There is lots of history showing that of the available options, use of a standard and easily assessed commodity as the exchange medium is pretty effective at keeping the local Sovereign from debasing the currency.
Not this time, although it has happened. Not sure who won though.
I'm not interested in getting into a discussions of endless complexities in an area that's been pretty simple since ancient times.
There are a million ways to make money if you are right about which way things will go. The better question is why the currency was ripe to be shorted. There was clearly a policy problem in the country whose currency was shorted to such dramatic effect.
Historically, that straightjacket has done exactly what people wanted it to do - constrain the Sovereign, stop him from stealing everybody's money.
Gold prevents recessions? I made no such claim. Where did that come from?
Again, there is a record going back to ancient times showing that the issues are independent.
We are talking past one another. The hope with gold is preservation of capital, not profit, not elimination of recession, et al. The level of interest in gold is ultimately an assessment of the stewardship and trustworthiness of the local Sovereign, and always has been.
Your arguments against convertability amount to assessments of what you think the likely effects would be. However, Convertability is clearly possible, as most currencies were gold backed in living memory.
While I question many of your assessments, even if they are correct it's beside the point, as the issue is distrust of the Sovereign, and for someone worried about loss of capital, the other issues are minor.
I should mention that the only gold I own is plated onto connector pins and shells.
Enough about the sovereigns. We don't have a sovereign. We have a Federal Reserve Bank, and they're not trying to steal your money, so I'm going to snip a lot of quibling.
Let's just look at why gold is not workable as a convertible backing for currency.
We don't have a sovereign. As for the US, when gold backing was 100% and was freely convertible, without recessions going on, inflation rates ran up to
25% per year (in the early 1900s). From 1915 through 1920, consumer prices DOUBLED. Who was debasing the currency? How was the sovereign stealing our money? How could it have happened, with gold being freely convertible at
100% backing?
Ancient history. There was a time when there was more gold than the amount required to back currencies. Today, in the US, which has the largest gold reserves of any country in the world, backing the currency with our 8,133 tonnes of gold would result in a gold price of over $5,300/troy ounce for M1. That's not a realistic number for the amount of money you'd really have to back (it would be around $30,000/troy ounce for M2, and you have to cover at least half of M2 -- the part that represents all currency and coin in circulation, personal checking accounts, and overnight-demand personal savings accounts -- to "back" your currency, so the realistic price would be on the order of $15,000/ounce unless you just decided to wipe out everyone's bank savings) but just backing M1 makes the point. Gold closed on the New York market yesterday at $731/ounce. That's what the free market says it's really worth. Does that give you a hint about what's wrong with the idea of backing currency with gold in 2008? If you believe what you said about gold's "inherent" value, you'd need 7.25 times more than the total value of gold we have, at market prices, just to back your currency.
Money supply grows because product and service outputs increase. Gold does not. So, tell us what happens when productivity growth outstrips growth in the gold supply.
This "area that's been pretty simple since ancient times" isn't so simple anymore.
The answers to those two key questions -- how we had runaway inflation with
100% gold backing and full convertibility, and why the market values gold at less than 1/7 what its value would be if it backed our currency -- provide the primary reasons why the gold standard is a farce.
BTW, if you want to discuss this further, please identify what you mean by "gold backed" currency. Do you mean 100% backing? And do you mean a regime in which private citizens can convert their dollars to gold at that 100% rate of backing? Because that's a world apart from the tokenized gold "backing" like we had under the Bretton Woods agreement, in which convertibility only applied to central banks and their equivalents.
Sure we do. It's the Government, specifically the legislature et al.
That's why I didn't use the word King or Monarch. Sovereign is actually a legal term, and used to this day. Partly it evolved as the Age of Kings passed into history. In that bygone day, all laws came from the King; there was no higher authority.
Said another way, the King made laws, but was himself above the law. This role is no longer held by actual Kings, but the principle endures.
I did not claim that the Fed was the problem, so this is a red herring. For one thing, the Fed is not soverign.
Sure we do. See above.
World War I. Paid for by debt, under political conditions that allowed the Soverign to take the money in full public view without much political backlash.
I don't know the exact mechanisms, but it isn't necessary to know. I expect that if I were a voter back then, I too would have agreed, for obvious reasons.
Actually I can guess one mechanism - rationing, which causes artificial shortages. But it isn't important; wars always seem to cause this.
The obvious answer is to back the currency just as banks back their deposits: Ordinary banks are allowed to loan out up to nine times what they hold in deposits. This is 9:1 leverage.
