Asymmetrical Information

IIRC from reading Mises (in The Theory of Money and Credit), the best arguments for the Gold Standard were that around the time he was writing (before the Great Depression), the Fiat Money people were of the opinion that inflation was a useful and almost benign tool for making their monetary problems go away.

Fortunately, as far as I know, nobody serious believes that for a second anymore, for reasons much as you said, of experience.

The problem with Don's post is that his definition of a free market is too restrictive from the get-go:

First of all, the definition here of a pure free market economy is one in which all actions consist of voluntary exchanges, expected to be mutually beneficial.

This rules out the existence of any externalities (pecuniary or otherwise), so frankly by that standard a free market itself is impossible.

Goldbugs bug me, but that's no reason to "like the Federal Reserve, the fiat dollar, and even the FDIC". Why does free-banking get such short shrift? Why on earth would you trust a monopolist more than you'd trust competition?

Has the supply of gold increased over time?

Do you mean the total supply of all gold ever mined -- since most of it is never consumed and remains on the market. Or do you mean the supply of newly mined gold.

I was under the impression that the gold supply served fine as a monetary base prior to the start of modern economic growth around 1800 when you measured growth in terms of centuries rather then years. But since modern capitalism emeged economic growth massively outpaced the growth in the supply of gold and this created major problem for the operations of modern economies
if they remained on a gold standard.

Second, isn't a monetary system tied to the supply of gold inherently procyclical and that
countercyclical monetary policies are impossible
under such systems?

Rothbard (I believe in the Mystery of Banking) argues that the panics of the 19th century were all caused by government meddling.

Let's see... the panics of 1819 and 1837 happened under the Second Bank of the United States, a precursor to the FED. Only one of your panics, the one in 1857, happened under the free banking system, and it's questionable how harmful that particular panic even was. 1873 and 1893 both happened under the National Banking Act, and of course the Great Depression happened under the Federal Reserve System with your beloved fiat currency - it was caused by countries' going off the gold standard to finance WWI.

Every single panic you speak of was caused by fractional reserve banking. Fractional reserve banking makes banks insolvent *by definition*. All the Federal Reserve System does it to allow banks to operate indefinitely while being insolvent. At least under a gold standard, banks can be allowed to fail so they do not spread their malaise to the whole country and nowadays the whole planet. Fractional reserve banking can exist under a gold standard, but the gold standard prevents it from spreading beyond the banks with the worst practices - in the case of a bank run, the worst banks fail. Deposits end up with the banks with the best practices, and monetary policy is determined competitively. The difference with a fiat system is that fiat currency cannot exist without fractional reserve banking.

Unfortunately, people who make bad choices with their money and people who want to make huge amounts of money off of fractional reserve banking (JP Morgan for example) whined to their politicians and got the Federal Reserve System created. The result? The Great Depression, the 70s, the .com bubble (though admittedly it wasn't entirely their fault) and the current housing bubble (along with Fannie Mae and Freddie Mac and the huge federal deficit).

The only reason the 20th century wasnt much worse than it was is that during that time the economy learned to work around the actions of the FED - it became more robust, not due to the FED but due to innovation.

The way to get rid of or at least seriously minimize the business cycle would be to outlaw fractional reserve banking altogether, but I don't really think it's necessary at all. We just need to ignore whiny idiots who put their money in the wrong place and greedy monopolists who buy politicians to get their way.

Now if only someone could explain to me how banks could lend money if they had to maintain reserves equal to 100% of deposits.

That's just it Jane, a free-market money supply isn't "controlled" by anyone. Everyone who had any money at all would have that much of a stake in the money supply itself. And while you can dig (a little) more gold out of the ground, you can't make it up out of thin air.

And yes, there were large money-related panics pre-fiat money, but they were largely related to the use of fiat money in a non-fiat system, e.g. "Wildcat banking". Economies experience difficulties to the degree that they deviated from a commodity money system, not to the extent that they stuck to one. Indeed your remark about the effects of the "gold standard" in the Depression era is either ignorant or disingenous, as not a single nation truly followed any such standard by that time.

