Re: Gold standard and the fiat money system (was: Information requested:

thorthor wrote:
> 
> John O'Donnell wrote:
> 
> > First is the oft made confusion between "backing" and "standard." The 
>"gold
> > bugs" stance always argues for a standard but simultaneously demands
> backing.
> 
> There may be some confusion here.  Just a few comments in an effort to 
>clarify
> the picture.
> 
> Gold standards have been run with relatively stable value of gold in 
>terms of
> paper currencies. For instance, in the US dollar - gold exchange standard
> lasting for almost 20 years, gold was priced at $35.

Yes, and so long as the demand for gold was such as to allow
both the government and the public to hold some gold, the
price of gold can be set by the government by offering to
buy and sell at a set price. However, such a condition has
nothing to do with the value of the currency relative to the
goods and services people actually want. One need only look
at the effect on gold trade following the establishment of
the price at $35 per ounce. The immediate result was to
increase the amount held by the U.S. government followed by
a period of slower accumulation and eventually to a period
of reduced holdings until the whole charade was dumped.

> Prior to WWI the gold
> standard run by the British had a gold value fixed at $21 (and an 
>equivalent
> fixed value in sterling) for decades. The central banks  had little 
>problem
> in achieving a stable price of gold, which represented a backing for the
> paper notes issued. What was a problem, however, was the amount of money 
>in
> the system, when a physical resource (gold) determined its supply.

No, what was a problem was the value of the currency
relative to all the goods and services people actually buy
and sell has no relationship to the arbitrarily set price of
gold. The "money" supply had no more limit then than now if
one counts bank credits as is done in computing all current
measures of money supply. The belief that economic
performance is limited by the quantity of money and money
substitutes rather than the quality of the monetary unit is
one of many popular fallacies that allow governments to
impose inflation in lieu of taxes.

> Triffin's "Dollar Crisis" was about the US printing more money notes than
> it had gold reserves to back. When the "allies" lost confidence in the
> dollar and demanded gold for their dollar holdings, the system broke down
> and dollars flooded the market.  The inflation that followed prooved too
> much liquidity had been injected into the system.

No, the idiots who believed in gold backing bid up the price
of gold to ridiculous levels only to later realize the
demand for gold really wasn't that large. Now the
governments that have no desire to hold the superfluous
amounts of gold they hold have to be very slow in ridding
themselves of the "treasure" accumulated in the false belief
that gold is needed to "back" money issues.

> The essential problem of a gold standard was its focus on the stable 
>"value"
> of money, with liquidity becoming the stochastic residual of the system. 
>The
> fiat money system, which measures value in reference to an evolving CPI
> basket, has solved the problem of adequate liquidity. However, this has 
>been
> achieved with "value" in some sense having become the stochastic residual 
>of
> the system. Hence inflation may be the new "threat", not inadequate 
>liquidity
> (expressed as deflation and falling activity).

No, the essential problem with the gold standard was its
reliance on gold backing to manipulate the price of gold
independent of the prices for goods and services that were
actually relevant to people.

> Specifically, the fiat money system may have a more unpredictable 
>transmission
> mechanism than is currently envisioned -- borrowing Marxist terms -- such 
>that
> central bank's focus on the "productive circuit" is misplaced, because the
> "money-circuit" (which captures the money used for exchange AND finance) 
>is
> absorbing a growing amount of the supply, resulting in stable value of the
> former. However, this may depend on the money circuit remaining in a 
>positive
> cycle (rising asset values). However, a shock to stock markets -- with 
>prices
> falling sharply -- could result in money returning to the productive 
>circuit,
> resulting in a rise of goods inflation.  However, as the central bank 
>controls
> this process, the system may continue ad infinidum.  That said, the 
>question
> arises if the US has again issued too much money for inflation to remain
> stable, especially if the system is at some point subject to a truly 
>exogenous
> shock.

The only problem with the fiat money system is the
unwillingness of governments to maintain the value of its
currency because of economists false belief that
"depression" is an inevitable accompaniment of "deflation." 

> > A better choice of standard, even with its difficulty of frequent
> > measurement, is an index based on a meaningful basket of goods and
> > services such as that used for the CPI.
> 
> In short, the problem of a monetary system (stable value and ample 
>liquidity)
> may not have been solved as decisively by the fiat money system as its
> proponents think.  It is always a matter of a trade-off.

The problem of a stable currency has not been solved because
there are those who choose to remain blind to the fact that
it is only the quality [i.e. -- value] of a currency that
affects its usefulness and not its quantity. [i.e. -- dM/dQ
= 0]

-- 
                        -- jbod

                Tax Privilege, Not People
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