Austrian Challenge: What Would the Macroeconomy on the 100% Gold Standard Look Like?

I’m fairly convinced by what I take to be the Austrian view that a 100% Gold Standard would in the long term lead to a mild negative rate of inflation (and that such deflation would not be a bad thing) with a relatively lower standard deviation; a higher average real growth rate (though perhaps not reflected in current claimed measures of GDP) with lower standard deviation and a lower average rate of true unemployment with lower standard deviation.

I wouldn’t put predicted values to any of these though because I have little faith in the conventional measures of inflation, growth or unemployment as accurate, unbiased or particularly meaningful measures of the quantities they purport to represent.

Like Friedman, I believe that such a system could only be practical or desirable with a restrained government whose size was less than 10% of GDP was was generally laissez faire and non-interventionist.

But the question doesn’t assume that, so I’ll assume we still have the Jabba the Government we have now, only with a “100% gold standard.”

In which case it’s simply impossible to tell. How will other nations react? What would it mean for international trade? In a laissez faire situation, it’s easier to say “in the long run unemployment and inflation and growth will all be better,” but there’s just no way to tell from here. You can’t predict that well, with so many variables. Hayek, and whatnot.

And I’m non-Austrian.

Oh, and nobody asked me but I’ll say anyway: if I could change just one thing about US economic policy, it would be to limit the size of all government expenditures to no more than ten percent of GDP.

^^^ Too right! ^^^

Go Grant!

Cycles like the one we are currently experiencing would be lessened significantly or eliminated.
>>>>>>>Nope, they would be even bigger and have bigger collapses. Your dead wrong hear

The entrepreneurs unable to forecast future economic conditions and interest rates would not have access to as much capital as they did under continuous credit expansion
>>>>>>>Again, wrong. The same “continuous credit expansion” would happen and it would be worse

, so fewer unsustainable business projects would be undertaken. Other businesses would then no longer have nearly as great of incentives to “keep up” with institutions who had embarked on doomed projects which produce short-term gains, but long-term losses.

>>>>>>>>>Wrong again

Credit markets would show better selection of prudent, credit-worthy borrowers, and the incentives to lower lending standards (via lobbying or however) in order to execute projects viable only in the short-term would not exist. Innovation would still take time for markets to price, possibly causing bubbles in the process, but the magnitude of duration of these bubbles would be reduced.
>>>>>>>>>>Wrong, those bubbles would be bigger

Without as significant of asset bubbles, cyclical changes in aggregate demand (which is often based off of perceived wealth; e.g. the value of one’s home or stock portfolio) would lessen

>>>>>>>>Wrong, those bubbles would be bigger.

Grant, “Austrian” economics is a fraud. Not just intellectually, but spiritually. You worship the international to such a extent, I would charge you with treason.

The same things that happened today, would happen under your “dream” system. Corruption, massive credit creation, massive unemployment, underemployment during downturns and probably a hire crime rate with the modern tendency towards violence.

…..average values and standard deviations of inflation, output growth, and employment?

No need to pose the theoretical question, there is plenty of empirical evidence from the 19th and 20th cent…. remember that CHF was backed by gold up to 1999….

-Inflation: much lower average, much lower SD (this more because of 100% reserves than gold)

-Output: higher long term as savings and accumulated capital work their compound interest magic. Lower SD.

-Irrelevant. Monetary effects on employment are an illusion. Depends much more on legal structure…incentives, flexibility.

(I lean austrian…evidently)

Competing currencies and the abolition of legal tender laws (and of taxes on alternative currencies) is the way to go.

While I agree that competing currencies is the way to go, I don’t think it is the way it will stay.

Say you have only fringos, but I really really want is chingos. Well, I can accept your money at a discount and then go to a currency broker. Clumsy. Not funny. Ineffective.

After all we already have a world of competing (national) currencies, at least, whenever we have cross-border trade. And we all know that the dollar (almost) became the currency.

Would 100% backed currencies trade at a premium to partially backed ones?… for sure

Do you see the problem here? At a premium relative to what?

You cannot answer the question of what would happen if you went to 100% gold reserves unless you say, “at what price of gold?”

If the price of gold is “too high” the the result would be inflation. Too low (which apparently is the usual assumption) then it is deflationary. And with just the right price…just the right level of nominal income.

The impact for real growth, variance, and the like, all depends on “100%” of what, exactly. Currency? Checkable deposits? What about overnight commercial paper? What about money market mutual funds? I predict that if there were 100% gold reserves for some narrow measure of money, then that measure of money would have a relatively low demand. The other financial instruments that people would hold instead of money would generate everything that fractional reserve banking once generated.

I think the result would be moderately worse than free banking.

Dr. George Reisman has several articles at mises.org on how to the US could quickly go gold, and his book “Capitalism” has excellent chapters on it. But not all Austrians favor a gold standard. Hayek didn’t.

The boom/bust cycle issues from the high leverage inherent in fractional reserve banking. A gold standard with fractional banking will experience the same business cycles that we have experienced for the past 400 years. As far as I can tell, based on my reading of Braudel, fractional banking began long before paper money in the middles ages in Venice and it began with gold dealers.

Hayek points out that it will be impossible to get rid of fractional banking. We have had it for centuries and the debate over it is just a long. And as De Soto points out in his book on money and banking, life insurance companies, mutual funds and many other types of businesses engage in fractional banking. One of the biggest bubbles and subsequent collapses in the 18th century happened not because of fractional banking but by a proliferation of bills of exchange according to Braudel.

Free banking might help, but we had something similar to free banking in the US throughout the 19th century and still had disastrous bubbles and depressions. For an example, check out Rothbard’s book on the panic of 1819.

My suggestion as an Austrian would be to return to Alan Greenspan’s early strategy of targeting the price of gold. I don’t know why he abandoned that strategy because I thought it worked pretty well.

Meanwhile, Austrians shouldn’t cry too much about the elastic money supply. It’s a wonderful opportunity to make a lot of money by timing the market according to the Austrian business cycle theory. Don’t worry! Be happy, and make a lot of money from the ignorance of mainstream economics!

Non-Austrian.

Business cycles would be longer and deeper, and recessions more frequent. The MC of gold would fall during booms, making booms boomier. The MC of gold would rise during busts, making busts bustier.

Extra credit: the big problem for the next two years would be where to set the peg for the transition. This is not remotely trivial. The current dollar price of gold provides no guide to the general equilibrium dollar price of gold after a switch to the gold standard. If the price is wrong (as it surely would be), then there would be a large inflation or deflation. Our current financial crisis would not ameliorate in any case, because it has very little to do with the “soundness” of the currency.

An alternative to radical change (let’s face it barring complete economic collapse radical change will not happen) would be make 4 separate competing FDICs and attempt properly incentivize them (even though they would still be Fed Gov. backed) and have them act like private insurers and threaten to drop insurance on banks that take too much risk. Any bank that could not get insurance would be liquidated.

“What would the immediate adoption of the 100% gold standard (as proposed here) do to the economy over the next two years?”

Rothbard does not present a “detailed blueprint” in this paper. In particular, he leaves out the price per dollar of gold, leaving it up in the air if it would be $35/ounce, “enough to make the gold stock 100 percent of the present supply of dollars”, or somewhere in between.

$35/ounce would cause nearly every mortgage in the country would fail. It’s hard to imagine the government allowing that to happen, and it’s hard to imagine what steps would be taken to mitigate such a crisis.

For the second measure, let’s say $8 trillion, which is M2 and seems to be a relatively recent estimate of all dollars “held in the U.S. branches of all FDIC member banks” divided by 8,000 tons of “official US gold reserves” gets us over $30,000/ounce. At that price, the gold in my wedding band is worth about $5600. The tiny amount of gold in my broken cell phone is worth about $35. I can’t help but think this is going to be disruptive to the economy and have negative effects over the short term (2 years).

“Somewhere in between” would probably be the most fair way to go. Let’s say $1000/ounce, since that’s roughly equal to the current market price and so nice and round. That said, I can’t estimate the effect on the economy, because there are too many unanswered questions. If most depositors demanded full payment in gold immediately following the switch to that price, the FDIC would likely find itself bankrupt. One way they might be able to avoid massive bank defaults would be to replace bank notes with IOUs, perhaps treasury bonds, but this would be a big drain on the economy in the future while the US Government engages in massive taxation to pay off this debt. Alternatively, the FDIC could simply be allowed to default.

