From: tcox@ssrl01.slac.stanford.edu (Tony Cox - (415)926-3105)
Subject: Re: gold standard
Followup-To: alt.individualism
Summary: Continuing discussions on currency systems
Keywords: money gold_standard keynes silver_standard federal_reserve_bank bankin
Reply-To: tcox@ssrl01.slac.stanford.edu
Organization: SSRL, Stanford Synchrotron Radiation Lab
Date: Wed, 7 Oct 1992 07:13:39 GMT
Expires: Thu, 5 Nov 1992 15:14:59 GMT

In article <1671@hsvaic.boeing.com>, eder@hsvaic.boeing.com (Dani Eder) writes:
> tcox@ssrl01.slac.stanford.edu (Tony Cox - (415)926-3105) writes:
> 
> 
>>   As a store of value, retreat from the gold standard has allowed
>>   politicians to do just what you would expect them to - they have
>>   devalued the money supply and generated quite remarkable inflation.
> 
>>   The market has responded to this in the way that Le Chetalier would
>>   have expected - the system (financial market) has responded to annul
>>   the constraint (the devaluing of the currency). There are no Silas
>>   Marners around today, except for the very stupid - people invest in
>>   stocks, futures, bonds, foreign currency and all manner of 'stores of
>>   value'. Amongst these various 'investment instruments' are gold, gold
>>   options and gold futures. You can store the fruits of your hard
>>   labour in gold, and preserve its value that way.
> 
> First, as a matter of history, the US was never officially on a gold
> standard.  The price of gold was fixed in terms of dollars, and
> dollars were defined as a certain amount of silver by weight.  In
> effect, a ratio was established between the values of gold and silver...

   Well, no problem, although I accept your historical correction. My
   arguments depend only upon the currency being tied to something
   specific (gold, silver, Madonna's attractiveness or whatever),
   rather than being a tradable commodity in and of itself. (The
   latter, with strict controls on quantity in circulation being my
   suggested solution for reasons discussed elsewhere).

> Second, the fact that there is a limited amount of silver or gold
> around is not a problem in running an economy any more than the fact
> that there was one prototype meter and one prototype kilogram
> limited economic activity.  In physical measures, you have to
> make your measures reflect the original, but you do not have to
> make all your meter sticks and balance weights out of platinum-
> iridium alloy (which is what the prototypes were made of)

   I don't think that your analogy is particularly useful. Surely you
   are not suggesting that one could use counterfeit gold to back your
   currency? Clearly that is the corollary.

   You can have as many meter sticks as you like, but the point
   of tieing currency to something is that you thereby fix the amount
   in circulation.

> The whole point of setting a standard of value is to remove
> from politicians the ability to play with the value of a currency.

   Yes of course. I do so agree. But in removing the power from the
   politicians, you have to be careful to do it in such a way that you
   don't transfer that power to private individuals (those owners of
   the commodity which you propose to use as the standard).

   I worry sometimes that libertarians see the government as the only
   encapsulation of evil. There are evil private individuals around
   too!

> 
>>   So why base the currency on Gold? Pure whim! There is NO difference
>>   in the final analysis.
> 

   Why do people continue to remove my leadin to this statement? The
   Gold standard is a PROMISE to retrieve note for precious metal,
   just as our funny money is a PROMISE to be able to use it to
   satisfy your debt with the government. There is no qualitative
   difference because both are based upon promises, which can be
   broken at any time. Breaking the promise was what got us in this
   mess today!

   You don't wriggle out of it by saying merely that dollars are
   _defined_ in terms of gold. 1oz. gold == $350, it is a meaningless
   statement unless you can actually perform the trade.

> The reason gold has been used as the major coin of value, even
> in the US when we were on a silver standard are: inertness, 
> compactness, and stability....

   Coin? No problem. As backing for a note - just a promise.


> 
>>   Inflation is an irritating feature of money I'll agree, but hardly a
>>   show stopper. It leads to interest bearing cheque accounts (etc.
>>   etc.), but apart from the tax consequences of artificially inflating
>>   asset values, it is harmless. As long as the RATE can be predicted
>>   (well, as long as Inflation = fn(time) can be predicted), its NO BIG
>>   DEAL.
> 
> That is exactly the problem.  With our Federal Reserve System alternately
> expanding and contracting the rate of money supply growth, the inflation
> rate has become unpredictable.  In the last few years, the Fed has
> said it now monitors commodities prices (including specifically gold)
> and has been using that as a factor in monetary policy.  We note that
> in the last few years inflation has stabilized at a relatively low rate.

   Again, I agree. If all we can go on is some post-hoc explanation of
   what the FED HAS been doing.... It should all be up-front and above
   board.


