Gold standard - unsustainable?

Economics Economics Questions
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1

Hello to everyone in the Mises community.

My question concerns a problem that seems to undermine the long-term stability of a commodity-backed currency (such as a gold standard).

First, suppose that we had a gold standard. Why would anyone want to actually own any gold at all? Aside from its practical uses in jewelry, electronics, etc., most of its value derives from the fact that people demand it as a medium of exchange. In other words, the vast majority of gold is not be consumed, but rather stored away with the expectation that it can be later traded for something of “actual” value (that is, something that can be used/consumed by an individual). Thus, to speak of gold having “intrinsic value” is misleading because its market value is far greater than what it would be if we did not have a gold standard.

Next, realize that people will always want to borrow gold at interest because they value the goods that can be purchased with that amount of gold in the present, more than they value the goods that can be purchased with a greater amount of gold in the future. The interest rate will always be positive because otherwise the lender might as well stash the gold away, and so they would have no incentive to lend.

So if you are possession of some gold, you can either spend it, lend it, or stash it. Nobody would choose to stash it when they can lend it at interest, so that option is out. But when you spend or lend the gold, the buyer or borrower who just received your gold is faced with the same set of choices, and for the same reason they would want to get rid of the gold as quickly as possible in order to maximize its usefulness.

Murray Rothbard explained why people would want to own cash (in this case, gold) as follows: “…the desire to keep a cash balance stems from fundamental uncertainty as to the right time for making purchases, whether of capital or of consumers’ goods” (Man, Economy, and State). However, a stash of cash provides no hedge against uncertainty that cannot also be provided by loans that are made for arbitrarily short periods of time (such as days, hours, or minutes).

Therefore, everyone would have an incentive to reduce the amount of time in which they are in actual possession of gold. In past ages, this time interval may have been quite long because of the physical constraints of acquiring and transporting gold, but in the modern age it can be reduced practically to zero by using electronic transactions. Thus, the velocity of money will increase without end, making gold useless as money.

All of this means that if competing currencies are allowed, then the gold standard would ultimately not be the market’s choice.

Are there are any flaws in this analysis? If you can enlighten me more about this issue, I would appreciate your input.

2

There are two obvious problems. First of all, even with modern technology, there are still transaction costs. Most people probably don’t want to rely on the repayment of a loan while they are eating in a restaurant to determine if they will be able to pay the bill.

The second problem is credit. What if you lend the gold and it’s not paid back? The repayment of a debt is never an absolutely sure thing.

3

Your argument, though critically flawed, could be applied to any money. Simply replace the word “gold” in your argument with any other medium of exchange. Would you not come to the same conclusion? Are you supporting a fiat currency?

The flaws in your analysis, which you could just as easily (and errantly) apply to any other money, that I caught: 1) “Nobody would choose to stash [gold].” 2) “A stash of cash provides no hedge against uncertainty that cannot also be provided by loans that are made for arbitrarily short periods of time (such as days, hours, or minutes).” 3) “In the modern age [the time it takes to transport money] can be reduced practically to zero by using electronic transactions.”

In a world where information is scarce, uncertainty will always exist. Where uncertainty exists, there will always be a need for money reserves. You may have a credit card to handle small surprises, but the credit card company will then need the money reserves to be able to lend to you on demand. They would be “stashing” it so that they would have money to lend when you asked for it. In addition, your ability to acquire the loan you need would depend on your credit-worthiness. This world is filled with people who have failed to repay their debts in accordance with their contracts. A prudent loan-maker would not loan to anyone for any reason. Also, while you correctly state that electronic transactions are nearly instantaneous, physical transportation of gold will still be necessary. Competing banks will constantly call upon each other to redeem their notes (electronic or paper) in specie. This is one attribute, the barrier to inflation inherent in a 100% commodity money, that makes gold a great choice as a money.

4

(And the industrual usefullness of gold is very small. It is actually a slightly worse electric conductor than copper.)

But I argue that gold IS intrinsically money! It is the substance which has the greatest comparative advantage to function as money. Whatever you try to replace gold with, will have higher opportunity costs and/or lower quality in performing the function of being money.

The “opportunity costs” is of course the value of what the metal (or other substance) could’ve been used for otherwise. Since gold isn’t chemically reactive, it has almost no industrial uses at all. It has the lowest opportunity cost of all elements. Compare that with for example copper, which is highly useful for electric purposes. Being demaded as money increases scarcity for other uses. This is negative for all industrial uses. But it is actually a positive for jewelry! Jewelry is valuable because it’s rare (see fashion theory)! If gold was cheaper, the demand for it in jewelry might well fall. Gold painted iron rings aren’t used as jewelry, although identical and cheaper than solid gold rings. Gold is the one substance which combines the lowest industial usefullness with the unique positive effect of increasing its usefullness as jewelry as its scarcity is increased.

