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Does a gold standard involve resource costs?
Milton Friedman said yes, but on this question I am not convinced. Friedman thought the costs would be as high as 2.5 percent of gdp.
The standard argument is that a gold standard means more gold held in vaults. That's less gold for tooth fillings or jewelry.
But the gold held in vaults involves an implicit option on conversion into jewelry. What is exactly the value of that option? Yikes, I feel confused after only a few sentences of this post.
But surely the real value of that option depends on the price level and also the division of gold into monetary and non-monetary uses. I therefore suspect there is some price level path where the option value on holding gold is equal, in risk-adjusted terms, to the returns on other assets. (A Mr. Smarty Pants TroubleMaker type might here cite Truman Bewley in response.) Probably that means deflation.
The gold in the vault is then no longer barren. It is no more barren than the gold held in your bureau, which is presumably an "option on wearing it to a fine dinner party."
The Friedman argument, to me, seems pre-Black-Scholes. Here are some related skeptical arguments.
That all said, I do not favor a gold standard. For behavioral wage-and-price-stickiness reasons I think mild inflation is better than a high probability of deflation.
Posted by Tyler Cowen on June 27, 2006 at 01:49 AM in Economics | Permalink
Comments
Transferring funds/assets would be a nightmare….the security concerns, the time it takes and logistics etc….(unless the gold is held by a central/government authority). Money doesn’t require physical transfer as it has no intrinsic value.
Some developing states have threatened recently to hold reserves in Euros rather than in USD to provoke the U.S. or devalue its importance. A gold standard would reduce the political prestige of states that hold stable currencies.
How is non-jewelry gold stored today? And how does it impact the currency market if at all?
Posted by: Chairman Mao at Jun 27, 2006 2:11:11 AM
Do you think there's a chance that downward price and wage rigidity is endogenous? I.e., if we had maintained a gold standard, wouldn't downward price and wage rigidity have caused such serious problems that it might never have become so common.
Posted by: EclectEcon at Jun 27, 2006 2:16:06 AM
A gold standard doesn't require that you keep gold on hand. I believe the government can issue debt to pay off any extraordinary demands for gold.
The alleged benefits of slight inflation are more than swamped by the destructive effects of inflation and deflation.
Posted by: Alan Brown at Jun 27, 2006 2:38:34 AM
Most monetary gold is held in vaults in the London area with the Bank of England and the major gold banks, particularly the members of London Gold Fixing (www.goldfixing.com).
Posted by: Guan Yang at Jun 27, 2006 5:01:54 AM
Tyler,
"The standard argument is that a gold standard means more gold held in vaults. That's less gold for tooth fillings or jewelry.
But the gold held in vaults involves an implicit option on conversion into jewelry. What is exactly the value of that option? Yikes, I feel confused after only a few sentences of this post."
This is unnecessarily complicated.
In a free market, any resource will tend to have the same exchange value for a marginal unit in every use, allowing for temporary conversion costs which are recovered with new supply.
If I dig up my backyard looking for gold, I must expect that I will find enough gold to at least make up for my opportunity costs.
Whether my expectations are met or not, if I find at least some gold, then it will tend to be distributed into all possible uses in such a way that the exchange value of a marginal unit of gold is reduced by the same amount in every use.
Thus a new supply of gold will always increase the supply of goods that use non-monetary gold, as long as some such uses exist.
Regards, Don
Posted by: Don Lloyd at Jun 27, 2006 5:56:48 AM
I always laugh when people treat financial economics as descriptive rather than normative.
ANY policy that directs human labor away from productive activity into book-keeping, and mining given a gold standard is a form of book-keeping, is destructive. The improved stability under a gold standard *might* justify this cost, especially if it reduced book-keeping costs elsewhere in the economy, but inflation and deflation could still occur under a gold standard as a result of variation in the rate of circulation of currency and of new gold finds. Also, economic growth would have STRONG deflationary tendencies, which would impair the ability of low interest loans to be made even when they were economically productive.
