Monday, November 5, 2012

Auburn v Harvard

The topic is evolution.

Excerpts from The "Costs" of a Gold Standard by Roger W. Garrison, from The Gold Standard: An Austrian Perspective:
The term "gold standard" in the present paper is used to denote the outcome of a market process. Using the term in this way serves to consolidate at least three propositions—based on both economic theory and historical insight—about the nature of markets and about the nature of money. (1) Left to its own devices, a market economy will give rise to medium of exchange. (2) The commodity that emerges as the medium of exchange will be one that possesses a certain set of characteristics. (3) This set of characteristics has its clearest and most pronounced manifestation in gold.

Market-oriented economists adopt a third view of the gold standard—one that differs from the views of both the market participant and the layperson pondering the gold question. The economists see the difficulties—and costs—of replacing an evolved custom with a designed system.

The proponents of gold are not suggesting that irresponsible tinkering is inevitable—whatever the nature of the monetary system; they are instead making the sharp distinction between a designed institution and an evolved institution.

From Macroeconomics, fourth edition (2000) by N. Gregory Mankiw; Chapter 7, pp.157-158:
How Fiat Money Evolves

To understand how the evolution from commodity money to fiat money takes place, imagine an economy in which people carry around bags of gold. When a purchase is made, the buyer measures out the appropriate amount of gold. If the seller is convinced that the weight and purity of the gold are right, the buyer and seller make the exchange.

The government might first get involved in the monetary system to help people reduce transaction costs. Using raw gold as money is costly because it takes time to verify the purity of the gold and to measure the correct quantity. To reduce these costs, the government can mint gold coins of known purity and weight. The coins are easier to use than gold bullion because their values are widely recognized.

The next step is for the government to accept gold from the public in exchange for gold certificates -- pieces of paper that can be redeemed for a certain quantity of gold. If people believe the government's promise to redeem the paper bills for gold, the bills are just as valuable as the gold itself. In addition, because the bills are lighter than gold (and gold coins), they are easier to use in transactions. Eventually, no one carries gold around at all, and these gold-backed government bills become the monetary standard.

Finally, the gold backing becomes irrelevant. If no one ever bothers to redeem the bills for gold, no one cares if the option is abandoned. As long as everyone continues to accept the paper bills in exchange, they will have value and serve as money. Thus, the system of commodity money evolves into a system of fiat money. Notice that in the end, the use of money in exchange is largely a social convention, in the sense that everyone values fiat money simply because they expect everyone else to value it.

Garrison's explanation seems to depend on our ability to identify the designers. If we can identify the designers, he suggests, the institution did not evolve.

Mankiw's explanation gets weaker, the farther you get into it. But he has one thing right: The change from commodity money to fiat money is part of the evolution. This he has right, and Garrison has wrong.

No comments: