Monday, August 27, 2012

John Carney — The Gold Standard and the Myth of Price Stability

I’m not convinced that a return to sound money is possible. Our government is too big, our banking system too entrenched, to ever permit a reversion to gold.
But if you are going to attempt an intellectual assault on the gold standard, you can’t just point to price instability in the 1920s. The Austrians have been here before you—and they understand the period much better. And, more importantly, the value of a gold standard does not hinge on price stability in the first place. 
CNBC NetNetThe Gold Standard and the Myth of Price StabilityJohn Carney | Senior Editor
John makes two good points here. First, politics trumps economics. One has to realize that the advocates of sound money advocate not only a return to the gold standard but also 100% gold reserves to money creation. Even it were the greatest idea ever, it's not gonna happen due to vested interests. Not only does it knock down policy space for governments, limiting their power to affect their national economies, it also adversely affects profits of the financial sector by reducing the amount of rent that can be generated.

Secondly, if you are going to argue against a position or meet objections to you position, you should deal the strongest arguments that have been advanced. That's a reasonable demand.


Anonymous said...

I'm sympathetic to some of the Austrian impulses here. But I believe their diagnosis of the problem is faulty and incomplete, and so they are going about the solution all wrong.

The problems of financial bubbles and their catastrophic, sometimes depression-inducing collapses isn't due to pathologies of money alone, but is inherent in the institution of credit itself. History has shown that people are both extraordinarily ingenious and magnificently reckless in their creation of credit instruments, and in the frenzied manufacture of mountains of fragile debt liabilities and debt assets. Promises are the easiest thing in the world to manufacture, and people are always making promises they shouldn't make, and accepting promises they shouldn't accept.

And the deeper the hole they dig for themselves, the greater the temptation to get out of it by making or accepting more promises, and by pawning bad promises off on gullible suckers.

If the government says, "Thou shalt not create a dollar unless it is backed and redeemable by a secure quantity of gold (or silver, or diamonds, or shells, or pig snot, or what have you)", then people will just go ahead and create new kinds of derivative credit instruments, IOUs for certain quantities of dollars - maybe they'll call the IOUs "shmollars" , or "bonds" or "certificates", or "securities" or "stamps", or "playing cards" - and trade these derivative instruments the way they would have traded the dollars they would have traded if there were no gold standard and the dollars could be created more easily.

This is the insight Minsky had that so many people have failed to absorb. If you want to prevent asset bubble inflation, you need to regulate the activity of credit itself. You need to regulate all borrowing and all lending. There is no one fixed and special form of credit instrument - True Money - the regulation of which will solve all the problems. Media of exchange and credit are constantly evolving and innovating.

Also, what does it really mean to say that some quantity of money is $100 backed by gold. There is an unavoidable element of fiat even under a gold standard - because the government sets the redemption rate, and determines what "100%" means.

PeterP said...

If the solution is good we should discuss it even if it politically not "feasible". Dropping it will ensure it to be so. So the GS and full reserve banking should be discussed on their merits not on political grounds.

paul meli said...

I see the Gold Standard as a solution looking for a problem.

I can't imagine anyone that understands the dynamics involved could make the argument that this would benfit the majority.

But I'm willing to listen (politics aside).

First you figure out what works in theory and make sure it is bullet-proof. Then you are in the position to make compromises that don't completely undermine the objective.

Otherwise, why bother?

Matt Franko said...

"sound money" ... that's a laugh.


"because the government sets the redemption rate,"

Right they miss this... I would think to have such "sound money" (joke!) they would have to advocate for use of actual WEIGHT measures of gold or silver or copper struck into coins like humans used at one time....


Tom Hickey said...

The thing is that currency is fully convertible right now by exchanging it for bullion, coins, ETFs, futures, and shares, as many many people are doing already that trust gold over currency as a store of value, use gold as a trading vehicle, or commit a portion of their portfolios to commodities-PM for diversification. There is a relatively open private market in gold other than cb action. So I don't see a need for a gold standard de jure when one already exists de facto. Why not leave people free to choose how they want to save.

The credit issue is separate and there is obviously a problem that both Austrians and PKE-Minsky economists see, but other economists not so much. How to deal with this is very much up in the air, with many proposals on the table. Tear and compare.

Anonymous said...

But Tom, the price of gold continually fluctuates against the dollar. What the gold standard people want is for the government to set a fixed dollar-gold exchange by fiat.

Trixie said...
This comment has been removed by the author.
Anonymous said...

Maybe Texas will secede. That would be fun.

Jose Guilherme said...

Narrow banking à la Minsky, Fiedman, Kotlikoff, Musgrave et alia seems to be a pretty good compromise that opens up the following possibilities:

1. Controlling the profits of the financial sector by forbidding their money creation at the stroke of a pen, while

2. Letting the government set the proper amount of deficit spending to get the economy to full potential via money issuance (an essential government power denied by the gold standard)

Why aren't more people backing this proposed reform to our money system, then?

IMO this is the kind of proposal that can bring together people from opposing sides of the political spectrum, because it transcends the classical, and presently senseless, division between right and left.

And it would deal a mortal blow to the power of the financial sector, if implemented.

Maybe this is the reason why it's being condemned to oblivion by the media?

Tom Hickey said...

But Tom, the price of gold continually fluctuates against the dollar. What the gold standard people want is for the government to set a fixed dollar-gold exchange by fiat.

Yes, but what I am saying is that now we have a near free market and people are using it for a variety of reasons. Why abandon that by fixing price?