Posted by: michael vassar at Jun 27, 2006 7:28:53 AM
There are several sources of demand for gold. As well as
jewelry there is industrial demand, traditional hoarding in less developed countries like India and monetary.
For a gold system to work the price of gold must be set higher
then any foreseeable market clearing price. This is one of the
problems that developed in the 1960s. At $35 the price of gold
was so low that jewelery, traditional hoarding and industrial demand
for gold became larger then the new additions to the supply of gold.
So central banks were no longer the residual source of demand with a
promise to always buy at a set price. The market clearing price was
higher then the set price the central banks bought and sold at.
If the price of gold is not well above the market clearing price the price of gold will fluctuate just like
other commodities and this
would create all kinds of economic problems in addition to the ones that we already know about.
Posted by: spencer at Jun 27, 2006 7:56:47 AM
Furthermore, there are vast reserves of gold in Chinese mines, waiting to be extracted by slave labor. I don't see why our monetary policy is better off in the hands of the Chinese government than the Fed.
Posted by: Ted at Jun 27, 2006 9:08:53 AM
[If the price of gold is not well above the market clearing price the price of gold will fluctuate just like
other commodities ]
Doesn't matter; the point of a gold standard is to stabilise the value of dollars, not of gold.
In general though, I think Tyler's option value idea is wrong. The whole point of a gold standard is that you don't have the option to sell the monetary gold (you have the option to sell any one ingot, but not the option to demonetise gold). Quick finance quiz; what's the value of a European option on a non-dividend paying stock with an exercise date of perpetuity?
Posted by: dsquared at Jun 27, 2006 9:16:59 AM
Why exactly is deflation a "bad thing?" That prices may be lower next year, does not stop me from buying three
meals a day today, or getting my car reparied today, or buying a computer when I need it, or shoes when the
holes in my soles get too big to patch with today's newspaper. My savings will have greater buying power ( so I
will not have to save as much to obtain my goals)tomorrow and on into my retirement, my investments will also since
they are the same thing. If the deflation in prices is due to increases in capitol efficiency or labor efficiency,
how is this a hurtful thing? Deflation in prices helps everyone but I suspect it helps those on the lower end of
the economic scale proportionately more than it helps those high up on the scale. Inflation is theft. It is one
of the trifecta of government extortionary tools: inflation, taxation and better weaponry than its citizens have.
Posted by: CK at Jun 27, 2006 9:29:40 AM
OTOH look at Japan's experience with deflation. And I know electronics deflation makes me reluctant to buy new stuff until I have to. "If I can wait a bit longer there'll be even better deals."
bookkeeping: yeah. Which leads to ideas of commodity basket currencies, where the "digging" at least produces more generally useful stuff. Or an energy-backed currency.
Posted by: Damien at Jun 27, 2006 9:58:06 AM
I've seen it claimed that the world economy is simply too big for gold to be a practical money anymore. Assuming gold keeps its current value while the entire world shifts back to the gold standard (which is a bad assumption, but an instructive one), there would not be enough gold for everyone to exchange for goods and services. The money supply would contract so massively that the entire world economy would be ruined.
But assuming gold went up in value to where it would have to be to make the world supply of gold equal the current world supply of money, we would wind up swapping just a paltry few atoms back and forth for most everyday transactions, which would grow inefficient in a hurry.
What can some economists tell me about these objections?
Posted by: Jason Kuznicki at Jun 27, 2006 10:51:13 AM
Jason,
"But assuming gold went up in value to where it would have to be to make the world supply of gold equal the current world supply of money, we would wind up swapping just a paltry few atoms back and forth for most everyday transactions, which would grow inefficient in a hurry."
Your paper currency claims to gold, your debit card, your credit card, your personal checks, etc., none of these will have any problem with scale. If you feel you need to keep coins, especially for vending machines, making token coins out of the cheapest metal possible, whether they are true claims on gold or not, won't be a problem either because of their relative insignificance.
