Experts and the Gold Standard

commodity money, fiat money, fed, gold standard, experts, economist
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commodity money, fiat money, fed, gold standard, experts, economistMany mainstream economists, perhaps a majority of those who have an opinion, are opposed to tying a central bank’s hands with any explicit monetary rule. A clear majority oppose the gold standard, at least according to an often-cited survey. Why is that?

First some preliminaries. By a “gold standard” I mean a monetary system in which gold is the basic money. So many grains of gold define the unit of account (e.g. the dollar) and gold coins or bullion serve as the medium of redemption for paper currency and deposits. By an “automatic” or “classical” gold standard I mean one in which there is no significant central-bank interference with the functioning of the market production and arbitrage mechanisms that equilibrate the stock of monetary gold with the demand to hold monetary gold. The United States was part of an international classical gold standard between 1879 (the year that the dollar’s redeemability in gold finally resumed following its suspension during the Civil War) and 1914 (the First World War).

Why isn’t the gold standard more popular with current-day economists? Milton Friedman once hypothesized that monetary economists are loath to criticize central banks because central banks are by far their largest employer. Providing some evidence for the hypothesis, I have elsewhere suggested that career incentives give monetary economists a status-quo bias. Most understandably focus their expertise on serving the current regime and disregard alternative regimes that would dispense with their services. They face negative payoffs to considering whether the current regime is the best monetary regime.

Here I want to propose an alternative hypothesis, which complements rather than replaces the employment-incentive hypothesis. I propose that many mainstream economists today instinctively oppose the idea of the self-regulating gold standard because they have been trained as social engineers. They consider the aim of scientific economics, as of engineering, to be prediction and control of phenomena (not just explanation). They are experts, and an automatically self-governing gold standard does not make use of their expertise. They prefer a regime that values them. They avert their eyes from the possibility that they are trying to optimize a Ptolemaic system, and so prefer not to study its alternatives.

The actual track record of the classical gold standard is superior in major respects to that of the modern fiat-money alternative. Compared to fiat standards, classical gold standards kept inflation lower (indeed near zero), made the price level more predictable (deepening financial markets), involved lower gold-extraction costs (when we count the gold extracted to provide coins and bullion to private hedgers under fiat standards), and provided stronger fiscal discipline. The classical gold standard regime in the US (1879-1914), despite a weak banking system, did no worse on cyclical stability, unemployment, or real growth.

The classical gold standard’s near-zero secular inflation rate was not an accident. It was the systemic result of the slow growth of the monetary gold stock. Hugh Rockoff (1984, p. 621) found that between 1839 and 1929 the annual gold mining output (averaged by decade) ran between 1.07 and 3.79 percent of the existing stock, with the one exception of the 1849-59 decade (6.39 percent growth under the impact of Californian and Australian discoveries). Furthermore, an occasion of high demand for gold (for example a large country joining the international gold standard), by raising the purchasing power of gold, would stimulate gold production and thereby bring the purchasing power back to its flat trend over the longer term.

A recent example of a poorly grounded historical critique is provided by textbook authors Stephen Cecchetti and Kermit Schoenholtz. They imagine that the gold standard determined money growth and inflation in the US until 1933, and so they count against the gold standard the US inflation rate in excess of 20% during the First World War (specifically 1917), followed by deflation in excess of 10% a few years later (1921). These rates were actually produced by the policies of the Federal Reserve System, which began operations in 1914. The classical gold standard had ended during the Great War, abandoned by all the European combatants, and did not constrain the Fed in these years. Cecchetti and Schoenholtz are thus mistaken in condemning “the gold standard” for producing a highly volatile inflation rate. (They do find, but do not emphasize, that average inflation was much lower and real growth slightly higher under gold.) They also mistakenly blame “the gold standard” — not the Federal Reserve policies that prevailed, nor the regulatory restrictions responsible for the weak state of the US banking system — for the US banking panics of 1930, 1931, and 1933. Studies of the Fed’s balance sheet and activities during the 1930s have found that it had plenty of gold (Bordo, Choudhri and Schwartz, 1999; Hsieh and Romer, 2006, Timberlake 2008). The “tight” monetary policies it pursued were not forced on it by lack of more abundant gold reserves.