Tom Hickey said...

Trixie :Food fight!"

This is what conventions were like in "the good ol' days."

Anonymous said...

Controlling the profits of the financial sector and preventing banks from creating broad money in the course of generating loans are two different issues and should be kept distinct.

For example, suppose banks operated entirely as public sector arms of the government and charged no interest - only reasonable service and insurance fees. We could still want them to have the ability to generate loans without reserve constraints, and thus to create money as agents of the government in the process of lending.

With a public banking system, there would not need to be any reserve requirement, as each bank would effectively operate as a branch office of the central bank which would be loaning directly to the public through these branch offices.

Bank officials would be compensated for a job well done, as measured by various public criteria. One such criteria would be the rate of loan repayment. Even without interest payments, failed loans would tend to indicate bad fiduciary judgement with the public's money creation ability, and economic waste for society as real resources are channeled into failed projects. So we would still want lenders to make good decisions on our behalf.

Tom Hickey said...

And it would deal a mortal blow to the power of the financial sector, if implemented. Maybe this is the reason why it's being condemned to oblivion by the media?

Inviting an "accident."

Jose Guilherme said...

The advocates of narrow banking argue that the restriction of credit that it would entail could be compensated by higher deficit spending by the government - that is, the issuance of money with no debt attached, whereas the present massive money issuing by private banks always carries debt as a byproduct.

It would be a different model of capitalism, more based on equity investing and with a decay of the power of the financial sector.

The present form of capitalism was well described in the opening sentence of Marx's "Class struggles in France": from now on, the bankers will rule.

It's about time to give a chance to the industrial capitalists, producers of real goods and services.

Tom Hickey said...

It's about time to give a chance to the industrial capitalists, producers of real goods and services.

A lot of them are already fuming at the financial sector — and especially with the administration for letting them get away with the big rip off that is costing business dearly and setting them back.

Jose Guilherme said...

If agitation for narrow banking picks up with support from left and right plus industrial capitalists that will surely scare the hell out of the big financiers.

And it surely would be pleasant show to watch: Blankfein and Dimon against the public as well as the private interests.

Anonymous said...

Jose, how would the money issuance be administered? Wouldn't it have to be done at a local level? You can't have some single office in Washington processing and evaluating every application for every guy who wants to open up a pizza shop or a hardware store.

Also, interest apart, would the principle on loans be expected to be repaid to the public? If I ask the public for $200,000 to start a business, do I have to pay the public back? Or do I get $200,000 for free? How would that process be disciplined? What would prevent me from taking the $200,000, buying $100,000 worth of supplies but then letting them go to rot, and then using the other 100K to charter a boat to Tahiti and buy a hut there to live out my remaining life among the beautiful natives? Capital provision - whether by the private sector or the government sector - without corresponding recipient obligations and economic disciplines, seems like a recipe for a massive waste of our available resources.

But if I have to pay the principle back, then I have a debt.

Tom Hickey said...

Dan , look at China. It is market socialism. The govt owns not only the PBOC but also most of the major components of the economy. It's "lending" is lending in name only. It's capital provision.

Anonymous said...

Tom, yes. But people have to repay loans in China. It is not an anarchist society where there is not such thing as debt, and it is not a centralized command system where every capital expenditure is made directly by the government without loans to individuals. Whether capital is in the control of the state or the private sector, there still has to be a system for its efficient allocation and use.

Even if lending is subsidized to promote various public purposes in an entirely not-for-profit system, so that loans are all made by the government at negative rates of interest, there is still debt. If I get a $200,000 loan at a -10% rate of interest, then I have a $180,000 debt.

Tom Hickey said...

We may have a chance to see, Dan. I doubt that if China got into a similar situation as the US, the response would be at all similar. China could not take that level of UE with risking a revolt, and they know that they have all the money they need anytime they need it at the stoke of a few keys.

Unforgiven said...

“I recall travelling to a University in Zhengzhou 3 years ago with a magnificent brand new purpose built campus on 500 Mu of prime agricultural land. The campus is able to accommodate 55,000 students.

In discussions with University leaders I asked where the funding came from as I doubted that the Central Govt would fund, Henan Provincial Govt had no funds and Universities are not a municipal responsibility. I enquired as to whether the University had borrowed ALL the money to which the Party Secretary replied that yes indeed all the capital to build the campus was borrowed. Asked how the University planned to pay it back, the Secretary simply commented with a smile, what would the bank do with a University campus?”

Leverage said...

A lot of 'debt' in China is just debt by name. The state indeed does provide capital (or equity) even if they call them liabilities; they only do it in convoluted ways, but ultimately the state is printing money to increase activity (be ware, increasing investments, not necessarily increasing demand).

Almost the whole damn banking system is in possession of the state, and ultimately local governments form part of the same system and are 'bailed out'. In fact they have been hiding all the problematic liabilities one way or an other or continuing to leverage paper to keep the machine going.

Free marketers say this will eventually explode due to malinvestment and an inflationary spiral may happen. I actually think it's very easy for them to control inflation, IF they want, as long as people has jobs and some survival means they can keep things in check.

Is very possible the central government is suppressing demand for strategic issues and long-term planning. (Americans are ultimately deluded if they think the planet can sustain >1500 mill. MORE with their lifestyle.)

paul meli said...

"(Americans are ultimately deluded if they think the planet can sustain >1500 mill. MORE with their lifestyle.)"

+1 for this.