Hey guys, I have a question regarding sound money. I’m having an argument with someone who says that sound money would inhibit investment. Here’s what the guy has to say:
“A strong gold-backed currency, high interest rates and so on would make money so expensive that investment just wouldn’t really happen.”
I know all about the detrimental effects of fiat money and inflation and the Fed’s manipulation of interest rates, but I don’t know the argument against his assertion that sound money would have it’s own weaknesses.
Interest rates as set by whom? Isn’t the idea to eliminate the Fed and have the free market set interest rates? How does this necessitate high interest rates?
I’m sure I don’t know the most about this but someone else may reply if I bring this back up.
The amount of money in a market has no direct effect on the total amount of productive goods. The reason sound money is better is because it provides a more reliable yardstick of true value because it cannot be manipulated by inflation like a fiat or fractional reserve money can. Aggregate investment in terms of real capital would not be any less under sound money, it would rather be directed more efficiently into the lines of production most urgently demanded by consumers because prices and interest rates could not be so distorted. In the long run the interest rate will drop with a gold standard because general prosperity will decrease people’s time preferences.
Interest rates would fluctuate accordingly to the demand for money. High demand, higher interest rate, low demand, lower interest rate. If banks think they can make money from lending, they will lend. If the lendee’s idea isn’t so great, the banks won’t lend.
The period between 1879 and 1893 was the most productive (or second most; I’m not sure how it compares to the period between 1950 and 2000) economic period in the history of the United States, and saw only a very minor increase in the supply of money.
Not sure what “strong” means in this context. If it means that it does not decline in purchasing power as time goes on, that’s a good thing.
Gold backed means that it could not be inflated away into loss of purchasing power. One cannot print gold coins, or enter them into a computer.
High interest rates. Who is talking about that? The interest rate would be whatever the market will bear. If it is high, so be it. Let’s remember that the lenders are there to make a profit. If lenders set interest rates so high that investors could not borrow it, what will they do with the money they are sitting on? They have no choice but to lower rates until someone agrees to borrow.
“Money so expensive”. Doe she think that if the money is made out of gold it will be too expensive to use in investing? What is he talking about? Does he think that if the money is made out of gold it will automatically command a high rate of interest? Why?
" Because people would rather have the gold coin than invest it in something risky. Bird in the hand and so forth."
“True enough, Until investments slow down so much that there are less goods produced, so that the gold cannot buy as much. In other words it will lose value. After all the value of money is its purchasing power, which depends on how much is out there to purchase. Supply and demand.”
Ask him to give you historical examples of countries that had a gold standard but had no investments. There are none.
I’m not sure low interest rates are really necessary for entrepreneurship to take place. Take a look at the federal discount rate during the Depression of 1920-21.
It seems to me that nowadays, with the current economic situation, there is some “passion” for the gold standard as a solution to all problems the world is currently facing whether on international, national or even individual level.
Taking into consideration the above mentioned points, let me suggest to discuss the possibility of not using the gold standard only, but let us imagine a hybrid standard, including several precious metals together, e,g. platinum, gold, silver, (any others?)
According to this scenario 1 Gold Dollar = 100 Gold cents = 500 Silver cents = 5 silver dollar = 0.5 Platinum dollar… etc. (for example)
At the same time 1 Gold Euro = 1.3 gold dollar =… =… etc.
The main obstacle to the above, how would/ why would a country or a government give up control over it’s money supply and/or exchange rate?
So, Is the gold or the suggested “hybrid” standard applicable only to individuals?
You need not discuss this point. Just tell him that ‘we’ are not for sound money, but for competing currencies. If sound money really leads to fewer investments, than it will loose in such a competitive environment. We need not worry ourselves with such thing, just let all various monetary theories compete it out.
No need to pretend we know what a free market in money would lead to. The gold standard is just an educated guess. If Friedman’s monetarism is right, and Mises is wrong, than inflating money will outplace sounder ones. Its that simple, really.
