Question-The Dollar, Fiat currencies, and Gold

[jon_perez]

Sadly, fiat money is here to stay. I think that competing currencies is an excellent idea, but the government is in too deep to swtich from their paper standard now.

That is, assuming forces do not succeed in completely destroying a particular fiat currency and generate calls for the restoration of hard money.

The back and forth swing between fiat and commodity money is a story as old as civilization.

 

[bale002]

Sure, but remember that if you do it at the expense of having a recession and US productivity slows down as a result ...

Actually quite the opposite. To be sure, production slows, or contracts, during a recession, but one of the purposes of recession is to restore productivity to the economy. Sure, statistically, we've had growth in the US economy during the 2002-2007 period, but US economic agents engaged in activity that has been far from productive, reflected in, for example, the housing bubble, overproduction of motor vehicles, and general inflation.

The economic policy challenge is to restore productivity, or cut out the fat if you will, without tipping the economy into a deep recession.

Current monetary policy at best may prevent defaults from spreading to other types of loans, such as credit card and car loans, and it helps keeps the flow of funding to companies that need to borrow, perhaps maintaining production and employment, though I doubt it will help them improve productivity.

In the interests of sound money, an increase in basic manufacturing production and an increase in productivity, I would prefer to see higher interest rates, but with a well-directed expansionary fiscal policy mix. For that to work, among other things, people would have to be willing to except factory wages, but nothing seemed to be wrong with that from, say, the 1910s to the 1980s. And you know what, one of the reasons that the unemployment rate is so low is that many people have given up on the the job market. So maybe we could give basic manufacturing a second chance.

So perhaps indeed the first step is to cut off the credit spigot and get people to live within their means again. Hence the cost to get from here to there may in fact be a deep recession, but not necessarily, we'll see.

I think with the right policy mix, we could emerge from this without a deep recession, but I have little confidence in the current crop of candidates. Hopefully the Ron Paul candidates will do well in the Congressional elections.

 

[Acala]

Disagree

Scooter,

The problems that followed Lincoln's war inflation were caused by - big surprise - Lincoln's war inflation, not the sound currency that followed. And, by the way, the growth in the US economy from after the civil War until 1913 was outstanding, although there were some problems caused by fractional reserve banking. Please cite evidence that gold fluctuated in some way.

You hold up bimetallic currency as being outstanding, but it was, in fact, a big problem. Pegging two metals to a single currency is a kind of price control. As a result, when the exchange values of the two metals moved independently, first one then the other metalic currency would vanish in accordance with Gresham's law. This is why bimetallism was abandoned.

There was no deflationary depression in the 1920's either. It was a time of extraordinary growth and prosperity. Unfortunately, it was built on the inflationary credit bubble created by the Fed after 1913. The deflation came at the beginning of the next decade. And that was not a result of gold, it was a result of fractional reserve banking.

I don't know what wild fluctuations you are talking about - gold and silver have almost always been stable against other commodities. The only exceptions being the rare events of major mining strikes or the conquest of rich countries, none of which is likely to occur now.

 

[scooter]

Bimetallism gave protection from one metal inflating or deflating out of control. I still don't think it was a perfect system, but it was better than the monometallic system. If the price ratio caused one metal to be the preferred exchange, then the supply of the other would be affected until the ratio reversed.

As for precious metal supplies being stable, you are wrong about that. I don't have any sources at the moment, but during the late 1800s that I spoke about, it was only the South African gold discoveries and a new extraction process that finally inflated the gold supply enough to rip the US out of its depression. The inflation that the free-silver folks were looking for ended up occuring naturally.

You are right in a sense that Lincoln's inflation caused the problems that happened later on, but only because that inflation had already been priced into the market. The government had to undertake a massive price deflation to prepare itself to return to gold exchange (i.e. the resumption acts). They didn't have enough gold to cover the currency then, and they sure as hell don't now.

