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The Gold Standard, Part 4

February 5, 2011July 19, 2017 Joseph Dewey

This entry is part 30 of 50 in the series 2011A

Einstein’s Greatest Error

“But,” says the gold standard advocate, “you can’t have indefinite expansion. After any period of inflation, expansion and prosperity we have to pay the piper and a period of contraction must take hold. This is the big advantage of the gold standard. Even though, it is painful it causes necessary cycles of contraction.”

But why should a period of contraction even be necessary? Does such an idea correspond to nature? Well, let us look at our universe. It has not only been constantly expanding since its creation over 14 billion years ago, but at the present time the rate of expansion is increasing! Some scientists predicted an expanding universe, but not one expected to find that it is increasing its speed of expansion.

Einstein’s original calculations predicted an expanding universe but this idea went against his belief system so he altered his equations to get the answer he wanted. Later when Edwin Hubble’s observations proved the universe was indeed expanding Einstein admitted that his rejection of an expanding universe was the biggest mistake of his life.

And what caused Einstein’s greatest error?

It was not his logic for his original math and reason told him the universe would be expanding. The cause of his error was his belief system got in the way and prevented him from looking at the math without filters.

Are economists making the same mistake? Many of them are telling us that we can only expand for so long and then we must have a depression or recession. Is their belief that all good things must end interfering with the wonderful truth that we can increase and economically expand indefinitely just as the universe itself is doing?

“But how can the economy expand indefinitely? If we overspend then a correction has to come,” says the skeptic.

The problem is that solid economic expansion does not involve wild overspending as many seem to think. What is overlooked is there are two types of economic expansion. Let us illustrate.

Example One: The Smith Family has been working hard and has been struggling to make ends meet. They’ve wanted to get a new car as well as vacation in Europe but the money to do so never seems to show up. Finally, they decided they deserved some of the better things in life and took out a substantial loan against the equity in their house. This loan was like a windfall and they began spending liberally.

In the eyes of their friends it appeared that the Smiths were experiencing an economic boom.

Then the time came the money ran out and the Smith’s expenditures were more than their income. Instead of taking belt-tightening measures they decided they didn’t want to give up their new lifestyle and borrowed to the max on every credit card they had.

For the next two years their friends thought the Smiths were having a continuing economic boom.

Finally the day of reckoning came and the Smith’s couldn’t borrow enough to pay their bills. At that time their economic world collapsed and they lost everything.

Yes, the Smith’s had to pay the piper for their apparent economic boom, but do all expansions have to end this way?

No.

Example Two:

The Jones family started out in the same situation. They also wanted some of the nicer things in life. They realized they could take out an extra mortgage on their home but decided against it because if this was all they did they would have difficulty in paying it back. They also didn’t like the idea of their hard earned money going into interest payments that merely financed luxuries.

Mr. Jones tells the family, “If we want some luxuries and do not want to suffer the burden of loans we cannot pay back then the only solution is to increase our income. Any suggestions?”

Mrs. Jones spoke up. “I have one. I will go back to work and this will give us the money we need to pay back the loan we are going to take out.”

“But we didn’t want to take out a loan for luxuries,” he said.

“I’m not talking about a loan for luxuries, but for seed money to start that internet business you’ve been thinking of for years. The money from my job can pay back the loan so even if your business fails miserably we will be no worse off financially than we are now. On the other hand, if you succeed then we can not only pay back the loan but we can buy a lot of things we have dreamed of for years.”

The family thought this was a good idea and moved forward with the plan. After two years the business proved a success, they paid back the loan and both Mr. and Mrs. Jones quit their day jobs to work their new business full time.

“Shall we buy some of those luxuries now?” asked Mrs. Smith.

“We could,” said her husband but I have some new ideas for the business that could pay off big time. If we take our extra money and invest in expansion there is a good chance that in a couple more years that we can buy any luxury we want.”

Mrs. Jones was reluctant but agreed and the family continued focusing on expanding and two years later the business and money supply grew just as anticipated.

At that time the Jones took some of their extra money and bought a few things they had wanted over the years. But most important they learned the rules of true expansion and only put money at risk that they could afford to lose.

They continued to apply these lessons and expanded their business, income and savings until they retired. Then they turned their business over to their kids who continued to apply the same common sense approach and the business continued to expand.

Now some may wonder why I am giving simplistic stories illustrating the obvious.

First, I might note that the truth behind these stories must be far from obvious.

Why?

Because our best and brightest that we hire (elect) and send to Congress seem oblivious to the common sense of the Jones family and, instead, act like the inept Smiths.

Secondly, many who are considered the best and brightest in the economic world believe we are eternally doomed to the fate of the Smith family. They tell us that any continued expansion of the money supply is like borrowing money on a credit card and must be followed by either collapse or deflation.

They overlook the fact that there are two ways to increase the money supply.

The first is to copy the Smiths and borrow the money with no sensible way to pay it back. Unfortunately this insane path is supported by the most intelligent people we can manage to vote into office.

Overlooked is the fact that there is a second way. If we increase our money supply using common sense principles, as did the Jones, then the economy never needs to contract but the money supply and economic growth can continue indefinitely just as happened in the story of the Jones and illustrated in the expansion of the universe itself.

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The Gold Standard, Part 3

February 4, 2011July 19, 2017 Joseph Dewey

This entry is part 29 of 50 in the series 2011A

The Problem of Deflation

There are a number of arguments made for returning to a gold standard. One of them is that the economy will be more stable. Unfortunately, as we have just illustrated, this has not been historically the case.

It is true that one can find other reasons than problems with gold and silver for many of the crises during the metallic years, but one can do the same thing concerning fiat money since 1933 or 1972 when we were taken off the gold standard.

