Wednesday, 24 November 2010

As good as gold? Or as bad as paper [updated]

"Of all the contrivances for cheating the laboring classes
of mankind, none has been more effective than that
which deludes them with paper money."
                   - Daniel Webster

I’ve bagged Bernard Hickey mercilessly (and deservedly) for his calls for a return to Muldoonist mercantilism, but in truth there’s one thing about Bernard that has to be said: he at least realises that the present monetary system is broken. He realises that we are living not just through global financial and economic crisis, but (more accurately) a monetary crisis. He realises, more perhaps than many of the other status-quo merchants, that the way the present system is set up makes it both unsustainable and destructive. Sadly, however, he is as incapable of proposing any solution to the crisis beyond reversion to many of the statist band-aids that helped cause it.

Developed in crisis and destined to die in another one, let’s join him at least in agreeing that the present system is broken, just like all the other systems of the last century from which it grew. But let’s disagree with him in saying that the only solution is his reversion to currency nationalism and the breakup of world trade. The solution, I suggest, is to revert to the system that built internationalism and world-wide prosperity just over a century ago.

The present system, which has lasted barely two decades, has been dubbed “The Great Moderation”: based on a model in which a government’s Central Bank Governor sets interest rates to maintain so-called price stability (while all around him booms and busts), it is a paper-based currency system built on organising ever-rising mountains of debt into ever-more ballooning quantities of currency.

From Europe to America, the system is clearly broken, not least here in New Zealand where (even when things were apparently running well) the new money entered the system as unsustainable debt, and the interest rates set to maintain domestic “price stability” set up a positive feedback loop punishing progress, rewarding stagnation, and (still) attracting the sort of hot foreign money to our shores that drives up our dollar’s exchange rate without making any real capital investment to compensate producers for the rises in their costs.

Hickey is right to criticise the present collapsing system; but he’s wrong to think that a few statist band-aids could, would, or should fix it. Like the few other commentators who’ve identified that things as they are now are indeed broken, he’s left floundering when it comes to what “new thing” to fix it all with.

And since ours is not the first monetary system to have collapsed, we’ve seen plenty of “new things” to fix the same old monetary problems over the last century—each of them purporting to be the way to wealth and riches (or, to use the words of John Maynard Keynes who was responsible for at least two of those systems, they way to effect “the miracle of turning stones into bread.”)

Consider, over the last century—ever since the First World War threw all the belligerents off their managed gold standards—there’s been fix after fix to the world’s monetary systems, each one lasting barely two decades before collapsing just like the latest system, taking in its wake the wealth, prosperity and hard-earned savings of everyone who trusted it.

Ever since gold coins were taken out of workers’ hands, we’ve seen a (mis-)managed bullion standard leading to explosive boom then catastrophic bust (1921 to 1933); worldwide competitive devaluations leading to monetary and military chaos  (1933 to 1946); the unsustainable Bretton Woods I, which collapsed in 1971 when the US defaulted on its gold obligations, and the world collapsed into a decade-and-a-half 0f stagflation;  and finally the “Great Moderation” of the last two decades which supposedly brought all the chaos under control.

Yeah right.

We’ve seen a century in which the world’s money has abandoned its links to gold, and has built instead a money that is built on debt, and lots of it; a century in which we’ve gone from a money that acted as anchor has been transformed to one that swings like a weather-vane; a century of chaos in which at least ninety-five percent of the value of every paper currency has  been destroyed—and people’s savings and prosperity with it.

Things certainly are broken.


Recognising the current catastrophe as just the latest monetary dissembling since the links to gold were dissolved, some folk are calling for a return to gold.

The present head of the World Bank, Robert Zoellick, has begun to suggest that the world needs to think seriously about “readopting a modified global gold standard to guide currency movements.”  What he means by that, however, is a “gold exchange standard,” something like the one (mis-)managed earlier last century in which governments and central banks hold gold in ingot form, and let people see it on television occasionally just to keep them happy it’s still there.

Without any doubt at all, this will work no better than it did before—particularly since no debt-laden government on earth is interested in sound money at this time.

Meanwhile, Financial Times columnist Martin Wolf asks, “Could the World Go Back to a the Gold Standard?”

_Quote It is not hard to understand the attractions of a gold standard. Money is a social convention. The advantage of a link to gold (or some other commodity) is that the value of money would apparently be free from manipulation by the government. The aim, then, would be to ‘de-politicize’ money.

But Wolf musters more objections than praise for the system that leaves money free from political manipulation (objections which Richard Ebeling masterfully dismisses).

