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The Gold Standard

Posted by publius2point0 on 2010/03/28

An urge to return to the Gold Standard seems to have become a rallying point in recent years. This is, frankly, stupid and probably exemplifies why Libertarians haven’t been able to wrest hold of the reins of the Republican party nor become a leading party in their own right since the word “libertarian” has become a decently known word in American parlance. A grand and noble desire for something that would be by all accounts wonderful still doesn’t negate the fact that reality needs to be considered when deciding what would and wouldn’t be wonderful.

Now it would be wonderful if the way that the world worked was something that could be understood without research and deliberation. It is after all much better when you can say that money is worth something because you can transfer it into gold, which is worth something because mumble mumble whirr squiggledybink. While as it is worse if you can only say that money is worth something because you can transfer it into products and labor, which are worth something because well…they’re useful.

Firstly, let us examine why gold was ever used as a necessary part of our economy to begin with.

The Value of Gold

As you will recall from Money and Philosophy, the simplest and basic goal of money is to be able to trade one person’s labor for another. Since a product requires some amount of labor to create, money is traded for it–representing that labor. Of course, how much one person’s labor is worth is dependent on how much each of us are willing to trade the products of our own labor for (i.e. our joint perceived value). See: On Scarcity and More on Pricing

If I give a certificate for my labor to Bob, and Bob goes to Jacky and offers my certificate to her in exchange for something, Jacky needs to be able to verify that the certificate is real. If she knows me, she might recognize my handwriting. If she lives near by, she can come over and ask, just to be certain. But historically, money was principally used to trade with other villages or people that you didn’t know very well. Jacky would much rather have something that she can verify the value of implicitly. Gold is a particular color, a particular weight, and it is ever so slightly malleable. That gold is exactly what it appears to be is something that makes it a decent token.

Of course, minus some sort of pre-arranged encryption strategy or whatever else, I have no way to create a certificate from me to any other random person on the planet. Much better than a personal certificate is to use a general token for anyone’s labor. If I give Bob a chair and Bob carries that chair to the next village, he can trade it to Jacky for its value as a chair. It has an inherent value as a useful object. A chair is quite unwieldy though, you really prefer something that is valuable even in small quantities. Salt, for example, was an early form of money because it is useful in small quantities, and it has an inherent value.

Another nice point of salt is that it is nearly infinitely divisible, so people can bargain about the relative values of their labor. If I only have a chair to trade, and I want Jacky to give me a cup of water, I have to consider whether a single cup of water is worth the value of an entire chair. It probably isn’t. But there is no way for me to cut off one leg and give it to her. The parts of a chair are not equal to the sum of the whole. And so I must go without the water even though I reasonably possess enough wealth to purchase it from her.

Now I could go out and sell everything I have for salt and end up with a large sack of it. With that sack I can go to any other town and, via trade, get back an equivalent amount of stuff for living and resume my life. In the interim though, that salt is really fairly useless to me. I can’t really eat it, it won’t protect me from the weather, it won’t warm me, nor will it help me to travel. While salt does have an intrinsic value, if you stockpile it, that value is based on its strength as a trade object, not on its utility.

Gold is a scarce resource, and so it takes a fairly decent bit of labor to attain. But, at least until modern chemistry and engineering came along, it had no utilitarian purpose. One could make jewelry of it, but that was only useful to make things that pleased the gods or pleased the powerful, because they could make jewelry to make themselves or their women look flashy. Looking flashy is of course a luxury.

But so, say that I have come to a new village with a sack of salt. If I want to resume my life, I need a house. I might have a house’s worth of salt in my sack, but that doesn’t mean that there is actually an available house for me to have. Only the most powerful people in town could see to it that labor is organized and works properly to build me a house or that someone is executed to free up one.

If you’re the voice of the gods on Earth or you’re the biggest baddest mofo with the largest group of trained warriors, the worries of survival are simply absent. Luxury and looking flash are really the only things of value that you can obtain. A bag of salt may be worth something to your average farmer, but the King or the High Priest wants ice, gold, foreign spices, or whatever other luxurious but less-than-utilitarian objects. (Note that while salt is useful as a spice, this was a secondary matter compared to its uses as a preservative.)

