The Gold Standard

Political Philosophy
21

It is pretty much universally accepted amongst respected economists across the political spectrum, from Milton Friedman to Keynes, that leaving the gold standard helped America’s recovery.

It is true that the Monetarists are also bad on the theory of fighting depressions, like their Keynesian brethren. They want monetary stimulus, while the Keynesians want fiscal stimulus. It is a mistake to think of the Monetarists and Keynesians as spanning a large spectrum of economics. They typically do span the political spectrum, but not the Economics one. In basic (“positive”) economics, they’re actually very similar.

I think this shows where you guys are unclear - your first sentence is exactly what a gold standard is defined as.

Not “you guys”. While Lethalmiko does not understand the gold standard, Thomas correctly clarified that the gold-standard implies that gold is money, with a dollar just another name for a particular quantity of gold. I suspect you simply mis-read or misunderstood what Thomas wrote.

Finally, on your graph. As Maarten said, it is pretty weak. It is not just that the upwards trends don’t particularly jump out at one, but also because many other variables were at play. However, there is a more fundamental problem with it: even if the post-gold upturn in GDP did happen, it does not imply that the gold standard is bad. Imagine a patient with a heart-attack, given a powerful drug to get him going again. One would not use this to claim that everyone should take that drug all the time.

To attack the gold standard, one cannot use the example within the depression. Rather, one has to attack it by showing that it did not work well across the centuries (or at least the modern decades of those centuries) when it was in place. You did mention that it causes deflation, etc. Though this is not true, it is the correct way to argue against the gold standard, rather than using the example from the depression.

Essentially. a credit boom is solved either by the passage of time or by the recognition of loss. There are all sorts of structural factors that slow the recognition of losses. The pre WW-1 notion of “liquidate labor and capital” simply meant: force everyone to take the losses as soon as possible. The recession of 1921 is a good example where capital was liquidated really fast, by bankers, and we came out of that little recession without much fuss, and without government stimulus. Going off the gold standard is simply one way to – overnight – force some people in society (especially creditors) to take a loss. To hell with fairness and justice: they’ll take the loss and it’s too bad for them! Still, despite the injustice, once losses are recognized, it does have a positive impact in the medium term. However, in the long run, by setting a precedent by which the government can throw out private contracts, it hands ever more power to government and essentially brings us to where we are today. Keynesians and Monetarists love to look at the credit-booms and recoveries they engineer, but refuse to take responsibility for the busts that come down the line. After all, in the long run, said Keynes, we’re dead.

22

I am aware that Dollar Bills originally were representations of the gold and silver you have in the bank, but under the current system where the Dollar has been divorced from gold by Richard Nixon, it may not be easy to go back just like that, short of introducing a new currency since there are more Dollars than gold. It is possible to have Dollars printed and used as money without necessarily being tied to gold as long as it is left to private banks. Dollars can compete against and work alongside gold.

Currently, about 165,000 metric tons of gold have ever been mined, valued at US$9.2 trillion (at US$1900/oz). Unless I am mistaken, there is more money in circulation just in the USA alone. Even if we mined all the gold in the world to add to the current stock, there is simply no way it can cover all transactions in the entire world without drastically increasing its purchasing power. Even if it is true there is enough now, what about 50 years from now?

Its value would therefore keep endlessly increasing since people would need it to do any transactions. What is more practical is to allow many other things to be used for money such as platinum, diamonds or emeralds.

23

In other words, for a one dollar bill, instead of saying it is backed by the good faith and credit of the United States, it would say redeemable for 1/2000 ounce of gold. And the government would not be printing dollar bills.

You are essentially saying that the government should stop issuing dollar bills and that private issuers should make their own bills at a rate of convertibility of their choosing.

Printing more nominal bills than gold available at the bank would be illegal, as this would be fraud,since each dollar issued by the bank would be a draw on its gold reserves.

If I have got your argument right above, then there is nothing to stop a private issuer from not having 100% gold reserves. You say it would be illegal and fraud to have fractional reserve banking, but I don’t see any basis for why that would be fraud. If the issuer freely chooses to have 10% reserves and everyone who uses those bills is happy, there is no problem. As long as the reserve level is advertised faithfully then it is not fraud.