Whatever the path, it would be quite painful to make the switch, but ultimately it is something we’re going to be forced to do eventually anyway, if not by an explicit move to the gold standard, then via a hyperinflationary collapse of the dollar.

I’m not an economist, and I came up with this off the top of my head. I’d love to hear whether or not my analysis is accurate, and in particular I’d love to hear a more well-thought out description of the effects by someone more knowledgeable than myself.

Oh, re average value of inflation: close to zero on products of established technology.

A nice suit costs the same ounce of gold today as it did in Medieval times. Don’t see any reason for that to change on most products. New technology would continue to show rapid price depreciation, as it does now, with no untoward “deflationary” effects.

Never mind the fact that if China is able to suddenly “find” lots of gold in them thar hills, we are suddenly not so rich of a nation.

Well, I’m glad you asked. Currently the reserve of extracted gold is something like 150 000 tons of gold. To put things in perspective the annual production of gold is 2 500 tons, which is a 1/60 of the currents reserves.

So, are you still afraid of Chines gold-miners? Or will you rather fear that the China will accidentally the whole treasuries market?

It’s not that gold standard is good. It’s that the absence of standard is so thoroughly abused by the political class.

Going gold would certainly have a contractive effect at least at first. But how otherwise do we control the profligacy of Washington?

Austrian leaner

If going to a gold standard dampens economic cycles, I would think that the theory of the Austrian business cycle would predict lower long term unemployment on a gold standard. If the reason for cycles is misallocation of labor and capital, then eliminating these misallocations would lead to better determination of their uses.

Say Susie became a web developer in 1998 because of the boom, then struggled for work until 2004 when she became a real estate agent. Lost her job in 2007, and now looking for another new line of work. If she hadn’t been deceived by inflation cycles she could have picked a sustainable career where she could have developedd some expertise by now, but instead she’s starting over. Her human capital is much less now because of the misallocation of her faculties.

In my view, the gold standard is merely a means to an end – removing any the option of fiddling with the money supply from the toolbelt of governments. The gold standard could achieve this, as could completely free, unregulated currencies. I would also have no problem with a fiat currency that was credibly constrained to remain fixed in eternity, or grow in lockstep with population growth.

The primary benefit of Block’s proposal would be that Washington would be forced to be honest in their confiscatory policies. Most Americans think that the Obama administration is doing some fancy-shmancy financial maneuvering to “fix” the economy; they don’t see the coming decade of 15% inflation as the massive tax increase it is. The gold standard would also decrease uncertainty for investors, homebuyers etc.

Greg, free banking seems to have been the position of Mises and Hayek. It seesm that Rothbard revived gold.

Is there one economists out of 50,000 who could explain to you the institutional operation of the gold standard, or even two different types of a gold regime.

I.e. are ANY of these economists intellectually competent to comment on the gold standard?

I’d say we have here something similar to botanists or genome researchers giving us their “scientific” judgment on global warming.

(Austrian-leaning but not an economist)

It seems that one of the primary concerns driving the debate is the profligacy of the Federal Government and the resulting incentive to inflate the money supply to meet the Government’s expanded obligations. It seems that there are really only two ways to limit the expansion of the Federal Government: Constitutional and financial.

The Constitution was intended to provide a check on the scope of the Federal Government by establishing a limited number of areas in which it was granted power from the States. The interpretation of the Constitution has changed over time, however, to the point at which there seem to be few areas of government involvement that would actually be deemed unconstitutional.

With the Constitution no longer impeding the expansion of the Federal Government, limiting the ability of the government to finance its operations may be the only effective check on its size. With that in mind, I am very much in favor of some kind of limitation on the ability of the government to inflate the money supply.

I am in favor of free banking, which ideally would prevent the Government from being able to unilaterally inflate the money supply to its own benefit. At the very least I believe that the Fed should be abolished. Rather than mandating a specific reserve, whether 100% gold or otherwise, the banks should be free to maintain the level and type of reserves that their customers will tolerate. I think that the transition to such a system (if possible at all without a collapse making it a necessity) might be painful in the short run, but will lead to greater stability in inflation and employment. The overall growth in output may not be affected in the aggregate as much as it might be smoothed through decreased volatility.