Ice is hard to transport, and spices (within Europe at least) were far too foreign. Gold might not be abundant, but it was something that is available anywhere in the world if you look for it. It is a good choice for ingratiating yourself with the head honcho.

Overall, gold has the following powers:

  1. Difficult to counterfeit.
  2. Valuable in small, transportable quantities.
  3. Infinitely divisible.
  4. Valued by the powerful.

The Value of Fiat Money

Fiat money, i.e. dollar bills, is specifically manufactured to be difficult to counterfeit. You can represent vast quantities of value within just your billfold, but you can also divide it into smaller quantities than are useful for anything. As such, three out of four, it already stacks up with gold as representative of labor.

The only question remaining is whether it is valued by the powerful. Since they can trade it in for gold or any other luxury or bit of flash, it seems to be just as good as gold itself. More importantly, whereas gold was only quasi-guaranteed as transferable to real goods via the powerful, fiat money is considered valuable by everyone. I can go to an architect and a construction company directly and get what I want without having to go through the middle-man of the powerful. He offers his labor to me because it has been proven that he can trade his labor for a sufficient amount of food and other supplies as to be able to survive and so he doesn’t need to be coerced into leaving his farm and helping to build my house. We all respect that his labor is worth trading for, so it is simply a question of the instrument for trading labor around. Fiat money does accomplish this goal.

The fourth power of gold is simply unnecessary so long as the first three conditions are met and everyone is willing to go along with it.

The only question that is left unanswered is, how do you value labor via fiat money if fiat money doesn’t–to start with–have any inherent value? That is a problem, if you’re starting an entirely new economy, but for one which has already been able to equalize at some particular accepted worth, it’s not really an issue. Even so, it’s still accomplished easily enough by simply starting with an arbitrary and constant quantity of money. By definition, all of that money becomes worth the entire value of all labor that exists. That will always be true and so money is inherently valuable.

And, remember also that like my sack of salt, when a commodity is used as currency its only value is for its ability to be traded.

“Printing Money”

When an accepted equilibrium of the value of money has been accepted, that money’s value is based on what can be traded for it. If I have a million dollars, I can buy a house. Hence, a million dollars is as valuable as a house. So long as the amount of money in the system changes slowly enough for prices to change with it, there is no issue. If the amount of money in the system changes rapidly, everyone knows that there isn’t really that many more houses or cars or whatever else in the economy, so they consider the money to be worth less than it was. But, seeing that it is changing at a fast rate, they are also afraid to trade because they can’t be certain how much their money will be worth at any given time.

It’s worth pointing out how “printing money” is accomplished. A big stack of money in a warehouse doesn’t affect anything. It must be inserted into the economy via some means. Generally, there are two methods.

Firstly, the central bank can give loans at zero interest. Since we know that 100% of all ventures don’t succeed, we know that not all of that money will be paid back. The money makes its way into the system based on impractical expectations of the future. The second method is by direct investing. That is to say, instead of merely offering loans at the central bank, the government actively goes out and convinces people to take their loans. If there had been enough confidence in the value of offering loans to those people to begin with, or the people had been confident enough of their own ventures to come seeking a loan, this wouldn’t be necessary. These are all going to be highly speculative loans and hence, again, fail at a greater rate than is reliable.

The Gold Standard

As you will recall from Tying it all Together, inflation occurs by giving loans and, essentially, letting the central bank go further and further into debt. This is acceptable because the central bank only loans to reasonably safe investments–charging interest to make up losses–and in end result creates new wealth (i.e. more valuable labor) that can pay itself off.

Now, my dad once told me (back before the internet) that the way that phone cables were set up, at most only 1/3rd of everyone could use their phone at the same time. This was a large enough value that it served all needs without adding unnecessary expense. If everyone did try to make a phone call at the same time, well, what the result might be is unclear, but it certainly wouldn’t work as desired.

A gold-backed system is like that. Everyone should, theoretically, be able to go in and trade all of their money for gold, and hence see that their money is worth something of value. But if you did that precisely, you couldn’t give loans at all. So instead you loan out to the extent that there’s only so much excess money in the economy that when people do come in to trade their money for gold, it can always be given. If everyone came asking for gold, they’d be out of luck, but everyone doesn’t do so, and so the system works.