Which then leads to the following problem with privately issued currencies - the issuer would simply print extra bills to a small % of the total number of bills each year and deposit them in its own bank accountsee note 1 below. They would quickly become the richest corporation ever while causing only a small amount of inflation.

You may argue that people would switch to other competing bills, but I don’t see that happening. Currency has a strong network effect; everyone will switch to the same bill because that’s what everyone else is using. Can you imagine a world in which every item in the supermarket has 20 different prices on it, one for each brand of dollar bill? That in itself is not desirable.

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Note 1 - That is essentially what the government does today. With quantitative easing it prints money and buys govt bonds with the money. This is essentially the government printing money for itself to spend. The difference with the government is that it is democratically accountable to the people. If a private issuer ever did this then they can spend the printed cash on whatever they want and are not democratically accountable.

24

Yes, I would be for ending the Federal Reserve and the nationalized monetary system run by the government. Let banks and merchants decide what they will accept as deposits and payments. This is the system we had in America for the first hundred years and it did not lead to a lot of confusions, primarily because gold and / or silver was accepted everywhere. By ending the Fed, we will no longer have to worry about the government printing itself money out of thin air, thereby causing inflation. And get rid of the legal tender laws. Right now we are stuck with the dollar per the Federal Reserve because it is illegal to use anything else as money, leaving them free to manipulate the dollar at will. In other words, take the power to print money away from the government and return it to private banks and merchants. As to your issue that they could just print at will, remember each note would be a draw on their reserves, so if they printed too many bills then they would go out of business as people came in to convert their bills into gold or silver – that is, if word got out that they were just printing money out of thin air, then depositors would come to get their gold or silver post haste.

As to fractional reserve banking. I don’t think that would be illegal per se. That is, the bank could loan out whatever fraction of their deposits they wanted to, but their customers and depositors would no long have ready access to their money deposited there. What I’m really against is the bank printing up currency to more than what they can account for in their reserves. Let’s say they have 1,000 ounces of gold on reserve or as deposited and they print out money to 2,000 ounces of gold. How are they going to cover those bills? They put a claim on themselves for 2,000 ounces of gold, and they only have access to 1,000 ounces of gold. So, I think banks wouldn’t do this as this would be a quick way of going out of business. But it should also be illegal, because I think it would be fraudulent.

But I don’t think we have to work out the details, and should let banks and merchants decided what to accept as currency, then the best system would win. However, a quick solution to the problem with our current currency is to end the Federal Reserve and make it illegal to print more dollars. In this way, the ratio of gold to dollars would stabilize and then we could transition to returning the gold in Fort Knox to the people, exchanging dollars for that gold at a set ratio dependent upon market conditions.

25

As a further analogy, if you have a checking account, what is to prevent you from writing checks for more than what you have in your account, something you say banks and private merchants would do if they printed their own bills or notes? What prevents that from happening is that your check would go back to your bank and they would see if you had money to cover the check, if you did not, then the check would not clear. Actual money notes works the same way. Each bill or note they print would be a draw on their overall deposits from their customers. If they print out too many bills or notes, their account would be overdrawn, and as people came to get their gold or silver, then the bank would run out of money. I think you are forgetting that the bills and notes would not actually be the money, but rather the deposits in terms of commodities would be the money. Bills and notes are simply like checks pre-written for a set amount (for that commodity).

26

It is pretty much universally accepted amongst respected economists across the political spectrum, from Milton Friedman to Keynes, that leaving the gold standard helped America’s recovery.

They have it exactly backwards. Leaving the gold standard caused the Great Depression, acknowledging the reality that we had left the gold standard and subsequently devaluing the currency forced prices up to fall in line with debt and allowed for rational trading and lending to resume.

