Relay-Version: version B 2.10 5/3/83; site utzoo.UUCP Posting-Version: version B 2.10.1 6/24/83; site ukma.UUCP Path: utzoo!watmath!clyde!cbosgd!hasmed!qusavx!ukma!plh From: plh@ukma.UUCP (Paul L. Hightower) Newsgroups: net.politics.theory Subject: The gold standard. Message-ID: <613@ukma.UUCP> Date: Mon, 4-Feb-85 16:50:44 EST Article-I.D.: ukma.613 Posted: Mon Feb 4 16:50:44 1985 Date-Received: Wed, 6-Feb-85 05:42:06 EST Organization: Univ. of KY Mathematical Sciences Lines: 72 >Subject: Re: Re: Re: Inflation in a Free Economy? (Nota bene, Baba!) > >[ Note the change of groups. ] > >> Find someone with a Federal Reserve Note (i.e. One Dollar Bill, Fiver, >> etc.). Examine it closely. Notice the words "This note is legal tender for >> all debts, public and private", examine the bill closely for the promise that >> the bill can be redeemed for some portion of the reserve on which it is based. >> Unless your bill is a collector's item you will not find such a promise. It >> is still a "Federal Reserve Note", but there is no reserve of gold or silver >> with which to back it up. Isn't it curious that all our significant battles >> with inflation have taken place in the short time since we got off the gold >> standard? >I can think of a few reasons why the gold standard is useless. If the >economy expands at say 5 % / year, and the gold reserves in Fort Knox >don't expand by the same rate, then you get deflation. (Assuming that >every dollar is worth a certain amount of gold.) I don't know much >about economics, I will admit, but deflation certainly isn't something >that seems desirable. > You share a common misconception about the gold standard. A gold standard does not require the Treasury to maintain $1.00 in gold for every $1.00 of money in the economy. In fact, the actual amount of gold kept on reserve is almost immaterial. Here's how it works: The Treasury announces it will buy and sell gold at some fixed price, say $350 per ounce. Meanwhile, the Federal Reserve is charged with maintaining a fixed supply of gold in the Treasury. The Fed (short for Federal Reserve) creates and destroys money through the banking system. If the Fed creates money faster than the economy creates goods and services, people will begin to notice inflation (rising prices) and will seek to exchange their devalued dollars for commodities, such as gold. The Treasury will find it is selling more gold than it is buying. This acts as a signal to the Fed to slow down the growth of money, and it will act to remove bank reserves (usually by selling securities.) Now people begin to notice that money is scarcer, i.e., prices are no longer rising. On the other hand, if the Fed creates too little money, money will gain in value relative to commodities, and people will line up to sell their gold for valuable money. Now the Fed notices that the Treasury's supply of gold is rising, so the Fed acts to inject more reserves into the banking system, which creates more money. This will halt the deflation. The theory, then, is that the gold standard provides the Fed with an auto- matic rule for deciding when to expand or contract the money supply. If the supply of goods and services in the economy grows at 5% a year, and this rule causes the money supply to grow at 5%, inflation should be non-existent. You should realize that, at present, the Fed uses NO fixed rule to decide when to expand or contract the money supply; the Fed frequently pursues incompatible goals, such as trying to peg both the price of money (interest rates) and the supply; and the history of the 1970's is a testament to the folly of ad hoc decisions on money growth. Paul Volker is widely praised for taming inflation, yet he has been directly involved in every major monetary decision since 1970 when he joined the Nixon administration and urged the complete abondonment of the gold standard. If it takes a decade of mismanagement to train a Fed chair- man, how are we going to replace Volker? Reasonable questions to be asked about the gold standard include: How can we be sure it will lead to the right amount of money growth? (Gold bugs believe it will, aurophobes are sure it won't. This seems to be a religious question. I don't know, but the current system does not appear to work, so maybe gold is worth a try.) What if outside factors cause wild swings in the supply or demand for gold? (My guess is that tying gold to dollars would serve to fix the value of gold in terms of other commodities. The supply of gold is historically rather stable, and grows only slowly, so gold bugs don't consider this a likely problem. Others have suggested a more general commodity standard, say a combination of precious metals, soybeans and pork bellies.) Well, that was much longer than I intended, but I hope it explains a few things. Paul Hightower University of Kentucky