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nonzerosum (89.98)

A gold standard is just government price fixing

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November 14, 2010 – Comments (10)

Isn’t it perplexing that people who advocate a return to the gold standard are often against big government and supposedly pro-market?  After all, the term “gold standard” is just a euphemism for government price fixing where the government sets an arbitrary, non-market price for the currency/gold conversion.  By now humans should have learned that government price fixing almost always leads to a host of bad, unintended consequences.  I’ll get to those in a moment.

But first, let me acknowledge that I fully sympathize with the intention behind the gold standard.  The intent is to impose fiscal discipline on governments.  History has shown time and again that governments need that discipline.  This is especially true in democracies where oftentimes the guy who promises the most free stuff gets elected.  The gold standard may have flaws, argue its proponents, but it is better than the alternatives.  Well, sorry, I have to disagree… I do have a better alternative, and you can read about it in the next blog post: “The Gold Equivalence Provision”.

So what are the unintended consequences? When a government enforces a non-market price on a commodity, be it gold or gasoline, then it has to enforce it.  That means it has to use brute force (which consumes economic resources) to make that price stick.  Franklin Roosevelt had to use police power and threats of jail time to confiscate all private gold in 1933.  Do my libertarian friends want a repeat of that?  I think it is much better to have a free market in gold where you can buy and sell it freely with no government intervention.  If the world’s net-exporters (China and Japan) want to hoard all the world’s gold they can do that today.  Nobody’s stopping them.

Another negative consequence is that a distorted gold price leads to wasteful behaviors.  If the price is set too low then everyone would swap the paper currency for gold and there would be no currency (duh!).  That means the price would have to be set higher than the market price.  So then a portion of the labor supply gets re-assigned into mining a commodity that has little economic value.  The government would quickly own the shiny-but-useless 67 foot metal cube that Warren Buffet talks about.  

Worst of all, if the price of gold was fixed then investors wouldn’t be able to profit from government stupidity as easily.  With a floating gold price I have the freedom to vote against government policy (and make handsome profits).  In a free market, the gold price contains valuable information which provides important feedback to all economic actors.  That information content is lost with an artificial, fixed price.

I totally support constraining reckless government spending.  But let’s do it with mechanisms that are consistent with free markets and basic economic reality.  See my next blog post.

 

10 Comments – Post Your Own

#1) On November 14, 2010 at 11:54 AM, nonzerosum (89.98) wrote:

Correction:

If the gold price is set too low then everyone would swap the paper currency for gold and the government would have no gold left for the standard (duh!).  

tj

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#2) On November 14, 2010 at 12:33 PM, devoish (98.78) wrote:

NZS,

Thoughtful piece. There is one specific comment you made that struck out at me though.

History has shown time and again that governments need that discipline.  This is especially true in democracies where oftentimes the guy who promises the most free stuff gets elected. 

 I would just like to suggest that in my lifetime -  I am fifty - it is the politicians who have promised the least free stuff in the name of fiscal discipline who have been getting elected. Cut welfare, taxes and entitlements is what I have been hearing from Democrats and Republicans and Tea Partiers alike.

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#3) On November 14, 2010 at 2:29 PM, sawchain (< 20) wrote:

If you're for limited government, you're doing it wrong.

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#4) On November 14, 2010 at 3:51 PM, tomlongrpv (82.67) wrote:

You left out the tendency of a gold standard to cause deflation.  We had very bad deflation in the US in the late 19th Century and it had dramatic social and political effects that we might not desire to repeat. 

There can be no promise that the supply of gold will match what is needed to act as a currency.  One of the most important functions of a currency is to set stable values for borrowers and creditors alike.  Presumably if deflation occurred at a predictable pace parties to a transaction could agree to a negative interest rate that resulted in a creditor getting a payback of an equal purchasing power plus compensation for risk and the use of the money over time.  But, as a practical matter, predictable inflation is easier to factor into creditor and borrower relationships than deflation is.  And deflation tends to feed on itself as much or more than inflation by encouraging delays in demand which, in turn, fuel downward price spirals.