In response to calls like Zoelick’s and Wolf’s, there are folk like Edwin Vieira who call for a return to the sort of real gold-coin standard that underpinned the long-term prosperity of the late-nineteenth century, a standard that leaves gold coins in the pocket of workers—giving them the power to manage their own affairs that the governments took away.  [Hat tip Antal Fekete]

But their remains this recalcitrant rump of people who do know that the world’s money is broken, but who resist the call for its full de-politicisation. Much of that resistance is based on the love of the state, but much is based on just flat-out ignorance.

Consider this piece by Nouriel Roubini, for example, one of the few folk to warn in advance about the onset of the latest crisis. Here's Why a Gold Standard Won't Work , he says. Let’s fisk what he has to say.

…a gold standard would make central banks unable to fight inflation or deflation, much less do anything to combat persistent unemployment…

Since the central banks’ paper is itself (during the boom) the source of price inflation, and the centrally-managed fractional reserve system the source (during the bust) of monetary deflation, this seems a bizarre complaint to make about a gold standard, particularly when those charts above show the sort of real  price stability that gold anchored over centuries of growing prosperity. Furthermore, the world had never seen the levels of structural unemployment seen in the 20th and 21st centuries of debt-based monetary booms and busts.

A fixed exchange regime, even if it is not a gold standard…just exacerbates the business cycle. Roubini asks us to imagine two countries: One that's growing very quickly, and one that's growing very slowly. The economy that is growing quickly would tend to "overheat"—an economic phenomenon characterized by accelerated growth, inflation and the potential for asset bubbles. In the economy that is growing more slowly, there would be a tendency toward deflationary pressure and recession. So, instead of having a central bank with the capacity to successfully counter-balance these tendencies, an economy with a fixed exchange rate regime would continue to reinforce the existing negative trends in the business cycle…

This really is flat-out ignorance. In a gold-based system of stable exchange rates (stable, because all prices everywhere are determined in weights of gold) the higher priced, overheating economy with lower interest rates would tend to lose gold (lose it because more imports are bought, and because money will be seeking higher interest rates), giving the precise counter-cyclical pressures that are needed; whereas the more depressed economy with higher rates and falling costs will tend to attract gold and new investment. 

Instead of having a central bank which over the last century has always made things work, gold effects a naturally-equilibrating process which has been known about for centuries (at least since David Hume first explained it in the 1700s) and which worked to harmonise world trade over the period in which it flourished most successfully.

….fixed rate regimes inhibit the ability of banks to provide lender of last resort support to an economy when necessary….

But as the present bank bailouts demonstrate, the “lender of last resort” fallacy leaves the world trapped in a cycle where new debt is simply passed round and round in circles.  We need a mechanism to wind up failed banks, not to reward them while impoverishing ourselves.

Roubini raises the following question: If you are on a gold standard, or modified gold standard, what do you do in the event of a bank run—if you don't have enough gold to fully back the currency? Roubini explains that most central banks in today's economy have far greater financial liabilities than gold in reserve. In fact, according to Roubini, in the case of most central banks today that ratio is about 40 or 50 to 1.
    Of course, many who support a gold standard would say that limiting the ability of central banks to increase their leverage would be a benefit of adopting the gold standard…

They certainly would. As Roubini must surely know (unless he’s simply being disingenous), virtually all of those arguing for a return to the classical gold standard have been in the van in calling for an end to the unstable fractional reserve system on which it was unfortunately based (and which still exists in the paper system, exacerbating the violent monetary inflations and deflations of boom and bust); and those who support a gold-coin standard like the one Vieira proposes insist that all central banks be kept away from gold as a matter of urgency, with those coins being put in the hands of workers, credit unions and private (non-leveraged) banks.

“We printed at once the notes, large and small,
Tens, twenties, fifties, hundreds and all,
You can't imagine how it pleased the folk, short and tall!”

- Goethe, Faust (Part II, Act I)

Of course, the major objection to the reintroduction of any gold standard is that it would take away the freedom of governments to “manage their own affairs,” by which is meant it would impose on them a fiscal discipline that would make impossible governments’ rampant profligacy, their inflationary electioneering, their multiplication of the welfare-warfare state, and the creation of all that paper-based “sovereign debt” in which the world, from Ireland to Sacramento, is now drowning.

It should be understood (and this is probably the most important lesson to take from all this) that far from being something about gold to decry, this discipline that it imposes on governments is in fact one of gold’s primary virtues.

UPDATE: The government thinks they own our money. George Reisman explains it is otherwise.


  1. You have a minor point about Kim Jong Hickey, but because his every solution, including the ones that don't contradict each other, involves the Huge State and lots of taxation, in my opinon he's more dangerous than the status quo.

