Questions about the Gold Standard

[uberliber]

First of all, I am referring to a 100% reserve banking system and no central bank whatsoever.

1) Would the value of gold be subject to inflation/deflation just like paper money? Pretend that the supply of gold remains the same, yet the amount of goods and services in the economy increase. The value of each unit of money would increase right?

2) Would there be a spiral with hoarding? If the value of gold kept going up, would people just keep holding more money since it is all increasing in value? Or perhaps this would cause a decrease in demand and the money would start losing value correcting itself.

3) With the supply of gold remaining the same, wouldn't it be impossible to issue receipts for gold which can be used as money since the value of gold is constantly varying? I am referring to the case where every receipt is a certain weight of gold.

I'm just reading Rothbard's book on the gold standard, and I'm trying to figure out some things. Help would be greatly appreciated.

[joel]

1) Would the value of gold be subject to inflation/deflation just like paper money? Pretend that the supply of gold remains the same, yet the amount of goods and services in the economy increase. The value of each unit of money would increase right?

Not just like paper money. It's supply is much more limited than the production of paper tickets. Yes, prices would likely decline slowly over time as production capacity increases. This is what one would expect when the general standard of living increases.

But it depends on people's demand for money too. If everybody sought to maintain a cash balance equivalent to one months living expenses (for example) then (given a fixed population size) prices (of living expenses) would likely remain relatively stable, even in the presence of increased production capacity.

2) Would there be a spiral with hoarding? If the value of gold kept going up, would people just keep holding more money since it is all increasing in value? Or perhaps this would cause a decrease in demand and the money would start losing value correcting itself.

The slow decline I mentioned above would not be a general decline of all prices simultaneously. It would happen here and there. For example, with electronics today we see a general decline in prices, but it happens because of particular increases in productivity and technology.

It could also happen that as the purchasing power of people's cash balances becomes larger, people seek to reduce their cash balances over time, which counteracts the decline in prices.

People don't hold on to their money forever in the face of falling prices. Money forever remains a medium of indirect exchange. People hold it only because they intend to exchange it for something else in the future. Suppose the economy experienced a steady small percent price decline and all signs indicate that it will continue at a steady rate indefinitely. People might delay purchases more than otherwise, but will eventually make purchases (as opposed to holding the cash forever).

Plus people will always save only a portion of their income.

Furthermore, if people wish to delay purchases for a lengthy period of time, they will probably lend the cash at interest (to someone who wants to make purchases now) in the meantime.

3) With the supply of gold remaining the same, wouldn't it be impossible to issue receipts for gold which can be used as money since the value of gold is constantly varying? I am referring to the case where every receipt is a certain weight of gold.

You're talking about warehouse receipts, right? Why should it be any different than warehousing any other good? As for their use as money, people will do so if they want. Most likely people will accept receipts only for warehouses they trust.

I'm just reading Rothbard's book on the gold standard, and I'm trying to figure out some things. Help would be greatly appreciated.

I haven't read that book of Rothbard's. But I have read a couple other books where he discusses commodity money. I can also point you to some good passages by Mises on money, money substitutes, and the gold standard.

[uberliber]

I haven't read that book of Rothbard's. But I have read a couple other books where he discusses commodity money. I can also point you to some good passages by Mises on money, money substitutes, and the gold standard.

Thanks for all the help. You answered all my concerns. But yea, it's a good (and short) book. If you are interested, I suggest getting the book "What has government done to our money" by Rothbard, because it's that book plus the case for 100% gold dollar. It comes right with it and it's only like $17 on mises.org.

But yea, could you show me those passages? I just bought "Theory of Money and Credit" by Mises, but I'm really struggling to grasp some of the concepts. I'm too spoiled from reading Rothbard. He is much less confusing and uses lots of analogies so that simple people like me can understand.

[joel]

For Mises, you could start in Human Action, chapter XVII "Indirect Exchange"
http://mises.org/resources/3250
You might also look at the study guide for that chapter (there's a link to it on that page).
Not all the sections of that chapter are directly related to your questions. Some sections, for example, explore the effects of foreign trade.

But yeah, Mises and Rothbard sure had different styles of writing.

[joel]

I had some more thoughts on the supposed spiral due to hoarding, and its supposed effects on demand. I posted them in another thread: http://www.theologyweb.com/campus/sh...5&postcount=15

You might also check out this article http://mises.org/story/2492 if you are interested.