There are of course serious economic historians who have done valuable research on the performance of the classical gold standard and yet remain critics. Their main lines of criticism are two. First, they too lump the classical gold standard together with the very different interwar period and mistakenly attribute the chaos of the interwar period to the gold standard mechanisms that remained, rather than to central bank interference with those mechanisms. In rebuttal Richard Timberlake has pertinently asked how, if it was the mechanisms of the gold standard (and not central banks’ attempts to manage them) that destabilized the world economy during the interwar period, those same mechanisms managed to maintain stability before the First World War (when central banks intervened less or, as in the United States, did not exist)? Here, I suggest, a strong pre-commitment to expert guidance acts like a pair of blinders. Wearing those blinders, even if it is seen that the prewar system differed from and outperformed the interwar system, it cannot be seen that this was because the former was comparatively self-regulating and the latter was comparatively expert-guided.

Second, it is always possible to argue in defense of expert guidance that even the classical gold standard was second-best to an ideally managed fiat money where experts call the shots. Even if central bankers operated on the wrong theory during the 1920s, during the Great Depression, and under Bretton Woods, not to mention during the Great Inflation and the Great Recession, today they operate (or can be gotten to operate) on the right theory.

In the worldview of economics as social engineering, monetary policy-making by experts must almost by definition be better than a naturally evolved or self-regulating monetary system without top-down guidance. After all, the experts could always choose to mimic the self-regulating system in the unlikely event that it were the best of all options. (In the most recent issue of Gold Investor, Alan Greenspan claims that mimicking the gold standard actually was his policy as Fed chairman.) As experts they sincerely believe that “we can do better” by taking advantage of expert guidance. How can expert guidance do anything but help?

Expert-guided monetary policy can fail in at least three well-known ways to improve on a market-guided monetary system. First, experts can persist in using erroneous models (consider the decades in which the Phillips Curve reigned) or lack the timely information they would need to improve outcomes. These were the reasons Milton Friedman cited to explain why the Fed’s use of discretion has amplified rather than dampened business cycles in practice. Second, policy-makers can set experts to devising policies to meet goals that are not the public’s goals. This is James Buchanan’s case for placing constraints on monetary policy at the constitutional level. Third, where the public understands that the central bank has no pre-commitments, chronically suboptimal outcomes can result even when the central bank has full information and the most benign intentions. This problem was famously emphasized by Finn E. Kydland and Edward C. Prescott (1977).

These lessons have not been fully absorbed. A central bank that announces its own inflation target (as the Fed has), and especially one that retains a “dual mandate” to respond to real variables like the unemployment rate or the estimated output gap, retains discretion. It is free to change or abandon its inflation-rate target, with or without a new announcement. Retaining discretion — the option to change policy in this way – carries a cost. The money-using public, uncertain about what the central bank experts will decide to do, will hedge more and invest less in capital formation than they would with a credibly committed regime. A commodity standard — especially without a central bank to undermine the redemption commitments of currency and deposit issuers — more completely removes policy uncertainty and with it overall uncertainty.

Speculation about the pre-analytic outlook of monetary policy experts could be dismissed as mere armchair psychology if we had no textual evidence about their outlook. Consider, then, a recent speech by Federal Reserve Vice Chairman Stanley Fischer. At a May 5, 2017 conference at the Hoover Institution, Fischer addressed the contrast between “Committee Decisions and Monetary Policy Rules.” Fischer posed the question: Why should we have “monetary policy decisions … made by a committee rather than by a rule?” His reply: “The answer is that opinions — even on monetary policy — differ among experts.” Consequently we “prefer committees in which decisions are made by discussion among the experts” who try to persuade one another. It is taken for granted that a consensus among experts is the best guide to monetary policy-making we can have.