Of course most gold standard supporters think that they are wedded to gold coins, but I suspect that that train has not only left the station, but that the tracks have been ripped up for scrap.
However, the transition problem is a real one, and may or may not be solvable.
Regards, Don
Posted by: Don Lloyd at Jun 27, 2006 11:24:03 AM
Whatever the implicit costs of gold standard, I believe them to be less than the costs of fiat money, i.e. high potential for systemic economic calamity, constant theft of value by the state, etc.
Also I believe wage stickiness and related issues are entirely behavioral conditioning, that is expectations. If mild, constant deflation were a fact of life, people would not expect pay increases as large, nor would they be as resistant to pay cuts.
Posted by: Noah Yetter at Jun 27, 2006 12:43:55 PM
Damien, and the problem of replacing stuff only when you have to is what exactly? At least electronics stuff has
deflated faster than you currency's buying power has been eaten away. With constant deflation, people might not
have to work as many hours to maintain the same standard of living. Satisficing behaviour is not unheard of.
Leisure hour's price would also deflate wouldn't it? So you work less live just as large as you have been and
have more hours to devote to your life as opposed to your gruntwork. Sounds like a winner to me. 2% defaltion =
40 hours less work per annum ( at least for the first annum ).
Posted by: CK at Jun 27, 2006 1:33:01 PM
I agree, Noah. In a sound economy, real wages are going up anyway, as the amount of capital deployed per worker rises. And perhaps it would be better if people only expected higher wages if they became more productive, not because time is passing.
Posted by: Alan Brown at Jun 27, 2006 1:33:48 PM
Gold jewelry adds no value to the economy. No one knows the difference between solid gold and some gold plated metal.
Posted by: Half Sigma at Jun 27, 2006 2:24:22 PM
The choice isn't between deflation and mild inflation, it's between mild deflation (except when the government itself gets obsessed about hoarding gold, as in the Great Depression) and occassional bouts of massive hyperinflation (actually very common in the 20th century when countries went off gold). Fortunately in the near term at least we have a competitive international currency market, with the euro and the dollar battling it out.
Posted by: nick at Jun 27, 2006 2:31:11 PM
"Gold jewelry adds no value to the economy. No one knows the difference between solid gold and some gold plated metal."
But the wearer knows the difference, and presumably that's where it matters.
"Your paper currency claims to gold, your debit card, your credit card, your personal checks, etc., none of these will have any problem with scale. If you feel you need to keep coins, especially for vending machines, making token coins out of the cheapest metal possible, whether they are true claims on gold or not, won't be a problem either because of their relative insignificance."
But what about the objection that the world economy has grown too large for gold? There's only so much of the stuff around to begin with, and we'll need more money than that, the argument goes.
Also, what if everyone "claims" the gold that their debit cards at once? And what if the banks don't have enough to go around?
Posted by: Jason Kuznicki at Jun 27, 2006 2:33:59 PM
Half Sigma,
Gold jewelry adds no value to the economy. No one knows the difference between solid gold and some gold plated metal.
That's funny. Monetary gold, like every other exchange-valued good, has no quantity-derived benefit for society, but just helps determine who gets what proportion of future consumption goods.
Regards, Don
Posted by: Don Lloyd at Jun 27, 2006 2:34:03 PM
I've written a long comment on my weblog at the address below. I don't think the option value idea will work.
http://www.rasmusen.org/x/2006/06/27/government-gold-reserves-and-the-gold-standard/#more-1223
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Posted by: linda at Oct 9, 2006 7:50:27 AM
Non-monetary inflation can be stopped.
"People today use the term `inflation' to refer to the phenomenon that is an inevitable consequence of inflation, that is the tendency of all prices and wage rates to rise." Ludwig von Mises - "Inflation: An Unworkable Fiscal Policy".
All prices do not rise. Only the prices of variable real value non-monetary items while many constant real value non-monetary items are not fully updated and many are not updated at all.