And if you think the Fed has an incentive to control inflation, just find a graph (it's all over the internet) of inflation over the US' history and compare pre-Fed to post-Fed. In this case a picture truly is worth a thousand words.

Indeed, I recall the government's historical inflation data has the price level from 1800-1900 going from 100 (in 1800 dollars) to ~52 (i.e. in nominal terms everything was half off), meaning simply hording your gold gave a 0.6-0.7% return over the century. After the creation of the fed, its something on the order of 4000 or whatnot comparatively. The Fed enabled the systematic confiscation of value from monetary holdings through systematic & unified inflation. Also, depressions are longer lasting post fed than after (even with the euphemism "recession")- you'll notice that the panics of the 19th century rarely have another year attached to them. Corrections were quick and severe, and growth continued shortly afterwards. The worst case scenario of fiat banking is the Great Depression- the Fed created the Roaring 20s and the "Kill me Now" 30s, and only the forced saving of WWII pulled us out. Since then the business cycle is both regular and pronounced (in length). The horror of the 1970s can be laid squarely at the foot of the Fed.

There are a lot of problems with goldbugism but the solution thus far has been far, far worse.

There is a free market for money, its the stock market. Each stock is in effect a private currency, issued by the company, and tradeable against other currencies.

Kevin Marks,

What do you think these stocks are all valuated in?

even though no benefit to society results from an increase in the supply of money

Actually, the US was chronically short of cash (not as in broke, as in, didn't have enought tinkly stuff moving around for the economy to work properly) up until paper money was introduced. If you think about it, that's what Brian Doss's figures are really saying.

The consequences of not having enough money weren't trivial, either. Part of the reason that the plantation owners had so much power in the Old South was that being so short on cash forced people into a credit economy, with the big plantations serving as the source of credit.

How timely! The US government just upped the debt ceiling to 9 trillion dollars; last year the Fed decided to stop publishing data about the money supply; the Iraq war is costing billions a month. Isn't it obvious that printing more money is the only option left and they're already doing it? Isn't that why commodities in general and gold in particular is at an all time high? What am I missing?

"Isn't that why commodities in general and gold in particular is at an all time high? What am I missing?"

Increased demand resulting from economic growth?

I'd be more concerned if the yield curve weren't close to a straight line at 4.7%.

Now if only someone could explain to me how banks could lend money if they had to maintain reserves equal to 100% of deposits.

Simple. They would need to have investors, and not just depositors.

"Simple. They would need to have investors, and not just depositors."

Do you mean full reserves required for demand deposits? The definition of a time deposit being about 20 years out of date and pretty lax, that might not be such a big deal. Do you mean a much stricter definition of time deposits, like effectively making depositors bondholders? Or do you mean equity only?

I can't figure out if you guys want a binary model of strict savings and loan mutual associations one one side (you old building and loan!) and fee-charing demand deposit institutions on the other, or if you're going for something totally wacky.

Anyway, if you thing lending to be funded by investors and not depositors, especially at the small neighborhood bank, I'll introduce you to the Securities Act of 1933 and make you run away crying.

"thing" = want. Sorry, I get worked up about our nation's banking system.

AT,

Just to be clear, I'm not "arguing" for anything; I was just answering your question.

As for the institutional structure of bank accounts under full-reserve, the money itself matters. With a commodity-backed currency, the units of currency are receipts to redeem specific units of commodity. With a fractional reserve system, the redeemability obligation is violated immediately. Then again, the bits of paper could simply say "you might be able to redeem this for 1/10 oz of gold."

Zach,

Actually, the US was chronically short of cash (not as in broke, as in, didn't have enought tinkly stuff moving around for the economy to work properly) up until paper money was introduced. If you think about it, that's what Brian Doss's figures are really saying.

This seems unlikely. If the problem were an actual shortage of money its unit value would have risen a lot more than the 0.65% per year that Brian quoted.

