Question on a gold standard fallacy!

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Kurosawa's picture
Kurosawa
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Question on a gold standard fallacy!

I think it's safe to assume that most on the board are advocates of the gold standard or money being backed by some sort of commodity in reserves. 

I'm having trouble arguing against the fallacy that suggests that there isn't enough gold to support an economy, in other words the arguement that suggests that with a commodity backed economy there are only limited transactions and stifles expansion.

I'm looking for an easy to understand explanation....

If there is limited gold in supply would prices just rise? and vice versa?

Look foward to you explanations.

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Re: Question on a gold standard fallacy!

Good question Kurosawa; and it's one that I've asked myself.

Kurosawa wrote:

I'm having trouble arguing against the fallacy that suggests that there isn't enough gold to support an economy, in other words the arguement that suggests that with a commodity backed economy there are only limited transactions and stifles expansion.

You just have to think of purchasing power and not quantity. If we wanted to back the dollar by gold again it would simply be a matter of determing the proper ratio of gold to dollars. All arguments of gold market manipulation aside, the market has done this for us. We can see that an ounce of gold is now worth approximately $1,000. So the dollar would be worth 1/1000th of an ounce of gold.

The idea that gold would "limit transactions and thus stiffle the economy" . . .

Keep in mind that a gold backed currency supply can be expanded or contracted in the following ways:

1. Raising or lowering the official price of gold. For example - If the government decided to raise the price of gold from $1,000/oz. to $1,100/oz. then the money supply would be increased by $100 per ounce of gold.

2. Raise or lower the reserve ratio at banks.

3. Dig more gold out of the ground.

4. Put more gold into the ground. (ie. someone takes some gold out of circulation and buries it). 

As you can see a lack of money would not be a problem.

History

The dollar was backed by gold until 1971. 1800 to 1950 were the golden years of the Republic (pun not intended). In the words of Marc Faber, those years were an "economic miracle." Just take a look at what happened to the dollar after 1971.

So that's my layman's understanding of a gold backed currency. I'm sure others on the forum will have better answers than me and I hope they will share their knowledge.

Your question has raised several new questions in my mind about a gold backed currency. Time to do some research!

Orion

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Re: Question on a gold standard fallacy!

OK, fair warning this is going to be a dumb question.

Regarding gold, and the physical stockpile that the US has in reserves for example in Ft. Knox, how much is this? I suppose it is some kind of secret, but there has to be some kind of analysts’ understanding of how much this is? An approximation?

So, in the calculations of US debt, in the materials on the Crash Course, is this counted as an asset? Maybe I missed it, but I don’t recall it showing up on the asset side of the ledger. Perhaps it is such a small magnitude that it does not matter in the grand scheme of things.

I mean an obvious if not sophomoric observation is that if gold rises to some stratospheric valuation, could this not equalize the debt in dollars if the US has sizable holdings? I wonder the magnitude of the US holdings in the context of this.

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Re: Question on a gold standard fallacy!

Kurosawa wrote:

I'm having trouble arguing against the fallacy that suggests that there isn't enough gold to support an economy, in other words the arguement that suggests that with a commodity backed economy there are only limited transactions and stifles expansion.

The "gold standard" was the original fractional lending scheme.  Goldsmiths would lend out 10 times as many "gold reciepts" as they had gold.  This was the precursor of fractional lending and the basis for modern banking ratio of reserves. 

According to Byron Dale, Modern Money Secrets, there was never enough gold to back up the dollar, even in 1900 when the U.S. adopted the "gold standard."  This would only matter if enough people would actually start to request their gold.  Unfortunately, that's exactly what happened in 1933 and the U.S. had to stop all domestic gold redemption.  Abruptly, the dollar was devalued by around 40% and the government began confiscating the people's gold (mostly was quickly sold at a heavy profit as gold almost doubled in value).

If the U.S. had enough gold, there would be no need to stop the redemption policy.  And, after the policy was changed, there really was no need to confiscate the peoples gold since the dollar was no longer redeemable...but that's another part of the scam.  Shortly after the confiscation, the U.S. went bankrupt, the gold standard had failed again.  I say again because a few years earlier the gold standard failed in Great Britain and other places where it had been adopted in Europe.

We don't have near enough gold

The big problem is that the United States holds very little gold - most of the worlds gold is elsewhere. The US may have as much as 3,100 metric tonnes of gold.  At $1,000/troy oz, that works out to be around $99.65 billion.

 According to Shadow Government Statistics, M3 is currently at around $15 trillion (the non-Federal reserve bank stopped publishing M3 in 2006).

