Saturday, January 30, 2016

Monetary imbalance arises equally for fiat and for gold

David Glasner, commenting on an op-ed piece by Eric Rauchway:
... I stopped nodding my head in agreement with Rauchway when I reached the fifth paragraph of his piece.

Under a gold standard, the amount of gold a nation holds in bank vaults determines how much of its money circulates. If a nation’s gold stock increases through trade, for example, the country issues more currency. Likewise, if its gold stock decreases, it issues less.

Oh dear! Rauchway, like so many others, gets the gold standard all wrong ...

The gold standard operates by fixing the price of currency at a certain value in terms of gold .... The amount of currency under a gold standard is therefore whatever quantity of currency is demanded at the fixed price. That is very different from saying that a gold standard operates by placing a limit on the amount of currency that can be created.

There's more. I'm leaving out stuff about Ted Cruz and stuff about reserve requirements and interest rates in the gold standard era. Good stuff. But the point I want to focus on right now is this: The gold standard did not limit the quantity of currency. That seems to be what David Glasner said.

I was wondering how the quantity of currency could increase beyond the limits set (or not set) by gold. Wondering what it means, that the amount of currency might be "whatever quantity of currency is demanded at the fixed price." I just don't see people lining up to pay an ounce of gold to get $35 of paper. I just don't see it. But then it struck me.

In those days it worked pretty much like it was working for us, while our economy was still working. You'd go to the bank and take out a loan and get some paper money and have money to spend. You didn't pay an ounce of gold for each $35 you got. You just took out a loan.

In the days of the gold standard, the money authority was not able to create base money on demand. These days the money authority can create base money on demand -- "from nothing", as people like to say. That's one difference between then and now.

But that difference is small, I think, compared to this one similarity: In both cases, then and now, it is the money created by borrowing, growing until it gets unsustainably large compared to the monetary base, that is the source of the troubles.