I understand your question. The answer is that new discoveries of gold would indeed set off an inflationary boom and then the eventual bust. But the inflation wouldn’t be as severe since gold serves two functions under a gold standard (industrial use and monetary use). As inflation increases, and as the value of gold falls, the demand for gold for industrial purposes increases, having a stabilizing effect. Furthermore, I mentioned the price specie flow mechanism because it is the main reason why Austrians support a gold standard. When one nation inflates, under a gold standard, it is hit with a deflationary shock, and elevates the market rate back towards the natural rate. There are self-correcting forces restoring equilibrium. Our international monetary system has no self-correcting market mechanisms and must inevitably lead to perpetual inflation.
Spain had a long period of inflation due to the influx of American gold and silver. But the thing that really killed the Spanish Empire was taxation. The English who went to fight in Spain in the 1930’s couldn’t believe how backward and primitive once mighty Spain was.
Esuric: Could I get your opinion on my comment, above? I read your comment about international gold flows, to paraphrase: In the OP’s scenario, monetary inflation would result from finding a large quantity of gold. Prices would rise, foreign goods would become more affordable, imports would increase, gold would flow out of the local economy. Also, industrial use would increase since gold is more plentiful. These effects would tend to bring prices back down. But, would time preference be affected by any of this?
At the micro level–and by this I mean in the area local to the mine where the gold was found–it is possible to create a boom-bust cycle of some sort, but gold is both labor and time intensive to produce. The news of the find would probably spread more quickly than the actual gold itself, so investors would be aware of the find and its effects on price levels. Also, the amount of gold that would be required to disrupt investment and/or the prices of goods and services would not appear instantaneously (except possibly locally), so the effects of the find would be dampened further–you would need thousands of tons of gold to affect national price levels.
The short answer is no. The long answer is as follows:
Any influx of new money will initially create some distortions in relative prices, so in theory, an influx of a large quantity of new money can give rise to bubbles, however, such bubbles are likely to be intratemporal in nature. ABCT is not a theory of intratemporal distortions, or a theory of just any bubbles.
ABCT is a theory of intertemporal distortion in the structure of production caused by a mismatch between the amount of loanable funds made available by the banking system and the amount of real savings. At the heart of the problem is the practice of maturity mismatching. Banks issue short term liabilities in order to invest in long term assets. Zero-term liabilities in the case of demand deposits.
The influx of new gold can be used in one of only three ways:
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The additional new gold would be spent on consumers goods.
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The new gold would be saved by holding it (hoarding)
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The new gold would be saved by making it available for investment.
Under a true gold standard, banks would not be able to inflate on top of any influx of new gold that may make its way into the banking system. The gold would be either held as demand deposits or made available to the bank for investment as time deposits. The crucial point to understand is that under no circumstances, can there arise a maturity mismatch under a true 100% gold standard. There can be no Austrian business cycle.
Your understanding is correct.
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Who is to say that the newly minted gold money would go into credit markets? Consider this: The gold miner extracts the gold. The gold miner then sells a portion of that gold to a money-minter. The money minter pays the gold miner some newly-minted gold coins in exchange for the raw gold. The minter then mints new coins with the raw gold, and proceeds to spend/save it at their discretion. So yes, there would be some distortions along the way, but nothing serious enough to cause a full-blown business cycle the way we normally perceive it.
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How much money do you think would be minted a year? Remember, in a free market, private money producers would compete among each other in providing alternative currencies. So there might be a “gold standard,” when in reality there could be three or four different “gold standards” competing with each other, each separate standard bearing the stamp of its mint. And since every minter would want to attract as many customers as possible while still making a profit, they would have to keep inflation under control. I would venture so far as to say that minters would very rarely expand the money supply at all, since people would want to use a naturally appreciating currency.
Maybe, maybe not. If it does change, it will be in the positive direction; but even if it doesn’t change, there will still be an inflationary boom, that is, inter-temporal disequilibria (market rate below natural rate). The deflationary shock/correction after the initial boom will adjust prices, and restore equilibrium. But the deflationary correction may go too far and elevate the market rate above the natural rate causing “secondary shocks.” This is/was the main argument against the gold standard–of course, we see how well the alternative system worked out.
Either way, the key is this self-correcting mechanism which prevents perpetual inflation. In our current system, nations can continuously inflate, making their goods more appealing on the international market, increasing exports. Furthermore, the reduced interest rate, caused by inflation, will put additional downward pressure on the currency, leading to runaway inflation. Of course, if all nations are doing this (which they are), then individual currency fluctuations are concealed (because every currency is being devalued). This is why gold, even to this day, is the most stable unit of account.