With only $99.65 billion of gold, we would back up the $15 trillion M3 dollars with less than a penny's worth of gold,  99.5% of every dollar would be fiat by definition.

And, it gets worse.  How would we pay the interest on our national debt ?  The interest on our national debt this year is projected to be around $600 billion dollars.  And our trade imbalance (money leaving the country) in 2008 was around $816 billion.  So far, during 2009, the imbalance is $417 billion.

According to the World Gold Council, the average annual "new" gold supply is around 4,000 tonnes globally.  This includes mined, scrapped and sales from central banks.  At $1,000/troy oz, that works out to be around $128.6 billion assuming that the U.S. buys 100% of the annual gold supply.  Even if we had enough gold to start the system, it could not be sustained. 

Fractionally backed dollars to compliment fractional lending?  At best, the U.S. could only back up a small part of each dollar.  If you want to "store" your wealth in gold or other commodities, you are free to do so now.  You can buy and hold the PMs of your choice and not rely on the banking system.

Hope this is helpful...

Larry

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Re: Question on a gold standard fallacy!

darbikrash wrote:

OK, fair warning this is going to be a dumb question.

Regarding gold, and the physical stockpile that the US has in reserves for example in Ft. Knox, how much is this? I suppose it is some kind of secret, but there has to be some kind of analysts’ understanding of how much this is? An approximation?

I think your question is a good one - let me try to answer it.  Many have suggested that Fort Knox is empty, but since it hasn't been audited for over 50 years, no one can say for sure.  However, in early 2007 the U.S. reported that 8,100 metric tonnes of gold. 

The United States Geological Survey [USGS] publishes monthly Mineral Industry Surveys designed to provide a macro-import/export-overview of the U.S. precious metals [gold] industry. The data in these surveys is supplied to the USGS principally by industry trade groups such as the World Gold Council as well as official sources like the U.S. Census Bureau. 

During 2007, over 2,000 tonnes were "exported" and in 2008, almost 3,000 tonnes were exported - (see full report here).  So, in 2 years, roughly 5,000 tonnes were exported representing more than 62% of reported sovereign U.S. gold reserves.  At best we seem to have around 3,100 tonnes of gold remaining.

Larry

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Re: Question on a gold standard fallacy!

Kurosawa,

This topic has been discussed several times on this site, but unfortunately I do not have a ready-list of all the threads.

Essentially, any amount of gold or any other commodity will work.  The common argument that "there isn't enough" is equivalent to saying there aren't enough inches to measure a football field.  Like any other monetary unit, gold is just a unit of measure, except it's also one that's highly portable, durable, and cannot be counterfeited.

The key to any hard-money system is the asset behind it.  In order to increase the supply of the asset, the asset itself has to be spent into the economy.  If we enter into a deflationary environment the cost of mining the asset falls below the value of what is mined, so more of the asset will be produced until the cost of mining it reaches the value produced.  It is really difficult to imagine any run away deflationary or inflationary scenarios with a true hard-money currency, which by definition would not be debt-based.

Gold critics will point to past experiences with coin-clipping and fractional reserves as if these had anything to do with gold and nothing to do with human fraud.  If you do not have honest men, or if honest men will not stand up for accountability, no system will ever work.

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Re: Question on a gold standard fallacy!

Farmer Brown wrote:

Essentially, any amount of gold or any other commodity will work.  The common argument that "there isn't enough" is equivalent to saying there aren't enough inches to measure a football field.  Like any other monetary unit, gold is just a unit of measure, except it's also one that's highly portable, durable, and cannot be counterfeited.

Patrick, your calculator may need recharged - the amount of gold does matter.  Gold is measured in value every day, today it was around $1,000/Oz.  If the U.S. Treasury really has 3,100 tonnes of gold, it would be worth around $99 billion.  The numbers and value are finite and easy to measure, the problem is the measurement comes up short - by over 99%.

How can $99 billion dollars worth of gold back up a $15 trillion M3?

Larry 

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Re: Question on a gold standard fallacy!

Flip your perceptions....

In 1900, one ounce of gold could buy $20 US

Today it can buy $1000 US

Any reason it cannot buy $10,000 in the future ??

The reason it could only buy $20 back then and $1000 now could be viewed as a simple supply and demand issue.

Massive supply causes a fall in price.......

 

You say "The numbers and value are finite and easy to measure, the problem is the measurement comes up short - by over 99%"

But numbers are also infinitely divisible.

Imagine a currency called  grams.

