The Gold Standard in One Country - would it work?

Economics Economics Questions
1

Scenario - a libertarian government is elected in the USA. It introduced a Rothbardian monetary policy, shutting down the central bank, introducing a 100% gold standard and thus ending fractional reserve banking. With the absence of inflation, interest rates are no longer artificially low and rise to their “correct” rate.

Many companies involved in the capital goods sector are thinking of expanding their operations. However, the higher interest rates deter them from doing so. The positive result of this is that it doesn’t set off an inflation-induced boom and bust that would occur if the old frb fiat money system were still in place.

Then those companies take a look around the world and see that the old fiat money frb system is still being used. Therefore, many other countries have (artificially) lower interest rates. The capital goods companies realise that if they borrow from these other countries at these lower interest rates, their plans to expand their operations will actually be profitable. So they run off to London and elsewhere and begin borrowing large sums of money which they use to fund their operations in America. It strikes me that this would pose 2 problems:

  1. It would kick off the old boom and bust process - instead of borrowing money at artificially low interest rates in the USA, the capital goods industries are raising the money outside the country courtesy of artificially low interest rates which is then used to expand their operations only to result in a bust.

  2. The American banks with their higher interest rates would be losing business to foreign banks with lower interest rates. The American banks would therefore be forced to lower their interest rates to attract back borrowers. The result would be to force interest rates down to an artificially low level and hey presto, boom and bust.

Feel free to let me know if and where I’ve gone wrong.

2

You do realize that this is temporary, correct? The artificial lower interest rates are always followed by higher interest rates. They can never depress the interest rate permanently.

The foreign banks would be severely limited in the amount of loans they could grant to US residents. This is because of the clearance transactions that would take place between the banks. Ignoring the complexity of currency exchange between the nations, there would be a tendency for specie to flow one way from the banks abroad to the sound banks here in the US. The foreign banks would go bankrupt. They would either have to abandon their inflationary system or refuse to grant loans to US residents.

3

I 100% agree with this analysis. The high yields would draw capital towards the U.S. and the value of the dollar would continuously appreciate (the market rate would rise above the natural rate–prices would fall faster than costs). The gold standard is only truly useful if it’s used internationally as world money. Now, if the U.S. incentivized other nations to adopt the gold standard (what the U.K did during the 19th century), then this situation would change. This, of course, ignores the fact that we would experience a deflationary catastrophe for a period of time, where the money supply would contract to the monetary base.

4

The US Government only has $11B of gold left in Ft. Knox according to the AP Dec. 21, 2009, 3:44PM, so the US government is continuously allowing our freshly printed US T-Bills, US Bonds, US Dollars and other Securities purchased and owned by foreigners to be redeemed by purchasing title to privately owned land, hotels, farms, businesses, casinos and other assets located in the USA that were created by previous generations of US citizens, before the de-industrialization of the USA, instead of redeeming these currencies for gold from Ft. Knox as other nations do to support the value of their currencies. These existing US located assets are finite, and the industrial nations will stop “loaning back” the US government more and more of their US dollars after the foreigners own (almost) all of the assets that are located in the USA.

The value of the outstanding US debt of 12Trillion in Bonds and T-bills plus $829B in currency will equal very little buying power of the US dollar if foreign nations stopped buying our freshly printed US T-Bills, US Bonds, or other US Securities and/or wanted the US government to redeem our currency in gold (just like any other nation).

Any family, tribe, country, etc. and its individual members can prosper or become debt ridden in accordance with their industrial behavior, government spending behavior, and/or other economic actions of the leaders of that family.

If any family or nation purchased imported things from outside of their family of less monetary value than the monetary (or otherwise useful value) of the items that they sold and exported to others outside of their family, then that family would have a net positive foreign trade balance of gold, grain, cattle, etc. into that family. Only a net positive foreign trade balance will increase the value of the accumulated real wealth of privately owned assets within that family.

Did the Biblical Jacob squander his assets unwisely and then became hungry when a famine occurred? Did Jacob sacrifice all of his cattleand grain to his god? Or sell his assets for food & wine to have a bunch of parties? Did Jacob burn his tents, grain and other assets as sacrifice to his god? When the Jacob’s family faced starvation, Jacob took his family to Egypt where there was grain stored and hoarded by the greedy Egyptians to insure the survival of Egyptians during times of drought and famine. Jacob and his descendants probably submitted themselves to be slaves of the Egyptians in return for food and shelter. Is the US government repeating these actions?