No. The ABCT is predicated on a boom instigated by means of credit expansion, i.e. artificial creation of loans depressing the interest rate, sending false signals to entrepreneurs who then engage in more lengthy productive processes. News of a gold influx would be akin to an open announcement that more notes are being printed. It might cause prices to rise, but that is all.
Banks would pyramid additional credit on top of their new reserves. Even if the influx of new gold (discovery of a mine) went directly to consumers, it would automatically put downward pressure on the structure of production. But it always finds its way to both consumers and the banking system. This happened to Spain after they discovered large gold supplies in South America, and it happened during the latter part of the 19th century when large gold reserves were found in Australia and California. An additional supply of money must necessarily lead to a recession insofar as the ratio between the demand for present and future goods changes.
I can see where this is going. You have to specify whether there is FRB in this hypothetical “gold standard”.
The decrease of the price of newly minted coins would make banks able to buy more and lend it at lower interest rates.
Indeed. But even with 100% reserves, an increase in the supply of money would still set off the ABC. Those who get the new money would increase their purchases, leading to Cantillon effects. The banks would get the new sums, and depress the market rate below the natural rate. The ABCT, in its most general form, focuses on the misdirection of resources towards unwarranted economic activities.
Well now, but that wouldn’t be a true 100% gold standard. You’re talking about the semi-gold standard of the 19th century. That’s not the gold standard in question.
Not so.
https://forum.freecapitalists.org/t/business-cycles-under-a-gold-standard/10880/25
A new influx of gold would indeed lead to Cantillon effects (would have be a large discovery). This misdirection of resources towards unwarranted economic activities, brought about by arbitrary changes in relative prices, is essential to Austrian theory–a key insight. Furthermore, if the newly found sums went into the banking system, there would be a right-ward shift in the supply of loanable funds, which would be lent out for investment purposes, but which wouldn’t be backed by real capital. The extent of this inflationary process depends on the size of the newly found gold mines; but if it enters the banking system, it must necessarily suppress the market rate below the natural rate. Unless you’re saying that gold = real capital. There would need to be a correction where prices adjust, restoring equilibrium.
100% reserves don’t magically eliminate business cycles. It’s merely one step towards the elimination of business cycles, but with its own economic ramifications (never mind the fact that it’s impossible to enforce). The problem with fiduciary media is that it acts like money proper.
Not bad! A rare case of very good and precise observation , which however, I claim still leads you to an erred conclusion. Bear with me on this one.
If the new money is surrendered to investment then there will be no intertemporal distortion.
First, think about what this next quote by Hayek really means with respect to the case of fiduciary media:
All that is required to make our analysis applicable is that,
when incomes are increased by investment, the share of the
additional income spent on consumers’ goods during any
period of time should be larger than the proportion by
which the new investment adds to the output of consumers’
goods during the same period of time. And there is of course
no reason to expect that more than a fraction of the new
income, and certainly not as much as has been newly
invested, will be saved, because this would mean that
practically all the income earned from the new investment
would have to be saved.29
In other words, if economic agents were to save all of the monetary income that results from the creation of fiduciary media, then there would be no intertemporal distortion. Of course, this is an impossible situation for the case of fiduciary media. Econmic agents won’t simply adjust their time pereference in accordance of with the creation of fiduciary media.
In the case of new gold that was surrendered by the individual as a time deposit, the above scenario of all the income being saved is precisely what happens. The monetary income that results from this new gold is saved for the obvious reason that the owner of this gold has already surrendered its use before it was loaned out.
Of course not. Think about the proportion between savings and consumption. Assume no change in timer preference as a result of new influx of gold, that is, the new gold is to be equally spent in the same proportion between consumption and savings. No change in the structure would take place. Prices would simply rise uniformly.
Now think about the case when the new gold is saved, then the proportion between savings and consumption will change. Time preference really has become lower. The new gold will be lent out but as stated above, the net amount of new income that is derived from it is obviously saved and not consumed since the use of the gold has already been surrendered. Relative prices will change and coordinate this process like any other change in time preference. No business cycle will take effect.
It won’t be a correction phase but a coordination phase. If the new gold is saved, then of course relative prices will change, but precisely because time preference is changing. If there is no maturity mismatching, as there won’t be with a true gold standard, then the new gold that is saved will induce a coordination phase, but not a business cycle.
Think about what Hayek is saying in the above quote about fiduciary media, but now simply reapply it to the influx of new gold, which can only be lent out if and only if, agents actually decide not to consume that gold.
Basically, only FRB or something effectively the same causes BC.
Otherwise, the theory of how price fluctuations direct resources to the best uses is flipped upside down, leading to a catastrophe singularity.
Yes, that’s absolutely correct - “or something similar”
Thanks?
