GOLD, PAPER, OR...: IS THERE A BETTER MONEY?

The Cato Institute ^ | 1-17-03 | David Friedman

[Nick Danger]

A fractional reserve system based on fiat money thus economizes on the cost of producing something that costs nothing to produce; it adds the disadvantages of a fractional reserve system to the disadvantages of a fiat system without adding any corresponding advantages.

That's not true. The author has ignored many other advantages of a fractional reserve system, and they are significant.

The first is that such a system decentralizes the process by which the money supply grows and shrinks on a daily basis; this means that small adjustments in the money supply are constantly being made in response to market forces.

A second advantage is that it physically distributes the function; this accommodates regional variations in growth rates, etc., better than a centralized "one issuer" system would.

A third advantage flows from the first and second -- distributing and decentralizing the function generates data concerning small movements and regional disparities that can be used by the central banking authorities to better manage large-scale adjustments in the money supply. In an economy as diverse as ours, just understanding what's going on out there is a problem, and this helps with it.

[ernie pantuso]

You are partially correct in that the future money is in electrons. But, there still must be an underlying basis to properly value the electron currency or else it becomes a worthless medium of exchange.

[ernie pantuso]

You are partially correct in that the future money is in electrons. But, there still must be an underlying basis to properly value the electron currency or else it becomes a worthless medium of exchange.

[discostu]

Nope, there doesn't. Because there never has been. All currency (gold, dollars, tulips, whatever) gain their value from people being willing to trade them for goods or services. That's the underlying basis throughout history. All "gold backing" does is layer it, the dollars are based on gold which is based on belief. things have functioned perfectly fine after getting rid of that misdirection. And when we go to full electronic they'll still function fine.

[Deuce]

But the problem with making a currency a better store of wealth is that currencies can ALREADY be used to purchase WHATEVER store of wealth one desires.

Replace the word "ALREADY" with "CURRENTLY" and you will see the same bigger picture that Thais, Filipinos, Indonesians, Malaysians, Russians, and Argentinians have seen over the last 5 years.

The problem, in a word, is "distribution." The mechanism for distributing new money is fatally flawed.

Money that is rigidly fixed in quantity or only gets distributed in exact proportion to the existing distribution (for those of you who incorrectly believe money supply has to grow for the economy to grow) will go a long way toward solving the 5,000 year old problem. It will do so by establishing the only money that is fully consistent with individual liberty and free enterprise: money over which nobody has control over any money supply other than his own.

[Liz]

In the early 1900s, the country suffered from recurrent liquidity crises b/c the banking system was constrained by (1) a rigid amount of currency that could not meet extraordinary demands, and (2) a system of reserves that pyramided up to New York. During these crises, businesses and farmers were unable to obtain credit to finance inventories, and crops production and transportation. The panics spread across the nation and converged on Wall Street, resulting in stock market plunges, numbers of bank and business failures, and even more currency shortages. Thus was the genesis of the Federal Reserve.

That being said, it's common knowledge among fiscal conservatives, that comments (any comments) on the subject can earn one lifelong enemies. Let's just say we'll have to agree to agree or disagree. Nice thread, though.

[Gunslingr3]

In the early 1900s, the country suffered from recurrent liquidity crises b/c the banking system was constrained by (1) a rigid amount of currency that could not meet extraordinary demands, and (2) a system of reserves that pyramided up to New York. During these crises, businesses and farmers were unable to obtain credit to finance inventories, and crops production and transportation. The panics spread across the nation and converged on Wall Street, resulting in stock market plunges, numbers of bank and business failures, and even more currency shortages. Thus was the genesis of the Federal Reserve.

"A fully free banking system and fully consistent gold standard have not as yet been achieved. But prior to World War I, the banking system in the United States (and in most of the world) was based on gold, and even though governments intervened occasionally, banking was more free than controlled. Periodically, as a result of overly rapid credit expansion, banks became loaned up to the limit of their gold reserves, interest rates rose sharply, new credit was cut off, and the economy went into a sharp, but short-lived recession. (Compared with the depressions of 1920 and 1932, the pre-World War I business declines were mild indeed.) It was limited gold reserves that stopped the unbalanced expansions of business activity, before they could develop into the post- World War I type of disaster. The readjustment periods were short and the economies quickly reestablished a sound basis to resume expansion."

"But the process of cure was misdiagnosed as the disease: if shortage of bank reserves was causing a business decline- argued economic interventionists-why not find a way of supplying increased reserves to the banks so they never need be short! If banks can continue to loan money indefinitely--it was claimed--there need never be any slumps in business. And so the Federal Reserve System was organized in 1913. It consisted of twelve regional Federal Reserve banks nominally owned by private bankers, but in fact government sponsored, controlled, and supported. Credit extended by these banks is in practice (though not legally) backed by the taxing power of the federal government. Technically, we remained on the gold standard; individuals were still free to own gold, and gold continued to be used as bank reserves. But now, in addition to gold, credit extended by the Federal Reserve banks (paper reserves) could serve as legal tender to pay depositors."