Your  balance on your credit card might read 120 g one day.

You can then you buy a cup of coffee for .086 g

Then you could go to the bank and demand a 100g bar of gold, leaving 19.914g in your account.

 

Cheers Hamish

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Re: Question on a gold standard fallacy!

gyrogearloose wrote:

In 1900, one ounce of gold could buy $20 US...Today it can buy $1000 US...Any reason it cannot buy $10,000 in the future ??

Hello Hamish, yes I agree, the price of gold may well be $10,000/Oz. in the future.  But if we switched to a gold standard today, with 3,100 tonnes of gold, we would have some $99 billion worth of gold (market price $1,000/Oz.).  I think we can agree that the M3 (amount of money) is around $15 trillion (see my post #3).  If this is so,  then by pegging the dollar to the market price of gold, we would essentially be devaluing the dollar by 99%.

During great depression (1930's) the dollar was instantly devalued by around 40% because we didn't have enough gold.  And, in comparison, we have even less gold to money, as a ratio, than ever before.  

Isn't this a mathematical issue rather than one of theory?

Larry

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Re: Question on a gold standard fallacy!
DrKrbyLuv wrote:

During great depression (1930's) the dollar was instantly devalued by around 40% because we didn't have enough gold. 

Again, flip you perception.

It used to be that for every $20 note there was 1 oz of gold.  After all the $20 note was nothing more than a recept for the deposit of 1 oz of gold in a bank, and had written on it  "may be exchanged for one ounce of gold"

But in 1933 there was a run on gold ( first in Britian, and when they "closed the gold window" it moved to the USA ), because the equivalent of CM followers worked out that the government had committed a MASSIVE fraud and there were many more $20 notes than there was gold, quite simply because they had printed them and used them without taking an oz of gold in exchange. These CM type people wanted to get as much gold at the old value before the govt did the inevitable.

So yes, the dollar was "instantly devalued by 40% ", but what was it devalued in relation to ? a meal? a car ? a gallon of gas??

No, gold.

Why?  Because there was a massive oversuply of FRN's

 

Think of today, people are concerned that the fed is printing FRN's, so what do they do?

Buy commodities with the ones they have before the flood of FRN's  renders them worth less or worthless.......

So it was not that they did not have enough FRN's, it was because they had TOO MANY FRN's in relation to gold.

And today we have many more times that already to high a number of FRN's

 

As a child I could buy an ice block for 5 cents, and individual sweets were priced at a number of sweets per 1c.

Today  1, 2 and 5 cent pieces are no longer in circulation because they are worth so little. ( and ice blocks cost $1.50 )

These days we have more than 20 times the amount of money, but we certainaly are not 20 times richer.

 

Cheers Hamish

 

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Re: Question on a gold standard fallacy!
DrKrbyLuv wrote:

Farmer Brown wrote:

Essentially, any amount of gold or any other commodity will work.  The common argument that "there isn't enough" is equivalent to saying there aren't enough inches to measure a football field.  Like any other monetary unit, gold is just a unit of measure, except it's also one that's highly portable, durable, and cannot be counterfeited.

Patrick, your calculator may need recharged - the amount of gold does matter.  Gold is measured in value every day, today it was around $1,000/Oz.  If the U.S. Treasury really has 3,100 tonnes of gold, it would be worth around $99 billion.  The numbers and value are finite and easy to measure, the problem is the measurement comes up short - by over 99%.

How can $99 billion dollars worth of gold back up a $15 trillion M3?

Larry 

Larry,

M3 includes bank reserves and other fractional-reserve-banking components that would not exist on a true gold standard does it not?  Secondly, the $ amount that gold is valued at today is not dependent on it being used as money.  If gold was declared to be lawful currency tomorrow - even if just at the spot price, the value would soar.  Thirdly, how can you even value gold, a hard asset, in pieces of paper that have no value whatsoever?  You talk of the quantities of dollars out there as if it were real money, when it's just a con-game going on its 39th year that will meet the same fate of the 3,000 sham currencies before it.  I have no problem imagining gold at $10K or $50K or $100K because I do not see any limits on the foolishness of US or other leaders in the world.

 

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Re: Question on a gold standard fallacy!
DrKrbyLuv wrote:


How can $99 billion dollars worth of gold back up a $15 trillion M3?

Larry 

Simple. Devalue the dollar. Is that not where we are headed?

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Re: Question on a gold standard fallacy!