In the recent financial unpleasantness, the institutions that failed had leverage ratios in excess of 20:1, most being around 30:1. No institution with only 9:1 leverage failed, partly because their leverage level was conservative, and partly because people willing to be that boring didn't buy into anything new and exotic, and so were saved when the new stuff turned toxic.
Gold grows as we mine more. There is an economic argument to the effect that gold served the ancient world well because the growth in world gold inventory matched the growth in population (and thus goods and services) reasonably well back then.
If the mismatch is only 7:1 after two or three millennia, and the advent of the modern world, that's doing pretty well. Little else is even close to that stable.
I don't know that further discussion is necessary, as our positions are clear, but I'll answer the questions anyway.
I'll grant that 100% backing may no longer be physically possible, so I would choose 100% convertability by all persons (not just governments). If the leverage (value of currency divided by value of gold in vault) gets much above say 15:1, the whole area would need to be revisited. I suspect I won't live to see that day, but perhaps.
As for Bretton Woods, it was intended only to smooth out exchange rates between major currencies, and so the fact that it didn't achieve anything else is irrelevant to the present discussion.
Not that there is any chance of any form of gold standard happening. The real problem with the gold standard (or silver standard for that matter) is that it works all too well, and soverigns universally abhor the constraint. So they forbid it if they can.
If you face the facts, better yet, if you know them, you can't help but see that having gold backing a currency today is simply a nutty idea. There ain't enough gold in the world to back up the amount of money in the world today. It's not possible to make transactions around the globe with gold. Gold is not something that has any value in today's financial system. People that think otherwise just don't know how things work. Today what money has become is a just a bunch of electrons that shoot all over the world and add and subtract to accounts which are nothing but financial abstractions. Gold, it's good for teeth and electronics and jewelry, that's about it.
You missed the point. The government doesn't control the money supply. The Fed does. And it's an independent banking system, with no other authority as a "sovereign."
There's nobody in charge of interest rates, reserve requirements, and the other things that control money supply, who has any incentive to "steal" money from citizens. They don't legislate. They aren't pandering to special interests for the sake of votes. They don't have to bring home the pork or keep the unions or farmers happy. They just have to keep the currency and banking systems on an even keel. That's why we have a Federal Reserve Banking System in the first place.
But you missed or ignored the point that they're the ones who run the federal banking system, and who control the money supply by setting lending rates and open market purchases.
If 100% gold convertibility and currency backing actually stabilized the currency, that couldn't have happened unless the currency wasn't truly convertible. But it was. So the gold standard really doesn't do what its proponents claim.
If you have partial backing and convertibility, that means you get, per your example, 1/9 of the value of your currency in gold, if you exchange it. But the government can't give you nine times the value of your gold in currency if you turn in your gold, or everybody would raid the treasury to get big a multiple of the value of gold they hold.
Once again, it doesn't work. Partial backing of a currency, at 9:1 ratios or whatever, has only one purpose: to stabilize currency exchanges between countries. That's what we had under Bretton Woods. And the convertibility problem is the reason there was no convertibility at the time, except among central banks that were part of the agreement. In fact, private citizens couldn't own gold bullion then for that very reason. Now, we can.
You're talking about completely different things. The reserves held in banking work only when people aren't making a run on banks. When they do, and banks are over-leveraged, the banks fail.
If you have partial backing of currency, you make nine times your money, using your example, if you trade in gold for dollars at the same rate that the government will give you gold for dollars. You'd break the US gold reserves overnight. Are you following this? That's why it isn't done. And when there was partial banking, that's why private citizens, or even non-participating central banks, were not allowed to play.
That assumes zero growth in productivity. But we've had large multiples in productivity since 100% gold backing was rescinded. That's why we have more
*real* money than we have gold, by a ratio of at least 7.25:1
The arguments from antiquity were good for antiquity. If we still plowed with horses and made our plowshares by hand on anvils, it would still have some validity. But we don't, so it doesn't. Our real national wealth, and our money supply, are now many times the amount of gold that we have. And they aren't mining it fast enough to keep up. So if you try to back your money with gold, the more productive you are, the more your money devalues. That won't work, for reasons that have been discussed in other threads.
The mismatch occurred over the course of a few decades.
It doesn't work as soon as the market says there is a ratio that differs by
0.0001% or so. Right now, it's over 725%.
No, it's quite relevant. The fractional backing that you're talking about was implemented under Bretton Woods, and the termination of convertibility, along with the outlawing of ownership of gold bullion by private citizens, was done for the same reason you'd face if you attempted a partial-backing regime today. It's spot-on relevant.
The real problem with the gold standard is that it can't possibly work in a modern economy, unless you completely re-align currencies to a different fraction of backing every time productivity drives it out of whack. And to do that you'd have to put an end to the private ownership of gold, just as we did when we had our last form of the gold standard.