    Never tell a politican he can be helpful by doing anything other than standing aside.

    Mind you, Kim Jong's real problem, as with the majority of our economists, even guys like Matt Nolan, is they have no philosophical underpinnings: they seem to believe economics happens in a vacuum outside of society, is simply a matter of levers and pulleys, and the freedom of the individual is not the primary goal (or even one) of a society and thus an economic system. I believe all of economics in its essentials boils down to a single transaction between two adults, as simple as that, the pricing mechanism off which a free society operates, and destroyed as soon as the State has a skerrick of a say (other than providing the system to enforce contract). Whereas none of the men I've mentioned seem to be able to conceive of an economic system in which the State is not holding a gun to at least one of the transactees heads.

    (There are some good guys though: Paul Walker, Eric Crampton ... any others?)

  2. ... that should have been consenting adults.

    (And the Reisman essay is a very good, timely one. Unfortunately the fraud he mentions is about to be the next theme in the West, starting with every European (+ Irish) austerity (yeah right) program.

  3. I am not really much of economist and the terms confuse me a bit..... but is one of the big problems with our financial system that we don't PRODUCE as much as we consume and that the difference is simply being filled by debt?

    Honestly, I am not asking a rhetorical question here; I just want to understand.

    I think this might be the case because, a couple of years ago my wife and I drove around Ireland. At the time I bored her by constantly repeating "Geez this place is fucked!" I kept saying this because everywhere there were formerly productive dairy farms which had closed and the land was being divided up into lifestyle blocks. We understood that many farmers were selling their EU 'quota' of dairy production to other countries and taking the money and then compounding their windfall gains by selling the very land which used to be productive!

    Obviously, the idea of an EU quota in itself is stupid. Farmers should be allowed to produce what the market will buy (and maybe this is another arguement); but I arrived at this conclusion on my own simply by observation and the Irish financial meltdown comes as no great surprise to me now.

    If I am (at least partially) correct in my assessment about production, then our country is due for an absolutely catastrophic meltdown in the near future because we seem to produce hardly anything of value any more and any industries which have survived are under constant attack by the socialists and eco-fucks.

    What are we going to do? Serious question. What are we going to do?

  4. PC yes, but what in reality in practical terms is the value gold, what can I use it for.

  5. Surely the issue is not about any particular monetary system, but a political system which encourages, almost requires, politicians with the help of self-interested bureaucrats to spend not only our money, but that of our childfen and grandchildren as well. How we fix democracy to reward prudence is surely the problem to grapple with?

  6. @JeffW: But that IS the issue being discussed here--or, at least, one important component of it.

    Because the gold standard not only facilitates international trade, without all the swings and changes of the present monetary set-up (it would be wrong to call it a system), it is a monetary system that imposes on the grey ones a fiscal discipline that makes impossible their well-demonstrated rampant profligacy.

    @Peter Quixote. Money, Peter. Money.

    @Dave. In a nutshell, yes. That's it.

    @Mark. The praise was only for rhetorical effect. Rest assured that I still hold Kim Jong Hickey in as much contempt as before.

  7. Very absorbing post...

    Thank you for the effort...

  8. The thing about Roubini is that while he is smart and understands economics, he's clearly not a libertarian. The crucial distinction is that Libertarianism is fundamentally a moral philosophy FIRST, and an economic one SECOND: The principles of liberty and 'you own what you earn' are given more importance than any perceived need to artificially engineer a supposedly "optimal" economy. In fact, the principles of freedom and ownership are regarded as MORE important EVEN IF they do not produce an "optimal" economy. Libertarians often fail to understand this themselves when attempting to defend against arguments of examples of so-called 'free market failures'. It's not about artificially engineering the 'best possible economy overall'. It's about liberty and private property rights. Very wealthy societies TEND to follow, but that's in some loose senses 'almost incidental', so to speak.

    Roubini understands economics, but it becomes clear if you listen to him that he places more importance on artifically engineering "optimal" economies in the Keynesian sense. He sees central banks and fractional reserve banking and stimulus and quantitative easing simply as simple tools to try help control and steer economies (whether they take money from the public or not), and the problems with modern currencies he feels could be dealt with by better policies under current ideological frameworks. To a certain extent he is right, but I think those 'better policies' he dreams of may be a false dream, they have failed to materialize anywhere where governments have the power to lend/tax/spend the way they do now. In fact there are numerous moral hazards built into the system that almost ensure governments will eventually make a mess.