The U.S. effectively left the gold standard in 1917 when it began the issuance of over $20B in Liberty Bonds, convertible to gold at maturity, to fund our participation in WWI. These represented 50% of the pre-war GDP and over four times the previous gold obligation of the U.S., an amount that the U.S. could never (and would never) pay off. Those bonds were converted to fixed-rate T-Bills over the course of the next decade in a scheme involving the Fed and Treasury that essentially allowed banks to buy T-Bills on credit at about 2%, sell them immediately to the public at slightly below par, and earn interest on the proceeds at 4-5% until the gov’t asked for the money to pay operating costs. The T-Bills rates were fixed at greater than market interest to ensure that all treasuries offered would sell, and the effect was that banks were guaranteed to sell all the T-Bills they purchased to secondary the market. In early 1929, the gov’t announced that it would no longer issue T-Bills at fixed rate, but would auction them off, as they still do today. This would cut off a huge source of profit to the banks, and by the time the first auction occurred, in November 1929, the market had already crashed. It was the public’s realization that the government had left the gold standard (i.e., could not honor its convertibility obligation), and the banks’ unwillingness to play along any longer, that precipitated the crash, and it was the gov’t acknowledgment of reality almost five years later that led to a short-lived recovery starting in 1934.

As for the gold standard, there’s a lot of misunderstanding going on here. All the gov’t needs to do to establish a gold standard is pass a law declaring gold convertibility of U.S. currency at a given rate. That rate would be an exact number = (currency in circulation)/(gold reserves). That number can be as high as it needs to be to provide 100% convertibility. That’s the definition of a full reserve gold standard. A fractional reserve gold standard means that the government print more money (or other obligations) than can be redeemed for gold… until the people catch wind.

Fractional reserve banking is a completely different concept. It involves adding other assets as backers of money (M1, M2, M3), so that the monetary base of gold-backed currency can be expanded into monetary aggregates of both currency and asset-backed deposits. A bank that maintains a reserve of currency for day-day transactions and backs its deposits with assets with values considerably larger than the amount of their loans, can operate safely and generate an expanded monetary supply far greater than what could be provided with just gold as a backer of money. This means that the limitations on gold supply act as a regulator but not a hard limit to money supply, even in a full reserve gold standard.

It is when banks fail to maintain adequate reserves that they risk a liquidity run, and it is when they fail to adequately evaluate collateral that they face a solvency crisis. It was the mis-evaluation of house values based on mark-to-market in a bubble that caused banks to back their deposits and MBS’s with insufficient salable collateral that caused the mortgage meltdown.

1 Like
27

What I’m really against is the bank printing up currency to more than what they can account for in their reserves.

But it should also be illegal, because I think it would be fraudulent.

This is what fractional reserve banking is defined as. However why is it fraudulent if all parties agree to it? It clearly isn’t, especially under a system of competing currencies that you advocate since people would simply switch currencies if they didn’t like it.

They have it exactly backwards. Leaving the gold standard caused the Great Depression, acknowledging the reality that we had left the gold standard and subsequently devaluing the currency forced prices up to fall in line with debt and allowed for rational trading and lending to resume.

Here’s that chart again:

You guys have said you think its weak but I don’t see that at all. What I see is that for the US, the UK, and Germany (the worlds 3 biggest economies during the 1930s), when they left the gold standard, a recovery ensued. Being the worlds 3 biggest economies, its also not surprising that a general upturn occurred in other countries even if they were yet to leave the gold standard.

As for the gold standard, there’s a lot of misunderstanding going on here. All the gov’t needs to do to establish a gold standard is pass a law declaring gold convertibility of U.S. currency at a given rate. That rate would be an exact number = (currency in circulation)/(gold reserves). That number can be as high as it needs to be to provide 100% convertibility. That’s the definition of a full reserve gold standard. A fractional reserve gold standard means that the government print more money (or other obligations) than can be redeemed for gold… until the people catch wind.

Yes, finally! Someone here understand’s the gold standard. Now I ask why is passing a law to fix gold at a government defined rate, preferable to the current system of letting the dollar float freely against gold?

Here is a good summary of the gold standards effects during the depression (http://www.j-bradfor…ldstandard.html):

The gold standard and the Great Depression. The current judgment of economic historians (see, for example, Barry J. Eichengreen, Golden Fetters) is that attachment to the gold standard played a major part in keeping governments from fighting the Great Depression, and was a major factor turning the recession of 1929-1931 into the Great Depression of 1931-1941.

