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Baiting gold bugs
In short, you don't get anything out of a gold standard that you didn't bring with you. If your government is a credible steward of the money supply, you don't need it; and if it isn't, it won't be able to stay on it long anyway. (See Argentina's dollar peg). Meanwhile, the limitations on the government's ability to respond to fiscal crises, the necessity of defending against speculative attacks in times of crises, and the possibility of independent changes in the relative price of gold, make your economy more unstable. It's a terrible idea, which is why there are so few economists willing to raise their voices in support of it.
Here is more, from Megan McArdle. I'll add the related sentence "Who wants a pro-cyclical money supply?", and we don't know what the new gold/dollar par should be, which means we risk a significant deflation during the transition to a commodity standard.
In the very long run, our monetary standard might be determined by what is least susceptible to counterfeiting or alchemy/nanotechnology. I doubt if this will help gold, and monetary economics will end up as a special case of a more general theory of encryption. One day they'll solve Riemann's Hypothesis and the price level will just go poof...!
Posted by Tyler Cowen on September 5, 2007 at 07:00 PM in Economics | Permalink
Comments
The gold standard is not equivalent to free competition of currencies. Few people truly want to return to a gold standard, most of those labeled as "gold bugs" actually support the freedom to base a currency on anything whatsover, especially in commodities. Thus, there is going to be limited concern for large changes in commodity-bundle currencies. As to the limitations on government's ability to manage an economy for good, this is not so clear and the prima facie case goes against this argument, especially when all the moral hazards and pernicious effects of monetary inflation are considered.
If it is a terrible idea, Megan's short post did nothing to explain why, and displays a weak understanding of what commodity currencies might look like compared with our present system.
Posted by: John Goes at Sep 5, 2007 8:40:56 PM
I've probably been reading too much Neal Stephenson, but I've been having similar thoughts about the future of money. Totally digital currency, uncontrolled by the government, backed by nothing (that is, everything), no way to fake it (except stealing someone's password/thumbprint/retina/DNA I suppose), no way to tell who has how much. But then, I know less about monetary theory than I do encryption, so probably not.
Posted by: mtc at Sep 5, 2007 9:03:01 PM
To the best of my knowledge, proving or disproving the Riemann Hypothesis wouldn't have any practical consequences for cryptography (I'm a mathematician, but not a specialist in number theory or cryptography; though if I'm wrong about this, I'd be interested to see the connection.) Also, it is important to distinguish the questions of what monetary tokens (e.g. coins, paper bills, cryptographically secured "digital cash") will be used, vs. what these tokens represent. On a gold standard, monetary tokens represent bars of gold (which, is inconveniently heavy to lug around). Fiat currency isn't backed by anything, although it is credit against one's future tax obligations. Since the purpose of money is to solve the Coincidence of Wants problem, it seems to me that that the only sensible option is to back a currency with a bit of everything that people want: this could be done using an ETF tracking an appropriately broad-based mixture of valuable commodities, stocks, etc. The fundamental problem with backing a currency with a single commodity such as gold is that the value of that commodity becomes inflated by its role as the medium of exchange. (Everyone then wants to keep a bunch of gold on hand not to make jewelry or electronics, but to keep transactions liquid.)
Posted by: Jacob Wintersmith at Sep 5, 2007 9:05:56 PM
I bet in the very long run our money will be based on a standard time unit of human labor. We'll have all the material goods we want, but our time will still be valuable.
"In our highly civilized society the scarcities I notice most often are those of attention and time." -- Tyler Cowen, Discover Your Inner Economist
Posted by: Gavin at Sep 5, 2007 9:28:53 PM
I very much appreciate what Herbert Simon once said that “money is neither a solid substance, nor a liquid, nor gas; it is simply a state of mind. More precisely, money value is a collection of states of mind of all people who use it. These states as history shows, can change is a short time from utmost confidence in a currency to utmost skepticism, and vice versa.” Holding our collective states of mind onto a commodity has a sure flavor of beating bias. Will it send our economy into a state of depressive realism?