Fischer continued:

Emphasis on a single rule as the basis for monetary policy implies that the truth has been found, despite the record over time of major shifts in monetary policy — from the gold standard, to the Bretton Woods fixed but changeable exchange rate rule, to Keynesian approaches, to monetary targeting, to the modern frameworks of inflation targeting and the dual mandate of the Fed, and more. We should not make our monetary policy decisions based on that assumption. Rather, we need our policymakers to be continually on the lookout for structural changes in the economy and for disturbances to the economy that come from hitherto unexpected sources.

In this passage Fischer suggested that historical shifts in monetary policy fashion warn us against adopting a non-discretionary regime because they indicate that no “true” regime has been found. But how so? That governments during the First World War chose to abandon the gold standard (in order to print money to finance their war efforts), and that they subsequently failed to do what was necessary to return to a sustainable gold parity (devalue or deflate), does not imply that the mechanisms of the gold standard — rather than government policies that overrode them — must have failed. Observed changes in regimes and policies do not imply that each new policy was an improvement over its predecessor — unless we take it for granted that all changes were all wise adaptations to exogenously changing circumstances. Unless, that is, we assume that the experts guiding monetary policies have never yet failed us.

Fischer further suggested that a monetary regime is not to be evaluated just by the economy’s performance, but by how policy is made: a regime is per se better the more it incorporates the latest scientific findings of experts about the current structure of the economy and the latest models of how policy can best respond to disturbances. If we accept this as true, then we need not pay much if any attention to the gold standard’s actual performance record. But if instead we are going to judge regimes largely by their performance, then replacing the automatic gold standard by the Federal Reserve’s ever-increasing discretion cannot simply be presumed a good thing. We need to consult the evidence. And the evidence since 1914 suggests otherwise.

Contrary to Fischer, there is no good reason to presume that expert-guided monetary regimes get progressively better over time, because there is no filter for replacing mistaken experts with better experts. We have no test of the successful exercise of expertise in monetary policy (meaning, superiority at correctly diagnosing and treating exogenous monetary disturbances, while avoiding the introduction of money-supply disturbances) apart from ex post evaluation of performance. The Fed’s performance does not show continuous improvement. As previously noted, it doesn’t even show improvement over the pre-Fed regime in the US.

A fair explanation for the Fed’s poor track record is Milton Friedman’s: the information necessary for successful expert guidance of monetary policy is simply not available in a timely fashion. Those who recognize this point will be open to considering the merits of moving, to quote the title a highly pertinent article by Leland B. Yeager, “toward forecast-free monetary institutions.” Experts who firmly believe in expert guidance of monetary policy, of course, will not recognize the point. They will accordingly overlook the successful track record of the automatic gold standard (without central bank management) as a forecast-free monetary institution.

91 comments

  1. Nice article. Selective quotes and comments:

    "self-regulating gold standard" – nothing in economics is 'self-regulating', as per the non-proof of the General equilibrium theory (Kenneth Arrow's proof was of a limited version)

    "The classical gold standard’s near-zero secular inflation rate" – but it was BELOW zero in the late 19th century, for a good part? Not that it would matter, as I think money is largely short-term neutral…

    "First, they too lump the classical gold standard together with the very different interwar period and mistakenly attribute the chaos of the interwar period to the gold standard mechanisms that remained, rather than to central bank interference with those mechanisms." – debt is to a degree irrelevant, and so is the monetary standard. Please explain how Britain in the pre and post-Napoleonic era, under a gold standard, ran up a Debt-to-GDP ratio of over 200% (akin to today's Japan), from their various wars vs the French, and was, say economic historians, only saved from default and/or hyperinflation/devaluation by the success of the Industrial Revolution? That's to say: why did a gold standard back in the 18th century not help prevent a debt buildup when Britain was fighting Napoleon? Bottom line: gold or fiat is irrelevant. It's what a country chooses to do with their resources: either start (or stop) a war, or do something more productive.

    Rest of the article on micromanaging an economy using monetary rules is Post Hoc, Ergo Propter Hoc logic, given money is largely short term and long term neutral.

    1. "The classical gold standard’s near-zero secular inflation rate" – but
      it was BELOW zero in the late 19th century, for a good part?