  • Countries that were not on the gold standard in 1929–or that quickly abandoned the gold standard–by and large escaped the Great Depression

  • Countries that abandoned the gold standard in 1930 and 1931 suffered from the Great Depression, but escaped its worst ravages.

  • Countries that held to the gold standard through 1933 (like the United States) or 1936 (like France) suffered the worst from the Great Depression

  • Commitment to the gold standard prevented Federal Reserve action to expand the money supply in 1930 and 1931–and forced President Hoover into destructive attempts at budget-balancing in order to avoid a gold standard-generated run on the dollar.

  • Commitment to the gold standard left countries vulnerable to “runs” on their currencies–Mexico in January of 1995 writ very, very large. Such a run, and even the fear that there might be a future run, boosted unemployment and amplified business cycles during the gold standard era.

  • The standard interpretation of the Depression, dating back to Milton Friedman and Anna Schwartz’s Monetary History of the United States, is that the Federal Reserve could have but for some mysterious reason did not boost the money supply to cure the Depression; but Friedman and Schwartz do not stress the role played by the gold standard in tieing the Federal Reserve’s hands–the “golden fetters” of Eichengreen.

  • Friedman was and is aware of the role played by the gold standard–hence his long time advocacy of floating exchange rates, the antithesis of the gold standard.

What surprises me most about this debate is the clear contradictions with Objectivism that the gold standard implies. All I have heard from you guys is “pass a law in order to regulate the amount of reserves banks hold (ie 100% reserves)” or “pass that law to guarantee convertibility to gold at such and such rate”. Whatever happened to the non-initiation of force?!

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IceFive, you are misunderstand my position, and I think Agrippa’s position. No one here is talking about force. What Agrippa is referring to is taking the gold in the Fort Knox and other government gold reserves, and using that as the gold standard, which it isn’t right now. In other words, he is stating that the gold in Fort Knox should be used to back the dollar. I’m looking for a more radical position – of getting the government out of the currency altogether and selling the gold in Fort Knox back to the people, so we can use it as currency as set up by bankers and merchants. Again, no force is involved on the part of the government. In addition, I say let the banks and the merchants decide what the currency will be by getting the government out of it totally. Agrippa’s solution doesn’t go far enough, as far as I am concerned.

Recovery from the Great Depression by devaluing the dollar, which is what Agrippa is talking about and what your chart shows, is like putting a band-aid on a large cut. The ensuing inflation that we are still living with caused the dollar to lose a great deal of its value, and basically made a tax on everyone at the rate of inflation. In other words, it was not a solution, but a Ponzie scheme to cook the books to make it look like we had recovered. It might have changed nominal values (in terms of dollars), but it did not fix the underlying cause – the devaluing of the dollar. It’s like diluting a drink and saying you have more of it, when you have just weakened it, and that is what has happened to our money. That’s one reason gold is at $2,000 per ounce now, when it was at $300 per ounce a decade or so ago. That is how much the dollar has been weakened over the decades, and it has been far more weakened by devaluing the dollar.

What you don’t grasp is the soundness of a gold standard, of having specific commodities as being money. Would this limit the economy? In a way, yes, but it would be a healthy economy based on a sound currency. Inflation (devaluing the dollar),simply cooks the books to make it look like we are accomplishing something when we are not.

29

All I have heard from you guys is “pass a law in order to regulate the amount of reserves banks hold (ie 100% reserves)” or “pass that law to guarantee convertibility to gold at such and such rate”. Whatever happened to the non-initiation of force?!

That’s hyperbole! That is surely not all you’ve heard.

Firstly, Objectivism definitely does not say the government should disallow fractional-reserve banking where the depositor and the bank are clear about the reality of the contract. The best argument against fractional reserve is that depositors think their deposit is a bailment contract when it is actually a loan. However, assuming that the terms and conditions are fully understood by all, the government should not ban fractional-reserve banking.

