Pure Gold Standard

Posted by PITHOCRATES - October 8th, 2012

Economics 101

To Expand the Money Supply under a Pure Gold Standard requires an Enormous Investment unlike it does for Fiat Money

Do you know why we’ll never have a pure gold standard?  Because a pure gold standard doesn’t need a government.  Or their economists (from the Keynesian school) advising them how to make the economy better.  A pure gold standard works all by itself.  And is hard to manipulate.  Governments can’t inflate the money supply to spend money they don’t have.  So it really takes the fun out of being a spendthrift politician.  And because it would work so well it would debunk a century or so of Keynesian economics.  And shut down most economics departments at our Universities.  Because that’s all they know how to teach.  Keynesian economics.

So there is a lot of opposition to returning to a responsible monetary standard like a pure gold standard.  Ronald Reagan was the last presidential candidate to include a pure gold standard in the campaign platform.  But the idea died quickly after inauguration.  Not because he lied.  There was just too much political opposition that would never let it happen.  For that’s the last thing our spendthrift politicians in Washington want.  Something restraining them from spending what they don’t have.  As that would only make it more difficult to buy votes.  Reward campaign donors.  And reward special contributors with federal jobs in an ever expanding federal bureaucracy.

No, what the spendthrift politicians like is fiat money.  The kind you make up out of thin air.  Easily.  And with very little cost.  Either by printing paper dollars.  Or adding numbers to an electronic ledger.  Something you can’t do when you use gold.  Because to expand the money supply under a pure gold standard requires an enormous investment to find it.  To dig the ore out of the ground.  To comminute it (break it into smaller pieces) usually by crushing and grinding.  To smelt it.  To separate the gold from everything else pulled out of the ground with it.  And add it to the money supply.  This process takes a while.  And costs an enormous amount of money.  Unlike fiat money.  Where they can simply expand the money supply with a few computer key strokes.  Over a cup of coffee.

The Keynesian Interest Rate will always have a Larger Inflation Factor Included than a Gold Standard Rate

Gold mining requires gold mining companies.  And these gold mining companies have to raise a lot of capital to finance their extraction of gold.  Often with stocks and bonds.  So digging gold out of the ground requires investors to take great risks with their investment portfolios.  So it takes a lot to get gold out of the ground.  Which is why under a gold standard you can never have runaway inflation.  Technically you could.  But it would require the company to invest an inordinate amount of money into that inflation.  And if they flooded the market with all of that gold it would only lower the price of gold.  So they would spend more to earn less.  Something a private company is not likely to do.  Which is why it would be very difficult to impossible to have runaway inflation.

One of the things that makes a healthy economy is low interest rates.  If the cost of borrowing money is low more people will borrow money.  And if they’re buying things that require loans they’re generating a lot of economic activity.  Creating a lot of jobs along the way.  This is why Keynesians want to print money.  To flood the market with dollars so it doesn’t cost much to borrow them.  But there is another factor in interest rates.  Inflation.  The greater the inflation rate the greater the interest rate.  To compensate lenders for the loss in purchasing power over the time of the loan.  And increasing the money supply devalues the dollar.  Leading to a loss in purchasing power.  And those higher interest rates.

As it is much easier to inflate fiat money than it is with gold interest rates are higher with fiat money than they are with gold.  Because there is always a risk for governments to print more money for political purposes (i.e., buying votes) there is more cushion built in interest rates.  If you remove the irresponsible government aspect from the monetary system interest rates will be lower.  Because lenders would ask for less cushion in their interest rates.  Because of this stability that gold gives you interest rates are low for extended periods of time.  Encouraging lenders to lend.  And borrowers to borrow.  Leading to economic growth.  And jobs.  What the Keynesians try to get by printing money.  But the Keynesian interest rate will always have a larger inflation factor included.  So their interest rates will never be as low as they are under a pure gold standard.

Because Gold is not a Friend of Inflation it is no Friend to Keynesian Economists or Spendthrift Politicians

Under such a gold standard we would not get rid of paper dollars.  We’d still have those.  Only there would be no fractional reserve banking.  Where the banks keep only a small percentage of their deposits in their bank vaults while lending the rest out.  Under a gold standard our dollars would be ‘receipts’ for the gold stored in those bank vaults.  If the price of gold was $50 an ounce (it’s not) then $1 would equal 1/50 of an ounce of gold.  So for every dollar in circulation there would be 1/50 of an ounce of gold in a bank vault somewhere.  If you had $500 in your checking account the bank would have 10 ($500 X 1/50) ounces of gold on deposit for you.  Which means if everyone came to withdraw their money at the same time everyone would get their money.  There would not be any bank runs.  And no bank failures like there were during the Great Depression.

But could banks still loan money with a 100% reserve requirement for demand deposits (i.e., checking accounts)?  Yes.  They would loan money that people deposited for a fixed period of time.  Like a 5-year certificate of deposit.  Where the depositor can’t withdraw it until that 5-year period is up without a significant penalty for early withdrawal.  If a bank makes a 4-year loan with a 5-year deposit the money should be returned to the bank in time for the depositor to withdraw it at the end of 5 years.  As most savings are long-term (such as for retirement) this would not hinder lending.  There would still be plenty of money to lend.  Only there may be tighter lending standards where only people who can actually repay their loans may be able to borrow money.  Which would be a good thing.  As it would prevent another subprime mortgage crisis from happening.

If the economy grows larger than the money supply there will be fewer dollars chasing all those goods and services.  Meaning that the dollar’s purchasing power will increase.  And prices will fall.  This is something Keynesians all fear (but not consumers who like lower prices).  For they say if prices fall there could be another Great Depression.  However, the Federal Reserve helped to bring about the Great Recession with their deflationary monetary policies.  They contracted the money supply by some 30%.  That can’t happen with a pure gold standard.  Because the money supply never gets smaller.  Because just as you can’t create gold out of thin air you can’t make it disappear.  For once they add it to the money supply it is always there.  The gold stock never shrinks.  It can only grow less than the economy.  So you can have a monetary deflation without a depression.  Which is a good thing.  For your paycheck will go farther.  You savings will give you a better retirement.  It even makes international trade fair.  Because gold is gold.  Which makes any currency based on a unit weight of gold difficult to manipulate when it comes to exchange rates.  As prices are, essentially, in weights of gold.

So who wouldn’t win under a pure gold standard?  Governments with welfare states.  Who like to buy votes with their power over the monetary system.  Who depend on Keynesian inflationary policies to give them those large sums to spend.  And because gold is not a friend of inflation it is no friend to Keynesian economists or spendthrift politicians.

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