Since deflation has not occurred in the US within the lifetime of anyone currently living, we tend to discount its impact.  But the demise of the gold standard in the US was produced, at least in part, by the struggles stemming from deflation and the Free Silver movement that was designed to counter deflation. 

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#5) On November 14, 2010 at 4:01 PM, ETFsRule (99.90) wrote:

"If you're for limited government, you're doing it wrong."

Riiiiight. Apparently no one can be for limited government, and also try to think for themselves and look at the gold standard in a new way?

I didn't realize it was actually a requirement for conservatives to just keep regurgitating the same rhetoric over and over again. Thanks for clearing that up.

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#6) On November 14, 2010 at 4:27 PM, starbucks4ever (99.53) wrote:

#2,

It's a misconception that the election of a politico depends on what promises he gives to the electorate. The result is determined exclusively by the number and quality of ads shown on the main channels. If you want to elect Obama with a 52% of popular vote, you just air the Obama and McCain ads in a 52:48 proportion, given the same quality of the ads.

#4, 

I said that many times and will repeat again, where are the signs of stagnation in that locomotive of the US economy, the IT sector, which also happens to be the only sector experiencing a very strong deflation?

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#7) On November 14, 2010 at 6:13 PM, tomlongrpv (82.67) wrote:

Zloj  Declining prices in a segment like IT from increased productivity is not "deflation."  Deflation is a downward spiral in prices that is independent of any particular economic segment and represents an overall structural problem.

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#8) On November 14, 2010 at 6:19 PM, nonzerosum (89.98) wrote:

#2: Yes, the rhetoric of the recent elections certainly would make one think we'll have austerity coming soon.  But how many of the candidates seriously talked about the biggest "free stuff" elephants in the room (social security and medicare)?  The Deficit Commission is getting excoriated for even putting them on the table.  Rand Paul wouldn't even agree to age extending them.

 #4. Yes, that's why I'm not completely against monetary policy, provided that, like with any tool, it is used wisely. I would point out that I think mild deflation is the "natural condition" of a healthy economy when it has real productivity gains.  You may be right about the practical benefits of mild inflation.  What the public doesn't realize is that it represents a hidden tax.  A double tax, actually, if you consider that capital gains tax your inflation loss a 2nd time. 

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#9) On November 14, 2010 at 10:14 PM, JakilaTheHun (99.93) wrote:

I agree with you.  I'm not sure why so 'pro-free market people' support the gold standard.  It's government price fixing at its worst. 

We see bad enough effects when the government fixes the price of one important good (e.g. oil, real estate, etc).  The gold standard is essentially like fixing the price of EVERY SINGLE GOOD in the entire economy.

 

Also, it's a bit of a myth that a gold standard deters reckless spending.  Actually, it's just the reverse.  The current system deters reckless spending more than the gold standard, because at least the government is held somewhat accountable via market forces (remember, the govt has to borrow from someone and interest rates are set by the market participants). 

Under the gold standard, the government is completely unaccountable. If the government recklessly spends, all it has to do is move the gold peg and ... VIOLA! ... debt removed.  It's a very arbitrary and inefficient system. 

The US actually doesn't have that sort of option under the current system; of course, reckless spending still will manifest itself in various negative ways.  It will under any and every system.  But at least under this system, the affects are determined by market forces and are predictable. 

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#10) On November 15, 2010 at 10:28 AM, FreeMarkets (99.25) wrote:

No system of money is perfect.  I like a gold standard and don't consider it gov't price fixing, as gold has no value outside of being used as a medium to purchase other goods/services.  That said, a gold standard has flaws, like running out of it, but more importantly if NO ONE ELSE is using a gold standard, eventually all our gold would be in other country's and we wouldn't have any gold to have a standard.  I would love to see a Constitutional Amendment in which we fix the number of dollars in circulation to the # of people in the country.  This would limit gov't spending, allow for a constant increase in the money supply, eliminate inflation and promote savings and wealth creation.

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