The fact is that we have had monetary problems with or without the gold/silver standard including the Great Depression during the standard and the Great Recession starting 2008 without it. It is a sad fact that there is a factor involved much more dangerous than what is the basis for our money and that is the human frailties of those who control or have access to the nation’s wealth. We not only need a sound money system but something needs put in place that will limit the damage our fearless leaders can do to it.

So, two things need to be in place if we are to have a consistently good economy. First a sound money system and secondly sound management over the money.

That said; let us continue examining the pros and cons of possible foundations of our money supply, the first half of any monetary solution.

Those who support the gold standard make a number of additional arguments in its favor. Right up there with the belief that it makes for a more stable economy is that it puts overspending in check and thus limits inflation.

Now it is true that if we had a pure gold standard (which we have never had) where each dollar spent was backed up 100% with gold and fully redeemable in gold then deficit spending would be very difficult but not impossible. They would most likely create some I.O.U. or promissory note system that would evolve into fiat money like we have today. Then as soon as there was a major crisis what’s left of the gold standard would be thrown out the window as it has been so many times in the past.

Before we had the graduated income tax the gold standard helped to reign in spending but now that it is in place our leaders have the power of unlimited taxation. If a gold standard limited the government’s ability to create inflationary dollars then they would just seek to tax us more and after they drained the last possible dollar from all taxpayers, rich and poor, they would find a way to negate the discipline of the gold standard so they could borrow and spend even more.

All governments are like addicts. They are addicted to spending and will do anything to get their fix. This tells us that a logical money system only supplies us with part of the solution. The other part has to come from the citizens. They must control their employees – our government representatives. This means that any monetary system by itself is not a magic bullet. Even so, the basis of money is the foundation of our economy and all possible solutions must be examined.

We must create the best possible foundation for money and the people must make sure the contractors creating the rest of the building remain honest and do the job we hired them to accomplish.

While it is true that the economies of the nations of the world have had their problems on and off the gold standard it is true that historically a gold or gold-silver standard does hold inflation in check better than pure fiat money. Some gold standard advocates go so far as to insist that and ounce of gold has always been worth the same amount over the centuries – which is an ounce of gold.

This is not logical thinking and is like saying an ounce of silver is worth the same now as it always has been just because it’s an ounce of silver, or a gallon of oil equals a gallon of oil. If gold and silver are always worth the same amount then their ratio of value should be fairly stable. Since there is 17.5 times more silver in the earth’s crust than gold in 1792 the Congress originally set the ratio value at 15:1, very close to the natural ratio. This ratio was problematic so they raised it to 16:1 in 1834. Since going off the artificial bimetallic standard the ratio has fluctuated from about 12:1 to 100:1.

Some of the fluctuations have occurred over a fairly short period of time. For instance, in 1980 the ratio was 17:1 and then in 1991 jut leaped to 100:1. Around the 2008 meltdown it was 80:1 and by 2011 it hovered around 50:1.

So, if a metallic money is always has the same intrinsic value then why the huge fluctuations in ratio? There’s no reason to believe that an ounce of gold always has the same value any more than an ounce of silver.

The fact is that even though gold and silver have held a high basic value over the centuries their value has fluctuated quite a lot. Whereas the fluctuation of fiat money is almost always toward inflation the precious metals go both ways. Sometimes their value is inflated and other times they suffer deflation. This is proclaimed to be a good thing, but is it?

A drastically overlooked fact by gold standard advocates is that, while too much inflation is admittedly a problem, any equal amount of deflation is much worse.

Let us take the deflation and inflation of the housing market before and after 2008. Before the housing meltdown it often took only a year or two for a home to increase in value 20%. Was there a big crises when this happened? No. Were homeowners complaining? Not really. Instead, they were bragging about their increased assets.

Was there a problem for anyone? There was some problem for buyers but because the interest rate was low, and they felt their purchase was a good investment, few were complaining.

Then as we approached the meltdown of 2008 home prices began to fall. Depending on the area of the country it did not take long before a corresponding 20% drop in prices was witnessed.

Was the problem of a 20% deflation equal in severity to a 20% inflation?

Not by a long shot.

Whereas most people saw the last 20% inflation as a minor annoyance the deflation of our real estate has caused untold grief and stimulated an economic collapse that has diminished all areas of our financial lives.

The same goes for inflation and deflation of money in general. A measured inflation decreases the purchasing power of our money, but because wages also go up most people deal with it as a minor inconvenience.

On the other hand, even a small amount of deflation can spell disaster for people in a number of ways not seen with normal inflation. Here are some.

(1) Those with high mortgages will see the amount they owe become more than the value of their house. This gives them incentive to not pay the loan and let the property go to foreclosure.

(2) Overall deflation is particularly hard on those who are in debt of any kind and have to use loans to finance their business. Agriculture always suffers with deflation. The price of commodities sinks whereas debt rises.

(3) In times of deflation money supply is tight, financing is difficult, investment is down, unemployment is high and overall life is miserable for those affected.

The most famous period of extended deflation was The Great Depression. Between 1929-1933 the money supply decreased by about 33% followed by the money income falling by a whopping 53%. In addition the velocity of money fell by about a third – this is the number of times existing money changes hands.

The wholesale price index decreased by 32%, the consumer price index dropped 23% and farmers received 52% less for their products. In addition, the value of global imports and exports decreased by almost 60%.

Then to top it all off unemployment went from 3.2% in 1929 to 25.2% in 1933.

You get the picture. The greatest contraction corresponded to the greatest depression.

Data taken from:
Monetary Central Planning and the State, Part 11: The Great Depression and the Crisis of Government Intervention by Richard M. Ebeling, November 1997. online book at:http://www.fff.org/freedom/1197b.asp

A Monetary History of the United States, 1867-1960; Milton Friedman & Anna Jacobson Schwartz, Pages 301-302

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