Gold Standard and Federal Reserve

Economics Economics Questions
1

Hi guys,

I am not an economist nor an economy student. Recently, I discussed the role of the fed and fractional reserve systen in the role of the current debacle with somebody, who I did not know at that time, has a major in economics. I have posted her arguments below. I need your help in answering her points which are as follows:

Okay, let me try to start with a general view of where I stand on the study of economics. Then I’ll move onto the gold standard or gold backed currency. I can’t address all the questions right here and now, but maybe this’ll help you understand the foundation of my views.

Professors and economists are usually “pure economists” who study “pure economics.” This is as close to 100% theoretic economics. It is the study of the ideal free market. In this free market, prices are set where supply meets demand. People behave optimally and rationally. This would be the open, free market that so many people tout as the ideal economic situation.

However, we do not live in an ideal world. Prices are not set where supply meets demand. People DO NOT (!!!) act rationally. Essentially, this renders the study of economics pretty useless. Trust me on this one - I’m an economics major. It is a useless topic except in theory. As one of my professors pointed out, “Economics is the study of absolutely nothing.” What he was saying is that it is the study of an ideal world while we are living in a real world. So why do we (especially I) even bother studying it? Because it offers guidelines and general trends and principles.

Let’s go back to an example of why prices aren’t necessarily set where supply meets demand. Say we’re in the labor marketplace. The price of labor is called wages. Ideally, where supply met demand, that would be the accepted wages. The problem with accepting those wages is that, more often than not, the market wages won’t allow for sustainable living. We’d have gross poverty, resulting in rises in crime, illness, etc. So the real world, inhabited by real human beings who care about each other and mostly their safety, dictates that we set a price floor. That price floor can be renamed “minimum wages.” What I’ve illustrated is how we’ve moved from a “free market” to a regulated one. Do you disagree with the shift?

As a small aside, the modifications from a truly free market to a regulated one are often created by governing or oversight bodies. In the case of wages, it may be a legislative body. In the case of inflation control, it can be another regulatory body (let’s maybe call it the Fed?).

Let’s talk about people acting rationally. Economic theory requires that people act rationally. Reality shows us that the biggest expression of irrationality in the financial markets is the human emotion fear. Fear makes people do all sorts of irrational things. The market systematically experiences panics, depressions, recessions, bearishness, etc. because of fear. People cause bank runs when they fear for their money. They pull money simultaneously from stock markets. To counterbalance this irrational fear, regulatory bodies are instituted to keep the markets from swinging erratically, which is detrimental to economic health. The FDIC insures money to prevent bank runs for example.

I hope I’ve illustrated why I feel we need regulatory bodies to prevent completely free markets from existing. At another time, I’ll address the Fed as a specific institutional regulatory body. I’ll also address inflation, unemployment, and the Phillip’s Curve at that time. We’ll toss in Alan Greenspan and the economy of the 90s too.

Now to gold backed currency. Why do you believe money should be backed by gold? Because it is valuable? What gives gold any kind of value? It’s metal. Gold has value because people assign value to it. People believe that gold is valuable. People believe in gold. It’s just a figment of their imagination that results in some sort of confidence. Just like people believe in gold, people believe in the U.S. economy. Fiat money has value because it is backed by the U.S. economy. It’s really not different from gold. The big difference is that gold is finite. So economies can’t really expand that much unless you revalue gold. Who’s going to stop speculation? If tomorrow I start hoarding gold which results in everyone else hoarding gold, won’t that overinflate the value of gold? Isn’t that just inflation?

Allow me to disclaimer, I don’t agree with everything the Fed does. But I do believe it is necessary. The easiest argument is point out the situation before the existence of the Fed. The panics were so detrimental, it was absolutely necessary that some sort of institution bridge the private sector and the government. The American economy has experienced life without the Fed… and it was terrible. The Fed is not private or governmental – it is considered a mix of both.