I agree with Merlin… people get too hyped up about the gold standard… we need competing currencies because that is the only true way curencies enter the market..
Money is the medium of exchange. Its most important role is to facilitate indirect exchange. The amount of money in existence is relatively unimportant so long as it is useful to those who need to exchange things.
Let’s consider the “there’s not enough gold in the world” argument, for instance. Well, if gold is being used as money, then as it becomes more scarce, the profitability of mining gold increases and gold that previously could not be mined at a profit will become profitable. If, even after the increased value of gold boosts gold mining, gold is still too scarce, then an alternative money may pick up the slack. Gold atnd silver have historically co-circulated (I’m not suggesting that this is because gold was “too scarce”, I’m just pointing out that two co-circulating monies was not a problem for our supposedly less-sophisticated pre-modern ancestors… only in the modern era did co-circulating monies suddenly become a problem.)
The interest rate is what governs investment. The interest rate only weakly interacts with the money supply. Mises and Rothbard have proven that, in a fiat money system, there is no interaction between the pure rate of interest and the money supply at all! The poor Federal Reserve… if only they knew.
Hulsmann has shown that, in a natural money economy, the interaction between the interest rate and the money supply occurs as capital is diverted from production of non-monetary goods to production of monetary goods… in other words, as demand for money increases, the interest rate will tend to rise as increased investment into money production (e.g. gold mining) bids away capital from other industries. As with all prices, this is a negative feedback mechanism… as the interest rises, the costs of money production themselves rise and, at some point, any further increases in money production will be unprofitable.
Furthermore, as money production increases, the original increase in demand for money is satiated and the profitability of money production further declines, causing a flight of capital out of money production and into other industries. Hence, money production in a natural money economy is regulated by the same harmonious economic laws as any other line of production with the added advantage that the government and the financial sector cannot surreptitiously siphon away a fifth of the national income or blow the economy up in inflationary busts and crack-up booms.
No need to pretend we know what a free market in money would lead to. The gold standard is just an educated guess. If Friedman’s monetarism is right, and Mises is wrong, than inflating money will outplace sounder ones. Its that simple, really.
Merlin,
This is Gresham’s Law, and is only true if there is a government-enforced currency (that is, the exchange value is guaranteed by government). In a free market, sound money is preffered over bad money, because the purchasing power of bad money is not guaranteed by government fiat.
This is Gresham’s Law, and is only true if there is a government-enforced currency (that is, the exchange value is guaranteed by government). In a free market, sound money is preffered over bad money, because the purchasing power of bad money is not guaranteed by government fiat.
Sure, that’s theory. Our theory, to be correct. But what if Hayek is right, and a strictly ‘sound’ currency fails the market test while a currency of constant value is seen as optimal? Gresham or inverse Gresham, what the customers want, they get. If they’ll want constant value in their money, than a less sound money will displace sounder money, whatever we might think now.
Trying to predict, by praxeological means, what kind of money (and of ‘monetary policy’) will win the struggle, would be like trying to predict whether planes in the future will get bigger or smaller.
So again, this is all an educated guess by our part.
I agree that its correct to mention that we are for competing currency’s but it is false to argue that a gold standard would not encourage economic growth.
It’s presumptuous to assume how much a business would be willing to spend to pay for expansion
There is no final rate of interest, it is constantly changing. If interest is high there are economic factors in place to encourage thriftyness which will lower it
Why are you trying to force the economy to pay for business expansions that people are not interested in?(Business Cycle)
IE, if an economy’s productive sectors slows it’s only because individual actors have shown a preference that they are not interested in expansion in those particular areas. That may change in a year or two. Why would we want to force a factory to produce 1000 widgets, when the market only demands 200? Therebye wasting scarce resources and driving up costs of other goods.
The fallacy here is the same exact fallacy that is believed which justifies central bank interest rate manipulation, and the same exact fallacy which justifies man made booms and busts.