Under Bretton Woods, gold was nothing more than an agreed-upon token for exchange between countries. It had nothing to do with the real market value of gold. Today, gold is traded freely the market sets it value. And the market says our currency is worth 7.25 more than it would be if it was backed by gold.
That's because the wealth of a country, as Adam Smith said over 200 years ago, has nothing to do with how much gold it has. It has everything to do with how much in goods and services it produces. The market knows this, and it knows that our output far exceeds our bullion reserves.
The free market has taught an important lesson in value, which the traders who do this for a living understand, but which the gold bugs, for the most part, don't understand. They never understood Adam Smith, nor any other serious economist. They don't understand that a currency is worth what you can buy with it, no more, and no less. And if a currency is well managed by a modern central bank, it will buy a lot more than you could with the gold that's available to back it.
That is, today, after we've benefited from vast increases in productivity and output. Now it's clear that gold won't work. It was arguable at one time whether it was the best basis for a currency, but no longer. Even the tokenized system of partial backing, which cannot coexist with private convertibility and which requires laws to prevent hoarding of bullion, no longer is needed nor is it constructive to a nation's economy. The proof is that we now have a free market for gold, and it works. Gold hasn't driven out currency, nor vice-versa. They trade freely in an orderly market.
The kick I get out of gold bugs is that they almost never demonstrate the courage of their convictions. They say that our money is being "stolen" from us because it isn't backed with gold. But if they believed that this is what actually is happening, and that gold always holds its value while currency does not, they have a perfect opportunity today to prove it. With gold trading freely on the open market, they'd simply turn in all their currency for gold, and just trade a bit of it back from time to time when they needed to re-charge their bank account to buy groceries and pay the mortgage. If what they claim was true, they'd always come out ahead, and the benefit they'd derive from it would be cumulative over time.
But they never do. Maybe they hold a little gold, but never as much as they could. Why, do you suppose? I think it's because they're afraid that they know, deep down, that they have no idea what they're talking about. They don't really understand what money is, and why it trades on the open market at such a high multiple of the gold available to back it. This fact is something new in history, but the principle on which its based was understood perfectly well by economists two centuries ago. Now it's so obvious from experience that it takes a true ideologue to hold on to the idea that gold-based currency is a good thing.
The Fed is independent like a dog on a leash is independent. It can go only so far. More later.
We had this debate some time ago, with respect to Volcker and President Reagan. Reagan backed Volcker, allowing him to cause the recession that at last ended the inflation (which peaked at ~20%/year) during the Carter years). Volcker could not have caused sufficient pain to stop inflation without Reagan defending him from Congress.
This is why the Congress set the Fed up to be "independent" (and thus largely insulated from the crash and bang of day-to-day politics), but this independence is by federal law, not by constitution, and can be altered at will by the true soverign here, congress and the president. The Fed is a creature of Congress.
See above.
In times of war, all the usual limits are dropped. I don't know exactly how this was done, and while I have some theories, I don't really care enough to do the research because it has always been so during wars, since the time of the ancients.
Um. You might want to revisit this. What you are saying is that depositors can get nine times their deposit back from the bank. I wish I knew how to do that and not end up in jail. But banks do work.
The traditional problem is if everyone wants their gold back at once, there isn't enough. This is in parallel to the classic run on the bank scenario.
Non sequitur. See above.
Really? The world economy (including mining) has been expanding exponentially (compound interest) for far longer than that.
Huh?
I'm sorry, but Bretton Woods was intended only to stabilize exchange rates to facilitate world trade. One can have stable exchange rates even when everybody inflates, so long as they do it together. Which they did.
Although Italy was out in front, if I recall. Something about deficit spending. When the Euro was being set up, one big dispute was between the Swiss and Germans (very hard money) and the Italians (not so hard).
At the scale of Bretton Woods, these things change very slowly.
True enough. Why is this important? It was never the intent to do anything but allow exchange rates to be stabilized, which requires a medium in which to make the comparisons. For political reasons, it could not be a currency, and gold had millennia of precedent and experience.
True.
Non sequitur. See bank example.
This is true. Adam Smith was reacting to the Mercantilism of his day, and the resulting beggar-thy-neighbors policies. Of which there were many.
But it actually has nothing to do with the question of gold backing of currencies. We know this because most currencies were gold or silver backed until very recently, long after Mercantilism mostly passed into history, long after Adam Smith died.
I wonder if Adam Smith directly addressed the issue of backed currency versus fiat currency. I'd guess that he would not favor fiat currencies.