"Keynes's diminution, the leakage, the excess of savings over investment, is income spent on, or added to, cash hoardings. But such an increase in the demand for cash has no effect on real income, consumption, or investment, as has already been explained. With the social money stock being given, a general increase in the demand for cash can only bid down the money prices of non-money goods. But so what?

"Nominal income, that is, income in terms of money, will fall; but real income and the real consumption/investment proportion will be unchanged. And people, along the way, get what they want, that is, an increase in the real value of their cash balances and in the purchasing power of the money unit.

"There is nothing stagnating here, or draining, or leaking"

[uberliber]

I had some more thoughts on the supposed spiral due to hoarding, and its supposed effects on demand. I posted them in another thread: http://www.theologyweb.com/campus/sh...5&postcount=15

You might also check out this article http://mises.org/story/2492 if you are interested.

"Keynes's diminution, the leakage, the excess of savings over investment, is income spent on, or added to, cash hoardings. But such an increase in the demand for cash has no effect on real income, consumption, or investment, as has already been explained. With the social money stock being given, a general increase in the demand for cash can only bid down the money prices of non-money goods. But so what?

"Nominal income, that is, income in terms of money, will fall; but real income and the real consumption/investment proportion will be unchanged. And people, along the way, get what they want, that is, an increase in the real value of their cash balances and in the purchasing power of the money unit.

"There is nothing stagnating here, or draining, or leaking"

Hmm.....I guess when I was thinking of hoarding, I was assuming the money was taken out of circulation completely. But instead, I bet it would be put in the bank, adding to savings and investment. Also, with more money in bank reserves, the interest rates would be lowered, not artificially, because the time preference would show that people want to save NOW and spend LATER. So it would be a good time for investment in the PRESENT.

So the interest rates would fall, but not because of distortion by the FED, but because of the time preference of the people. That way, the investments would be correct, and by the time people want to spend, the investments will mean demand is ready to be met because of the correct prediction of time preference.

This means since investment increased, the deflation would either stop or it would slow down at least, making people see that hoarding is no longer profitable. But if that's the case, people's time preference will change again, and they may want to spend now.

But still, what I just said assumes that a FED is not fixing the interest rates. It also assumes fractional reserve banking is still the system. It seems that hoarding would be a much bigger problem in a 100% reserve banking system. That's because the money people store in the bank would be in the bank, but usable for loans. So the interest rates would be irrelevant to the amount of reserves.

Perhaps the investment would take place because of the lack of spending, not the lowering of the interest rates. Maybe hoarding would just be a sign for businesses to invest.

I don't know, what do you think?

[joel]

Hmm.....I guess when I was thinking of hoarding, I was assuming the money was taken out of circulation completely. But instead, I bet it would be put in the bank, adding to savings and investment. Also, with more money in bank reserves, the interest rates would be lowered, not artificially, because the time preference would show that people want to save NOW and spend LATER. So it would be a good time for investment in the PRESENT.

So the interest rates would fall, but not because of distortion by the FED, but because of the time preference of the people. That way, the investments would be correct, and by the time people want to spend, the investments will mean demand is ready to be met because of the correct prediction of time preference.

This sounds right--in the absence of fractional reserve banking. With fractional reserve banking, if you take a dollar out of your cash holdings and deposit it at the bank, then you've increased bank reserves, so the banks are likely to expand credit and multiply that dollar into, say, 10 dollars, and the interest rates will tend to be (temporarily) pushed below what time preference would determine.

This means since investment increased, the deflation would either stop or it would slow down at least, making people see that hoarding is no longer profitable. But if that's the case, people's time preference will change again, and they may want to spend now.

One distinction that is useful to keep in mind is the distinction between time preference and the demand for money.

A person can do 3 things with their money: spend money on consumption, spend it on investment, or hold it as physical cash. Cash balances comprise the demand for money. Time preference determines the ratio between investment and consumption spending. Time preference does necessarily not impact cash holdings, and cash holdings does not necessarily impact time preference or investing.

When people seek to hold larger cash balances this means the demand for money has increased. This causes the purchasing power of money to increase (for a given money supply), including the money spent on consumption and investment. For this reason, increasing cash balances ('hoarding') does not reduce the amount of real consumption/investment spending.

