Given that the worldwide supply of gold is more or less constant, but the world population and amount of stuff we all have is constantly expanding, how would a gold-backed currency with fixed supply and expanding demand avoid steadily increasing in value? And if it did, would this not stifle investment in wealth-creating industry, since simply sitting on a pile of gold would itself be a lucrative investment?
There would be a steadily increase in purchasing power. That is correct. This is not a bad thing at all.
The idea that holding money or hoarding is somehow detrimental is simply incorrect.
Here is Mises on this matter (Bold highlights are mine):
Whenever an individual devotes a sum of money to saving
instead of spending it for consumption, the process of saving
agrees perfectly with the process of capital accumulation and
investment. It does not matter whether the individual saver
does or does not increase his cash holding. The act of saving
always has its counterpart in a supply of goods produced and
not consumed, of goods available for further production
activities. A man’s savings are always embodied in concrete
capital goods. . . . The effect of our saver’s saving, i.e., the surplus
of goods produced over goods consumed, does not disappear
on account of his hoarding. The prices of capital goods
do not rise to the height they would have attained in the
absence of such hoarding. But the fact that more capital goods
are available is not affected by the striving of a number of
people to increase their cash holdings. . . . The two
processes—increased cash holding of some people and
increased capital accumulation—take place side by side.
(Mises, Human Action, pp. 521–22)
Holding money in a deflationary environment would still have less return than other alternatives involving risk, that is, entrepreneurs would have to pay interest rates sufficient to attract investors and the interest paid would also become more valuable over time, so the incentive to invest is driven by the interest rate. The only variable that would be affected would be the interest rate, but there are other reasons to believe the interest rate would actually be fairly low in a free currency (and banking) economy. In other words, plenty of investment will occur even in a deflationary environment, the Keynesian argument that deflation stifles investment is pure hokum.
Guido Hulsmann has linked the interest rate with the price of money in a commodity money economy but if there is a free market in currency issue, the supply and demand naturally balance themselves through the price level as they do for any other sort of good or service.
Also, it is a common fallacy to suppose that gold supply is constant. Far from it. The gold supply fluctuates with the profitability of mining gold. If gold were to become a hand-to-hand currency again, the value of gold would skyrocket and the profitability of mining would likewise. Deeper and more dilute deposits would become profitable mining prospects, old mines which had once been closed would be re-opened, and so on. If the population and demand for money still ultimately outstripped the capacity of gold mines to keep up, despite the increasing value of gold, then the market would shift to a more abundant commodity, such as silver or copper. That commodities can’t be produced at the cost of ink and a slip of paper is their virtue, not their vice. The amount of paper money can be increased essentially without bound (witness Weimar, Zimbabwe) but it is costly to produce commodity currencies, thus, their supply is naturally regulated on the market by the price level. The supply of paper currencies is primarily dictated by the interests of the party controlling the printing press.
Clayton -
I don’t think those conclusions quite follow. Sure, other investments would be profitable. But relative to an inflating currency, wherein you MUST risk investment or face depreciation? Especially considering the psychological component? (Humans are far more averse to losing what they have than they are amibitious to gain what they don’t.)
And I know the gold supply isn’t constant. But it doesn’t exactly “fluctuate.” It always increases, because gold never degrades (one of the reasons it is useful as wealth storage). And while the rate of increase does fluctuate, it’s always quite small relative to total supply, for the same reason: almost everything that’s ever been produced is still sitting around, owned by somebody. This relative stability of supply is kind of the point, no?
Well, we are speaking of a gold (commodity) standard, not paper money. Paper money is a different situation. If the central bank announced it would not issue a single dollar more and was destroying all printing presses, etc. people would become very eager to hold that paper because of its virtually risk-free appreciation.
But as a commodity money becomes more valuable, the seigniorage which can be earned on minting, the commissions which can be earned assaying or dealing, and the profitability of mining the monetary commodity all increase. This means that these industries will “arbitrage” the value of the monetary commodity, whenever it increases, until its “price” reaches the level dictated by demand. The only way your commodity money will become more valuable is under any or all of the following conditions:
- The demand for money increases
- The supply of money decreases
- The demand for non-money goods and services decreases (this is related to (1) through the interest rate, see Hulsmann on this)
- The supply of non-money goods and services increases (this is related to (2) through the interest rate)
Well, the monetary gold supply can go up or down. If the supply of newly-mined gold is less than that demanded for industrial, jewelry and other non-money uses, then gold bars will be melted and converted to their most valuable use. I don’t think this would happen as often in a free currency economy as it does in the highly manipulated currency economy we live in today. But it could happen.
Clayton -
Not if we could use fiduciary media instead.
“but the world population and amount of stuff we all have is constantly expanding,”
i am not sure about what you mean when you say stuff is expanding.
do you mean choices of goods to use? because i thought matter on earth was basically fixed ??
And you consider this a positive thing?
Interest rates (the market rates) would continuously rise, making investment more lucrative relative to sitting on a large pile of gold coins (for the initial lender). The problem, of course, is that it would elevate market interest rates above the natural or equilibrium rate, retarding business activity. So you’re right and wrong. People would put their money to work, but excessively high interest rates would prevent entrepreneurs from engaging in warranted investment ventures (limiting capital supply).
This question is more complicated than you think, and it’s wildly debated.
“how would a gold-backed currency with fixed supply and expanding demand avoid steadily increasing in value?”"
until all gold was mined and made into money it wouldnt be fixed.
i believe this has been discussed in the blog before.
why would it need to be avoided? if the myriad of other goods was declining price due to productivity advances the increase in gold value wount need to be avoided, right?
“would this not stifle investment in wealth-creating industry, since simply sitting on a pile of gold would itself be a lucrative investment?”
how do you get so much gold to sit on?
A supply of goods produced is not being consumed! Resources are freed from consumption and made available for investment. For your statement to be true, those resources would have to just sit there idle.
It does not matter whether the individual saver
does or does not increase his cash holding. The act of saving
always has its counterpart in a supply of goods produced and
not consumed, of goods available for further production
activities. A man’s savings are always embodied in concrete
capital goods. . . . The effect of our saver’s saving, i.e., the surplus
of goods produced over goods consumed, does not disappear
on account of his hoarding. …
The two processes—increased cash holding of some people and
increased capital accumulation—take place side by side.(Mises)
The full quote is up thread.
You should read this too by Hoppe: http://mises.org/daily/3449
I’m not saying that hoarding is a problem, since high interest rates (relative to natural rate) would prevent hoarding. Hoarding is only a problem with a defunct financial system. Savings and real capital would indeed flow to the loanable funds market (from initial lender to financial intermediaries).
The problem is that the interest rate, due to money demand, would continuously rise above the equilibrium rate, which would prevent investment even in warranted productions. But this comment has revealed something that I haven’t thought about, namely that this implies a condition where banks sit on real capital instead of lending it out. Now this could be possible if the price affect outweighed the output effect; or, in other words, that banks would profit more from an elevated interest rate and fewer loans than from increasing lending at a lower rate of interest (the natural rate). Something else to think about.
“banks sit on real capital instead of lending it out…”
the money that makes its way to the bank…where does it come from?
if the money wasnt intended to be loaned wouldnt the money-holder just keep their money, to spend or hoard as you call it.
or loan it themsleves?
" Hoarding is only a problem with a defunct financial system. "
what is a defunt financial system?
and why would hoarding be a problem in any financial system?
ie, hoarding until just before one dies and then destroying ones money?