At last some one who understands the issues.

    8. Jay Manifold Says:

      “One of the resons comdity moneies are preferable is becuase their is a non monitary use for the comodity that an excess of the monitary commodity will flow in to.”

      Such as? I am talking about quantities that are a large multiple of all the gold ever mined. The asteroid Eros contains tens of trillions of dollars’ worth of metal, including precious metals, and it’s only 3% metallic. Declare an elemental metal to simply be money, without qualification, and you create the strongest possible incentive to flood the market with that substance.

    9. setbit Says:

      James,

      Did anyone in their right mind want to simply hand that kind of power to Russia and China? What happened if they cut back on production, and the gold supply dried up?

      Do the degree that gold is an important industrial commodity, especially for electronics, the Russians and Chinese already have this power. Reducing their own gold production would be incredibly more harmful to them than it would be to anyone else, but they could do it if they chose to, and it would cause plenty of problems.

      As to the monetary effects that such a move would have on a hypothetical US gold standard, that would only be meaningful if the 9.7 million ounces that the Chinese mined last year were a significant proportion of the entire US Federal Reserve Monetary Base. (They aren’t.)

      And are you seriously suggesting that variations or manipulations in gold production could have monetary effects worse than, oh I don’t know, this? Far more significant would be the effects that a gold standard would have on the price of gold as a commodity, rather than the other way around. That, to my mind, is the number one argument against a gold standard.

      I realize that it is melodramatic and more than a little rude to say so, but this post is the most depressing thing I’ve read this week. There are plenty or rational arguments to be made for or against a gold standard, James, but you have made none of them. The fact that this much fundamental economic confusion made it to the front page of Chicago Boyz suggests that the level of economic understanding in this country is even worse than I thought.

    10. Jay Manifold Says:

      As opposed to this chart?

    11. Dan from Madison Says:

      I am a simple guy so I have a simple question. Just yesterday, IRL, I just received funds (they were dollars US) electronically into one of my accounts. If we had a gold standard, would I receive the dollars and/or a gold certificate that says I now have “X” amount of gold?

    12. Marty Says:

      Making gold be the store of value behind currency would only encourage production to the extent that the valuation was higher than teh cost of production—if gold was set at, say $500/oz and it cost $600 to produce, no reason to think the market would suddenly be glutted.

      Dan–you would get dollars, which would still be legal tender and the medium of exchange, but under terms set by law you could convert to gold, which would be the store of value.

      As I undersatnd it (and I’m not a specialist in teh field) the post-WW1 problems were that the war-damaged (by debt and demographic losses, and lack of investment, not by combat) British economy, in particular, could not produce enough value to justify the pre-war parity. But for reasons of prestige and ego and world expectations, they would not set a new, lower parity (devalue), so they limped along for years, basically in denial. Interesting to speculate what would have happened had the Bank of England just taken a 20-30% haircut in 1923–pissed off the French, for sure, but long term, very complicated.

    13. setbit Says:

      Declare an elemental metal to simply be money, without qualification, and you create the strongest possible incentive to flood the market with that substance.

      …which would be a very big concern if it had anything to do with what Ron Paul, or anyone else, has proposed, which it doesn’t.

      A gold standard, as traditionally defined and as used by hard money advocates (or at least the ones who know what they are talking about) refers to a monetary system where paper currency is redeemable for a certain fixed amount of physical gold. It does not mean, nor has it ever meant as far as I know, either of the following:

      * That the issuer of a gold-backed currency is required to provide paper money to anyone who presents it with physical gold.

      * That the issuer is required to redeem any currency other than its own, even if that currency is gold backed. That is, even if both the US and China were on a gold standard, you wouldn’t be able to walk into the US Federal Reserve with a pile of Yuan and walk out with a stack of gold coins.

      However, you do bring up a valid point, which is that any commodity money is subject to the supply of the underlying commodity. If the supply of that commodity changes drastically, then the assumptions underlying the currency have to change as well.

      For example, imagine a situation where gold became as common as sand, whether from mining on Eros or a breakthrough in alchemy or whatever.

      Further, suppose a gold standard where the Federal Reserve was allowed to monetize physical gold without any restrictions. That is, the Fed could freely print as much money as it wanted, and then use that money to buy gold at some legally fixed rate. The gold would go into the US Treasury vaults, and the paper money would enter circulation as legal tender.