      Money does not operate in a vacuum. The US industrial revolution was occurring in that period. With massive, unprecedented productivity improvements and a relatively stable money supply, deflation was the sign of widespread prosperity – wages while stagnant or falling did so at a dramatically slower pace than the cost of living. The US had never had it so good.

      Contrast with the 1920s, when the Fed sought a stable price level in a second period of massive productivity gains. The result was massive inflation that erased the deflationary effects of productivity gains.

      To assume fiat currencies – redeemable in nothing and created at will – are as benign economically (long or short term) as a redeemable currency in a hard money regime strains credulity…

      1. Exactly correct. The "secular deflation" of the latter part of the 19th century was the natural result of a growing economy and a (relatively) stable monetary base. It had the effect of distributing some of the benefits of that economic growth to _everybody_ , even those not directly involved with it. It was good for all. The idea that the monetary base must expand in tandem with economic growth in order to "support" that growth is patently ridiculous; the idea that there should be some base level of inflation is an outright fraud (it is simple theft from savers).

        1. @Laird – so you're saying money is bad when there's inflation (theft from savers to borrowers), but when there's deflation money is good (benefits of greater industrial output distributed to all)? Hmm…doesn't seem to make sense. Some class is being 'robbed' even in deflation it seems under this theory. Granted, I believe money is largely neutral mind you, so I have no dog in this fight.

          1. Secular deflation is the natural state of a growing economy with honest money. It means that the "value" of money (its purchasing power) gradually increases in tandem with overall economic growth. The only persons arguably harmed by that (and even there, only slightly) are borrowers, which means that they will be somewhat more cautious when incurring debt (i.e., they will require a higher degree of confidence that the purpose of the debt is economically worthwhile). And they can always decline to borrow, and thus avoid any downside from deflation; debt isn't strictly necessary for economic growth. On the other hand, saving is a necessary component of economic growth; without it there can be no capital to invest. And inflation (which robs savers) is a conscious decision of the monetary authorities to debase the currency. It really is theft, whereas secular deflation is mere market action. So I reject your argument that the two are opposite sides of the same coin, moral equivalents. They are not.

          2. @Laird – ok, fair enough. But if you believe money is not neutral, then you either have to back a 'self-regulating' or 'self-balancing' monetary standard (that automatically adjusts to the natural state or neutral interest rate or whatever monetarist term you wish to use), like presumably the gold standard, or you have to assume the central bankers will 'do the right thing' with some monetary rule, or, you have to posit, like I do, and as as the evidence seems to show, that money is neutral.

          3. Ray, I guess I don't know what you mean by "neutral". To me, money which responds solely to market forces (what you call "self-regulating"), and is not distorted by governmental action, is "neutral". So yes, I support a commodity-based (gold) monetary system which is outside of the control of politicians. (And no, I do not ever expect central bankers to "do the right thing"; they will always do the politically expedient thing.)

          4. Money neutrality is a technical term meaning people respond to money illusion. What this means is that if you double the money supply overnight, and distribute the money to the people, they will feel richer and spend more ('helicopter drop' as Friedman once wrote). So if you declare one dollar or one pound is now worth two dollars or two pounds, people will shop until they drop, feeling like they just got twice as rich. Ridiculous. But that's the bedrock of monetarism. That and 'sticky wages and prices' (slightly more defensible).

    2. "nothing in economics is 'self-regulating',"

      "Nothing?" So, outside the realm of police powers, a society's economy would never have any regularities?

      Does that mean microeconomic theory, in which police action is not always a consideration, is pretty much 100% wrong?

      1. Yes, correct, it was shown in general an economy is not self-regulating, see the proof of the general equilibrium theory in economics. Put another way: if everything was self regulating we'd not have recessions or depressions that last more than a few days or weeks. I don't think you need police action to make an economy self-regulating however; to the contrary the police are less likely than a businessperson to know what to do right.

        1. It was shown that microeconomics is pretty much 100% incorrect? Or it was proved that an economy does not have a stable general equilibrium, ergo a gold standard cannot be self regulating? Or both?