The quality of gold in the function of money is undoubted. First of all, it cannot be manufactured cheaper than market costs for mining. There it has a decisive advantage over any paper or electronic money. Gold is immune to political decisions, which is proven by the fact that gold dug down thousands of years ago, when found again today has a similiar purchasing poweras it had back then. It also has several minor advantages over other elements. One is that gold is the element with the highest density (about 19 times that of water). Lead has only about 11 times the density of water. The few elements with similiar or higher density of gold are either radiactively very unstable, extremely toxic and very rare, actually more expensive than gold. The exception might be Tungsten (Wolfram) but it is actually the metal with the highest melting point of all, and very brittle, so it’s still difficult to use it in forgery of gold. You might fairly easily notice the difference between solid gold, and something else covered with a layer of gold.

Anyway, the point is that GOLD IS MONEY for natural causes. It’s not something which humans have made up freely without reason. Gold became money because it is the substance which is most suitable to be money. Not least because of its lack of chemical reactivity which makes it uniquely useless for industrial purposes.

5

Can you explain this some more? It seems to me that the restaurant scenario falls under your second point (credit), rather than under the topic of transaction costs.

It’s possible to work out an arrangement such that the risk of non-payment is borne by another party. For example, suppose there were a full-reserve gold warehouse that issued deposit certificates to customers in order to spare them the trouble of dealing with physical gold all the time. If on January 1 Alice wanted to lend 1 ounce of gold to Bob for 1 month, Alice would take her gold to the warehouse, which would give her a certificate saying “This certificate is redeemable for 1 ounce of gold any time after February 1,” and then give Bob a certificate saying “This certificate is backed by 1 ounce of gold held at the warehouse, which you can see at any time but you can’t have it because we don’t trust you not to abscond with it.” (Adding an interest payment complicates matters, but the basic idea is the same).

This argument only applies to forms of currency that do not pay interest to those who possess it. Such a currency is accepted only because the person accepting it believes that it will retain its value in the future; otherwise, they would refuse the currency or immediately go out and spend it. As I understand it, modern fiat currencies do not have this problem because they are created alongside an equal and opposite amount of debt which must be repaid in the currency. This means that people have an incentive to exchange real goods for the currency so that they can repay their debts.

The problem with modern fiat currencies is that the centralization of the banking system separates the benefits of printing money from the costs thereof. As this paper puts it, “with a monopoly currency, however, part of the cost of lending can be passed on to the rest of the banks. This happens because the original loan becomes only a small part of the monopoly money supply.” Therefore, I support not a centralized fiat currency, but decentralized fiat money, where each individual in effect prints his or her own money. Here is not the place to discuss that; I first want to know more about how a gold standard would work.

Can you further explain what the problem is with this statement? When I say “loans that are made for arbitrarily short periods of time,” I mean that someone who has extra cash that they might have to spend at any time would not choose to stash it away, but would instead continually lend it to someone for a day at a time until the cash is needed for spending.

Even if banks every so often physically transfer gold to settle debts, the problem still remains because the ownership of the gold can be transferred practically instantaneously.

6

This is not a priori true. Why not use silver if there is not enough gold for example?

7

Actually, I think it has been done, at least in France where they use the same word for “money” as for “silver” [:D]

My point was that it is wrong to exclude the function of being money from the list of functions supposedly defining the “intrinsic value” of a metal. Money is only one of the items in that list, along with electric, metallurgic, medical et cetera potential uses. If all metals and all potential uses where to be listed and the “best match” between metal and use were identified, then gold would rule in the function of money. It is as intrinsic to gold to be used money, as it is intrinsic to copper to be used as electric cables. (This was true also in pre-industrial times, since gold is too soft and heavy to be used as a tool, weapon or armour (although it might compete with lead in bullets…)).

8

no its moneynesss comes from regression theorem. it is not intrinsic but extrensic, dependant on the subjective valuations of human actors, who base a lot of their future expectations on past conditions. this might make it ‘seem’ intrinsic, but its not. at least ,not in the way i use intrinsic.

9

Zavoi,

A society with maximal borrowing (i.e. everyone borrows and everyone lends) where all borrowers are creditworthy is impossible; the return would be too low to make lending attractive. A society with maximal borrowing where all borrowers are non-creditworthy is impossible; the risk would be to high to make lending attractive. A society with maximal borrowing where some borrowers are creditworthy and others aren’t is impossible; lending proceeds only at stastically favorable odds. In short, a society with maximal borrowing is impossible.

10

That’s certainly true in spanish. “plata” means both silver and money.

11

Whatever the return is, it is always more profitable than keeping your gold without lending it (because time preferences are always positive).

It’s possible to place the risk back on the borrower, as I mentioned before.