The second inevitable consequence of inflation is the tendency of many constant real value non-monetary items NOT to rise at all - during the Historical Cost era while some constant real value non-monetary items are not fully updated.
Inflation today has and always had a second consequence during the 700 year old Historical Cost era.
Inflation has a monetary consequence, called cash inflation refered to above by Ludwig von Mises and defined as the economic process that results in the destruction of real economic value in depreciating money and depreciating monetary values over time as indicated by the change in the Consumer Price Index.
Inflation´s second consequence is a non-monetary consequence defined as Historical Cost Accounting inflation which is always and everywhere the destruction of real economic value in constant real value non-monetary items not fully or never updated (increased) over time due to the use of the Historical Cost Accounting model or any other accounting model which does not allow the continuous updating (increasing) in constant real value non-monetary items in an economy subject to cash inflation.
Inflation´s second consequence is solely caused by the global stable measuring unit assumption.
The stable measuring unit assumption means that we regard the annual destruction of a portion of the real value of our monetary unit by cash inflation in low inflation economies as of not sufficient importance to update the real values of constant real value non-monetary items in our financial statements.
This results in the destruction of at least $31bn in the real value of Dow companies´ Retained Income balances each and every year. Globally this value probably reaches in excess of $200bn per annum for the real value thus destroyed in all companies´ Retained Income balances.
The International Accounting Standards Board recognizes two economic items:
1) Monetary items: money held and "items to be received or paid in money" – in terms of the IASB definition.
2) Non-monetary items: All items that are not monetary items.
Non-monetary items include variable real value non-monetary items valued, for example, at fair value, market value, present value, net realizable value or recoverable value.
Historical Cost items valued at cost in terms of the stable measuring unit assumption are also included in non-monetary items. This makes these HC items, unfortunately, equal to monetary items in the case of companies´ Retained Income balances and the issued share capital values of companies without well located and well maintained land and/or buildings or without other variable real value non-monetary items able to be revalued at least equal to the original real value of each contribution of issued share capital.
The stable measuring unit assumption thus allows the IASB and the Financial Accounting Standards Board to conveniently side-step the split between variable and constant real value non-monetary items. This is a very costly mistake in low cash inflation economies - or 99.9% of the world economy.
Retained Income is a constant real value non-monetary item, but, it has been in the past and is, for now, valued at Historical Cost which makes it, very logically, subject to the destruction of its real value by cash inflation in low inflation economies - just like in cash.
It is an undeniable fact that the functional currency's internal real value is constantly being destroyed by cash inflation in the case of low inflation economies, but this is considered as of not sufficient importance to adjust the real values of constant real value non-monetary items in the financial statements – the universal stable measuring unit assumption which is the cornerstone of the Historical Cost Accounting model.
The combination of the implementation of the stable measuring unit assumption and low inflation is thus indirectly responsible for the destruction of the real value of Retained Income equal to the annual average value of Retained Income times the average annual rate of inflation. This value is easy to calculate in the case of each and very company in the world with Retained Income for any given period.
Everybody agrees that the destruction of the internal real value of the monetary unit of account is a very important matter and that cash inflation thus destroys the real value of all variable real value non-monetary items when they are not valued at fair value, market value, present value, net realizable value or recoverable value.
But, everybody suddenly agrees, in the same breath, that for the purpose of valuing Retained Income – a constant real value non-monetary item – the change in the real value of money is regarded as of not sufficient importance to update the real value of Retained Income in the financial statements. Everybody suddenly then agrees to destroy hundreds of billions of Dollars in real value in all companies´ Retained Income balances all around the world.
Yes, inflation is very important! All central banks and thousands of economists and commentators spend huge amounts of time on the matter. Thousands of books are available on the matter. Financial newspapers and economics journals devote thousands of columns to the discussion of the fight against inflation.
But, when it comes to constant real value non-monetary items:
No sir, inflation is not important! We happily destroy hundreds of billions of Dollars in Retained Income real value year after year after year.