          "if everything was self regulating"

          You're changing arguments. There is a difference between "everything" and not "nothing". Just as there is a difference between a gold standard and a general equilibrium.

          I suspect microeconomic analysis does often reflect real world tendencies, and that such analysis helps explain how in fact gold standards were self-regulating (i.e. supply and demand analysis explains how changes in gold flows affect countervailing price changes, or how supply-driven deflation stimulates inflation of the monetary base through increased gold production, or other such self-regulation phenomena).

          1. I think you mean "macroeconomic analysis" not "microeconomic analysis". As for equilibrium, when dealing with humans you have non-equilibrium all the time (they are not gas molecules which are more predictable). An example would be a panic run on the bank, even a sound bank that uses a gold standard. You can model this run, even call it rational, but it's a non-equilibrium that may or may not correct quickly. I recall a state of Maryland USA bank run back in the 1980s, that was insured by a state fund (not a federal FDIC fund) that took over a year before customers, some of them elderly and living on their bank savings, got their money back.

          2. "I think you mean "macroeconomic analysis" not "microeconomic analysis"."

            No. Microeconomic analysis is sufficient to explain the self-regulating features of a gold standard, at least as far as how the general price level is regulated, which is Professor White's point. After all, the explanation is essentially a simple matter of the supply and demand of gold. Neither general equilibrium nor any other aspect of macroeconomics has anything to do with that (though the converse certainly isn't true).

            Microeconomics is also about in general how prices regulate economics self-regulates trade quantities through prices, which is why your (broadest possible) claim that "nothing in economics is 'self-regulating', as per the non-proof of the General equilibrium theory" essentially claims microeconomics has been disproven.

            " As for equilibrium, when dealing with humans you have non-equilibrium all the time (they are not gas molecules which are more predictable). An example would be a panic run on the bank, even a sound bank that uses a gold standard."

            I wouldn't dispute that. I only dispute that it pertains to the self-regulating properties of a gold standard.

        2. Aren't you assuming that that particular mathematical model is actually a valid representation of the economy? As the joke goes, "An economist and businessman are walking down the street, the businessman says, "Look $20 on the ground, let's pick it up and go get lunch." The economist responds, "Don't be silly there is no $20." The joke is that in equilibrium the economist is right, but the fact that we periodically find $20 bills on the ground means we are not always in equilibrium. That is, GE theory is not really all that relevant I'm afraid.

    3. How did Britain manage to run up a Debt-to-GDP of over 200%? One suspects they did not succeed in borrowing to this degree from willing lenders without something similar in deceitfulness and compulsion to today's fiat money (which clearly facilitates today's unpayable level of debt). What trick did they employ beyond patriotism and fear of the ogre Napoleon?

      1. I'll go ahead and answer: Britain suspended the gold standard and inflated pretty substantially. Plus ca change, plus c'est la meme-chose.

        With free market provision of money and banking, your only being able to borrow money from someone who has saved it first (and is willing to lend to you) is a wonderful regulator of debt.

        At any rate you are wrong that Britain ran up that debt on a gold standard.

        1. Nice answer W Ferrell, thanks. But you will agree that it worked out for Britain, even with their "fiat money trick". When growth is greater than the rate of interest, you can actually have a perpetual bond (that is, a bond with no date of expiration, that runs forever) and in fact the Dutch back 300-400 years ago had such bonds. Gold is just a medium of exchange, it can also be fiat, Bitcoin, silver, even giant stones like in the South Pacific.

  2. The author repeats the conventional wisdom that the authorities just lack information. The groundhog could predict the coming of spring if he just had more information about his shadow.

    In truth, no matter how much information is provided to the groundhog, it won't succeed in fulfilling the expectations placed on it. It still won't know when spring will come.

    A valid theory can produce correct outputs if it has the required inputs. But if there is no theory, then what is lacking isn't data. No amount, or quality, or timeliness of data can possibly fix the problem of the lack of a procedure which has been proven to produce correct results, given the required data.

