Stable Money
September 5, 2010
"The gold standard" is the answer to a question. The question is: "How
do we create stable money?"
Until you understand the importance of stable money -- in short, until
you ask the question -- the answer won't make any sense.
July
25,
2010:
The
Argument
for
a
Gold
Standard
(2010
edition)
I spend most of the first chapter of my book Gold: the Once and Future Money,
and in actuality all of my book, explaining why stable money is
desirable. So, in some sense, this little essay serves as an enticement
to learn, in much more detail, why stable money works, and why unstable
money (floating currencies) do not, by reading the book. However, I
don't want to just repeat what I said in the book here, so let's go at
this in a slightly different fashion.
First of all, what is a "stable money?" It is money that doesn't change
value. Its "purchasing power" may change. For example, a twenty-dollar
bill has less "purchasing power" in downtown San Francisco than it does
in Bozeman, Montana. In other words, prices tend to be higher in San
Francisco than Bozeman. However, the value of the dollar is the same.
In the past, people discovered that gold is stable in
value. So, if their currency's value was linked to gold, then the value
of their currency would also be unchanging, or at least as stable as
gold. For the most part, this worked beautifully. But, even if you
didn't take gold to be a benchmark of monetary stability, you could
still use the same principle and devise some other system with the goal
of maintaining a stable currency value. However, historically, this
never happened. There never has been, to my knowledge, a currency
system whose aim was stability of value, that used some other method
than a gold (or occasionally silver) standard.
The idea that stable money is good
used to be self-evident. I say that no
economic
problem
in
history
has
been caused by stable money.
Without getting into the theoretical specifics, we understand this
instinctively from daily experience. Have you ever seen this on CNBC?
Maria
Bartiromo: Peter, what's
causing the economic difficulties in Anglia?
Peter Moneyshuffler: Well,
Maria, it really comes down to this. The currency is much too stable.
The government needs to make the currency much more unstable. Nothing
is going to get better until this excessive stability problem is
resolved.
Maria: Norbert? What do you
think?
Norbert Bigdome: This is
contrary to all the known laws of economics. Capitalism simply cannot
function with a stable unit of account. An unstable currency is one of
the primary means by which speculators can appropriate the wealth of
the productive classes. The currency in Anglia has been so stable, that
speculators' profits have fallen miserably. We all know what that means
in today's speculation-based economy. Financial engineering as a
percentage of GDP has fallen to perilously low levels. Instead, the
economy is focused on producing useful goods and services, which, of
course, is unproductive.
Peter Moneyshuffler: Maria,
there hasn't been an asset market bubble in Anglia in at least twenty
years. During my entire professional career, interest rates have
fluctuated in a 100 basis point range. I've been reduced to reading
financial statements and researching business plans. Frankly, Maria,
for a moneyshuffler of my stature, it's embarrassing.
Maria: Let's go now to Bob
Pisani, who is on the street in Robertsburg, Anglia's capitol, where
public demonstrations have broken out criticising the government's
response to the economic crisis.
Bob Pisani: Maria, it's
incredible down here. People are showing their anger at a government
they call corrupt and incompetent. Let's see what they have to say.
(Turns to demonstrator.) You sir, what are you most angry about?
Demonstrator 1: We're having a
currency crisis! Look, I have here a ten-dragoon note. Ten years ago, I
could buy lunch with this. Or get a taxi ride across town. Today, I can
still buy lunch with it, and taxi prices are about the same. Can you
believe that? Its value hasn't changed a bit. Not in ten years! My gold
investments have been a total disappointment.
Demonstrator 2: Our government
promised us that the value of the currency would fluctuate
unpredictably, and possibly even collapse. Instead, it has remained
pegged to gold for the last fifty years. The way things are going, it
might remain pegged to gold for the next fifty years. How am I supposed
to run a business like this? What does this mean for my children? I
feel betrayed.
Never happens, does it? And yet, if you look at the present state of
understanding, almost nobody today is an advocate of stable currencies.
Everyone is the other way. They think they can solve all their problems
with currency manipulation. For the last eighty years, economists have
been building up a sort of religion of currency manipulation. This is
expressed in our present floating-currency system. There are no stable
currencies today. There isn't even a single government that attempts to create a stable
currency.
Thus, we have two different viewpoints: the stable money people, and
the funny money people.
April
26,
2009:
Two
Monetary
Paradigms
"Stable money" is itself the answer to another question. The question
is: "What is the best way to manage a capitalist economy?"