The monometallic standard during the industrial revolution that occured at the end of the 1800s caused all kinds of problems until the new African money supply came out. You can talk all you want about the horrible inflation we have now, but there is no answer for the depressionary effects of deflationary money that gold causes.

I don't really want to argue either way. I just don't like it when the goldbugs forget the inconvenient parts of the metal's history. I also question the "out of thin air" talk that most people use. Sure, fiat money isn't backed in the conventional sense by some specific commodity, but it's backed by the willingness of its government and the international community to accept it. So far that willingness has gone down for dollars, but there are absolutely no signs of it going away. Already there is pressure in Europe and Asia to lower rates and inflate their currencies because our inflation is causing a painful deflation over there. But of course, you would say deflation is a good thing and should be welcomed. History tells a different story.

 

[Acala]

Hmmm

Scooter,

I'm not sure where you are reading your history. And I don't mean that facetiously. I would be very interested to see a reference to gold or silver CAUSING deflation. I'm not even sure how that could happen unless you had economic growth - and hence demand for money - shooting theough the roof. Or perhaps in the case of silver, some huge new industrial demand that outstripped new supplies by some significant margin. Other than that, how could you have the quantity of gold or silver decline faster than its new production? Deflating a paper currency to match gold (assuming that ever happened) isn't caused by gold, it is caused by the inflated paper currency.

I would also like to see a reference for bimetallism as a stabilizing influence.

 

[Paulitician]

So long as we have tyrannical government and moronic politicians running things, we're never going to have a sound, stable monetary system.

 

[Acala]

Agreed

Paulitician, I agree.

At this point everything depends on wresting power from the hands of the power-hungry mob we have allowed to take over the government. Assuming we can do that, then we need to reinstate institutions that prevent such a power grab from happening again. Among the things government has proven it cannot be trusted to control is the currency or banking. And it never will be.

Over time we need to:

1. Repeal all legal tender laws,

2. Repeal and prohibit all taxes on transactions in bullion,

3. Prohibit fractional reserve banking (hanging offense)

4. Abolish the Fed and prohibit central banks Constitutionally

5. Prohibit fraudulent coinage (hanging offense)

 

[kyleAF]

Again, do some historical research on money. There were many cases of depressions and turmoil in markets because of currency problems. You are right that the currencies weren't "destroyed," but you ignore the extreme problems caused by the deflationary depressions of the 1890s and 1920s. Also, it is important to remember that a gold standard wasn't present until 1879. Before that we were on a bimetallic standard where silver was the preferred metal.

The last part of your comment is good. Returning to a gold standard under previous conditions is not possible following the massive growth in output and money that has occured since then. It would have to be done under new ratios and would need to be handled differently. If you think "a great deleveraging and deflation" would be a fun time, then I suggest you read a little bit of William Jennings Bryan's speeches and writings from before his 1896 presidential bid. Most of the working class was NOT happy with this very same effort that was undertaken to restore gold after the Civil War.

It's called closing the barn door after the horse has already been stolen.

I don't think that a great deleveraging and deflation is going to be fun at all. I only think that it might happen anyway, and that we can't stop it, except by inflating wildly. But inflationary depressions result in the same thing in the end... a depression. And the helicopter scenario's limitations are the reasons why...

 

[kyleAF]

Paulitician, I agree.

At this point everything depends on wresting power from the hands of the power-hungry mob we have allowed to take over the government. Assuming we can do that, then we need to reinstate institutions that prevent such a power grab from happening again. Among the things government has proven it cannot be trusted to control is the currency or banking. And it never will be.

Over time we need to:

1. Repeal all legal tender laws,

2. Repeal and prohibit all taxes on transactions in bullion,

3. Prohibit fractional reserve banking (hanging offense)

4. Abolish the Fed and prohibit central banks Constitutionally

5. Prohibit fraudulent coinage (hanging offense)

You're absolutely right that the bankers won't avoid fractional lending without a little capital influence (pun intended). And the economy can still grow, without the use of fractional lending to spur it on, it just won't outpace its real economic (productive) capacity. Imagine that! A notional economy based on a real economy...