It would be no problem going over to a multi-commodity standard just so long as no fractional reserve were tolerated anywhere. This would be a costless exercise. In fact it would shore up the situation by keeping our extraction industries ahead of the game.

Our Austrians at Mises.org grossly understate their case on this matter. There are only two industries that need to stay ahead of the game to avoid a general civilisational collapse. And thats the food industry and the energy/extraction industries taken as a whole.

The medical industry could disappear tomorrow and that would be tragic for many individuals. But if the energy, extraction, or food industries were to tank we would run the risk of a energy-capital-vortex developing. Where we don’t have the energy to get the capital and the capital to get the energy and so forth.

The difference in my view, is not to try to go to gold all at once. In transition we want to nuance matters so we have maybe half a dozen fully backed moneys… and fully anticipating that perhaps in 100 years or 200 years gold may have taken over entirely.

But actually so long as we can be assured that even the smell of fractional reserve is not present, then it ought to be the case that four or more monies ought to be able to keep off the ground. It would be fortunate if we had a stored commodity that was digitized that represented an explicitly energy-based commodity. Like liquified-coal or something of that nature.

But the thing is we will lose all hope for anything to compete with gold and silver so long as even the smell of fractional reserve is with us. We can have a digitized money that doesn’t have all the portability of pre-information-age-money and it still could be feasible. But this is an idle speculation unless there is absolute zero-tolerance against fractional-reserve.

We can learn from a 1000 years of banking you know. We ought to be able to learn from this history and retain the knowledge. We can learn that fractional reserve must always mean bank/government collusion and there is no getting around that.

There is absolutely no need for massive deflation if you start off going after half a dozen FULLY-BACKED commodity monies in the phase-out.

You see the first thing is you have to be phasing out fractional-reserve even before you are phasing out fiat money. But by the time you are at a 50% reserve asset ratio for the compulsion-cash you can start transitioning over to these various commodity monies.

Ironically the first step to phasing out the fiat-cash is to print more of it because your first step is to reduce the ponzi-money. As the reserve asset ratio for the fiat-cash starts inching above 50% the other monies will be able to compete.

The thing is it costs a lot of RESOURCES (it costs a lot of money) to keep this paper-money going. The fundamental costs for paper money are much higher then they are for coins.

Well those charges ought to be passed on to the consumer. And if there is no efficient way to do this then all you need to do is make interest earnings on 100%-backed commodity money or even on hybrid loans non-taxable.

Then you have a push-factor for the paper-money to be phased out. And once fractional reserve is halfway to being phased out then it will be the case that these other monies can start getting some traction.

I recommend a straight tax advantage for commodity money as a stress-free way to see it edging out the compulsion cash.

But there is not way to do it seamlessly without first charting the course to edging out the ponzi-money.

Non-austrian.
A gold standard is deflationary so we would have an asset that would return a real interest rate with no investment necessary and an especially high rate during recessions. There would be periods of growth with the introduction of new technologies, optimism, and credit, interspersed by lengthy recessions during which gold would be hoarded. Growth would be lower overall as it was in the 19th century and more sporadic as only investments with a higher rate of return than gold would be profitable. Inflation would be negative its variance would increase over recent history as the economy switched from growth to recession. Growth would slow and variability increase. Employment would suffer from this increased volatility and the minimum wage would be a disaster since wages would have to fall with prices over the long term. Wars would become extremely expensive and without devaluation after them would be inevitably followed by depressions to reset the price level, at least until it was abandoned as it would be.

Restoring sound money – from a paper currency, or even from a paper-inflated gold standard – is a lot like landing an airliner in a river. If you see it done wrong once, it looks like a recipe for disaster. But it only has to be done right once, too.

Rothbard’s landing plan, for example, is a bad one. It sets the gold/paper exchange rate way too low. Instant bust-up. The same can be said of the gold-exchange standard attempted after WWI. The correct answer, which would have averted the first Great Depression, was a level of devaluation against gold which struck the gutless parliaments of the ’20s as politically unacceptable. The pound had always been inflated with paper, but this time the goose was overstuffed.

Your goal in the transition is to set the gold/paper ratio so that it minimizes the disruption to your present economy, which, while basically fscked after a century of subsidized credit, is at least somewhat functional. In other words: activity which is economically rational before the transition should remain rational after it. Economies do not heal instantaneously.