You can make a lot of intellectual arguments regarding this topic, but
I think it is best to start with a brief overview of history. I'll do a
little handwaving and say that "capitalism," as an economic system,
emerged most recently in Europe from the end of the Middle Ages, around
the 14th century. The Middle Ages were characterized by a simple
agrarian system, in which households (or, more broadly, the medieval
manor), were more-or-less self-sufficient. People grew their own food,
made their own houses, and made most of their other household goods
such as clothing, using locally-available materials, without
interacting, in a commercial sense, outside of their immediate
environs. Money wasn't used much, and monetary contracts, such as
stocks, bonds, employment contracts, pensions and so forth, were rare.
Then, we have the growth of capitalism from about the Renaissance
period. The early capitalists were found mostly in Italy, in places
like Florence, Venice or Genoa. By the 17th century, Europe's most
impressive capitalist powerhouse was Holland. The 18th and 19th
centuries were dominated by Britain, with Germany, the U.S. and Japan
taking a role in the later 19th century. The United States took over
the lead in the 20th century.
During this time, there were many, many experiments with all sorts of
floating currencies, devaluations, and whatnot. Hundreds and hundreds
of experiments with every sort of unstable-money system. You can read This
Time
Is
Different for a very brief overview of what I'm talking
about. Glyn Davies' A
History
of
Money is also a wonderful reference. You can even go
back to the Plato/Aristotle debates, where Plato was a soft-money guy
and Aristotle was a hard-money guy. Also, during this time, there were
hundreds of experiments with stable money systems, which, historically,
has always meant a gold standard. I guess nobody could think of a
better one -- although they tried, and you can look at the discussions
in the 1870s about William Jevons' commodity basket proposal if you
like.
The point is: the great successes during the entire modern history of
capitalism over the past 600 years or so were all hard-money systems.
At the end of the day, a capitalist economy is an economy of cooperation. No longer do we grow
our own food, make our own houses, and sew our own clothes from fabric
that we wove ourselves from thread that we spun ourselves from flax
that we grew ourselves. Although this cooperation is anonymous, and
often has competitive elements, nevertheless, the way in which we
produce our goods and services is by specialization and trade. If you
think of a capitalist system as a vast network of cooperation,
organized by money, money-measurements (profit and loss), and money
contracts, then it is easy to see that if this fantastically complex
system of cooperation is organized via money, then it is important to
keep this "communication system" as clear and uncorrupted as possible.
Thus, humans have always sought the most stable money possible, and
concluded that gold is the best real-world representation of this ideal
of perfect, unchanging stable money.
In short, the capitalist cooperation-system (specialization and trade)
works best with stable money. That's why all the great economic
successes over the past 600 years were those that had stable money,
i.e., gold-linked money.
August
5,
2006:
What
is
Economics
About?
This was the case up until 1971, when the world left the gold standard.
At first, the dollar floated, but all major currencies remained pegged
to the dollar so exchange rates were stable. Today's floating-currency
system did not fully appear until 1973, when major currencies began to
float against the dollar. This system was never planned. There was
never a great international convention, like the Bretton Woods meeting
of 1944, in which everyone discussed the pros and cons and concluded
that we should have a floating currency system. The break with gold in
1971 was an unplanned consequence of Richard Nixon's attempt to goose
the U.S. economy with "easy money" before presidential elections in
1972. Oops!
I'm trying to put a picture in your head: 600 years in which the
biggest, most successful capitalist industrial economies (Britain,
U.S., Germany, Japan) all had hard money/gold standard systems, against
40 years in which we've had worldwide chaos as the consequences
of the funny-money manipulators' attempts to fix economic
problems with currency games. 600 years vs. 40 years. And yet, somehow,
during those 40 years, the funny-money guys have managed to convince
everyone that the previous 600 successful years did not exist, or are
irrelevant.
I like to represent this 600 years of stable money:40 years of floating
money ratio with this graph of the value of the "dollar," which was
originally a standardized European coin called the "thaler." We see
that the "dollar/thaler" didn't change in value from its inception in
1513 until 1933, where it undergoes a single step-devaluation. The
"floating dollar" doesn't appear until 1971. It's that little wiggle on
the far right of the chart.
Likewise, if you have two countries with currencies pegged to gold,
then of course the two currencies have stable exchange rates. I don't
think people today believe me when I say that exchange rates used to be
stable and unchanging. This chart helps:
That's the way it's supposed to work. The
way
capitalism
is
supposed to look.