> I suggest that a firmer connection to a commodity standard would
> stabilize infaltion even more and make the rate more predictable.

   I don't argue that inflation would not be lower on commodity
   standards than the present system. I do not support the present
   system for the reasons given. I also think we can do better than a
   commodity standard, my motivation for getting into this in the
   first place!

> 
>> 1) Why pick on Gold as having a special place in the system? My
>> attraction to libertarianism has always been based upon its even handed
>> approach to human relationships. Why give owners of Gold an advantage
>> in the market place? On the gold standard, owners of Gold (or gold
>> miners) have a GUARANTEED price for their product. Why should they have
>> advantages over (say) Milk producers? Why not a guaranteed price for
>> milk?
> 
> It's not a guaranteed price, it is just a unit of measure.  If
> gold is itself the standard of value, then stating that the 'price'
> of gold is $360 per ounce is merely stating that the dollar is
> defined as 1/360 of an ounce of gold.  You are just establishing
> the unit of measure, like fixing the ratio of ounces to kilograms.

   I fail to see the difference. I may claim that my car is worth
   $20,000, but unless I can actually sell it for that, people would
   take my assertion as just hot air. The point of the gold standard
   is surely to generate confidence that the currency has some explicit
   value.
   If the politicians claimed that each dollar was worth 1/360th oz of
   gold, noone would believe them unless trade was occurring at that
   rate. If trade is occurring, miners have their guaranteed price, or
   close to it.

   Are you proposing some restriction of trade to make the edict match
   the facts of the market?

   Lets investigate this further....

   It is easy to see how gold producers can benefit in such a
   situation, and at whose expense. Suppose that gold is priced at
   $360/oz. Suppose now that I, as a gold producer, can generate the
   stuff for $300. I go to my local 'free bank', and I offer to sell
   for (say) $330. The 'free banker', not violating his contract with
   his investors, takes my gold and circulates 360 of those wonderful
   gold-backed dollars - 330 to me and 30 to himself. I have my
   guaranteed profit, and he has his commission.

   Who is the loser here? It is economic system as a whole, which now
   has more of those $$$'s floating around, but the economy is NO
   BIGGER than it was before. There has just been one non-recurring
   trade, from me to him. $300 worth of gold has been produced and
   $360 of gold backed $$'s have found their way into the system.
   Result - Inflation.

   What if the 'free banker' decides on moral principle to decline my
   offer? Well, I just go the another banker, or set up my own bank.
   The new gold-backed dollars so produced are exactly equivalent to
   the notes that the morally pure banker issues. You have the same
   claim on gold with those notes as the pure ones.

   The only way to prevent this is by state intervention, which is
   something that every contributor to this thread has been at pains
   to prevent! You can restrict such trade, but then the question
   becomes how and by whom. No more free banks.

   Supposing that, on the contrary, gold costs $400 to produce. All
   the mines shut up shop for the duration. The beneficiarys now are
   the consumers of gold, who, instead of having to pay the 'economic'
   extraction price of $400 for each ounce, cash in on the banking
   system and retrieve gold according to contract for $360.

   So you can have your `free banking' based upon gold, but in doing
   so you open the door to inflation benefiting not politicians, but
   gold producers.

   The extent to which it happens, and how many people start to
   notice, depends upon the size of your economy and the rate at which
   new gold enters the system. You could probably get away with 0.1%
   inflation in such a circumstance - that, after all, is well within
   the noise of any economic monitoring device.

   Who amongst us would not be happy with a windfall of 0.1% of the
   total number of $$$'s in circulation?

>> 2) Suppose that someone comes up with a cheap way of extracting gold
>> (Oh Rubbish! says an earlier post). Well, suppose that Rumours start
>> that someone is experimenting with such a process (shades of cold
>> fusion, if you will). Energy stocks gyrated after cold fusion hit the
>> world. Why make your currency system fluctuate with peoples fears in
>> such a limited way. Surely you should base your currency on as large a
>> 'value sink' as possible?
> 
> ...............................................Finding an extraction
> process a million times more efficient seems a pretty far out
> possibility.  I would worry more about locating another large gold
> field, or an extra-terrestrial (asteroidal) source.

   I'd prefer not to worry at all, hence my proposal.