(Also, there is basically no way to solve the problem without making present holders of gold very, very rich – although this can be attacked via one-time taxes, ie, confiscation. Otherwise, they are simply doing well by being right. What could be more American?)

Your goals are to (a) replace all paper money and paper-denominated financial instruments with allocated gold; (b) leave everyone with the same relative purchasing power as before the transition; (c) terminate in a stable system, which does not use accounting tricks to expand the amount of apparently available present gold (ie, MT/FRB).

There are many ways to do this, but here is one. Nationalize the entire dollar financial system, converting market-traded assets to dollars at current market price. Add as many dollars are needed to render USG itself solvent, considering all liabilities and entitlements. Convert these dollars into notes against your gold reserve. The gold/paper ratio (“gold price”) is then a matter of division.

This yields a gold/paper ratio much higher than the present market figure, of course. Thus any proactive conversion requires decisive, effective action on the part of USG – for this reason, among others. I believe this is the main obstacle to any return to sound money – not any matter of economic principle.

Besides, frankly – the very question is impertinent. It’s the professional paperhangers who need to explain why we should construct another house of cards to replace the one that just collapsed.

Precious metals were the basis of human monetary systems throughout Greek, Roman, and European history. Paper money was universally regarded as the department of the monetary crank. And indeed, it is the patent-medicine econasters of the 20th century who, were there any justice at all, would be prostrating themselves and whining for mercy before the jury of the past. I’d like to see Professor Caplan explain to, say, George Bancroft, why the printing press is an essential feature of modern civilization.

Mencius,

Bancroft starts off by saying that “[g]ood money must have an intrinsic value.” I’m sorry, but nothing has any intrinsic value, gold included. If you accept his initial argument then there is no such thing as good money.

“Austrian Challenge: What Would the Macroeconomy on the 100% Gold Standard Look Like?”

Its almost the wrong way of looking at it right there. LIFE IS BETA. Thats the way to look at it. A free market 100% backed monetary system will always be in transition if its done right. To understand the whole thing one needs to think of the money supply industry, as always evolving and being in transition like any other industry.

But the main thing is to get rid of fractional reserve for all time and then let the evolution of the money-supply-industry begin.

There would be price deflation, which is what most people consider deflation, since the amount of goods increases while the amount of gold does not (almost), but growth would likely decline to the level of gold increase, stabilizing prices and leaving gold with no real return.

Fr. re writes:

> in my opinion a 100% gold standard system is
> unsustainable without a strong, quasi-
> authoritarian, government to enforce it. The
> problem is that gold standard is probably not
> an evolutionary stable strategy ; banks and
> customers will always be better by agreeing
> on some other non-100% system.

I think that the government would still have to decide what it would accept in payment of taxes. If the government specified that taxes had to be paid in gold — or always and promptly swapped any notes for gold — would you still hold the same opinion? (This is not a rhetorical question.)

Chris

I think this is the wrong question to ask, because it assumes that government would continue to hold a monopoly on money creation.

Free banking should be the objective. For all I care the government could continue to print toilet paper if they would give ME the opportunity to opt out. Unfortunately, if I am smart and keep my “money” commodity backed instruments, I am ultimately taxed on its appreciation relative to the toilet paper they pass off as federal reserve notes.

Remove the tax implications of holding commodity money and the Fed would eventually disappear on its own. But of course, so would the influence and power of the federal government, so we know that it is fantasy to think it could happen.

What disappoints me most is that there are “economists” who still believe the central governments should hold a monopoly on money creation. They should be ashamed of themselves. It is immoral, coercive, and economically destructive.

Jeff
“Yet it appears that many of the people commenting on this post and others like it actually think they know better than Friedman did. Unbelievable.”

…yes Jeff, human beings are possessed of individual brains. That’s why arguments from authority only sway those that can’t think for themselves.

I’ve read most of what Friedman wrote on the subject and was not convinced, despite admiring the man and agreeing with him on many things.

In fact he changed his mind on the subject in his late years…

“Yet it appears that many of the people commenting on this post and others like it actually think they know better than Friedman did. Unbelievable.”

Friedman was a great freedom fighter but he’s not the ultimate authority on money. And you have to learn to think for yourself.