This is her response to famous quotes:

  1. “If the American people ever allow private banks to control the issuance of their currency, first by inflation and then by deflation, the banks and corporations that will grow up around them will deprive the people of all their property until their children will wake up homeless on the continent their fathers conquered.” Thomas Jefferson
    JEFFERSON WAS A STAUNCH STATES-RIGHTS SUPPORTER AND AGAINST CENTRALIZATION OF GOVERNMENT - A TOTALLY ACCEPTABLE SITUATION GIVEN THAT AMERICANS WERE FLEEING THE CENTRAL GOV’T OF ENGLAND DURING THE TIME OF THE REVOLUTION. DE-CENTRALIZED GOV’T WAS THE WAR CRY OF HIS ERA. ALSO, THE FED (AS POINTED OUT ABOVE) IS NOT A PRIVATE BANK.
  2. It is well that the people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning. - Henry Ford I AGREE. ONCE PEOPLE REALIZE THAT OUR FISCAL POLICY IS WILDLY REPUBLICAN (SPENDING MONEY WE DON’T HAVE ON A WAR WE WERE LIED TO ABOUT), THE REVOLUTION WILL BE CALLED PRESIDENT OBAMA.
  3. “Who controls money controls the world”, Henry Kissenger. THINK CAREFULLY FOR WHOM YOU VOTE. CAN WE MAKE A CONNECTION WITH IRAQ HERE?
  4. “During economic crisis, wealth is not destroyed, it is merely transfered”, Larry Bates. FAIRLY OBVIOUS. THERE IS AS MUCH MONEY TO BE MADE IN THE BUILDING UP OF A CIVILIAZATION AS THERE IS IN THE DOWNFALL OF A CIVILIZATION. UNFORTUNATELY, THE WEALTH IS OFTEN TRANSFERRED TO THOSE WHO ARE ALREADY RICH. DID YOU HEAR ABOUT THE AIG EXECUTIVES WHO REC’D BILLIONS IN BAIL-OUT MONEY AND THEN WENT FOR A WEEKEND AT A RESORT FOR ABOUT $0.5M??
  5. “Give me control over a nation’s money supply, and I care not who makes the laws”, Mayer Amschel Rothschild IRONICALLY, THE CONTROL IS HANDED OVER BY OUR BELOVED PRESIDENT. MAYBE WE SHOULD BE CHOOSING THEM MORE WISELY?
2

Wait…which part was that?

The part where she only half applies supply/demand to minimum wage ignoring that the marginal workers are now priced out of the market?

Or perhaps the unsupported assertion that ‘fear’ is the cause of all the economic turmoil?

That’s the second person in the last few days who’s bought into the Greenspan ‘irrational exuberance’ business cycle theory hook, line and sinker without presenting any argument to back it up.

Where’s this from anyway?

3

-People do not currently act “rationally”, because there are restrictions that disallow the free market from performing correctly. If the free market was allowed to function, people would use rationale, because otherwise the price and quantity would drastically fluctuate.

-If the wages you were being offered were not to your liking, you could not work for the firm. If there were no other firms you could start your own, and this would naturally cause the wages in the area to rise, not allowing people to suffer and die.

-Like the past few weeks…is that what regulatory bodies do? They keep the market from swinging erratically, which has blatantly not happened.

-We are now fleeing the central government of America, because they are oppressing our freedom, rights, common sense and overall well being by their nanny state ideologies.

-Henry Ford was a known socialist/communist, so if you follow this persons so called “logic”, that means she believes in communism and socialism, which seems directly in line with her choice for President.

-If you are a kook who tries to blame George Bush for everything, I bet you could blame him for the supposed Roswell coverup, but again that doesnt follow logic. George Bush does not control money, and if this person is a supposed Economics major, she should understand how the money flow works and realize that he has virtually no control over it.

-Money is paid for a good or service, based on what is perceived as the value of that good or service. If the AIG executives did not deserve the money, they would not have received it. The very fact that they were the executives of the company shows that they did something special to deserve being in that position, ie they get paid accordingly.

-Ironic since she wants to give the “power” to a known socialist.

4

I’m sorry, but…wow. Just reading her argument made me feel depressed.

5

Hi Jonathan or anyone who may choose to respond.

How do you respond to this argument??

6

Fiat currency isn’t backed by anything other than FAITH. And faith is believing what you know isn’t true.

7

I’d just respond that it’s a bullsh*t tangled knot of circular logic but that’s probably not too helpful.