On a different note, if the code of a certain commodity is someday broken, something like gold could be fruitful and multiply. Wouldn’t the proof of Riemann's Hypothesis be the savior not the destroyer of the price level? Now, many encryption methods already assume the Hypothesis holds, and use the zeta -function to churn out prime numbers in abundance. The trouble is if Riemann was wrong. Then the world can keep no more secrets.
Posted by: Yan Li at Sep 5, 2007 9:48:34 PM
Could someone please explain how a currency pegged to gold is a "pro-cyclical money supply?" It has been sometimes since I studies macro and I can't follow the mechanics.
Posted by: david barry at Sep 5, 2007 9:49:29 PM
David,
I believe it means that the money supply would shrink during recessions, and expand during booms. Keynesians would say this could be disastrous, Austrians would say this would be great.
In any event, no one really argues for an enforced gold standard anyway. They just argue for the denationalization of money. Most gold bugs think the market would choose gold as its currency, just as it has in the past, and that doesn't seem like its such an unreasonable prediction. I suppose only Keynesians would argue that government is needed to force people to accept an inflationary currency and prevent excessive savings (although I still have yet to see any logic in his conclusions, given that excessive saving is possible in any good, and doesn't cause serious problems).
The harder part is probably getting the government to agree to release its monopoly on money. I suspect any politician who tries will have about as much success as Ron Paul.
Tyler, or anyone else, have you looked at the Ripple project?
http://ripple.sourceforge.net/
Posted by: G at Sep 5, 2007 11:24:11 PM
I just read her article, and I must say that it does not help one's case, even when that case is solidly in the mainstream, to fight straw-men. The author seemed to equate price deflation with monetary deflation, a gold standard with America's bimetallic standard, and Ron Paul's position with that of a government-enforced gold standard.
In any event, I'm curious what most economists think about the Swiss Franc's gold backing for so many years? If I'm not mistaken it was backed by 40% gold reserves, and never had much of an issue with it, correct?
Posted by: G at Sep 5, 2007 11:35:31 PM
Baiting gold bugs is so much fun!
"The gold standard is not equivalent to free competition of currencies. Few people truly want to return to a gold standard, most of those labeled as 'gold bugs' actually support the freedom to base a currency on anything whatsover, especially in commodities."
Which would also include the freedom to base a currency on nothing. How does gold enter the picture? Why do 'gold bugs' keep talking about gold then?
I've gotten into a number of email arguments with gold bugs. They are living in the past. (The "Liberty Dollar" people are really funny. My blog has more details.)
Posted by: Sameer Parekh at Sep 6, 2007 12:33:12 AM
Sameer Parekh,
Most gold bugs think that gold would once again be selected by the market as a currency. They often cite Mises's theory on the origins of money arising as a good of some value in the marketplace. While I agree with this, I also think money could arise out of any good of value, even ones valued because of government fiat.
In any event, I don't think their prediction of gold once again arising as the preferred currency is too unrealistic. I hope it doesn't happen - paper is easier to make, after all - but its not unlikely. Most or all of the current crop of private internet currencies are simply pure gold.
I agree that the Liberty Dollar is silly.
Posted by: G at Sep 6, 2007 12:40:57 AM
To the best of my knowledge, proving or disproving the Riemann Hypothesis wouldn't have any practical consequences for cryptography (I'm a mathematician, but not a specialist in number theory or cryptography; though if I'm wrong about this, I'd be interested to see the connection.)
You are correct. Finding an easy way to factor large composite numbers is what would be required to break modern public key encryption systems (and many believe there may not be a feasible way to factor huge numbers in a reasonable amount of time short of quantum computation). Finding a proof of the Riemann hypothesis is a different thing altogether. The only relationship is that both are significant problems of number theory.