The US government is going to have to print and sell these US T-Bills, US Bonds, and other currencies mainly to foreign manufacturers FASTER AND FASTER to get the foreign held US dollars back from foreign manufacturers in order to pay for the growing US government expenses that are in excess of our US federal government tax collections. This includes high-speed rail projects, environmental cleanups, roads, bridges, utilities, and other pork barrel projects in politically contested areas that will create temporary employment and make President Obama appear to be improving the economy by spending borrowed dollars to win re-election votes and improve approval ratings. The US government also needs more and more US dollars to pay for wars, military jets with active duty military USAF pilots for the personal use of specially privileged members of congress (ala Pelosi), government bureaucrat payrolls, government retirement checks, courts, federal police, failed business bailouts, cash bonuses to the various Wall Street forgers of SEC documents that contributed to political campaigns, Las Vegas corporation junkets for failed corporation employees, foreclosed house mortgages for big spenders with bad credit, new multi-million dollar French manufactured personal corporate jets for political contributor’s bankrupt corporations, pork barrel projects, high speed rail projects, research contracts, Welfare, Social Security, Medicare, Medicaid, SSI, expensive corporate vacations, new infrastructure, wealth re-distribution, mental health services, foreign aid and any other thing that congress and the president decides to use taxpayer US dollars to acquire, build or just give to their political campaign contributors and various other privileged individuals.

5

Interest rate manipulations are temporary short term adjustments. Real wealth and real monetary value is created and/or acquired ONLY when the members of a family (or a nation, tribe, city-state, etc.) plant, grow and/or harvest something of commercial value from the earth, extract something of commercial value from the earth, provide professional services (medical, legal, dental, engineering, architecture, accounting, land surveying, technology, etc.) to others outside of that family, and/or manufactures or constructs something of commercial value that is consumable (or permanently useful for income or rent) and then SELLS, LEASES OR RENTS these items and/or services to parties outside of their family, IN RETURN FOR A NET TRANSFER OF GOLD, CURRENCY OR COMMODITIES from other parties outside of their family into their own family. The members of that family can reflect their real wealth with the accumulation of grain, gold, cattle, jewels, land, buildings, commodities and/or other marketable products for reserve use in times of emergency and/or also to raise the standard of living for the members of that family.

Various US government policies encouraged the US companies to cease making things for US consumption and export in order to generate national wealth, and instead to import these consumer items in exchange for titles to existing US wealth such as privately owned land, hotels, farms, businesses, casinos and other assets located in the USA that were created by previous generations of US citizens transferred to the foreign nations that elected to industrialize and generate wealth by making and exporting consumer items to the USA.

6

This is true. High (relative) interest rates and an appreciating currency would attract foreign investors to the United States. In fact, this would probably create a significant carry trade with foreigners borrowing from their banks at low rates and investing in the US at higher rates. Interest rates in the US would have to fall significantly below interest rates in other countries, since the US currency would also become attractive based solely on the fact that it would continually appreciate vs. other currencies.

Such capital flows have encouraged some governments to impose capital controls. Thailand was one country where high interest rates and an appreciating currency attracted huge amounts of Japanese capital. Both China and Brazil now seem to be in a similar position to pre-bust Thailand due to the US carry trade.

7

So let me get this straight. A gold standard in just one country is untenable, because it would be much too good for that country? Jeez, all that foreign capital flowing into your economy, we can’t have that! We might get better off!

8

Prices would fall faster than costs. The gold standard is useful if and only if it’s used as world money. The price specie flow mechanism prevents nations from continuously suppressing/elevating their interest rates relative to the natural rate. If we’re on the gold standard, and all other nations are continuously inflating with fiat money, then we would see massive international imbalances (massive capital flight, currency swings, ect). Unless we could convince them to go on the gold standard (don’t know how this works but the U.K. managed to do it).

9

I wouldn’t say that going straight to a free market currency would be bad. It just wouldn’t eliminate the boom-bust cycle entirely.