Change in demand for money also does not necessarily affect interest rates because the demand for money can change independently of time preference. The increasing of cash balances can come out of nominal consumption spending, or investment spending or both. If time preference did not change then it will come out of both in the same proportion so that the ratio of the two remains unchanged. Thus a change in the demand for money alone does not affect interest rates.

Likewise time preference (and thus the investment/consumption ratio and thus interest rates) can change without people desiring to change their amount of cash holdings.

This directly contradicts Keynes who claimed that interest rates are directly related to the demand for money (aka 'liquidity preference').

So, in response to what you said, suppose that people were holding larger cash balances because they anticipated falling prices. And then the price-fall slows or stops, causing the demand for money to drop. This does not affect interest rates or time preference because this additional spending out of their cash balances will be divided between investment and consumption according to time preference. There's no reason it would all be spent on consumption unless time preference independently changed at the same time.

And, yes, I think you are right that a change in time preference (shifting from consumption to investment) would not cause prices to fall (and thus would not exacerbate price-deflation), but would cause interest rates to fall. But if I anticpate price deflation, that would not cause people to delay purchasing consumption goods and instead buy shares of, say, IBM, because they would expect deflation to affect the price of both. It would also not cause them to shift from consumption to lending (e.g., to a bank) because the very same anticipation of falling prices will cause nominal interest rates to fall, in the same way that expectation of rising prices will cause nominal interest rates to be higher (Mises refers to this part of nominal interest rates as the "price premium."). Interest rates will be discounted to take into account the fact that the debt will be paid back with dollars that are worth more, so people won't expect to benefit from falling prices by lending, and thus the incentives to consume/invest remain unchanged. So expectation of falling prices does not affect time preference. But it does affect the demand for money.

Does this make sense to you?

It seems that hoarding would be a much bigger problem in a 100% reserve banking system.

Maybe, maybe not. People would still lend to banks (e.g. in the form of CDs that you can't demand redemption for until they mature). And the bank would invest those funds. CDs would likely become used much more than they are today. And people would still buy bonds.

But even if it is true that if we abolished fractional reserve banking all the portions of wealth people hold in demand deposits would instead be held in 100% reserve deposits (which will bear no interest and may even be charged a fee), it is not clear that this would be a problem.

[uberliber]

Yup, I think that all makes sense. I learned about the Theory of Liquidity Preference a while back, but I don't remember it now. All I remember is that I don't understand it. Is there any way you could explain it to me...and why it's wrong?

Also, I just got "Man, Economy, and State" by Rothbard, so that's why I haven't been on. I've been a little busy with that beast.

[joel]

Yup, I think that all makes sense. I learned about the Theory of Liquidity Preference a while back, but I don't remember it now. All I remember is that I don't understand it. Is there any way you could explain it to me...and why it's wrong?

Also, I just got "Man, Economy, and State" by Rothbard, so that's why I haven't been on. I've been a little busy with that beast.

So, as we said, you can do 3 things with your money:

1. spend it on consumption
2. hold on to it
3. spend it on investment (e.g, lend it)

Now, Keynes thought that people did this based on two decisions:

• First people divide their income between 1 on the one hand and 2/3 on the other. That is, they decide how much they want to consume and 'save'.
• Then people divide their savings between 2 & 3.

Keynes furthermore believed that the ratio between 2 & 3 is directly connected with interest rates, and that 1 has nothing to do with interest rates. This is in opposition to Austrians, for example, who argue that the 2-3 ratio is irrelevant, and instead the ratio between 1 & 3 is the cause of interest rates. The reasoning for Keynes was that people prefer to hold their savings in a liquid (cash ) form--they have a preference for liquidity (over illiquidity) regarding their savings. But people can be persuaded to part with their liquidity (their cash holdings) by paying them interest. The stronger the liquidity preference, the higher the interest required to get them to part with liquidity, and vice versa. Or looking at it the other way, given the interest rates, the liquidity preference determines cash holdings. So liquidity preference, cash holdings, and the demand for money, are all the same thing.

One way Mises refutes Keynes at this point is by considering the theoretical state of equilibrium (or evenly rotating economy). In the state of equilibrium, there is no need for money, and money disappears and thus 2 (cash holdings) becomes zero. In Keynes' theory, this would mean that liquidity preference is zero, and therefore interest rates would be zero. But Mises also shows that there would still be positive interest rates in the state of equilibrium because people still prefer immediate consumption goods to future consumption goods. Thus interest is a real phenomenon, not a monetary one, as Keynes supposed.