The fact that many gold bugs are delusional is no more relevant than the fact that many securities investors are delusional. We are now in the days of truthtelling, but the fact that people deluded themselves does not mean that financial securities (stocks, bonds, et al) are useless.
Well, this confuses two very different things. One can hold that the currency ought to backed by a commodity versus be a fiat currency without having to put all of one's assets it that commodity, for a number of reasons.
First of all, a soverign backing the currency is not the same thing as an individual personally buying something.
Second, what works at the scale of a nation may not work for an individual, as the transaction costs are very different, and the volume is very low so there is not much to amortize those costs over. Gold falls into this category. DoN explained this fairly well in a recent posting.
Joe, you're off on a wild speculative trip, based on gold-bug dogma and without any attempt to check your facts.
The US never stopped gold convertibility throughout WWI, nor in the years leading up to or following it.
US gold reserves *increased* during WWI, as the US became the creditor nation to the belligerents, and even while we were engaged in the war itself.
The Fed monetized that newly acquired gold, which led to an oversupply of currency and inflation. Price levels roughly doubled during the period with NO debasement of the currency. In fact, it was "stronger" than ever, in the sense that it was all backed by gold actually sitting in our reserve vaults, and anyone could exchange their dollars for gold at the fixed rate.
So the gold standard and convertibility, far from stabilizing our currency, was the proximate cause of inflation during the war years.
In other words, it's one more example of how the gold standard does not do what the gold bugs say it does. If you bought gold before 1914, it was worth half as much, in terms of what it would buy, in 1920. Gold didn't provide any store of reliable value, and it didn't protect against inflation. Price levels responded to the mechanism they always respond to: money supply, production of goods and services, and the resulting supply and demand, not to gold supply. When the war was over, the true price of consumer goods was almost doubled in terms of how much gold it took to buy them, as well as currency, because the currency was pegged to gold and it was 100% convertible at a 100% rate of backing.
I get a little annoyed when someone repeats some ideological dogma to argue a point with me and expects me to supply facts, without checking the facts themselves. If you want to start backing up your claims I'll address the rest of your post. If not, this is just wasting my time, and the conversation is over.
You think that I am a gold bug, which is not the case, and which would be apparent upon close reading of what I did say.
I knew you could solve it - it's simple supply and demand.
My basic problem with all this is that you are claiming that something that has been universally used for thousands of years is suddenly impossible, and therefore cannot have been. Umm. I'll have to think about that.
Sound money is not based on the supply and demand for gold. As you said yourself, gold supply can change -- in no necessary relationship to the output of goods and services.
If you control money supply through good economics, as the Fed has done pretty well in recent decades, you have good control over inflation and some tools that can prevent deflation. If you control your money supply based on the gold in your treasury, you're a victim of whatever is going on with gold in the world.
In times long ago, the relative stability of the supply of gold was a lot better than the flaky economics of the time and the political exploitation that resulted from the vacuum of knowledge and understanding. But there isn't enough gold for that today, and we can avoid depressions a lot better than we could then. In fact, we haven't had one since we got off of the gold standard, except for a whipsaw effect around 1935 - 1937 when our government lost its nerve and stopped priming the pump.
No, the fact that it's impossible now doesn't mean it could not have been. But your basic problem is what's happened to gold regimes.
When an "economy" meant how many tubers you could dig out of the ground, and world trade meant trading your wolf pelts for nutmeg and salt, gold was as good as anything else. Better, in fact, because its monetary value was based on a desire for the gold itself, and it was among the more immutable materials at hand. Supply and additions to gold stores was slow and stable -- except for Spain under Philip II, which had the misfortune to find all that nice gold in the Americas and which then experienced, as a result, a fierce and destructive inflation. (I think this is what prompted Adam Smith to re-think the whole thing.)
Since the Industrial Revolution, it's been a mess. I'd have to check this to be sure but I think that our current fiat regime has lasted longer than any gold regime lasted since 1860. What the gold bugs ignore is that the gold regimes at that time were constantly changing, from bimetallic to monometallic, from full convertibility to restricted or no convertibility, from gold coin and "specie" currency to token coins and partial backing of currency, from free exchange of gold between citizens and banks, to almost complete outlawing of private possession of monetary gold. Back and forth they went, from 1800 until after WWII.
Gold regimes don't last in modern economies. Now that the output of goods and services is so high relative to the supply of gold, the value of gold as currency backing would be astronomical, and would suddenly give a windfall to holders of gold that's so large, it would upset economies everywhere. And if we used partial backing, we'd have to withdraw bullion from private hands, just like we did from the 1930s into the '70s. That would result in hardening of some important arteries.
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