    He (far as I can tell) sees public debt as just another investment and fundraising vehicle and printing currency to pay for public debt (effectively raising taxes by stealing wealth through inflation) as just another means of keeping the system going - government lends money, public pays it back, and public spending helps keep people employed and smooths things over during rough times (in his view). To a certain extent, there is some truth in that, but it misses the point.

    But Roubini simply understands economics. I don't think he contemplates moral ideologies or the philosophies behind them much. Humans are just pieces on a chessboard. I think he sees himself as a kind of "economic engineer". Moving vast amounts of money or debt around with a few strokes of a pen are to him just tools to engineer good economic statistics.

    Basically if I had to have a Keynesian economy I would trust him to do a much better job of running it than the palookas we have now, but if you want a libertarian system he's not the man.

  9. The thing about Roubini is that while he clearly understands economics, he also clearly is not a libertarian. The distinction here is that libertarianism is fundamentally a moral philosophy FIRST, and an economic one SECOND: The principles of liberty and 'you own what you earn' are given more importance than any perceived need to artificially engineer a supposedly "optimal" economy.

    Roubini understands economics, but it becomes clear if you listen to him that he places more importance, especially right now, on artifically engineering 'optimal' economic scenarios in the Keynesian sense. He sees things like central banks, fractional reserve banking, stimulus, Quantitative Easing (effectively raising taxes to pay for public debt by stealing wealth through inflation), public debt etc. simply as crude tools to try help control and steer economies (regardless of morality of taking money from people or forcing them to work for decades as debt slaves to pay for government's debt), and the problems with modern currency frameworks he seems to feel could be solved by better policies under current ideological frameworks. Theoretically that is true, but I think those 'better policies' are likely a pipe dream, they have failed to materialize anywhere where governments have the power to lend/tax/spend the way they do now, and in fact there are so many moral hazards built into the system that it seems inevitable governments will eventually make a mess.

    I don't get the impression he has spent much time contemplating moral ideologies. I think to him humans are just pieces on a chessboard, and he sees himself as a kind of "economic engineer"; moving vast amounts of money or debt around with a few strokes of a pen are to him just tools to engineer good overall economic statistics on paper.

    To summarise, if I had to have a Keynesian economy I would trust him to do a much better job of running it than the palookas we have now, but if you want a libertarian system he's not the man.

    - DavidJ

  10. Sorry for double-post there, the first one gave me a 'too long' error message - yet now I see it's there. David.

  11. "but is one of the big problems with our financial system that we don't PRODUCE as much as we consume and that the difference is simply being filled by debt"

    Think of a private company that raises debt by issuing stocks (bonds), uses it to increase production and pay people to create and sell something, then pays off the debt. Fine. Now we have a system whereby government can pretend to run like a company by also issuing bonds to raise money. However unlike corporate borrowers they aren't on the hook to pay back returns to the investors, the PUBLIC are through taxation. There's a moral hazard right there; politicians lend and spend, but you and I and our grandchildren have to pay it back by working our nuts off forevermore (which is why it's important for Keynesian economies to try keep 'full employment' - aka debt slaves, in a truely free economy that would be allowed to deflate we would in fact be able to reap the fruits of our work by having more leisure time where we could still afford to buy things like food, instead of having to stay on the treadmill for 'full employment' because our money keeps weakening). The more government lends and spends, the harder they have to keep everyone working in order to raise taxes to pay it (hence the problem with falling employment = falling production and tax collection base = more pressure on government to move in ever more socialist/communist direction to 'keep people employed' and prevent a crash).

    But now the problem is that the current crop of governments has literally borrowed and spent so much that the amounts have become IMPOSSIBLE for the public to pay off, ever, no matter how hard they work. Over-leveraged. Now unlike a corporate borrower, government can always pay returns to its investors by simply printing currency (QE). So, less risk (except when the entire thing eventually comes crashing down, like Greece/Ireland).

    This is also means that private investment vehicles compete with the "faux-investment" vehicle that is governments, but the latter is usually a safer bet because goverments can just print currency in lieu of a default (up to a point). This takes investment money away from private productive potential investment. And pushes cycles of lend/spend like bubbles until they reach unsustainable levels. Ireland already tanked, but national debt levels and deficits are still out of control in bigger economies like Spain, UK, US. And if and when these fail, there will be no 'Martian economy' to 'bail out' the Earth economy.

    - DavidJ

  12. I should add, if a private company ever borrowed-and-spent anywhere near as ludicrously and inefficiently as governments, no investor would ever lend so much as a cent to it. The only reason governments can do it and still attract loan financing is precisely their power to pay back by printing currency (aka stealing from the public) as well as to make the debt slaves keep working harder and harder and taxing them as much as it needs. - DavidJ


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