As for gold-standard, a “dollar” should simply be a weight of gold. This is merely a question of setting rates and measures, just as one would define an official, legal gram or ounce. It really is not essential, since one could use physical units too. The government really does not need to decide whether we will use a gold-standard or a silver standard or a multi-commodity standard. Still, setting nomenclature (as in “a dollar is X ounce of gold”) is not too objectionable on the face of it… until one sees the havoc it played by allowing Roosevelt to change it.

30

Actually, I would be for just using weights for monetary transactions, buying and pricing things in terms of weights of gold – a car would cost you 10 ounces of gold (instead of $20k). This would end a lot of confusion between the dollar and gold. However, it must be kept in mind now that force is being used against you in the continued devaluation of the dollar. Government is using force against you buy printing up more and more dollars to chase goods and services. It’s called inflation, and it is like a percentage tax on everything one purchases. So, what I am proposing is *ending* the force being used against us by the government – get the government out of currency, and let private bankers and private merchants decide what they will use as a medium of exchange. I think they would switch to gold or silver, as they have in the past,and then we could either define a dollar as a certain amount of gold or silver (ever hear of the gold dollar and the silver dollar?) or get rid of that nomenclature altogether and use weights of gold and silver, but going directly to weights would be the best and less confusing standard. In other words, instead of thinking in terms of dollars, one would think in terms of weights of gold. You would earn weights of gold in your income, and pay out weights of gold when you purchase things. The Federal Reserve “dollar” would be ended, and we would have a gold and silver currency.

31

Someone needs to explain how a gold standard can cover all the transactions in the economy since the quantity of gold in the world is finite but money supply has to necessarily increase as the economy grows.

32

Someone needs to explain how a gold standard can cover all the transactions in the economy since the quantity of gold in the world is finite but money supply has to necessarily increase as the economy grows.

Money supply does not have to necessarily increase as an economy grows.

However, more importantly, a gold-standard is simply one concrete form of value-based money: i.e. a system where some type of value has become acceptable enough as money. It is useful talk about this particular type of money because it has a historical basis. Silver was used too: China and Mexico being the two big examples. There are other values that could work as well.

Many values do not work well as money. E.g. land does not work well because it is not fungible, nor physically divisible into tiny units, nor transportable. However, there are other commodities in the world that have quite a few of the characteristics of money. In our modern electronic/digital world even things like oil can be the basis of “near money” if it is under the protection of a strong and reliable government that guarantees property-rights. [This is where a dissenter brings up John Law as a strawman]. So, in general, there is no shortage of things that people can use as a basis for exchange.

33

Firstly, Objectivism definitely does not say the government should disallow fractional-reserve banking where the depositor and the bank are clear about the reality of the contract. The best argument against fractional reserve is that depositors think their deposit is a bailment contract when it is actually a loan. However, assuming that the terms and conditions are fully understood by all, the government should not ban fractional-reserve banking.

Best short summary of the Fractional Reserve issue I’ve ever seen. Of course we will continue to have people come here and say it’s necessarily immoral and/or a violation of rights.

I’d go so far as to say perhaps a FRB banknote is fraudulent if it doesn’t state right on it that it is a share of a loan a bank made, rather than actually being a dollar or ounce or whatever, as a paper receipt for a warehouse deposit would be (a case where it actually is a bailment). Both would have some value and both should be allowed to circulate–and people should be allowed to refuse payment in them, as well.

34

Someone needs to explain how a gold standard can cover all the transactions in the economy since the quantity of gold in the world is finite but money supply has to necessarily increase as the economy grows.

Deflation would occur. So the money supply would stay fixed but the price level would fall.

Firstly, Objectivism definitely does not say the government should disallow fractional-reserve banking where the depositor and the bank are clear about the reality of the contract. The best argument against fractional reserve is that depositors think their deposit is a bailment contract when it is actually a loan. However, assuming that the terms and conditions are fully understood by all, the government should not ban fractional-reserve banking.

I completely agree with this. Thank you for clarifying Objectivism’s position.