The Case for a 100 Percent Gold Dollar by Murray N. Rothbard

Objections to 100 Percent Gold

Certain standard objections have been raised against 100 percent banking and against 100 percent gold currency in particular. One generally accepted argument against any form of 100 percent banking I find particularly and strikingly curious: that under 100 percent reserves, banks would not be able to continue profitably in business. I see no reason why banks should not be able to charge their customers for their services, as do all other useful businesses. This argument points to the supposedly enormous benefits of banking; if these benefits were really so powerful, then surely the consumers would be willing to pay a service charge for them, just as they pay for traveler’s checks now. If they were not willing to pay the costs of the banking business as they pay the costs of all other industries useful to them, then that would demonstrate the advantages of banking to have been highly overrated. At any rate, there is no reason why banking should not take its chance in the free market with every other industry.

The major objection against 100 percent gold is that this would allegedly leave the economy with an inadequate money supply. Some economists advocate a secular increase of the supply of money in accordance with some criterion: population growth, growth of volume of trade, and the like; others wish the money supply to be adjusted to provide a stable and fixed price level. In both cases, of course, the adjusting and manipulating could only be done by government. These economists have not fully absorbed the great monetary lesson of classical economics: that the supply of money essentially does not matter. Money performs its function by being a medium of exchange; any change in its supply, therefore, will simply adjust itself in the purchasing power of the money unit, that is, in the amount of other goods that money will be able to buy. An increase in the supply of money means merely that more units of money are doing the social work of exchange and therefore that the purchasing power of each unit will decline. Because of this adjustment, money, in contrast to all other useful commodities employed in production or consumption, does not confer a social benefit when its supply increases. The only reason that increased gold mining is useful, in fact, is that the large supply of gold will satisfy more of the non--monetary uses of the gold commodity.

There is therefore never any need for a larger supply of money (aside from the non-monetary uses of gold or silver). An increased supply of money can only benefit one set of people at the expense of another set, and, as we have seen, that is precisely what happens when government or the banks inflate the money supply. And that is precisely what my proposed reform is designed to eliminate. There can, incidentally, never be an actual monetary “shortage,” since the very fact that the market has established and continues to use gold or silver as a monetary commodity shows that enough of it exists to be useful as a medium of exchange.

The number of people, the volume of trade, and all other alleged criteria are therefore merely arbitrary and irrelevant with respect to the supply of money. And as for the ideal of the stable price level, apart from the grave flaws of deciding on a proper index, there are two points that are generally overlooked. In the first place, the very ideal of a stable price level is open to challenge. Hoarding, as we have indicated, is always attacked; and yet it is the freely expressed and desired action on the market. People often wish to increase the real value of their cash balances, or to raise the purchasing power of each dollar. There are many reasons why they might wish to do so. Why should they not have this right, as they have other rights on the free market? And yet only by their “hoarding” taking effect through lower prices can they bring about this result. Only by demanding more cash balances and thus lowering prices can the dollars assume a higher real value. I see no reason why government manipulators should be able to deprive the

consuming public of this right. Second, if people really had an overwhelming desire for a stable price level, they would negotiate all their contracts in some agreed-upon price index. The fact that such a voluntary “tabular standard” has rarely been adopted is an apt enough commentary on those stable-price-level enthusiasts who would impose their ambitions by government coercion.

Money, it is often said, should function as a yardstick, and therefore its value should be stabilized and fixed. Not its value, however, but its weight should be eternally fixed, as are all other weights. Its value, like all other values, should be left to the judgment, estimation and ultimate decision of every individual consumer

---------------------------------------------------------------------------------

Depending on how we define the money supply—and I would define it very broadly as all claims to dollars at fixed par value—a rise in the gold price sufficient to bring the gold stock to 100 percent of total dollars would require a ten- to twentyfold increase, This of course would bring an enormous windfall gain to the gold miners, but this does not concern us. I do not believe that we should refuse an offer of a mass entry into Heaven simply because the manufacturers of harps and angels’ wings would enjoy a windfall gain. But certainly a matter for genuine concern would be the enormous impetus such a change would give for several years to the mining of gold, as well as the disruption it would cause in the pattern of international trade.

http://mises.org/story/1829#CASE

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Re: Question on a gold standard fallacy!

Austrian and Keynesian economics are based on theories that are fundamentally flawed.  In the case of the gold standard theory, it is easily debunked with mathematics.

Post #12 above explains Rothbards logic:

The major objection against 100 percent gold is that this would allegedly leave the economy with an inadequate money supply...These economists have not fully absorbed the great monetary lesson of classical economics: that the supply of money essentially does not matter.