> 
>> 3) Who decides how much gold to store, and how much currency to issue?
>> Will anyone who brings gold to the bank be able to exchange it for
>> currency? If not, why not? If so, and '2)' ever occurs, how do you stop
>> a massive expansion of the money supply.
> 
> Any bank may issue bank notes representing a precious metal stored.
> They need to keep the metal in sufficient quantity on hand to 
> redeem notes presented for conversion, if they issue convertible
> bank notes.  They are free to issue non-convertible notes, but
> why would someone trade a convertible note for a non-convertible
> note, or trade gold for a non-convertible note?  Coinage and melting
> down should be a free process.  Setting a standard merely ensures
> that all 'one dollar' coins contain the same amount of precious
> metal, just as setting a weight standard ensures that all 5 pound
> bags of flour actually have the same weight of flour.
> 

   I have no problem with trade at all. You can even trade gold
   squeezed into little blobs with 'one dollar' on the front. It would
   probably trade for several times its face value...

   ...the point being that setting weights and measures and fixing
   currency standards are an arbitrary equivalence which ought by
   rights to be separate.

> For this reason, I believe that we could eliminate the dollar
> entirely and have a monetary system that runs like this:
> 
> The government will establish one precious metal as the standard
> and a set of precious metals that it will accept as payment and
> use itself for payments.  Metals other than the standard will
> be accepted and payed out at the current market ratios of their
> values.  If you have to pay a tax or fine, or collect interest on
> a government bond or payment for selling the government toilet
> paper, then you know that these are the terms you will have to
> deal with them on.

   I'm not sure I like your government.  Acting as commodity brokers?
   I prefer a minimalist state.

> 
>> 4) A process to generate cheap gold would be a license to print money.
>> The rewards would be so substantial that it would create an artificial
>> impetus to design such a process - the philosophers stone of the 21st
>> century. Why should libertarians tolerate such a market distortion?
> 
> People have been searching for gold for thousands of years.  It
> is still scarce.  If you think that transmutation will become available
> to make gold out of base metals - then other things can be made by trans-
> mutation too, so the prices of many things will fall.  Diamond represents
> a poor choice for a commodity standard for the reason that there
> is lots of carbon in the world, and people can and do re-arrange
> molecules and crytalline forms.  There have been methods developed
> to make diamond out of carbon.  Changing something into gold, however
> requires changing the nucleus - which requires millions of times
> the energy of breaking chemical bonds.

   "Unlikely" is all that saves you from economic crisis?
   Why even tolerate that. Take my advice and you become immune!

> 
>> 5) Suppose that a new industrial process comes along which uses large
>> quantities of gold. The owners of the factories come to you with
>> fistfuls of dollars to retrieve their gold (it is a very profitable
>> and useful process). Do you keep exchanging gold until it is all gone
>> and there is no money in circulation? Who makes that decision? 
> 
> Like any other commodity, if it gets used up and becomes scarce, the
> price (in terms of what other things can be exhanged for it) will
> rise until the industrial process becomes un-economic.  It is unlikely
> that a process will be developed that uses more gold than the 
> amounts of platinum that are used in auto catalytic converters - since
> few things are made in as large quantities as automobiles.  Platinum
> is scarcer than gold, and the industrial uses have not materially
> affected it's value.

   There is that "unlikely" again. How unlikely do you think it would
   be that the first bomb dropped on Leningrad (as was) during WWII
   would have killed the only elephant in Leningrad zoo?

   So in that instance, Gold would rise in value eh (in terms of
   things it could be exchanged for)? Since Gold = $, the price of
   everything else would drop. Not drop because people became
   marginally less interested in other commodities as they sort gold,
   but drop precipitously as gold remained the same price.

   Instead of (say) gold becoming twice as valuable as before, and
   other commodities (being marginally less favoured) decline slightly
   in value, we have gold remaining the same price, and everything
   else (peanuts, rent, cars, wheat, movie tickets, etc.) being worth
   1/2 what they were before.

   So this is an improved economic system eh?

> 
>> In short, you can corner the market in a commodity, or in trying to do so,
>> drive the price up to unnatural levels (re: Hunt brothers). Money tied
>> to this is susceptible to such machinations.
>> You just cannot do this if your money is tied to the size of the
>> economy - it is a zero-sum game.
> 
> 
> The quantity of gold stock in the world is something like 2 billion
> ounces.  The market value is around $700 billion.  I can't imagine
> anyone cornering that market.  The largest concentration of gold
> holdings ever was when the US depository gold reached 25% of the
> world's supply.  It took the largest economy in the world removing
> all it's population's gold at gunpoint to acheive that concentration.

   So, in terms of the world global economy, gold represents what?
   The US economy is around $6,000 billion/year right? Total world economy
   is probably around $20,000 billion/year. So all the gold in all the
   world represents around 3.5% of one years economic activity.

   Hard to imagine cornering that market, but then you don't need to
   corner to influence. Seems like, large as it is, gold makes up only
   a small part of the total world wealth.

   Why have the tail wag the dog?

Tony Cox, Stanford, CA
   "This is nonsense that could only come from someone who's
    illiterate about the theory of money. " - Tim Starr
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