As for gold-standard, a “dollar” should simply be a weight of gold. This is merely a question of setting rates and measures, just as one would define an official, legal gram or ounce. It really is not essential, since one could use physical units too. The government really does not need to decide whether we will use a gold-standard or a silver standard or a multi-commodity standard. Still, setting nomenclature (as in “a dollar is X ounce of gold”) is not too objectionable on the face of it… until one sees the havoc it played by allowing Roosevelt to change it.

I agree that the government need not and should not decide whether people use a gold standard.

Actually, I would be for just using weights for monetary transactions, buying and pricing things in terms of weights of gold – a car would cost you 10 ounces of gold (instead of $20k). This would end a lot of confusion between the dollar and gold.

Imagine with the general deflation that would occur, the smallest denomination of gold would get increasingly minuscule. To the point that you would be paying things in nanograms and atoms of gold. I guess it could be implemented with a suitable electronic system to account for everyone’s holdings of gold and its location. You could even account for fractions of atoms of gold (I’m being serious).

I’m not going to pass judgement on such a system until I’ve had a think about it a bit more.

35

Imagine there is only $1 million worth of gold in a small island community and all transactions are covered with $50,000 left over in the bank. Productivity and consumption goes up 100% across the board due to a baby boom. The total value of all the productivity is now worth more than the $1 million but there is no new gold being added. How can it possibly be true that “Money supply does not have to necessarily increase as an economy grows”?

The Deflation argument assumes that demand for goods/services has dropped, necessitating a reduction in prices. But in the scenario above, demand has actually increased so how does a limited supply of gold lead to deflation and thereby solve the problem I raised?

36

Someone needs to explain how a gold standard can cover all the transactions in the economy since the quantity of gold in the world is finite but money supply has to necessarily increase as the economy grows.

I think you are suffering from a modern economics course, because, no the physical amount of gold does not have to increase to have a booming economy – just the opposite is true.The overall amount of gold in the world will not change all that much. Yes, it is being mined in all sorts of places, but not in very large quantities. That is precisely what makes it valuable and what makes it a great store of value – the fact that it is rare. What would happen is that prices would tend to fall as production increased, that is things would get lower and lower in prices, just as we see with electronics today, but this would be true of everything. Far from this being a problem, it would show the value of a gold standard. It wouldn’t be deflation, which is defined as a decrease in the money supply (under gold it would remain relatively constant), but rather the virtue of production would be readily seen (as it is in electronics today, but across the board).

As far as using micro-ounces for small transactions (i.e. what now cost pennies), we could either use an electronic basis (your debit card), or have bills and notes with that denomination on them. There would be notes and bills for fractions of an ounce on them that would be redeemable for gold at your local bank. Or as an alternative to that, there could be silver and even copper being used as money, which is the way it used to be before the Federal Reserve came and stole all of the gold and silver.

For those who continue to claim it wouldn’t work, it did work just a century ago, and it worked well. But that has nearly been forgotten since the Feds stole the gold and gave us paper instead.

37

Someone needs to explain how a gold standard can cover all the transactions in the economy since the quantity of gold in the world is finite but money supply has to necessarily increase as the economy grows.

In a gold standard, only the currency in circulation is backed by gold. Demand deposits, savings and time deposits, and money market securities are part of the larger money supply and are tied to currency only by the reserve requirement (whether required by law or by principle) of institutions issuing them. Money supply can expand by decreasing the reserve requirement. Typically the reserve requirement would only lower if interest rates rise enough to offset the increased risk, as judged by institutions and depositors/lenders.

Past the short term, true, there is a finite amount of gold in the world, but the vast majority of it is not economically extractable. Gold is mined only from the relatively small deposits that are profitable. As the economy expands beyond the capability of gold to act as a monetary base, the price of gold (in terms of goods) increases, and the amount of ore deposits that can be economically mined increases quickly. Mines increase production to exploit newly profitable ore deposits, and the money supply increases.

Longer term, as harder-to-get gold becomes profitable the pressure to invest in more efficient gold extraction mounts, and technological innovation makes extraction from all sources cheaper. This expansion of gold extraction technology interacts with broader technology expansion, the main driver of economic growth, so that gold extraction and the economy tend to grow at similar rates. When an economy slows down the profitability of gold extraction drops, mines close, and the money supply falls (if necessary) due to attrition into gold-consuming industries.