However, when you are operating in an economy with hyperinflation, then we all agree that, yes sir, you have to update everything in terms of International Accounting Standard IAS 29 Financial Reporting in Hyperinflationary Economies: Variable and constant real value non-monetary items.
But ONLY as long as your annual inflation rate has been 26% for three years in a row adding up to 100% - the rate required for the implementation of IAS 29. Once you are not in hyperinflation anymore (for example, Turkey from 2005 onwards), then, with an annual inflation rate anywhere from 2% to 20% for as many years as you want, you are prohibited from updating constant real value non-monetary items. Then you are forced by the FASB´s US GAAP and the IASB´s International Accounting Standards and International Financial Reporting Standards to destroy their value again – at 2% to 20% per annum - as applicable!
For example:
Shareholder value permanently destroyed by the implementation of the Historical Cost Accounting model in Exxon Mobil’s accounting of their Retained Income during 2005 exceeded $4.7bn for the first time. This compares to the $4.5bn shareholder real value permanently destroyed in 2004 in this manner. (Dec 2005 values).
The application by BP, the global energy and petrochemical company, of the stable measuring unit assumption in the accounting of their Retained Income resulted in the destruction of at least $1.3bn of shareholder value during 2005. (Dec 2005 values).
Royal Dutch Shell Plc, a global group of energy and petrochemical companies, permanently destroyed $2.974 billion of shareholder value during 2005 as a result of their implementation of the stable measuring unit assumption in the valuation of their Retained Income. (Dec 2005 values).
Revoking the stable measuring unit assumption is actually allowed this very moment by IAS 29 but ONLY for companies in hyperinflationary economies. At 26% per annum for three years in a row, yes! At any lower rate, no!
It is prohibited by US GAAP and IASB International Standards for companies that are operating in a low inflation economy.
That means the following at this very moment in time: Today all companies in, most probably, only Zimbabwe (1000% inflation) are allowed to update all their variable real value non-monetary items as well as all their constant real value non-monetary items.
But not the rest of the world.
The rest of the world is forced by current US GAAP and IASB International Standards to destroy their/our Retained Income balances each and every year at the rate of inflation because of the implementation of the stable measuring unit assumption whereby we are all forced to regard the change in the value of the unit of account - our low inflation currencies - as of not sufficient importance to update the real values of constant real value non-monetary items in our financial statements.
We are forced to destroy them year after year at the rate of inflation till they will reach zero real value as in the case of Retained Income and the issued share capital values of all companies with no well located and well maintained land and/or buildings at least equal to the original real value of each contribution of issued share capital.
The 30 Dow companies destroy at least $31bn annually in the real value of their Retained Income balances as a result of the implementation of the stable measuring unit assumption. Every single year.
Retained Income can be paid out to shareholders as dividens. Poor Dow company shareholders. They will never see that $31bn of dividens destroyed each and every year.
We have all been doing this for the last 700 years: from around the year 1300 when the double entry accounting model was perfected in Venice.
When we do this at the rate of 2% inflation ("price stability" as per the European Central Bank and as per Mr Trichet, the president of the ECB) we are forced to destroy 51% of the real value of the Retained Income balances in all companies operating in the European Monetary Union over the next 35 years - when that Retained Income remains in the companies for the 35 years - all else except cash inflation being equal.
Each and every one of those 35 years will be classified as a year of "price stability" by the ECB and Mr Trichet. Mr Trichet will not be the president of the ECB in 35 years time.
I think we will do ourselves a great favour by revoking the stable measuring unit assumption as soon as possible.
FREE DOWNLOAD : You can download the book "RealValueAccounting.Com - The next step in our fundamental model of accounting." on the Social Science Research Network (SSRN) at http://ssrn.com/abstract=946775
--------------------
Nicolaas J Smith
http://www.realvalueaccounting.com/
Posted by: Nicolaas J Smith at Jan 10, 2007 2:11:10 AM
Posted by: at Oct 14, 2008 1:36:58 AM