And maybe ask them how the fiat currency came into being in the first place when, according to their ‘argument’, it’s original value can’t be traced back to gold.

Or to quote myself from another thread, “Mises’ regression theorem, anyone?”

8

Yes, she’s correct that valuation is subjective. Now whence does it follow that it is akin to fiat money? It is valued precisely because it has all the qualities conducive to it being a medium of exchange.

-Jon

9

Given that we’re coerced into using fiat money, isn’t the very fact that all valuation is subjective the very reason that fiat money is inferior? because it doesn’t reflect the subjective valuations of society?

10

It is more or less.

-Jon

11

I kind of addressed this in my other post, I believe. We only use money in the first place because we need something of value to exchange for goods or services. Money has been the most convenient because it can be fixed to something of value. For the longest time it was fixed to gold, because gold had a supply to which we have seen no end. Gold backed currency also tended to stray away from the inflation that fiat currency currently causes, because the government could not endlessly print money whenever they felt like it. Gold caused and forced the government to be semi-responsible with how they handled the printing of money. Fiat money only has the promise of worth, because that promise is backed by the United States government, which is not a promise that we should have to live with. This girl says that gold is finite, but so is paper. The only worth of paper money is that which it is printed on, since a promise is worth nothing in real dollar terms. Gold would not need to be revalued, because in fact at the current rate the price of gold would fall if we backed it to currency, since the US government holds a certain amount of gold, and could not just buy as much as they wanted(in theory). Gold would revalue itself according the usual supply and demand model that most real(ie not this girl) economists use and abuse everyday.

Facts are a powerful creature, especially when used to disrobe the monster of lies, indoctrination and lack of though.

12

I hope she isn’t paying for this degree because it is absolutely worthless… and her professor even told her as much!!

I’ll just pick one gem, “People DO NOT (!!!) act rationally.” By this, she means that people do not behave like charged particles in the equilibrium equations used by classical economics. Big whoop. I like David Friedman’s definition of rationality, “… I do not know other people … well enough to incorporate their irrationalities into my analysis … What I do know about them is that they, like me, have purposes they wish to achieve and tend, albeit imperfectly, to correctly choose how to achieve them. That is the predictable element in human behavior, and it is on that element that economics is built.” [Emphasis added]

Humans are not predictable and their choices certainly do not conform to equilibrium equations. However, humans are not completely unpredictable, either. This woman’s professor has renounced the possibility of knowledge simply because he can’t write a differential equation to describe human choice. What an idiot.

Clayton -

13

OK, I have to respond to some more of this drivel.

“Now to gold backed currency. Why do you believe money should be backed by gold? Because it is valuable? What gives gold any kind of value? It’s metal. Gold has value because people assign value to it. People believe that gold is valuable.”

What a revelation! Valuation is the result of subjective, human preference!

“People believe in gold.”

Yes, there is a naturally occurring metal called “gold” and I believe in it. Surely, this confused woman also believes in gold!?

“It’s just a figment of their imagination that results in some sort of confidence. Just like people believe in gold, people believe in the U.S. economy. Fiat money has value because it is backed by the U.S. economy.”

Not quite. People believe in fiat money because it has a regressive connection with market money. As far as drawing an equivalence between “believing in the US economy” and “believing in gold”, that is a ridiculous and meaningless red herring. I have no idea what it means to “believe in gold” though it seems she’s trying to say that gold is valued by the market. If that’s her meaning, then what does she mean when she says that people believe in the US economy?! That people value the economy? What is the price that you put on the economy? How do you value, buy and sell interactions?

The point is, there are so many fallacies here that untangling them is almost hopeless.

“It’s really not different from gold. The big difference is that gold is finite. So economies can’t really expand that much unless you revalue gold.”

Huh? An economy cannot grow without more money? That’s just plain childish.

“Who’s going to stop speculation? If tomorrow I start hoarding gold which results in everyone else hoarding gold, won’t that overinflate the value of gold? Isn’t that just inflation?”

What?! That would deflate gold, not inflate it. This woman is upside-down, inside-out and backwards.

