Paper $ or Solid Gold?
February 25th, 2008Tough choice eh…..well not for jewelry lovers. The gold bugs have been enjoying the ride up in the price of gold as well as making fun of Gordon Brown who unloaded a huge brick of the UK gold reserves back in 2001 much to the chagrin of UK taxpayers.
But with the $ swift decline into obscurity the fans of something more solid than the US Treasurer’s signature on a piece of paper are clamoring fro the return of the Gold Standard as a way of preserving the value of paper and controlling the impulse of bankers to keep printing the stuff.
Well yes that does seem to be a problem. I’ve touched on this before when looking at how the Bank of England experienced several runs just after it was formed. Why? Because they printed way more paper than they had in reserves of gold. So gold or no gold, there is nothing to stop authorities or private banks printing paper or more accurately filling up spreadsheets with lots of numbers.
I’m ambivalent on this gold business. Storage issues, never mind the horrendous process of digging the stuff out of the ground, present problems as do the ability to carry it safely but really its a confidence thing.
Readers of this blog should hopefully know by now that money is an artificial construct. We can make it anyway we like. It’s created into existence in some form in order that we can exchange goods, services and labour in an efficient manner.
It is subject to the laws of supply and demand like any other product or service.
William Rees-Mogg makes some interesting points about it here but the reality is still the same gold or no gold. We must control the supply of money. 1:1 exchange for gold is a way to do that but its so last century. Surely we can come up with a smarter way of doing it.
My favoured approach is for a central monetary authority to issue interest free new money into the system directly. that supply of money (the only supply) could be controlled on an annual basis responding to set limits, constraints and changes in demand, population etc.
Goodbye interest, goodbye inflation and goodbye financial markets as we know them.
Gold bugs or not, we have to do something about the current system before it blows up and makes the 1930s depression look like an afternoon tea party.
Tags: amero, bank of england, banking, central banks, currencies, debt, forex, gold, inflation, markets, money, money supply, policy ideas, systems
March 4th, 2008 at 10:58 am
Place your trust in human frailties (paper money) or place your trust in gold. History makes it clear that when you elect people, then power corrupts them.
An old paraphrased quote: “The two surest ways to achieve inflation with paper money are: War and Democracy.” Milton Friedman advocated what you are proposing, a set fixed rise in the paper money supply every year. Ludwig von Mises said this was folly. So far Ludwig is winning.
Do not wait for humanity to perfect itself and to do what is clearly logical and rational but instead buy gold where a trust in humanity doing the right thing is not required. I have gotten old. I used to call this way of thinking cynical; now I call it practical and realistic.
Finally, remember the 4 G’s: God, Guns, Grub and Gold. If you keep this in mind, then you will be just fine over the next 5 years.
March 4th, 2008 at 11:38 pm
I didn’t propose a fixed rise every year but I take your point. However, supporters of a gold backed form of money have yet to provide a convincing argument as to why paper money backed by gold will be any different. As i’ve written before there are many ways to corrupt that process.
So the question is how do we create a stable money system?
March 20th, 2008 at 9:28 am
Hi everyone
The real issue is money supply and the qualities required for money to be used as a medium of exchange. But let’s first look at money and what it is.
Money
——-
Money is really a medium of exchange. For arguments sake lets say you could exchange 2 corns for a sheep, and one cloth for a sheep. If you are a corn farmer and want cloth, but the cloth producer only wants sheep, then you can’t buy any corn. So what happens is one readily available commodity, sheep in this case, becomes a means of exchange. It becomes money. You exchange your corn for sheep (money) and use it to buy the cloth.
Originally money was gold. Gold works because it has all the qualities required for a reliable commodity to be used as money in exchange:
1. it has a value itself (you won’t exchange a thing of value for another of no value)
2. it has a limited supply (keeping its value relatively stable)
3. it must be readily available and in high demand (everyone must want it for it to e a reliable medium of exchange)
4. it must have a high value per unit (easy to carry around for high value purchases)
5. it must be devisable into equal parts of equal value (main reason for using gold)
6. it is easily transferable (transported with ease)
7. it must be non-perishable (sheep or grain won’t do)
So this is how gold became money. Later gold was replaced by paper and deposit accounts (backed by 100% gold) purely because it is easier to transport / transfer the money (with the banks holding the backing of gold in their vaults).
Money supply
—————-
Now let’s get back to the sheep example. Say everyone starts using sheep as money the word will spread and sooner or later people will start to farm sheep (i.e. create money). Once everyone has sheep the value of sheep will be “devalued” and no one will accept it as money any longer. There is not a limited supply (no.2 above).
If we can impose the requirements of reliable exchange mentioned above on paper money, it can work. Problem is the fractional reserve banking system used in today’s financial system and the Fed’s ability to print money out of thin air (as it does not have to be backed by gold) results in the creation of new money. Every time the Fed creates money (and they have complicated ways of doing this (other than actual printing money that is) they create inflation and devalue the $. It is similar to the idea of dilution of earnings per share during a bonus/rights issue.
* The fractional reserve system:
Under this system only about 10% (as set by the Fed via power obtained from government legislation) your deposit to the bank (think of it as actual money - a commodity or asset) is actually held with the bank. The rest is used by the bank to issue loans. The money gained from the loan is in turn used to buy goods from merchants. Merchants deposit this money in the bank, who then only hold 10% and lend the rest out as loans again. And so on and so on. Thus the bank is creating money from your original deposit. While all the time only holding 10% of total cash deposited.
Another example, lets say I deposited grain at a granary. I come back to claim my grain and I find that the granary realised it could lend out my grain to speculators while they are holding it for me and make some profit out of it. They do not have my grain (only 10% of it). I would be furious they have defrauded me and I would sue.
Then why are we accepting the fact that banks do not actually have our cash deposits? To get around this problem of not being able to pay deposits to the customers of the bank the Fed obtained the ability to print / create money out of thin air.
* The Fed’s ability to print/create money out of thin air:
The abolition of the gold standard resulted in money (paper) not meeting the requirements of exchange as set out above, because money can now be printed/created at will by the Fed (as it does not have to be backed by gold). This development is largely the result of the fractional reserve banking system. New money is needed to keep the banks solvent.
Having a gold standard limits the supply of money to actual underlying commodities / assets, therefore keeping the value of the money stable and not “devaluing” the money. This idea is not very popular because it will expose the biggest fraud in history that is the fractional reserve banking system.
* The result:
The real problem is the fact that paper money does not meet the requirements of exchange as set out above. This is partly due to the fractional reserve system and partly because the Fed can print/create money out of thin air (like in the sheep example) as money is not backed by gold any longer. Both these factors violates the requirements of exchange and with the fractional reserve banking system creating the boom bust economic cycles as money supply contracts and expands.
For further reading refer “The case against the Fed” - M Rothband and writings by the Ludwig von Mises Institute.
Regards,
Aquitaine