Thus gold acts as a short term regulator on economic growth providing monetary base stability to allow natural interest rates to regulate the economy naturally, but long term, gold tends to flex to economic pressures to expand the money supply.

BTW, I agree that the Federal government should not mandate use of a federal currency. The adoption of a currency standard (i.e., definition of a dollar) voluntarily by private banks would allow those banks to compete with the government in the issuance of notes. If the gov’t (or any bank) started to overprint money and move towards a fractional gold standard, the conversion of suspect gov’t dollars to gold and then to competing dollars would put a quick stop to it. As to objections to the use of multiple currencies, with the modern trend away from cash and the technology available, vendors could easily convert prices from a benchmark currency (their choice, but probably standardized over time) to any currency being issued, and make a similar conversion when depositing collected revenues into their accounts. The Free Market, not gov’t, should provide the solution to these imagined “problems.”

Government force, in the form of mandating that only gov’t-issued dollars be used for all private transactions, is a fatal weakness in any gold standard because it leads to abuse by the gov’t. It’s no coincidence that the gov’t starting issuing “gold-convertible” Liberty Bonds just four years after establishing the Fed, and that the collapse of the gold standard quickly followed.

38

Thomas, I do not disagree with a gold standard. I am just seeking clarification on the “finite quantity problem”. Your assumption that prices fall with more production is only true if demand does not increase correspondingly. Which is why I introduced the thought experiment above to take things to the extreme and see how well the gold standard holds up. So far, your explanation does not address my island situation in which demand and supply have increased almost equally, thereby increasing demand for money to transact (unless I am missing something).

agrippa1, your explanation sort of makes sense but even if I accept that the purchasing power of gold increases over time in my island scenario above, what about the fact that the paper currency backed by gold has a fixed quantity? ie there is only $1 million of paper currency at a fixed rate to the gold and since the gold quantity cannot increase, there will be a severe shortage of money supply, making new transactions impossible. Would this therefore not mean that the ratio between gold and currency would need to be changing every day, thereby going back to an earlier point I made?

39

Also, in the very long term, there are considerable amounts of gold (and other rarer elements) present on both other planets in the solar system, as well as asteroids. I think the price of gold is already high enough (at 1700/oz it’s about $54 500/kg or 54.5 million per metric ton) that it could be profitable to launch a spacecraft and get the stuff somewhere else. If not profitable today, that would certainly become profitable very soon if either the price of gold continues to rise, or it gets cheaper to launch stuff into space. There are basically limitless quantities of gold in the Universe (practically speaking, it’s of course not really limitless, but for all intents and purposes it is), just waiting for someone to retrieve them.

The same holds true for many other expensive elements. Yeah, someone has to take a risk and start a venture, and figure out how to mine in space, but I wouldn’t put it past an enterprising businessman to come up with a solution like that.

*I am not an expert on current launch costs, but I’d be very surprised if 54.5 million per ton is not above what it costs to launch something into space. I think it is considerably less than that with a good, cheap heavy lift vehicle.

40

Thomas, I do not disagree with a gold standard. I am just seeking clarification on the “finite quantity problem”. Your assumption that prices fall with more production is only true if demand does not increase correspondingly. Which is why I introduced the thought experiment above to take things to the extreme and see how well the gold standard holds up. So far, your explanation does not address my island situation in which demand and supply have increased almost equally, thereby increasing demand for money to transact (unless I am missing something).

agrippa1, your explanation sort of makes sense but even if I accept that the purchasing power of gold increases over time in my island scenario above, what about the fact that the paper currency backed by gold has a fixed quantity? ie there is only $1 million of paper currency at a fixed rate to the gold and since the gold quantity cannot increase, there will be a severe shortage of money supply, making new transactions impossible. Would this therefore not mean that the ratio between gold and currency would need to be changing every day, thereby going back to an earlier point I made?

How is an island with only enough resources to have 1 million worth of paper/gold equivalents going to have an economy that booms so much that they’re having currency shortages? That seems a tad counter-intuitive?