If I were you, I would not bother thinking about anything this extremely benighted woman has to say. Even her befuddled professor would throw her out of class for saying that gold hoarding results in inflation!

Clayton -

14

Gracenj,

Guido Hulsmann has recently released The Ethics of Money Production. This is a great place to start.

Gold has a value that is established over time in the market. The price of gold or any other commodity is not “set” one day by some person or authority. Commodities come to have an agreed value through voluntary exchange based on a variety of interrelated conditions. The question “what gives gold any kind of value?” is meaningless as posed.

More importantly, imagine if you place paper money on a table and a bit of gold beside it. We can know for certain that the gold was originally introduced into trade only after the original owner exerted productive labor. The paper money, on the other hand, required no labor because production of paper money is essentially costless.

Would you rather be paid for your hard won productive labor by a person who hands you costless dollars rolled out of a printer in an instant, or a person who hands you a commodity for which he also labored? The paper money case is properly viewed as theft and the commodity case is exchange.

There are two critical elements here. First, because the gold requires labor to produce, newly mined gold can only be introduced through productive labor, the same as labor required to grow potatoes or build a house. This equal footing protects your property rights. Secondly, because the supply is limited both physically and through the throttle of labor and market value, new gold causes negligible, indeed acceptable, distortion to the value of gold that already exists.

While more can be said, these two points illustrate the central ethical problems with fiat money and ethical soundness of natural money.

15

Wow… so when she is sick, and I offer my services and say “Trust me, I’m majoring in medicine” then all is well?

Yes, they are. We may not see all the different nuances of every market, but there’s a reason it’s called the Law of Supply and Demand, and not the Theory of supply and demand. If ever there is a scenario where supply and demand schedules do not meet to prove the law, you will find government regulation and interferance is the culprit. In that case, Free Market operations are negated, and the Law of Supply and Demand is (temporarily) being subverted.

To paraphrase: Irrational behavior is caused by fear. Fear is caused by a lack of faith in the financial market, which is caused by tampering with Free Market Forces in the form of regulation by the Government (The FED, inflation, etc.). Therefore, MORE REGULATION is needed to calm public fear and reduce irrational behavior. Circular logic FTW!

5,000+ years of cultures who place intrinsic value in a rare metal makes it valuable. Gold has been, and will continue to be, the measure by which all currencies are valued. Economists would do well to pay close attention to the dollar value of gold, because, over time, it is the best indicator of the dollar’s worth.

And yet, she plugs Obama at least twice, a known sicialist. Great. Doesn’t she know that a socialism has no need for economics? Change majors, maybe?

16

Alright, I’ll quickly respond to this.

This is the neoclassical methodological structure. They assume equilibrium and derive economic law from there. This is not an applicible critique to austrian econ, which derives laws from praxeology, human action and what it entails (preference/value, trade, etc.)

Prices are not set by supply and demand, they are set by a subjective value. A good entraperneur will only spend as much money towards production which he expects to get an equal or greater return on. This applies to all levels of production (intermediary goods/services) leading up to the final good.

In the case of rationality, it really needs to be defined to be a viable term in discourse. It can mean many things.

Perfect description of neoclassicalism.

only when there is inflation, taxation and tarrifs, and import sanctions.

Price floors hinder the expansion of the labor market, are a barrier to entry for small businesses, and create structural unemployment. How very caring.

LOL!

Fear theory of the business cycle. Horror movies cause financial crisis.

Banks cause bank runs when they only hold a fraction of it in reserves and will give it out on a first come first serve basis.

And men in suits who’ll kidnap you for violating legal tender laws.

Yes if you’re talking about inflation in the sense of value, it’s also price deflation.

And it’s experienced life with the Fed and suffered the most severe panics in it’s history.

17

I don’t want to be a discussion killer, but seriously, there’s too much content in that looooong second-hand, undefended blockquote to warrant any serious consideration here.

Beginning with “economics is the study of nothing”. That’s flunk-the-final wrong.

18

No problem david_z. You won’t kill the discussion.

gracenj asked for some guidance in response to arguments she encountered. The consideration is not to imagine one is debating the economics student. The consideration is in support of a person who is asking questions so she can understand and respond. I’m pleased gracenj is looking for answers and getting feedback.