EDIT: Actually, now that I think about it, international capital flows wouldn’t create bubbles. If (for example) an investor borrows Japanese Yen and purchases the new gold-standard US Dollar in order to invest in US assets, then that doesn’t mean that any credit is created in the United States. What it does mean is that some already-existing USDs are taken and reallocated into whatever investment projects the investor takes part in. So no credit is created out of thin air in the US, which means that no bubble in the US can occur.

10

What do you mean? The price of bread would fall faster than the price of grain?

Yeah, currency swings in our favour and capital flight into our economy. We would be reaping the real-money dividend. The only downside I can think of is that it would probably make us lazy. Seeing we would be the recipients of more investment than we deserved according to the level of the deregulation of our economy the pressure to reform in order to attract foreign investment would be lessened.

11

You are almost taking a mercantalist position here often propagated by advocates of central banking and especially those that want a global monetary policy coordinated by a world bank . That’s like saying that a prudent non-inflationary policy in one nation would be useful if and only if the rest of the world would follow similar policy. Or that it is beneficial for central banks to coordinate their inflationary policies. In fact, the current lack of ability of central banks to perfectly coordinate their expansion is at least for now, serving as the last remaining check on credit expansion by any single central bank before the threat of the crack-up boom becomes apparent. Think interbank clearance mechanisms. (it’s like free banking between nations)

A gold standard in one nation, especially in such a major economy as the US, would exert pressure on foreign banks to halt their expansion much sooner.

While yes, it would be greatly more beneficial that the entire world adopt the gold standard together, it will still be a tremendous benefit for any country that adopts it on its own. Not only would the local economy be much more stable and less prone to speculative bubbles, but if a major economy like the US adopt a gold standard, it would put pressure on other economies to follow suit.

12

Mercantilist’s believe that money = wealth, and an international gold standard has self-correcting automatic adjustment mechanisms. It prevents perpetual inflationism from various governments and their central banks (gold flows). If America was on a 100% gold standard, and other nations continued to inflate (reduce the market rate below the natural rate), then the U.S would have to elevate its market rate way above the natural rate in order to prevent international instability and crises. America, even if it was completely sensible and truly liberal, would never agree to this asymmetric scenario.

I suggest “Monetary Nationalism and International Stability” by F.A. Hayek (it’s short but packed with information).

13

There wouldn’t be any bad gold flows. If the USA had a gold standard, then it more than likely would be running current account and balance of payment surpluses, since foreigners would be pouring investment money into the US. There also wouldn’t be any speculative bubbles, since no credit would be created inside of the US, instead, money would simply be reallocated from consumption purposes to investment.

14

America, even if it was completely sensible and truly liberal, would never agree to this asymmetric scenario.

And yet I still prefer AU over TP (toilet paper).

15

Well, first of all, if America is the only nation on a gold standard then there wouldn’t be a gold flow at all. But the point is that there would be massive interest rate parities and all sorts of capital flight. In order to prevent inter-temporal international disequilibrium, we would have to elevate our market rate above and beyond the world natural rate. This would put continuous downward pressure on our interest rate, and upward pressure on the PP of the dollar (forcing us to continuously elevate the market rate relative to the natural rate). It’s the exact opposite of an inflationary induced boom (a deflationary induced bust).

Also, I don’t see how you reach this conclusion:

After the initial catastrophic crises, the USD would be the most valuable currency in the world, leading to current account deficits and massive capital account surpluses (already mentioned). You never run “balance of payment surpluses” (for any significant period of time), the capital, current, and reserve accounts balance each other.

16

Mercantilists believe a lot of things. not just that.

What are you talking about? Foreign banks would be forced to restrict their lending of fiduciary media to US residents or they will go bankrupt due to Inter-banking clearance mechanism.

Ensuric, you’re basically saying -if they inflate, we must also inflate. This is preposterous!

Why don’t you advocate for a world central bank while you’re at it since we can’t have our gold standard. If we follow your position to their natural conclusions, we can’t possibly privatize money because the market is not likely to select money that is loosing in value. You’re basically now have to make the same case for any type of free market money. Unless our government coordinate a global monetary system, all will be chaos. This is what you’re saying, no?

You haven’t responded to any of the specific points in my post. You just quoted it and reiterated the same position.

If I recall, in “Monetary Nationalism and International Stability”, Hayek is talking about the international gold standard. I can’t possibly think of what had made you, based on that, reach these conclusions. I’ll have to revisit this work.