"When business in the United States underwent a mild contraction in 1927, the Federal Reserve created more paper reserves in the hope of forestalling any possible bank reserve shortage. More disastrous, however, was the Federal Reserve's attempt to assist Great Britain who had been losing gold to us because the Bank of England refused to allow interest rates to rise when market forces dictated (it was politically unpalatable). The reasoning of the authorities involved was as follows: if the Federal Reserve pumped excessive paper reserves into American banks, interest rates in the United States would fall to a level comparable with those in Great Britain; this would act to stop Britain's gold loss and avoid the political embarrassment of having to raise interest rates."

"The "Fed" succeeded: it stopped the gold loss, but it nearly destroyed the economies of the world, in the process. The excess credit which the Fed pumped into the economy spilled over into the stock market-triggering a fantastic speculative boom. Belatedly, Federal Reserve officials attempted to sop up the excess reserves and finally succeeded in braking the boom. But it was too late: by 1929 the speculative imbalances had become so overwhelming that the attempt precipitated a sharp retrenching and a consequent demoralizing of business confidence. As a result, the American economy collapsed. Great Britain fared even worse, and rather than absorb the full consequences of her previous folly, she abandoned the gold standard completely in 1931, tearing asunder what remained of the fabric of confidence and inducing a world-wide series of bank failures. The world economies plunged into the Great Depression of the 1930's."

"With a logic reminiscent of a generation earlier, statists argued that the gold standard was largely to blame for the credit debacle which led to the Great Depression. If the gold standard had not existed, they argued, Britain's abandonment of gold payments in 1931 would not have caused the failure of banks all over the world. (The irony was that since 1913, we had been, not on a gold standard, but on what may be termed "a mixed gold standard"; yet it is gold that took the blame.)"

"But the opposition to the gold standard in any form-from a growing number of welfare-state advocates-was prompted by a much subtler insight: the realization that the gold standard is incompatible with chronic deficit spending (the hallmark of the welfare state). Stripped of its academic jargon, the welfare state is nothing more than a mechanism by which governments confiscate the wealth of the productive members of a society to support a wide variety of welfare schemes. A substantial part of the confiscation is effected by taxation. But the welfare statists were quick to recognize that if they wished to retain political power, the amount of taxation had to be limited and they had to resort to programs of massive deficit spending, i.e., they had to borrow money, by issuing government bonds, to finance welfare expenditures on a large scale."

"Under a gold standard, the amount of credit that an economy can support is determined by the economy's tangible assets, since every credit instrument is ultimately a claim on some tangible asset. But government bonds are not backed by tangible wealth, only by the government's promise to pay out of future tax revenues, and cannot easily be absorbed by the financial markets. A large volume of new government bonds can be sold to the public only at progressively higher interest rates. Thus, government deficit spending under a gold standard is severely limited."

"The abandonment of the gold standard made it possible for the welfare statists to use the banking system as a means to an unlimited expansion of credit. They have created paper reserves in the form of government bonds which-through a complex series of steps-the banks accept in place of tangible assets and treat as if they were an actual deposit, i.e., as the equivalent of what was formerly a deposit of gold. The holder of a government bond or of a bank deposit created by paper reserves believes that he has a valid claim on a real asset. But the fact is that there are now more claims outstanding than real assets."

"The law of supply and demand is not to be conned. As the supply of money (of claims) increases relative to the supply of tangible assets in the economy, prices must eventually rise. Thus the earnings saved by the productive members of the society lose value in terms of goods. When the economy's books are finally balanced, one finds that loss in value represents the goods purchased by the government for welfare or other purposes with the money proceeds of the government bonds financed by bank credit expansion."

"In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value. If there were, the government would have to make its holding illegal, as was done in the case of gold. If everyone decided, for example, to convert all his bank deposits to silver or copper or any other good, and thereafter declined to accept checks as payment for goods, bank deposits would lose their purchasing power and government-created bank credit would be worthless as a claim on goods. The financial policy of the welfare state requires that there be no way for the owners of wealth to protect themselves."

"This is the shabby secret of the welfare statists' tirades against gold. Deficit spending is simply a scheme for the "hidden" confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights. If one grasps this, one has no difficulty in understanding the statists' antagonism toward the gold standard."

-Alan Greenspan, "Gold and Economic Freedom"

[AdamSelene235]

Let's just say we'll have to agree to agree or disagree.

I haven't asserted anything and all your points are well known and acknowledged in the paper. How can we disagree?

[Deuce]

In the early 1900s, the country suffered from recurrent liquidity crises b/c the banking system was constrained by (1) a rigid amount of currency that could not meet extraordinary demands, and (2) a system of reserves that pyramided up to New York.

The National Banking System (1864-1913) did have a built-in pyramidic structure. Rigid amounts of money did NOT cause the perplexing money panics, however, that occurred every 20 years or so between 1800 through 1933. It is factually verifiable that every single money panic was preceded by the creation of substantial amounts of liquidity going mainly into speculative enterprises. When the spigot is turned off the unhealthy, unsustainable flow of liquity is, admittedly, choked off. In March 2000, the NASDAQ suffered a lack of liquidity, but the bust was caused by the preceding bubble.

[Deuce]

Where is the Greenspan of old? One establishment author in a recent book, described "Gold and Economic Freedom" as a youthful indiscretion. Trouble is, he was a 42 year old "youth" in 1968.

[Liz]

Proved my point. Thanks.

[AdamSelene235]

Proved my point. Thanks

I think you've got me pegged wrong.

[Copernicus]

Ammo-the preferred currency of the 21st Century.

But you already knew that.

Best regards,