Competing currencies is BY FAR the way to go. You cited Gresham's law earlier, which is a good point to bring up. A competition in currencies will yield a new currency, but it will be the market's equilibrium currency, which could then shift to a new one as/if needed down the road.

The government doesn't want competing currencies, because the government is almost NEVER able to compete on a level playing field (read: without gun-backed legislation) with the private sector... The dollar would fall victim to Gresham's law. It's practically guaranteed.

 

[scooter]

Scooter,

I'm not sure where you are reading your history. And I don't mean that facetiously. I would be very interested to see a reference to gold or silver CAUSING deflation. I'm not even sure how that could happen unless you had economic growth - and hence demand for money - shooting theough the roof. Or perhaps in the case of silver, some huge new industrial demand that outstripped new supplies by some significant margin. Other than that, how could you have the quantity of gold or silver decline faster than its new production? Deflating a paper currency to match gold (assuming that ever happened) isn't caused by gold, it is caused by the inflated paper currency.

I would also like to see a reference for bimetallism as a stabilizing influence.

One thing to note in these threads is that I'm taking a contrarian position to give a little bit of the other side of the story.

As for my history. Go read anything political from the 1890s. Anyone with the slightest bit of debt were getting hurt badly because the money was deflating significantly causing wages to go down while they owed debts from the previous nominal values. Luckily for Republicans, the cyanide process for extracting gold was discovered and a massive ore deposit was located in South Africa which added a significant sum to worldwide reserves and finally allowed for some currency growth. This achieved William Jennings Bryan's inflation without having to go to silver and crushed his political movement.

If you have not read William Jennings Bryan's "Cross of Gold" speech as I mentioned, I suggest you do so. That will give you an idea of the emotional outbursts that were going on from the farming community specifically because they were getting strangled by debts that were increasing in value.

It is important to realize that both inflation and deflation are terrible for the economy if they are not expected. A little bit of expected deflation can be worked out, and a little bit of expected inflation can be worked out. The problem is when you go in either direction in high values that are not expected.

The metal standards proved to be pretty good at giving expected low rates of deflation for a long time. However, do you believe that the natural conditions of the markets will always work out in that favorable way? The way I see it, we were lucky with metals a few times. As the new discoveries in California and the Yukon came into the market, the United States was on a bimetallic standard fixed at 16 to 1. This, as has been mentioned, is a price-fixing mechanism, but it did work to keep the appreciation of one of the metals from significantly increasing inflation, because as the ratio went slightly higher than 16 to 1, the country was effectively on a silver standard. If the ratio dipped slightly below, the country was effectively on a gold standard. This balancing act seemed to keep the metals pretty close to the desired ratio, although it did have to be adjusted a couple of times in various countries.

In the 1870s, the US government started to deflate the currency in preparation for a return to a metal standard, but the bankers (yes they were the ones behind it) wanted to return only to gold because they enjoyed its deflationary aspects. Currency deflation is good for creditors, bad for debtors. When the country went only to gold, it did create bad deflationary problems. You can get any evidence you want from the political achievments of guys like Bryan and the free-silver movement.

I'm not here to defend fiat money in any way. I just try to have some good discussions on both sides of the aisle because it is irresponsible for some to believe that there is a perfect system out there that is flawless. The negatives in my mind to a gold standard are that you are tying your currency to a commodity with no physical use, when every other country in the world does not back its currency with the metal and it trades with the jewelry market. This time period is nothing like the previous gold standards, where the other countries were onboard and allowed for gold to trade as a currency rather than as a pretty yellow metal.

The negatives to fiat currency are not that they are "printed out of air" or "based on nothing." In fact, they are designed to be based on all commodities in the economy, rather than just one. They are designed to be a reflection of the output of a specific country, with their worldwide acceptance as their backing. The real negative is that they are managed very poorly, at least in this country. Our central bank should just have a mandate to maintain purchasing power of the currency, but instead they have separate mandates to prop up the banking industry and maintain economic growth. These are things that are impossible from a currency perspective.

