February 21, 2011

This entry is part 40 of 50 in the series 2011A

One of the main reasons gold standard advocates want us to return to gold as a backing for money is its stability. Gold has always been a stable valuable metal, they say. Some go so far as to claim that gold has always kept its same value over the ages. For instance, some claim an ounce of gold bought a new suit of clothes in the days of the Roman Empire, in the 1920s and even today.

Overlooked by them is the variables in the cost of clothes. As of this writing one can buy a high end suit for the price of an ounce of gold (around $1350) but a consumer can get a nice suit at the Men’s Warehouse for around $200 and less than that in some discount stores. This means you can get seven suits today for what it cost a Roman to buy one.

On the other hand, a decent suit cost $30 or more in the 1920s, which was equal to one and a half ounces of gold, valued at $20.67 and ounce.¹

So instead of gold maintaining the same purchasing power for a suit of clothes over the centuries, in relation to this one item, it lost 50% of its it’s value by 1920 but gained by almost 700% by 2011.

Just as gold varies in value compared to a man’s suit of clothes even so did we illustrate great fluctuations in relations to the other monetary mental – silver.

How about other items? Would the value of gold fluctuate over the decades and centuries compared with wheat, beef, land, diamonds, seasonings and other items?

Yes it would and in many cases the variation of value is quite profound.

But what if we don’t single out the value of one commodity in relation to gold but take an average as is done with the wholesale or consumer price index?

We have illustrated the fact that deflation of value can occur during a depression, but how about inflation? Can this occur while relying on a gold standard?

It is common knowledge that pumping too much money into the financial system will cause inflation. Has this happened in the past when large amounts of gold was added to the supply?

Adam Smith points out that the value of gold is not always stable using Spain as an example.

“Gold and silver, however, like every other commodity, vary in their value, are sometimes cheaper and sometimes dearer, sometimes of easier and sometimes of more difficult purchase. The quantity of labor which any particular quantity of them can purchase or command, or the quantity of other goods which it will exchange for, depends always upon the fertility or barrenness of the mines which happen to be known about the time when such exchanges are made. The discovery of the abundant mines of America reduced, in the sixteenth century, the value of gold and silver in Europe to about a third of what it had been before. As it cost less labor to bring those metals from the mine to the market, so when they were brought thither they could purchase or command less labor; and this revolution in their value, though perhaps the greatest, is by no means the only one of which history gives some account. But as a measure of quantity, such as the natural foot, fathom, or handful, which is continually varying in its own quantity, can never be an accurate measure of the quantity of other things; so a commodity which is itself continually varying in its own value can never be an accurate measure of the value of other commodities.”²

Spain thought it had hit a huge bonanza when it began to rob the New World of its gold and silver. It plundered 1,230 tons of gold and 60,440 tons of silver from 1493 to 1690 but all that inflow of precious metal not only led to high inflation but to its undoing as a world power.³

A major problem was that their attention and labor was directed toward plundering as much gold and silver as possible instead of manufacturing at home. Why produce anything when they could just buy it from other nations with all that gold and silver?

Consequently their true base of power and wealth – productive labor – declined and they fell off the stage as a world power.

The period of the California gold rush was another famous example. Australia also had its own gold rush about the same time. From 1851 to 1861 the world’s gold supply increased 161% accompanied by inflation of around 5% per year.⁴

In the gold rush communities inflation was much worse. It cost an ounce of gold (worth $1350 in today’s money) to just hire someone to wash and iron a dozen shirts. Good food and supplies were also outrageously inflated.⁵

Not only did gold discoveries increase money supply and inflation but so did technological advances in mining and processing. These caused an increase gold supply and inflation. From 1897 to 1914 the U. S. gold supply increased 7.5% per year and prices rose about 50% during this period.

This led to a tremendous increase in our leveraged money supply. “From June 1896 to June 1914, total bank deposits rose from $3.43 billion to $14.32 billion, or an increase of 317.5 percent or an annual rise of 17.6 percent…”⁶

Variations in gold supply has influenced its value since then but the next big change in the purchasing power of gold came not from supply but by presidential decree from FDR in 1934 that instantly changed the value of gold from $20.67 an ounce to $35.

Then when Nixon took us off the gold standard in 1971 it went from the decreed value of $35 to over $500 an ounce in 1980 and then down to $288 an ounce in 1998, then up to $1350 by 2011.⁷

Conclusion: Truly it is established by history that, even though gold is one of the more stable commodities, it is susceptible to value fluxuations up and down just like everything else. Gold and silver have been used for money, not because they are the ideal, but because they are the most practical of metals

Concerning gold, even the hero of the gold standard philosophy, Ludwig von Mises, said:

“But even if the 100 per cent reserve plan were to be adopted on the basis of the unadulterated gold standard, it would not entirely remove the drawbacks inherent in every kind of government interference with banking.”⁸

“The gold standard is certainly not a perfect or ideal standard. There is no such thing as perfection in human things. But nobody is in a position to tell us how something more satisfactory could be put in place of the gold standard. The purchasing power of gold is not stable. But the very notions of stability and unchangeability of purchasing power are absurd.”⁹

Friedrich Hayek, another gold standard hero stated:

“The gold standard, even if it were nominally adopted now (1992), would never work because people are not willing to play by the rules of the game.”¹⁰

If gold, the most practical of metals for money, is far from an ideal standard then are we doomed to be held hostage to a very fallible money system? We will consider this question and explore the alternatives.

Notes:

1. http://www.thepeoplehistory.com/20sclothes.html

2. Adam Smith; Wealth of Nations, Part 1

3. Lost Science of Money By Stephen Zarlenga; Page 102-3

4. A History of Money by Glyn Davies, 1994, Pages 481-482

5. California Gold Rush Cooking; Lisa Golden, 2001 Schroeder, page 18

6. The Case for Gold by Ron Paul and Lewis Lehrman, Pg 120

7. http://www.goldinmind.com/gold-basics/how-much-can-you-lose-by-investing-in-gold.html

8. Human Action; Fourth Revised Edition; Fox and Wilkes, 1996, , Ludwig von Mises, Page 440

9. Ibid, page 473

10. Interview with Thomas W. Hazlett from the July 1992 issue of Reason http://reason.com/archives/1992/07/01/the-road-from-serfdom/print

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Day: February 21, 2011

The Gold Standard, Part 5