      The outcome of such a situation would be truly horrific. It would, in fact, be almost exactly the same monetary system as we have in the US right now.

      As I understand it, current US law allows the Fed to accept anything, and I mean anything, as a Reserve deposit. If the Fed governors decide accept sand for deposit at $100 per ten pound bag, they have the legal authority to do so. That’s what an “independent central bank” means. Historically the Fed has only purchased US government bonds, but lately, as the financial crisis has evolved, they’ve branched out into “temporarily” purchasing all sorts of shaky financial instruments, up to and including mortgage-backed securities. The only thing that limits how much they purchase is political pressure and their own good judgment. (That’s right, I used the phrase “good judgment” to describe the operation of the Federal Reserve. be afraid, be very afraid.)

      Similarly, in a world of gold standards and abundant gold, the central bank could decide to voluntarily limit the amount of currency it issued. In that case, the redemption value of the dollar would become meaningless. Who’s going to redeem their dollars from the Treasury at $1000 per ounce of gold when they can buy it on the open market for $30? The value of the dollar in that situation would float based on the same factors it does now: the trust that people place in the Fed and state of the US economy.

      Alternatively, the Fed could decide to monetize like crazy, resulting in a hyperinflation. But legally, they could do that today if they chose to. They could even monetize gold.

      None of this should be interpreted as an endorsement of a US gold standard. I’m just saying that many of the arguments being made here are based on some pretty big misunderstandings of monetary theory. I’m arguing from an Austrian perspective, but I don’t think anything I’ve said should come as a surprise to anyone who understands the Chicago School.

    14. James R. Rummel Says:

      “I realize that it is melodramatic and more than a little rude to say so, but this post is the most depressing thing I’ve read this week. There are plenty or rational arguments to be made for or against a gold standard, James, but you have made none of them. The fact that this much fundamental economic confusion made it to the front page of Chicago Boyz suggests that the level of economic understanding in this country is even worse than I thought.”

      We Chicago Boyz are a diverse bunch. Contributors are not confined to people with a background in economics, but represent a very broad spectrum of interests, with an eye towards maximizing viewpoints from the largest areas of expertise possible.

      So far as I am concerned, my background is in law enforcement, self defense, and military history. That is why I framed the scenario above in strategic terms, as it is a bad idea to hand control of a vital resource to regimes that have a proven track record of opposition to the US.

      So far as your depression is concerned, I would suggest that you buy some tequila and get drunk. It admittedly isn’t a method that I’ve ever used myself. But, then again, I’m not unserious enough to get depressed over blog posts.

    15. setbit Says:

      We Chicago Boyz are a diverse bunch.

      Point well taken. But you were the one who took it upon himself to write a post on monetary policy and claim that the idea of a gold standard is “crazy”. I’d say that puts an expectation on you to understand what a gold standard is, and what its proponents are actually suggesting.

      Think of it this way: suppose one of the other Boyz wrote a post on military history that made it clear they didn’t understand the difference between the German V1 and V2, or a post on gun ownership that reminded readers to “always store a revolver with the safety on, otherwise the black powder might self-ignite”.

      Then further suppose that half the commenters wrote posts agreeing and elaborating on those points.

      I’d say that would qualify as discouraging.

      (Which is the word I meant to use, not “depressing”. My bad. If I got depressed every time somebody offered a strong opinion on a subject they didn’t understand, I’d need a lot of tequila indeed.)

    16. Stephen Houghton Says:

      I wrote
      “One of the reasons comdity moneies are preferable is becuase their is a non monitary use for the comodity that an excess of the monitary commodity will flow in to.”

      Jay wrote

      “Such as? I am talking about quantities that are a large multiple of all the gold ever mined. The asteroid Eros contains tens of trillions of dollars’ worth of metal, including precious metals, and it’s only 3% metallic. Declare an elemental metal to simply be money, without qualification, and you create the strongest possible incentive to flood the market with that substance.”

      Well hear is the thing yes their is lots of gold still to be found and yes their would be a mild inflation over time, but the inflation would be part of the process of monitary stability. Inflation would increase the cost of production of gold and thus limit production. Non monitary uses would sop up excess gold when it was being over produced and would release gold into the market when there was a shortage of money. The non monitary uses for gold are jewlry and electronics.