Another way to look at it: People hold cash because of uncertainty. So some of the cash holdings is due to uncertainty regarding lending/investing. But also some of the cash holding is due to uncertainty regarding consumption; I don't know at the first of the month (or week or year or whatever) exactly what I will want or need (or be able) to acquire for consumption that month, so I keep a buffer of extra cash. Thus, not all of my level of cash holding has to do with interest rates.

So, given Keynes' assumptions, you have supply and demand curves on a chart where the x axis is quantity of money and the vertical axis is the 'price' of money--i.e.,interest rates. The demand for money is therefore a downward sloping curve, and the money supply at any point in time is a constant--a vertical line. Where these cross determines the equilibrium interest rate.

An Austrian would be quick to point out (besides the above objections) that the 'price' of money is obviously not interest rates but the purchasing power of money. The appropriate supply/demand chart here is where the vertical axis is the purchasing power of money. Where the demand and (vertical) supply of money curves intersect would be the equilibrium purchasing power of money.As Hoppe pointed out:

"'Interest,' writes Keynes, 'is the reward of not-hoarding, the reward for parting with liquidity', which makes liquidity preference in turn the unwillingness to invest in interest-bearing assets. That this is false becomes obvious as soon as one asks the question, 'What, then, about prices?' The quantity of beer, for instance, that can be bought for a definite sum of money is obviously no less a reward for parting with liquidity than is the interest rate, thus making the demand for money an unwillingness to buy beer as much as an unwillingness to lend or invest."
http://mises.org/story/2492

It looks like Rothbard discusses Keynes' liquidity preference in chapter 11 of "Man, Economy, and State".

[joel]

Since writing the last post, I read chapter 6 and the section in chapter 11 of Man, Economy, and State. I also started reading Keynes' General Theory so that I could hear what he had to say for himself instead of relying upon what other people said Keynes said, as I had done until now. I am now a bit past Keynes' chapter 13 "The General Theory of the Rate of Interest" and I believe I can answer your question much more succinctly. Keynes summed up the theory as follows:

"Thus the rate of interest at any time, being the reward for parting with liquidity, is a measure of the unwillingness of those who possess money to part with their liquid control over it."
http://www.marxists.org/reference/su...eneral-theory/
(in chapter 13)

This is easily seen to be false on two accounts:

First, the rate of interest is certainly not the only reward for parting with liquidity. Purchasing and drinking a coke sacrifices liquidity. Thus enjoying consumption too is a reward of parting with liquidity.

Secondly, insofar as one decides to fund one's lending by refraining from consumption (as opposed to decreasing one's cash balances) then there is interest paid without a "parting with liquidity", but as a reward for not consuming. (For example, if I was going to purchase and drink a coke, and instead I decide to lend the money, then I was going to part with liquidity either way. At best we might say that interest was the reward for parting with liquidity in one way rather than another, not the reward for parting with liquidity itself.)

So, there are rewards to parting with liquidity without interest, and there is interest without a net 'parting with liquidity'. Therefore the two are certainly not equal.


Some other of Keynes' mistakes in this chapter are also addressed in my previous post. There is one other major mistake he makes here that we haven't addressed in this thread. Keynes recognizes that "there are forces causing the rate investment to rise or fall so as to keep the marginal efficiency of capital equal to the rate of interest." In other words, the interest rate on business loans tends to be equal to the rate of business investment returns. Rothbard points this out in his chapter 6, and even includes both under the term "interest." But what Keynes does here is to suppose that the returns due to business enterprises tends to adjust themselves toward the prevailing interest rate, while the interest rate remains fixed (or rather, that it is determined by something else). That is, when considering these two things, Keynes supposes that the former is dependent on the latter, and the latter is independent of the former. But this is easily seen to be false. For example, if the expected return on a company's bonds is lower than the return on its stock, then investors can shift from the bonds to the stock. This does not merely reduce the expected rate of return on the stock, it also causes the price of the bonds to fall. That is, it causes the rate of return (the interest) on the bonds to increase. Thus it is not true that one of the rates merely adjusts toward the other while the other is determined by independent causes. The two both move toward each other. This alone is sufficient to show that Keynes' attempt to discover the independent cause (liquidity preference, he thought) was misguided from the beginning.