17

Actually, I’m saying the exact opposite.

Yes, they also believe that the interest rate is a purely monetary phenomenon. But, what does this have to do with my comment? I fail to see where/how I mentioned or sounded like a Mercantilist.

I don’t know what you’re trying to say here. You don’t understand my argument, and I don’t know how familiar you are with international economics. An international gold standard doesn’t need centralized coordination–it coordinates and regulates itself. Which is why it’s so valuable.

Read the book and you’ll find out. Also, he talks about all 3 systems (real gold standard, pseudo gold standard with credit superstructure, and monetary nationalism–Friedman’s plan), but doesn’t talk about our current monstrosity (monetary nationalism with fiat money as world currency). Remember, the natural rate is not a national phenomenon, but an international phenomenon, and each nation chooses their own market rates. Divergence between the natural (international ) and market (national) rates leads to disturbances.

18

How can they do the opposite? The amount of gold is whatever it is. Why are you complicating things with your “international economics”? (

Think about what a 100% reserve bank would do to another competing bank that attempts to engage in credit expansion. The latter would lose reserves to the former. The former would force the latter to restrict its own expansion. Either the latter would have to abandon its inflationary policy or go out of business. The sound bank would bring stability. The exact opposite of what you are claiming.

I will revisit that work by Hayek ,but I am quite sure you are misapplying whatever is there to analyze this hypothetical scenario.

19

This question must necessarily include international economics. Like I said, the natural rate is also an international phenomenon, and the market rate, which is determined by the banking system (or central banks) of various nations, is a purely national phenomenon. Divergences between the rates (natural and market) must lead to inter-temporal misallocations. If all nations, expect one, are inflating (suppressing market rate below natural rate), then we should expect a massive malformed international capital structure. We would see illusory comparative advantages across the board, and therefore currency fluctuations. This is what we saw after World War one (and to this day), where every nation had to inflate in order to keep their interest rates lower than those in London, in order to prop up the pound, and keep it the reserve currency (England had to elevate its market rate above the natural rate in order to do this, causing all sorts of problems). A gold standard does nothing if it’s applied to only one nation–it doesn’t prevent banks from inflating, nor does it prevent governments from inflating. The specie flow mechanism is what does this. 100% reserves would prevent the U.S from inflating (massive deflation), but not France, Germany, the U.K. ect. (interconnected global economy).

Do you understand this? Do you understand that capital flows from low interest rates to high interest rates, and that this puts upward pressure on the purchasing power of currency (when capital flows into your nation)? Perpetual forced deflation is a bad thing. And if the nation with the gold standard wants to prevent an international catastrophe, it must carry the entire burden–that is, continuously increase the market rate above the natural rate (prices fall faster than costs). Your analysis is extremely simplistic, and, to be quite honest, naive.

One thing: If America chose to do this, then it would incentivize other nations to follow. But I don’t know how this happens. If it did happen, though, then it would most certainly be a good thing (the U.S. did it in 1919).

Yes (but it’s much more complicated than this–read lecture 4 of Prices and Production), prices fall faster than costs when the market rate is elevated above the natural rate.

20

We are not talking about a semi-gold standard susceptible to government and central banking manipulation. This is not the problem at hand.

I’ll say again what I said before. An international gold standard is of course the ideal, but it doesn’t follow that a gold standard in one nation is worst then the current fiat international floating exchange system. Quite the contrary, it would be a tremendous improvement.

You can’t escape the inevitable conclusion of your analysis, which is that it is desirable to continue to inflate as long as other nations also inflate. This is what follows from your own analysis when rejecting the 100% gold standard if implemented only in a single nation.

Somehow, according to you, the current instability of all inflatable fiat currencies floating one against the other, is more stable then one nation having a stable and sound money and credit coordinated by pure market forces. Somehow, the planners at the central banks can deal with foreign inflationary policies better then the free market?

I claim that the market will better coordinate and deal with all of the potential issues you have raised, but to my surprise, you, of all people, are challenging this basic premise.

And you haven’t provided a very good argument as to why clearance mechanism between the banks would not greatly keep all of these potential imbalances in check. This is after all, one of the key market mechanism that would make free banking a much more stable system then the present. “simplistic” is no argument?