Presumably people who didn't have money to spend were people that didn't have employment that paid money. You can't blame money for a part of the economy that doesn't use money.

Alternately, people in the middle of a hyper-inflation always say that there isn't enough money and the suppliers agree and try to outpace prices with paper. Are you sure that you aren't referring to an historical era where paper circulated and gold was hoarded?

Regards, Don

Cornelius:

You can still have fractional-reserve banking and commodity-backed currency. When during the "gold standard" was U.S. currency entirely backed by gold? Wasn't it only fractionally backed?

Jane, in all those panics you mention that were so awful, we had fractional reserve banking. That is, banks were legally allowed to create money out of thin air. Just print it and lend it out. It is not surprising that a prima facae fraudulent practice would give rise to economic problems; in fact it is a necessary consequence. The fact that gold backed money was not the problem. It was fraudulent, but explicitly legal, business practices.

It's also true that all sorts of problems were significantly worse in the past, when our society was dirt-poor by modern standards. In fact IIRC you've made this point yourself regarding other comparisons of the past to the present.

Finally, your ideas about what the bureaucrats running the Fed are risible. If they want to control inflation so much, why does the value of the dollar always decrease since the Fed monopolized the money supply? Why did Greenspan, alone, crush the value of the dollar by roughly 1/2 since he took office? (And that as officially measured, by officials who have every incentive to minimize reported inflation.) Just bad luck? Do you really believe Greenspan cannot or will not adjust his speaking fee for inflation? Please.

As compared to gold, which reliably deflated around 2%/year for 100 years when it was standard. And here's another zinger: that Anglo American controls the gold supply. Oh, really? How much of the world supply of gold do they control?

There's several argument for the gold standard, not least of which is that it what happens when men are free. However, one practical argument is exactly the matter of control of the money supply: in a gold standard, there is very little that humans can do to affect the supply of gold. If money is scarce, there will be somewhat more incentive to find gold. But men cannot make gold appear by simply acts of will, as is the case for, i.e. dollars. Finding gold is expensive, and difficult.

But do not forget that the price elasticity of supply for the world's largest gold producer --South Africa -- is negative. That's right, when the price of gold goes up the South African supply goes down. That really sounds like a base for a stable system that we can base our long run plans on.

when the price of gold goes up the South African supply goes down.

If this were true, it would be due to factors other than the shape of the supply curve. Take a microeconomics class before propagating such rubbish.

AT,

Yes, the U.S. dollar was only fractionally backed by gold. Your point?

Isn't the real problem with the dollar as the unit of account is that the US government can go deep into debt because it is all "paper"? I believe the US government is functionally bankrupt right now. The dollar as the unit of account masks the damage. Just keep printing and running up the Debt. Maybe no one will notice there's nothing behind the curtain.

The way I look at it is there's Debt and there's debt. Debt is the long-term debt we have no intention of ever paying down. debt is what we include in our budget to pay the interest on the Debt. When debt gets bigger than revenue, we're busted. Even though people will insist up until that moment that we are not really bankrupt. How do you convince people to buy bonds so you can pay the interest on other bonds? At that point, the ponzi scheme unravels and bread goes to $5,000,000.

It will start happening soon, too. 2019 should be an interesting year when debt plus SS, Medicaid, Medicare, pensions, and other welfare is many times the revenue.

Where will your Fed be then?

the real problem with the dollar as the unit of account is that the US government can go deep into debt because it is all "paper"? I believe the US government is functionally bankrupt right now. The dollar as the unit of account masks the damage. Just keep printing and running up the Debt. Maybe no one will notice there's nothing behind the curtain.

If the government were trying to inflate the debt out of existence, we'd have hyperinflation and nobody would doubt what's going on. The issuance of debt securities isn't exactly "printing money," unless the bond markets have been wrong all these centuries.

"Where will your Fed be then?"

I don't know, but personally I think that by the time the Fed is nowhere, your shiny yellow ingots won't be worth much either. Ammunition with a long shelf life seems like a better investment.

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