Obviously, if solving the Riemann Hypothesis had any practical effect on factoring, then one could simply assume the conjecture true or false and see where it leads.
Posted by: tommy at Sep 6, 2007 3:01:56 AM
Surely anyone who wants to can effectively go on the gold standard already.
Simply buy a Gold ETF with your money as you receive it, and convert it back
to dollars just before you spend it. The cost is fairly small to do this in
an internet trading account. Dollars simply represent in this system, a
medium to efficiently transfer gold from the seller to buyer (assuming both
wanted to use the gold standard). The reality is that most people don't do
the above, therefore why should we require the government to do it?
Posted by: ChrisA at Sep 6, 2007 3:39:55 AM
As long as fiat money is legal tender, it is not backed by "nothing" ... it is backed by the nation's (and nowadays, to the extent the currency is well-accepted like the dollar, the world's) economy.
As long as fiat currency is as hard to counterfeit as gold, I don't see any reason why it has any less intrinsic value. Worth is a function of the rarity/scarcity coupled with the difficulty in producing counterfeit substitutes and wide acceptance (which naturally follows).
Posted by: bruce at Sep 6, 2007 7:08:48 AM
I like the idea of commodities. The government could abolish farm subsidies but back the currency in food.
Posted by: 8 at Sep 6, 2007 7:31:23 AM
Yan_Li: That's one of the important insights about money I've heard, and Paul_Birch expands on it quite
a bit in his essay Honest Money.
In short, "money is information". It is the collectively held information about the net debt owned to
each person. Some implications about this insight:
-All theft of money qua money can be equivalently expressed as manipulating the public's
knowledge about a few people's net debt owed to them.
-To the extent that someone has a right to their monetary earnings, they have a right to the thoughts of
other people. (See also: debates about the "right to reputation".)
-It's no accident that many languages use the same term for arbitary monetary units, that they do for
"public belief". (In English, "credits".)
-Reparations can be extracted from someone with enough funds, without using force. The public need only
change its collective mind about how much he is owned.
The implications of the "money is information" insight alone, or even just its implications for
libertarianism, are worthy of their own discussion.
Posted by: Person at Sep 6, 2007 9:40:48 AM
Jacob I have also thought of something like the ETF that you describe and I think that freedom to print private money might lead to that. IMO the diversity that the freedom to print private money would lead to, would in turn lead to stability.
Also to believe that gold would lead to bad cycles is to believe that people (including those who run business) would not learn. Even with the current system economists are not sure were the stability comes from. It might come from the fact that enough people have learned not to panic and do things like lay everyone off after a year of bad losses, and that consumers have learned to not panic and horde cash in a downturn. After all if you continued to buy stocks through the crashes of 1929 and 1974 (say dollar cost averaging) you did quite well. People may be stupid but society is smart. Money is moved from fools to wise leaving the wise with more power over the markets.
Posted by: Floccina at Sep 6, 2007 10:10:24 AM
g wrote:
"I believe it means that the money supply would shrink during recessions, and expand during booms. Keynesians would say this could be disastrous, Austrians would say this would be great."
I believe that the Austrians are also against fractional reserve banking and believe that free banking would lead to an end to fractional reserve banking thus in deflationary conditions gold mining would be more profitable leading to more gold mining and in inflationary periods gold miners would go out of business thus having a leveling effect.
Posted by: Floccina at Sep 6, 2007 10:41:34 AM
Ignorance sbout Gold abounds in this thread.
Try reading this and learn something.
A GOLD POLARIS
by Jude Wanniski
http://wanniski.com/searchbase/gp1.htm
Posted by: russ at Sep 6, 2007 12:51:26 PM
and we don't know what the new gold/dollar par should be,
But we do know,try the 30 year moving average of spot gold.
Which gives a rough approx of excess $ liquidity for the last 30 years.
Posted by: russ at Sep 6, 2007 1:14:52 PM
I propose a used tissue paper money standard. Its about as relevant as the gold standard.
