(MIG Tournament) Conservative Showdown #2: Gold Standard

C1: The business cycleWhen the money supply is tied to mining and exploration, there is a risk that the money supply will not match the growth in the economy. The example of Spain shows that a gold standard does not inherently prevent massive inflation. Pro didn't dispute that. Exploiting colonies is not in play, but anything that significantly increases the supply of gold would have the same effect of producing inflation.I granted at the outset that economically extracting gold from sea water has never been done. However, it is subject to a technological breakthrough. Economically deriving power from uranium was not accomplished until about fifty years ago, but the previous centuries of it not being done did not stop the ultimate breakthrough. It came suddenly and unexpectedly. If gold is equated to money, people will be interested in all manner of technology for extracting gold. It's not just sea water, but extraction from all types of low-density sources.Pro argues that gold extraction will automatically adjust to the requirements of the money supply. The assumption is that mining technology is about the same, so that production depends mainly upon capital invested according to the market need. That might have been a good assumption a hundred years ago, when technological advances were more predictable, but it certainly doesn't apply to technological breakthroughs.Technological breakthroughs are not accidental. People try very hard to break the cost curves, like the one upon which the gold standard relies for gradual growth. A "breakthrough" means that some invention allows a dramatic increase in production for a relatively small cost. That's what the high tech billionaires think they can do with Planetary Resources, Inc. The venture is funded by people who made fortunes by taking risks that paid off in enterprises like Google and Microsoft. The chance of their success cannot be discounted. Pro argues that results are likely to be incremental with gold produced at costs comparable to traditional mining. That's not likely. More likely it will be either a complete bust or big success. If it's a success, the gold standard fails.I gave examples of how technology might emerge to produce gold at lower cost than conventional mining, but a breakthrough might come from a technology that no one now contemplates. It makes no sense to base a monetary system on any commodity, because the technological risk is omnipresent.C2: Threat of deflationThe problems from deflation are not very controversial. Progressive Nobel-prize economist Paul Krugman points out that deflation discourages buying, worsens the position of debtor by increasing their real debt, and because there is resistance to cutting salaries, worker are laid off instead. [10. http://krugman.blogs.nytimes.com...] From the conservative American Enterprise Institute, economist John Makin of the conservative American Enterprise Institute calls deflation "a classic prolonger of crises." [11. http://tinyurl.com...] It's true that we don't care if something like price of computers drops because buying power is retained overall; the problem is when deflation is across the board.Pro argues the the Great Depression was not real deflation, saying "deflation was measured only within the decrease of price rather than with a decrease in the money supply." But the money supply definitely decreased. "In October 1929 the monetary base was $7.345 billion, and by October 1930 it was $6.817 billion. That’s a drop of over 7%, one of the largest declines in the 20th century." [12. http://wallstreetpit.com... ] The Fed had cut interest rates in hope of increasing the money supply, but they missed by a wide margin. Pro argues that the decrease in the money supply was an effect rather than a cause of the Depression. However, the deflation occurred in the first year, too quickly to be an effect, and analysis shows that the Fed in fact erred in its attempt to increase the supply. Pro attributes the Depression to "uncontrollable factors," but that denies the central role that the money supply plays in the business cycle. If uncontrollable factors produce the business cycle then controlling the money supply with a gold standard won't help.Pro goes on to argue that the money supply is unimportant, saying "Any amount of real investment can take place with any amount of money because prices adjust not only to the quantity of goods but the quantity of money." If so, we certainly don't need a gold standard, because all the gold standard does in control the amount of money. If the amount of money doesn't matter, then there is no need for monetary policy at all. The error in that argument is that investment is made by borrowing or using savings in anticipation of future. The money received is less, then the loan cannot be paid back, or the investors lose their savings. If an investment is made with expectation that widgets can be sold for $10, but deflation means they can only be sold for $8, then the investment fails.Japan presents a good recent example of chronic deflation. The claimed bad effects happened with even modest deflation. “...why has there been so much concern expressed over the possibility of renewed deflation? One reason is the mediocre economic performance that has been associated with the Japan's deflation.” [13. http://eh.net...] “The implications [of deflation] for the Japanese economy are hard to understate. These gaps are likely to significantly worsen Japan’s fiscal position in the future ...” [14. http://www.voxeu.org...] C3: The chance of war Pro says that with a gold standard, necessary wars will be possible but unnecessary wars will be impossible, and that's true even if necessary wars cost ten times as much. How does the gold standard know what's necessary? There is no way to tell which wars are necessary and which are not. Elected representatives vote on what is necessary. If Pro is arguing that it is in general harder to raise money for a war of any kind, then than remains a disadvantage of the gold standard, because when the country needs to fight a war for it's survival, the task will be more difficult. I agree that poor judgments can be made about what is “necessary,” but attempting to prevent things that are really necessary is not a cure for that problem.N1: Using a formula is superior to the gold standardFriedman's proposal to replace the Fed with a formula is simple to implement. We currently have measures of the money supply like M3, so there is no problem monitoring it. If the money supply drops, the formula will lower the interest rates the government charges, and that will increase the supply. If the money supply grows too much, then rates are raised to slow the growth of the money supply.Pro objects that politicians may yield to the temptation to not obey the formula and inflate the currency. The same problem exists with the gold standard, wherein the temptation is to print some extra money under the assumption that not all the currency has to be backed by gold, because it's unlikely that everyone will rush in at once and exchange dollars for gold. The US was once on a gold standard, and that didn't stop the decision to abandon it. N2: Transitioning to gold is impractical We have six trillion dollars in the money supply and only enough gold to back about 2.5% of it at the current price. So how do we get the $6 trillion worth of gold? Pro says it would be phased in slowly. That does not change the need for $6 trillion in gold, acquired quickly or slowly. Because only the US is going to the gold standard, only the US has an unconditional need to buy gold. The rest of the world will sell it, but not cheaply. Pro gives “oh, don't worry” generalities, but no data on the costs of transitioning. It won't work.