As I see it, fiat currency can work well if handled right. It works fine in Switzerland and it is starting to work fine with the euro. Those currencies are only getting underminded by the fact that they are starting to deflate against the dollar because they are managed so well and it is managed so poorly. If the central bank utilized inflation targeting rather than all of this banking BS, it could mimic the gold standard with fiat currency and be able to eliminate all of the potential negative effects of a monometallic system.

 

[HenryKnoxFineBooks]

One thing to note in these threads is that I'm taking a contrarian position to give a little bit of the other side of the story.

As for my history. Go read anything political from the 1890s. Anyone with the slightest bit of debt were getting hurt badly because the money was deflating significantly causing wages to go down while they owed debts from the previous nominal values. Luckily for Republicans, the cyanide process for extracting gold was discovered and a massive ore deposit was located in South Africa which added a significant sum to worldwide reserves and finally allowed for some currency growth. This achieved William Jennings Bryan's inflation without having to go to silver and crushed his political movement.

If you have not read William Jennings Bryan's "Cross of Gold" speech as I mentioned, I suggest you do so. That will give you an idea of the emotional outbursts that were going on from the farming community specifically because they were getting strangled by debts that were increasing in value.

It is important to realize that both inflation and deflation are terrible for the economy if they are not expected. A little bit of expected deflation can be worked out, and a little bit of expected inflation can be worked out. The problem is when you go in either direction in high values that are not expected.

The metal standards proved to be pretty good at giving expected low rates of deflation for a long time. However, do you believe that the natural conditions of the markets will always work out in that favorable way? The way I see it, we were lucky with metals a few times. As the new discoveries in California and the Yukon came into the market, the United States was on a bimetallic standard fixed at 16 to 1. This, as has been mentioned, is a price-fixing mechanism, but it did work to keep the appreciation of one of the metals from significantly increasing inflation, because as the ratio went slightly higher than 16 to 1, the country was effectively on a silver standard. If the ratio dipped slightly below, the country was effectively on a gold standard. This balancing act seemed to keep the metals pretty close to the desired ratio, although it did have to be adjusted a couple of times in various countries.

In the 1870s, the US government started to deflate the currency in preparation for a return to a metal standard, but the bankers (yes they were the ones behind it) wanted to return only to gold because they enjoyed its deflationary aspects. Currency deflation is good for creditors, bad for debtors. When the country went only to gold, it did create bad deflationary problems. You can get any evidence you want from the political achievments of guys like Bryan and the free-silver movement.

I'm not here to defend fiat money in any way. I just try to have some good discussions on both sides of the aisle because it is irresponsible for some to believe that there is a perfect system out there that is flawless. The negatives in my mind to a gold standard are that you are tying your currency to a commodity with no physical use, when every other country in the world does not back its currency with the metal and it trades with the jewelry market. This time period is nothing like the previous gold standards, where the other countries were onboard and allowed for gold to trade as a currency rather than as a pretty yellow metal.

The negatives to fiat currency are not that they are "printed out of air" or "based on nothing." In fact, they are designed to be based on all commodities in the economy, rather than just one. They are designed to be a reflection of the output of a specific country, with their worldwide acceptance as their backing. The real negative is that they are managed very poorly, at least in this country. Our central bank should just have a mandate to maintain purchasing power of the currency, but instead they have separate mandates to prop up the banking industry and maintain economic growth. These are things that are impossible from a currency perspective.

As I see it, fiat currency can work well if handled right. It works fine in Switzerland and it is starting to work fine with the euro. Those currencies are only getting underminded by the fact that they are starting to deflate against the dollar because they are managed so well and it is managed so poorly. If the central bank utilized inflation targeting rather than all of this banking BS, it could mimic the gold standard with fiat currency and be able to eliminate all of the potential negative effects of a monometallic system.