If society collapsed and I needed something to barter, pardon me while I believe in the potatoes and ammunition standard.
Posted by: Jacob at Sep 6, 2007 1:33:35 PM
Even if we found an efficient way to factorize large numbers, that would only break RSA encryption. There are other methods of public-key encryption which would then become standard. There would presumably be some adjustment, but we would adapt. I know there are some primality testing methods whose proof of correctness depends on the Riemann hypothesis, but that's not nearly as relevant since a polynomial time primality testing algorithm was developed. I don't believe that the Riemann hypothesis has any relevancy to the problem of factorization anyway. It has more to do with the distribution of prime numbers, which is a related (though quite distinct) problem.
Posted by: Lucas Wiman at Sep 6, 2007 2:18:44 PM
The harder part is probably getting the government to agree to release its monopoly on money.
What monopoly? The government does allow private currencies, so long as you don't get any ideas about getting out of paying taxes ;-). Check out the Ithaca Hour, a labor-based currency. I believe you have to fill out some paperwork.
They don't grow very fast because they aren't as useful as dollars, and it's a pain keeping multiple currencies around without some real return. You can't buy much, investment money is even harder to come by, and the dollar has the Fed to defend against monetary attacks and recession. Really, the big appeal is that it's fun to mess with. Also, I might be biased because the basis of the Hour biases against people like me who've invested alot to raise the value of their labor.
So far, nobody's created a currency useful enough to make it beyond the community that created it. Electronic currencies haven't gone far because it turns out to be easier to just use $ or euro instead. That's what people in places with weak currencies do, or in places that have just undergone crises like the one that motivated the idea of the Crypt.
Anybody can create a gold-backed currency, but only goldbugs will use it, since nobody else sees the dollar going to pot.
Note, the principles behind modern cryptography have survived alot of very smart people attacking them for 50 yearsish. I'm not too worried on that score. I'm more worried about quantum computing, which has cool properties that would allow very fast attacks on modern crypto (I believe, including likely on the alternative being installed now). Although, quantum's been having MANY teething problems, so maybe it isn't such a worry, after all. If quantum computing shows up, then we all have to go to quantum crypto for secrecy. As far as I know, nobody's yet found a way to issue certificates with quantum crypto, but neither quantum nor security are my specialty. Similar, nano and biocomputing have the potential to raise processor creation rates enough to cause problems by obsoleting overly short keys in circulation.
There's a continuous arms race in ANY public-key crypto between key length and processor speed. since processors speed up at an exponential rate. Similarly, longer keylength means exponentially more processor work to crack it. So it all works, but you have be pretty conservative about keylength when you issue new keys. That's why acceleration of processor production rates is a menace - you thought 512 bits would last you til 2050, but then nano, say, makes it weak in 2030ish.
Posted by: Jon Kay at Sep 6, 2007 6:25:00 PM
Isn't fiat money backed by the value of italian automobiles?
Posted by: triticale at Sep 6, 2007 6:56:04 PM
"it is important to distinguish the questions of what monetary tokens (e.g. coins, paper bills, cryptographically secured "digital cash") will be used, vs. what these tokens represent."
Cryptography in digital cash involves just the representation, but proof-of-work schemes like bit gold use cryptography to provide good estimates of the computational effort and luck that went into "mining" the bit gold.
Bit gold like gold gives freedom from having to trust third parties not to inflate the currency, but without the security vulnerabilities of gold that have all too often occurred in history.
Posted by: nick at Sep 6, 2007 7:57:13 PM
Ron Paul told a story a few years ago that he had recently met with Greenspan. In preparation, he took a copy of an article that Greenspan had written in the sixties defending the gold standard. When Ron showed him the article, Greenspan said (AIRBT) "You know, I was thinking about that article a few days ago. I wouldn't change a thing." I believe that Greenspan used the term "to depoliticize money".
Posted by: Nathan Zook at Sep 7, 2007 3:07:50 PM