The funny-money guys all try to convice you that if you adopt a gold standard, your head
will explode. How is it, then, that Britain, which has one of
the greatest records of currency stability in the world, 233 years of a
gold standard at the same parity (1698-1931, with some lapses), became
in the 19th century:
The world's leading industrial economy
The world's leading financial center
The source of the world's premier international currency
The center of an empire that spanned the globe
British Empire, 1897. Islands that were part of the Empire are
underlined in red.
British 5-pound gold coin.
After 1931, Britain descended into Keynesian money manipulation, with a
series of devaluations between 1931 and 1971. Britain's industrial
leadership? Poof! Premier international currency? Kaput! World-spanning
empire? Gone! It is still a leading financial center, although that may
be in part because The City is not quite the same as Britain.
The baton was handed to the United States. The U.S. has perhaps the
second-best record of hard-money stability in the world, with 182 years
(1789-1971, with some lapses) on the gold standard with just one
permanent devaluation in 1933. As a result, in the 20th century, the
U.S. became:
The world's leading industrial economy
The world's leading financial center
The source of the world's premier international currency
The center of an empire that spanned the globe
Wow, what a coincidence! The same action produces the same results!
Yes, people, it really is that obvious. Guess what: their heads didn't
explode. Instead they became a global
colossus.
What about Holland? Remember them? They were the economic leaders of
Europe before Britain adopted the gold standard in 1698. During the
17th century, Holland's era of economic pre-eminence, they enjoyed a
gold standard organized around the Bank of Amsterdam. And what
happened? During that time, Holland was:
The world's leading industrial economy
The world's leading financial center
The source of the world's premier international currency
The center of an empire that spanned the globe
Think about that. Holland! A rinky dinky nowhere, on some of the worst
land of all of Europe. The population of Holland was 1.8 million people
in 1700, and less before then. The population of Amsterdam in 1660 was
200,000. And yet, this 1.8 million people from rinkydinkyland -- this
is the population of greater Charlotte, North Carolina -- were able to
build an empire that included parts of (or all of) today's:
Sri Lanka
Taiwan
Australia
Iran
Iraq
Pakistan
Yemen
Bangladesh
India
Indonesia
Oman
Burma
Thailand
Malaysia
Cambodia
Vietnam
China
Japan
South Africa
New Netherlands (United States, including New Amsterdam, now known as
New York)
Netherlands Antilles and Aruba
Suriname
Guyana
Brazil
Virgin Islands
Tobago
Colombia
Chile
Ghana
No exploding heads in Holland either. Try to imagine, if you can, the
people of Charlotte, North Carolina
conquering the world. Actually, the Dutch were more interested
in trade than conquest, but you get the idea.
The U.S. has been able to hold onto its top-dog position despite
leaving gold in 1971, because the dollar has been the most stable currency in a world
of worse options.
The U.S. middle class used to be an amazing story of ever-increasing
wealth and prosperity. However, the middle class hit the wall exactly
when we went from hard money to soft money, in the early 1970s.
June
21,
2010:
What
Happened
to
the
Middle
Class?
Wow, what a coincidence! Soft money produces economic stagnancy and
decline, exactly like the hard money
guys have been saying for six hundred years!
The same action produces the same results!
"Soft money" usually means a currency that declines in value. Sometimes
there is a persistent rise, as Japan experienced in the 1985-2004
period. But that is very, very rare. Sometimes there is a period of
fluctuation within a range, as was the case in the U.S. in 1982-2004.
This causes a persistent ill-health and underperformance. However, in
the long-term picture, "soft money" inevitably means "easy money"
during a period of economic weakness, and this ultimately leads to
declining currency value.
When a currency loses value, then obviously nominal wages paid in that
currency also lose value. Wages may rise to offset this currency
devaluation, but they usually do not rise anywhere near the degree that
the currency declined, so on balance wages fall in real,
devaluation-adjusted terms, which in practice means in terms of gold.
This makes perfect sense from a productivity standpoint as well. Most
any economist will tell you that wealth is a direct function of
productivity. You can't enjoy more goods and services unless you make
more goods and services. Where would they come from otherwise? Outer
space? Since unstable money distorts and corrupts the capitalist
cooperative system of specialization and trade, we can see that we
cannot generate more productivity from making a mess of the system that
makes productivity possible. In short, productivity will also decline
as a result of currency instability, which is why that although nominal
wages may rise in response to the currency devaluation, they do not
reach their old peaks, except perhaps after a few decades of recovery.
To summarize: soft money = lower wages.