    17. Shannon Love Says:

      Just to toot my own horn, I wrote about the failure of the gold standard in my post on The Evolution of Money

      Short story, any money that preserves “value” will deflate in an economy typified by steadily increasing productivity. The primary advantage put forward by advocates of a gold is that a gold standard will not inflate. This is true but it is a bug nor a feature in the modern world.

      For example, every year, we grow more and more grain. That means that the same unit of gold will buy more grain tomorrow than it will today. This is true of almost everything bought and sold. This creates a powerful incentive for people to hoard gold or gold backed currency. Note I said hoard as opposed to save and invest. With a constantly inflating fiat currency, a person has to put money to work in order to maintain its value. By contrast a gold currency will increase in value if you just bury in the backyard.

      This is why deflation is as big a problem with gold and other commodity back currencies as inflation is with fiat currencies. Deflation was the major problem in the 19th century and that is why most places abandoned the gold standard.

      I think it best to treat monetary systems as forms of technology. Different technology works at different scales. When the economy was small and intimate, barter worked fine. As it grew larger we moved onto using universal trade goods like gold or cocoa. As it grew again we created currency made of standardized units of traded metals. Then we moved to paper representations of metals and then paper fiat money. Today, we use a highly connected set of computerized accounting tables. Today, money is largely just information.

      We can’t manage an economy of our present scale using a technology of a prior much smaller scale.

    18. Steph Houghton Says:

      Shannon
      I am going to reply line by line because you make some interesting points.

      “Short story, any money that preserves “value” will deflate in an economy typified by steadily increasing productivity. The primary advantage put forward by advocates of a gold is that a gold standard will not inflate. This is true but it is a bug nor a feature in the modern world.”

      This depends by what you mean by deflate. If you mean an increase in the value of the monetary unit then you are right. If you mean a contraction in the supply of money, then you are mistaken.

      “For example, every year, we grow more and more grain. That means that the same unit of gold will buy more grain tomorrow than it will today. This is true of almost everything bought and sold. This creates a powerful incentive for people to hoard gold or gold backed currency. Note I said hoard as opposed to save and invest. With a constantly inflating fiat currency, a person has to put money to work in order to maintain its value. By contrast a gold currency will increase in value if you just bury in the backyard.”

      It is a powerful incentive if ½ a percent per year is good rate of return. What is true is that people will do some hording especially poor and uniformed people who are currently always losing their shirt on investments they don’t really understand.

      As an empirical matter hasn’t the rate of savings has fallen since the abandonment of the gold standard.

      Further one could argue that this would make people less risk averse because a one year investment that lost ½ a percent would allow the investor to recover the same purchasing power that he had at the beginning of the year. A brake even investment would give a return in purchasing power of ½ a percent. All profitable investments would be that much more lucrative.

      You are also over stating the harm done to the macro economy by hording. Yes it is a reduction in the quantity of money, but as long as production of gold, dishoarding, and transfer of gold from other uses to monetary uses is greater than hording, then the supply of money will remain constant or increase.

      “This is why deflation is as big a problem with gold and other commodity back currencies as inflation is with fiat currencies. Deflation was the major problem in the 19th century and that is why most places abandoned the gold standard.”

      It was not much of a problem, it was one of the era’s of greatest economic growth in the history of mankind. The gold standard was abandoned because of the problems of fractional reserve banking.

      “I think it best to treat monetary systems as forms of technology. Different technology works at different scales. When the economy was small and intimate, barter worked fine. As it grew larger we moved onto using universal trade goods like gold or cocoa. As it grew again we created currency made of standardized units of traded metals. Then we moved to paper representations of metals and then paper fiat money. Today, we use a highly connected set of computerized accounting tables. Today, money is largely just information.”

      Well money is a means to command goods. Computerized fiat money is information about who can command goods. The real problem is when you get a sharp decrease in the quantity of money which causes large scale business failure. That is an artifact of fractional reserve banking, not of gold. That is why the second largest such contraction just happened with a fiat money system.

      “We can’t manage an economy of our present scale using a technology of a prior much smaller scale.”

      Traditionally paper circulated less widely than gold or silver, from that perspective maybe it is paper that is technology for a smaller system that can not adopt to a world wide scale without problems.