Murray Rothbard claimed in his book "What Has Government Done to Our Money?  basically said the same thing:

We come to the startling truth that it doesn't matter what the supply of money is.  Any supply will do as well as any other supply.  The free market will simply adjust by changing the purchasing power, or effectiveness, of it's monetary unit.

Milton Friedman explained that Rothbard's theory was proven incorrect during the great depression:

And what happened is that [the Federal Reserve] followed policies which led to a decline in the quantity of money by a third. For every $100 in paper money, in deposits, in cash, in currency, in existence in 1929, by the time you got to 1933 there was only about $65, $66 left. And that extraordinary collapse in the banking system, with about a third of the banks failing from beginning to end, with millions of people having their savings essentially washed out, that decline was utterly unnecessary.

Friedman was right, the quantity of money is important and most economists agreed which helped give rise to Keynesian economics. Rothbards theory was proven wrong as the depression taught us that a significant contraction in the money supply leads to a depression or worse.  Rothbard's theory was throw out the window, by the early 40's the Keynesians were the dominant theory for economics.

Rothbard's flawed theory is basically what the Austrians argue in support of the gold standard.  The "gold standard" wasn't dropped because it became unpopular, it was dropped because it failed in the U.S. in 1933 and through most of Europe and Great Britain in 1930-1931.  It failed everywhere it was applied because there has never been enough gold (at least through the past 300 years).

The reality is that we have around $15 trillion dollars out there (M3) how would that be handled?  If we go to a 100% gold backed currency as prescribed by Rothbard, we will devalue every dollar just as we did in 1933 when the dollar was abruptly reduced 40%.  Only this time it will be much worse; we have a lot less gold than then and much more money.  If we only have $99 billion dollars in gold, the dollar would be devalued by 99% (see my Post #3 for the math).

In closing, I suggest you do the math and trust your own judgment over a controversial theory

Here are some other arguments against the gold standard:

Larry

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Re: Question on a gold standard fallacy!

Tycer wrote:

How can $99 billion dollars worth of gold back up a $15 trillion M3? - Simple. Devalue the dollar. Is that not where we are headed?

Yup, agreed.  And if we go back to the gold standard; the devaluation will be sudden and severe.  The "reset" would make the great depression look like a period of economic boom.

Larry

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Re: Question on a gold standard fallacy!

I am not 100% convinced that Rothbard is correct, nor do I see anyway to get from here to there, but I don't think you can say that the Great Depression proved him wrong.  The gold standard that Rothbard is in favor of would eliminate central banks and fractional reserve banking which he considered to be fraud.  That is certainly not the gold reserve system that we were living under in the 1930's.

My gut feeling is that if there was a way to get from the current system to a Rothbardian 100% gold standard, it would probably work.  I just don't see how to get from point A to point B short of a violent revolution which is far more likely to result in Authoritarian government than Libertarian government.

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Re: Question on a gold standard fallacy!
DrKrbyLuv wrote:

 

And what happened is that [the Federal Reserve] followed policies which led to a decline in the quantity of money by a third. For every $100 in paper money, in deposits, in cash, in currency, in existence in 1929, by the time you got to 1933 there was only about $65, $66 left. And that extraordinary collapse in the banking system, with about a third of the banks failing from beginning to end, with millions of people having their savings essentially washed out, that decline was utterly unnecessary.

Friedman was right, the quantity of money is important and most economists agreed which helped give rise to Keynesian economics. Rothbards theory was proven wrong as the depression taught us that a significant contraction in the money supply leads to a depression or worse.  Rothbard's theory was throw out the window, by the early 40's the Keynesians were the dominant theory for economics.

Rothbard's flawed theory is basically what the Austrians argue in support of the gold standard.  The "gold standard" wasn't dropped because it became unpopular, it was dropped because it failed in the U.S. in 1933 and through most of Europe and Great Britain in 1930-1931.  It failed everywhere it was applied because there has never been enough gold (at least through the past 300 years).

But what had happened the run up to 1929?

The fed had floodded the economy with cheap money and credit. Ever consider that that may have been the cause of the crash.

Oops, what is the cause of this crash,?? the fed pumping money and credit into the economy......

 

The gold standard was "dropped" because the government had been caught with their pants down printing more notes than they had gold to back them.

 

Please explain how there is not enough gold, without relating it to "dollars"( because what is a "dollar" but an arbitary unit with an arbitary value.)

 

Every "flaw" that the fed supporters claim for gold as money I see as a virtue.

 

Cheers Hamish

 

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