Also, what do you mean by “maximal borrowing”? Isn’t an unlimited amount of borrowing possible?

Another cost is the time and labor spent mining gold—time and labor that could have been spent producing other things.

Money is, as Mises said, “neither a production good nor a consumption good.” Rather, it is a medium of exchange. It is not useful or valuable to anyone except insofar as it increases the efficiency with which goods are allocated to individuals. You may remember the story of how gold came to be used as money—how bartering is inefficient because it requires a double coincidence of wants, whereas the use of money allows indirect exchange to take place. Gold became the predominant form of money for the reasons that you mentioned. However, it may soon become possible to facilitate indirect exchange without using money. Consider an example:

  • Alice has a sheep, and is willing to trade it for a chicken.
  • Bob has a chicken, and is willing to trade for a goat.
  • Carol has a goat, and is willing to trade it for a sheep.

Ideally, Alice should give the sheep to Carol, who gives the goat to Bob, who gives the chicken to Alice. This is mutually beneficial because each person values the animal he/she received more than the animal he/she gave away. If Alice, Bob, and Carol all knew what the others wanted, they could arrange this trade without using money. Money only becomes necessary (and therefore valuable) if they don’t know each other’s wants. But gold will become less and less valuable as it becomes easier and easier to arrange transactions like this without using money.

Hopefully that makes sense. If not, I’ll try to provide a more detailed example.

12

money is a productive good. it can always be lent to people with higher time preference than you.

13

All value is subjective.

Stop posting. Start reading.

14

Or the pound sterling, or the dollar, which comes from the name of a silver coin.

15

gold is a production good (capital good) despite Mises. Block and Barnett wrote an article that convinced me of this.

16

Can I read this article online?

17

http://www.gmu.edu/rae/archives/VOL18_2_2005/4_Barnett.pdf

bon appetite!

18

It is very convincing indeed. If, as they demonstrated, there is no a third alternative, money is a capital or intermediate good. But anyway, as they reckon in another article cited in this one: “the optimum quantity of a commodity money is whatever amount is provided in a free market”. That doesn’t happen in any other capital good what makes me think that in this case, and only in this case (or whatever other commodity money) the fact that gold is a capital good it is not very relevant to the discussion raised by Zavoi.

Would gold (silver, platinum, etc.) be the free market’s choice? Probably, but not sure. What is really important is that whatever choice or choices are made, they are free choices, free from state intervention. What Zavoi seems to be worry is velocity, but just finding a case where all the incentive is to ‘hoard’/accumulate money will be enough to prove that velocity is not infinite. See XIX century, people accumulate gold for many years for consuming that gold or silver when they were not able to work anymore or for letting their children to reduce uncertainty. Actually as productivity increased faster than gold quantity -what it would be very naive to think that can permanently occur in a fiduciary system, well, as naive as Milton Friedman could be- gold’s purchasing power increased.

Anyway, it is no other thing that Rothbard’s quote. Zavoi goes a step further substituting gold for loans made to serve as rent source and also hedge, but the obvious flaw in this argument is default risk.

19

You should be from South America ¡¡¡ In Spain ‘plata’ is no longer used, perhaps because all the silver stolen in XVI and XVII centuries actually created a huge inflation. It is curious that in other countries ‘lana’ (wool) is slang for money. Chances are that in some time in the far past wool was money, what would reinforce how flexible free markets are for finding the right money for the right time.

20

That phrase, taken isolated, sounds much as if the “intrincic” value of a money commodity (gold) for consumption (jewelry) or production (industrial) purposes might not be the most important factor which determines the value of each unit money (gold). Maybe the money commodity (gold) is valued mainly because of its use as money, rather than for its potential alternative (so called “intrinsic”) uses?

Of course! SOME good will become money.

What I’m talking about is one of the potential reasons to why exactly gold became money! Why not cows or copper? I argue: Because cows and copper have meaningful alternative uses, so using them as money robs their holders of alternative uses (such as meat or weapons/electric cables). Those alternatives have important opportunity costs. Gold doesn’t, at least not to the same degree.

Yes, if all that would become calculable at negligable cost, in some super-information-intensive future, then the concept of money would loose it demand. Still, it does not relate to WHAT would be used as money until then.

Actually, we can value what a hypothetical perfect bartering system of “perfect information for everyone all the time about all aspects of all goods and services” could be worth! The maximum possible benefit it could achieve, would be to make money uses of goods (gold) worthless. I.e. the only positive effect of such a system would be that all gold in the world would be freed for OTHER uses: So what is the non-monetary industrial value of gold? I claim that it is surpricingly small, and hence an important reason for why gold won the competition against all other goods to become the money good! (Gold getting cheaper for jewelry purposes would only make it less attractive as jewelry).