If the ratio between the demand for current goods relative to future goods remains unchanged, then there is no inter-temporal disequilibrium. But why do you expect this to be the case? This may happen, but probably not. A change in either direction (favoring the latter or former) must necessarily distort the structure of production. Furthermore, if you approve of Hayek’s analysis, then you should support a free banking system (or at least acknowledge its potential benefits) that’s sensitive to the demand for cash holdings. This also means that you don’t believe that an elastic money supply must automatically and necessarily lead to business cycles.
Again, this is a major assumption which hasn’t been substantiated. This assumption only holds if the ratio between the demand for current goods and future goods remains absolutely unchanged.
No. The time preferences of society won’t change, but the time preferences of those individuals who mined the new gold will most certainly change. Let’s say that it declines, even though we should expect the opposite to be true, and that they save the entire supply of newly mined gold. If the supply of this stock of gold is enough to change the interest rate, below societies time preference, then we would still see inter-temporal disequilibrium. So just to be clear: if party A mines X amount of new gold, where X is half of the entire money supply, and if they choose to save the entire sum of X, then we should expect a depressed market rate below the natural rate, causing forced investment towards more roundabout methods of production, without an adequate supply of real capital. The process would be practically identical to increasing half of the supply of money in the broader sense by creating fiduciary media (and that’s the problem–fiduciary media acts as if it was money proper). But we wouldn’t see a continuous expansion of the structure of production–just one round.
“It is quite conceivable that a distortion of relative prices and a misdirection of production by monetary influences could only be avoided if, first, the total money stream remained constant, and second, all prices were completely flexible, and, third, all long term contracts were based on a correct anticipation of future price movements.” -Prices and Production, pp. 304
All three conditions must be present, according to Hayek.
I don’t. I just started out with this scenario as an example. Later I change this assumption.
I would be more cautious with using the term distortions in this case. Since when are changes in prices that reflect changes in real supply and demand distortions? Sure, they require energy and effort by economic agents. Nobody likes change. A change in either direction of the real time preferences of economic agents does not “distort”, more then a [sharp] change in preference from hot dogs to hamburgers ! The changes in relative prices will be indicative of the real change.
That’s a strange conclusion.
First, Hayek himself never recognized any benefit for Fractional Reserve Banking whatsoever. So your logic here doesn’t compute.
Second, Of course I support free banking. Free banking without the special government privileges that no other business enjoys. But Let’s avoid this argument right now.
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Elasticity as in Monetary Equilibrium Theory? You see the similarity, which is good, but it’s not quite the same.
First, if you agree with the above assertion of yours, then you should acknowledge that my explanation is sound and that indeed, the new gold, if saved under a 100% gold standard, will not cause a business cycle. Even the free bankers acknowledge this.
Second, it’s not the same because MET suffers from serious theoretical flaws.
Why did you stop reading the post in the middle? Continue another line and I change this assumption. I made the assumption only as part of the theoretical analysis, where I later talk about a change in time preference. Read it again.
Again, I know it will probably change. I specifically addressed this.
Why? Why should the opposite be true. The owners of the new gold may either consume it, hold it, or invest it. How do you know what they will do?
I see where you are going with this … Let me wait for the next comment:
OK, I hope I am not misunderstanding the point you are trying to make here. Of course if they save for say one year, and then when they receive their income (principle + interest) they consume it all (or part of it) instead of reinvesting, then we have a problem. But there is nothing special about this hypothetical example with respect to the influx of new gold, although there probably will be some practical differences, which I’ll address below. You can also save existing stock of Gold for one year, signal a lower time preference, and then after a year change your mind, and signal back a higher time preference. All you are saying is that if people were to flipflop with their time preference, then we couldn’t see a “continuous expansion of the structure of production”. Of course! But theoretically, your “just one round” scenario is not unique for the influx of new gold.
Practically, if you want to make the case that new gold has the potential to cause more confusion and errors, I’ll certainly give you that. But it doesn’t change the fact that due to the inherent soundness of the 100% system, there can be no wide spread systemic crisis for the banking industry. There is no maturity mismatching so it’s not as if all the banks are suddenly all revealed to be bankrupt. According to your example, people who have previously saved may upon maturity of the loan decide to reallocate some of that gold (or all of it if you wish) back to consumption as they may experience a fall in real wages. I would be very cautions in describing the above as distortion. Rather, it is simply a change in preference, although, as I have acknowledged, it may be a more volatile and less stable upon the influx of new gold, as oppose to simply a change based on current stock of gold. But again, there can be no wide spread banking crises, which is after all, a major ingredient of the ABCT.
First, In my original post of this thread, I said that any new money will initially distort prices. Misdirection of production also refers to intratemporal distortions and not just intertermporal. Remember also that Hayek in Prices & Production is considering a monetary system with fractional reserve banking. Not one with a 100% gold standard.
more deposits = lower time preference
less deposits = higher time preference
deposits = credit
= no distortion