But, that caps the maximum amount of debt that the central bank can go in to, which means that the number of businesses and individuals they can offer loans to is capped, regardless of whether they have practical and worthwhile ventures that they are planning or not. That those ventures would offer greater wealth to humanity and pay themselves off may be certain, but because there’s a limit to the amount of gold that can be dug up out of the Earth’s crust, you can’t finance them. Obviously, that’s just silly.

No matter what basis you use to value your money, the ultimate purpose of money is to trade labor for labor. Whether the token that is traded about has its own value or not has no relationship to the amount of labor that there is in the economy to be traded. If all of the economies in the world collapsed, yes, gold would have more intrinsic value than a piece of paper and you would rather have it of the two. In practical terms though:

1) There is no reason to think that all of the economies in the world could somehow fail. Firstly, it’s never happened in all history. But more importantly, let’s consider what would really happen as result. Say for example that the US suddenly disappeared from the face of the planet. The US has borrowed money from many countries and holds the money of several countries. Knowing that the US will never return again, will never pay off its debts, and will never give back the money it held, all of the remaining countries can either play through the rules as they currently stand and let their banks all fail and return to the stone age, or they can simply pretend like the US never existed, that there was always only this much money in the world, and otherwise come up with some convenient lies to patch over the issue. There will be real issues with actual valuables like cars or food that was expected to be imported or exported, but money is all just a fiction to begin with. So long as everyone can mutually agree on the rules for patching over, the fiction can be changed however we wish. There simply is no way for “all economies in the world to fail”. If somehow all of the most powerful countries on the planet realized that the economies of all of them were messed up, they’d all mutually agree to pretend the problem doesn’t exist, rewrite all the rules to get rid of it, and proceed on merrily. All that matters is real wealth. So long as we have valuable goods and want to deal with each other, we’ll modify quantity and rules of money to match the real economy of true valuables.

2) A gold standard is more likely to cause economic collapses since it artificially limits the economy, which causes strife.

3) Limiting the economy limits innovation and the rate at which the quality of life on Earth can advance. Given the nigh-impossibility of total global economic collapse, this really just comes for free.


2 Responses to “The Gold Standard”

  1. Roberta said

    I agree that, at least in modern societies, it is not possible to stick to a gold standard for countries as it obviously limits an economy on growth — as an ecomony can only grow to as much gold as a country has…and that’s it. That having been said, how can you limit a country on spending too much and getting into a huge debt since it now feels that it’s not limited to any line beyond which it’s probably not wise to spend above?

    • Firstly, government debt isn’t necessarily a bad thing. If the populace pulls out of the market, you have the option of letting all of the various businesses of the nation fail, or you can have the government temporarily take the place of the general populace and buoy them up until the people return. So long as there isn’t true economic ill, all of this money will be paid back when things improve.

      Secondly, if you vote in people who want to spend money but refuse to raise taxes, well there you go. If you don’t want to go into debt, vote for and give campaign money to someone who wants to raise taxes and reduce spending. Note that higher tax rates don’t necessarily mean that you will be taxed more.

      Take for example pay-day loaners. A person comes in and borrows a hundred dollars for a night of fun and games. When the next week comes around and he is to pay off his debt, he is only able to pay the interest, and the same the next week, and the week after that. He’s eternally out a given amount of money for the rest of his life because he took on debt that he couldn’t actually pay. The same thing happens to the average tax payer if he refuses to pay for the things his representatives affected. Those representatives go to a bank or a foreign nation and borrow money. Now, instead of incurring just the cost of government services, you’re also incurring the cost of interest. Eventually, that debt falls on the taxpayer. There isn’t a “government” debt, there’s only a taxpayer debt. If you raised taxes to pay for government services exactly, to begin with, you end up spending less, while as if you don’t you end up where the tax rate comes to be pegged to the basic needs of government services plus enough interest that the debt stays constant since the government isn’t allowed to raise taxes high enough to actually reduce the debt. You incur that interest fine every single month.

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