Friedman also was subject to the incredible pro-fractional reserve religious impulse. Not necessarily in himself but he would have been subject to the astonishing peer pressure in this regard. And he had at first advocated 100% backing then backed away from that. Perhaps if he hadn’t of backed away from it he may have been sent into obscurity. So strong is the tendency towards macromancy.

Mark B.: “US banks in the 19th century did not maintain a 100% reserve ratio, and that is one of the reasons why they were susceptible to periodic financial crises.”

I was responding to Eli’s statement that under a gold standard depressions would be deeper and longer than under fiat money. Yes, it was fractional reserves and paper money that caused the depressions of the 19th century.

Jeff: “Yet it appears that many of the people commenting on this post and others like it actually think they know better than Friedman did. Unbelievable.”

As Mises and Hayek pointed out, Friedman’s monetary theory was simplistic. Friedman wasn’t the only intelligent person who ever lived and wrote about economics. Many other people were better economists than Friedman, such as Mises and Hayek, as great as Friedman was. Friedman had lashed himself to Keynes and could not escape the consequences.

Joe (immediately above) is absolutely right. The essential insight of Burkean conservatism is that institutions evolved to their current state for good reasons. Proposing fundamental changes to something as essential to civilization as the monetary system without an appreciation of what’s right with the current system is both radical and stupid.

(Austrian leaning)

Why not just abolish the FDIC?

Isn’t that the real problem? People would reign in the banks a lot quicker that way, like they used to.

“Under a 100% fractional reserve system, what would prevent banks/bankers from extending credit to increase their margins?”

Fines and jail and the loss of all their equity? How does that sound? If its illegal and you break the law you get fined or jailed. What is so hard to conceive about that.

The creation of bank-cash-pyramided money requires collusion between two or more banks in most cases. So if one bank doesn’t want to go under for breaking the law he won’t be an enabler of another bank that wants to flout the law and sell or loan non-existent assets. Which is always fraud.

On another note the key advantage to 100% commodity banking is finally we will have stability of spending. Stability of the volume of spending. Stable growth not just as a national aggregate, but regionally as well.

The advantages are really about correcting all the deficiencies of fractional fiat. Which causes gyrations in spending all over the shop. Since when the new bank-ponzi-money is created it starts changing hands and starts the process of erratic spending patterns.

Fractional fiat has many costs associated with it. But one big one is that it amounts to a full frontal attack on the price-and-spending-volume system for the allocation of resources when it comes to business spending. It throws a wrench in our price(and spending volume) system.

Some people seem to think that their ideals change the nature of reality in the strangest ways. Your anarchism doesn’t change the nature of monetary-economics. Being for anarchism and then claiming that 100% backing is utopian is pretty bizare right there. But in fact fractional reserve would destabilize any functioning anarchic system and can pass no market test.

Under any functioning anarchism you need profit-making enforcement agencies. To make a profit they would need to avoid enforcing contracts that are expensive to enforce or that cannot be enforced. A fractional reserve contract is such a contract. The most important fellow in the enforcement-agency would be the fellow who helped any two parties alter a contract so that it would be cheap to enforce. Since the way to be profitable is to basically just take your fee and not have to use up valuable resources enforcing dud contracts. Once ponzi-money is out in the system it no longer becomes possible to decide who owns what.

Sooner or later a market anarchy system would have to learn that it must not tolerate fractional reserve. Even if the lesson was painful and took them a 1000 years to learn. But we have a 1000 years record of banking to draw from and we ought to have learned that lesson by now.

Your transition strategy is moronic since it runs the risk of a monetary collapse, followed by a collapse in the velocity of circulation, which could destroy the economy with it, and discredit commodity money for a century to come.

Ideals do not overcome technical facts as some sort of utopian crazies imagine. I’m a pessimistic anarchist and a hopeful minarchist but I’d have to say that I get a bunch more pessimistic when I see people blithely dismissing the realities of monetary-economics in this way. All anarchists must come to grips with the reality that if they are serious, then an anarchistic society would have to take a zero tolerance approach towards fractional reserve.

Alwasy nice to see libertardians throwing out freedom of contract when it becomes uncomfortable.

Fractional reserve contracts cannot be enforced. And freedom of contract is only to do with your own property. Not with scamming people by lending or trading items that you are not in lawful possession of. Bank cash pyramiding is a case of straight fraud.