Obviously,
if
wealth/productivity/economic
health
and vigorousness is
represented by higher wages,
then a method that produces lower
wages isn't going to get you there, is it?
These are "weekly wages of production
workers," excluding management, income from capital, healthcare costs
and other nonwage compensation,
etc.
Or, as they used to say: "You can't
devalue yourself to prosperity."
Just as currency instability/devaluation results in poorer workers, it
also results in poorer corporations. Here's the Dow Jones Industrial
Average, as measured in real money -- gold.
We're back at a mid-1920s level!
Whoops!
April
15,
2007:
The
Value
of
Today's
Dollars
in
1854
Dollars
Traditionally, the hard money guys have run into difficulties when
faced with a recession. They tend to want to stand around and "do
nothing." This is not an easy political sell even when it is the right
thing to do, but it is even worse when it leads to a sort of
obliviousness about economic developments. The Classical economists'
solution to the exploding worldwide trade war set off by the
Smoot-Hawley Tariff in the U.S. in 1930 (with preparations in 1929),
was: do nothing! When this was
followed by an even more destructive trend around the developed world
toward soaring domestic tax hikes, exemplified by the 1932 Hoover tax
hike, their response again was: do
nothing! Even in less dramatic times, economists need a better
solution than: do nothing. In fact there is quite a bit a government
can do instead of "easy money." I've listed a few options:
June
27,
2010:
U.S.
Tax
Hikes
of
the
1930s
September
14,
2008:
Depression
Economics
October
12,
2008:
Effective
Bank
Recapitalization 2: Three Examples
October 5, 2008: Effective Bank Recapitalization
September
28,
2008:
Every
Crisis
is Like All the Others
January
27,
2008:
Crisis
Management
November
10,
2008:
"Austerity"
November 2, 2008: "Stimulus"
January
18,
2009:
"Austerity"
and
"Stimulus" 2.0
June
24,
2010:
Stimulus,
Austerity,
and
the
Spiral
of
Decline
December
9,
2008:
Preventing
Bubbles
April
6,
2008:
Liquidationists
vs.
Interventionists
May
2,
2010:
Thoughts
on
Greece
May
30,
2010:
The
Flat
Tax
in
Russia
The soft-money guys really come into their own when politicians are
looking for solutions to their problems. This might be something minor,
like Nixon's re-election plan, or something major, like the Great
Depression. The soft-money guys have a zillion proposals, although they
all boil down to the same proposal: "easy money." Combined with
government "stimulus" spending, it's their one-size-fits-all soution
for every kind of economic event. Politicians fall for this time and
time again, because, often, it works! For at least a short time, it
seems like the economy is improving, although as we've seen before this
never seems to persist in any sort of "long run." It's all illusory.
Plus, it doesn't seem to cost anything, seems to bypass the
difficulties of the democratic legislative process, seems like it can
be implemented immediately, and generally flatters politicians' Master
of the Universe fantasies as they imagine themselves to be "macro
fine-tuners" of some sort. When the inevitable long-term results appear
-- economic stagnation and decline -- it is hard to attach blame on the
soft-money managers, who are always ready with a blizzard of confusing
nonsense to cloud the issue.
July
28,
2008:
"Why
Not
the Gold Standard?"
March
23,
2010:
China
Vs.
U.S.:
Clashing
Monetary
Paradigms
Another very real problem with "hard money" today is that hardly
anybody knows how to make it happen. Someone can say "oh, it would be
so wonderful if we had a proper stable money/gold standard system," but
if they don't know how to implement it, then the result could be a
disaster. Most of the "hard money" proposals I've seen in recent years
would almost certainly create a disaster. Unfortunately, noble
sentiment alone is not enough. You need to have some technical
competence to go with it. One reason that people cling to today's
soft-money system is that at least it is the Devil We Know. Thus far,
from 1982 to the present, it seems to be tolerable enough, the "Great
Moderation," although that era is surely slipping by as we embark on a
new phase of currency devaluation today. It won't be until the Devil We
Know is getting to be so horrible that people are willing to chance a
turn at the ignorance and stupidity of today's hard-money guys -- the
Devil We Don't -- that things may change. It would all be a lot easier
if we just learned how to play this game properly, and then the
transition could be an occasion of celebration.
January
3,
2010:
The
GLD
Standard
November
23,
2008:
Redeemability
and
Reserves
August
26,
2007:
How
To
Operate a Gold Standard
August 19, 2007: Gold Standard Fallacies
June
2,
2008:
World
Without
Paper Money
May
6,
2008:
The
Key
to
Managing
Currencies