Thanks scooter. I'm glad you are taking the other side of the argument. I learned alot from this thread.

 

[Acala]

Fiat currencies not working fine

The Swiss franc and especially the Euro are suffering from inflation just like the dollar. Just because they are increasing their value relative to the dollar does NOT mean that they are not inflating. They are. And inflation is not just a problem when it causes one currency to lose value against another. Inflation is a problem entirely within an economy.

Inflation, even mild inflation, causes misallocation of resources resulting in distortion and error in the structure of captial. It is this malinvestment that causes recession/depression when the market corrects it. Additionally, inflation erodes savings (inhibiting capital formation) and although it benefits some sectors of the economy temproarily, it does so at the cost of other sectors - typically rewarding the financial elite and punishing the middle class and working poor.

So to summarize, NO fiat currency is doing well. They are ALL inflating, like they ALWAYS do because government cannot be trusted with control over a money machine. The dollar is inflating so badly that it makes some other currencies look good by comparison, but don't be fooled.

 

[scooter]

You see Acala, you missed my point completely. A little bit of inflation or a little bit of deflation either way, in an expected manner, is not a problem. There was always small movements and manipulations of the money supply under a metal standard, and sometimes big movements. If the money supply changes slowly and in an expected manner, there is hardly any harm to the price and income environments. In fact, there have been economists who have argued that a slight bit of inflation is actually desirable if it is slow enough to not cause rapid price changes but still gives workers the feeling that their wages are rising. It doesn't really change things statistically, but slow inflation has always made workers feel more comfortable than deflation. People are much more capable of thinking nominally.

Re-stating Ron Paul's position on malinvestment and structure of capital isn't going to change this argument. That is Ron Paul's complaint about interest rate manipulation in the United States, and does not apply to those currencies who utilize inflation targeting rather than stock market worries to drive their decisions. I particularly agree with him on this complaint, but it has nothing to do with the currency. The malinvestment comes because the interest rates are not set by the free markets or are not set with inflation targets in mind. That's when you get malinvestment of capital.

 

[Acala]

Disagree

I still don't understand how you propose that there can be DEFLATION of a metal currency. The volume of gold increases slowly but steadily and is consumed only in very small amounts. Please explain gold deflation - and I don't mean the deliberate paper money deflation you have cited.

If you had an absolutely stable currency supply, you WOULD have slow deflation over time as the economy grew and demand for money grew. Prices would need adjust and their might be some problems associated with the "stickiness" of wages - particularly with organized labor. But it is a relatively minor problem because this kind of deflation is not controlled by politicians or bankers or any other power group and it occurs evenly throughout the economy rather than causing a disparate impact as it spreads from a point of origin.

Inflation in gold money is very rare. I am only aware of two instances in human history - the California gold rush and the importation to Europe of looted gold from the New World. Please cite another example with some kind of reference I can check.

The idea that even small inflation is a bad thing is not just Ron Paul's idea. It is an idea that has been developed by the Austrian school. It was at the basis of the Austrian economists' prediction of the Great Depression when everyone else was praising the strong economy. Even though price levels were relatively stable!

Inflation creates problems that deflation does not because inflation is controlled by particular institutions that profit from it. This makes it subject to manipulation.

Inflation of the money supply as we see it now occurs mostly through fractional reserve banking backed by the Fed. Even at levels so low that prices don't rise, this inflation cause malinvestment. It distorts capital structure because it gives the appearance of a willingness by the public to postpone present consumption for an increased future consumption. When the wave of inflation dissipates, this false signal is revealed and the market shifts resources causing the correction we call recession. Then the Fed pours more money into the market to try and keep the error from correcting. That is what is happening now.

Inflation caused by government creating money to spend on its own programs does not create the same erroneous signal as money created by lending, but it STILL creates the problems associated with an uneven movement of the new money through the economy. It also creates a false signal of excess demand in those businesses that serve government.

You may choose to disregard the capital-based macroeconomic theory of the business cycle, but it really is the only explanation for the historical facts.