  3. "they subsequently failed to do what was necessary to return to a
    sustainable gold parity (devalue or deflate), does not imply that the
    mechanisms of the gold standard — rather than government policies that
    overrode them — must have failed."

    If a central bank has issued $100, against which it holds various assets worth 100 oz. of gold, then it has no choice but to maintain a value of $1=1 oz. If the bank tries to deflate, so that it maintains convertibility at $1=1.1 oz., then it will face a bank run, and the bank will collapse. (Unless it devalues to $1=1 oz.)

    On the other hand, if the bank "goes off the gold standard" and suspends convertibility, then markets will automatically value the dollar at $1=1 oz, and the bank avoids the risk of a run. It's this avoidance of runs that is the real advantage of going off the gold standard.

    1. Runs are only a problem in a fractional reserve system, gold based or not…

          1. Strictly speaking, a "warehouse" commits fraud if it lends out its customers' property. However, time deposits, wholesale borrowing and equity are not bailments ala demand deposits and are traditionally considered loanable funds subject to government restrictions such as required reserves…

          2. "bailments ala demand deposits"

            Demand deposits, of course, couldn't possibly be bailments, nor could they be reasonably misconstrued as such by those making use of them.

            In your mind, how short a term can a CD be before it stops producing loanable funds?

          3. Learn the history of banking . Your assertion is not supported by that history. Fractional reserve banking was TRADITIONALLY considered a fraud upon the people by its perpetrators because it allowed the lending out of what could be demanded 24/7 by its original owners. We both cannot have the same ownership right to the same money.

            That today's public is ignorant of that history does not make it less a fraud. Here's a nice example; there are others.

            https://mises.org/sites/default/files/Money_Bank_Credit_and_Economic_Cycles_De%20Soto.pdf

            And worse, fractional reserve lending is the source of the business cycle – a true externality with economy wide implications.

            A CD can produce loanable funds up to the point the owner has a right to get his money back in total…

          4. "Fractional reserve banking was TRADITIONALLY considered a fraud upon the people by its perpetrators"

            That "history" has of course been long ago itself been debunked as a fraud, a long after the fact creation, as many readers of this blog are well aware.

            And demand deposits have *nothing* to do with simultaneous ownership of the same thing. Never have.

            But since this is only about the 3 millionth time this blog has debunked this old fallacy, maybe a perusal of past issues is overdue.

          5. You should at least acknowledge the criticisms, Milton_Hayek: see my article "Those Dishonest Goldsmiths" (Financial History Review) and "The State and 100% Reserve Banking" (Alt-M). Just because the Mises Institute crowd keeps repeating something doesn't mean that it's true!

          6. Sorry but my back and forth with "viking" became repetitious and simple contradiction, hence my last reply to him.

            I'll read your suggested links, but not all support for hard money, the end of central banking and 100% reserve banking is associated with Mises Institute.

          7. Amen. Mises.org contributors needs more Misesians.

            Then we could hear your objections to Mises's, Hayek's, Huerta de Soto's, Machlup's, and Hoppe's actual theories, and where you agree with them.

            Rather than all this fallacious argumentation ('my argument is true because I said it's true, etc.') and argument based on the either semantic confusion about terms like "FRB" ('FRB is fraud because Rothbard said it is…whether there was in fact deception or not is therefore moot and I will not discuss it'), or the fundamentally anti-Misesian mixing of scientific inquiry of FRB, whatever precise definition is agreed to for purposes of discussion, with investigation of logically independent moral issues, legal questions, and sociological questions ('what percentage of checking account customers actually believe that they have a fungible goods deposit contract with the bank…sorry George, I almost said 'irregular deposit contract' but then I remembered that you'all are not big Huerta de Soto fans when it comes to Roman legal history), rather than a loan contract, and what do they imagine is meant by "depositing" (and thus retaining ownership of) goods which cannot possibly be identified?

            I have asked you in the past what agreement checking customers (and of course savings customers, etc.) THINK that they have made (irrespective of what the laws of, say, the US and the States clearly say they have made.)

            I think that your answer at the time is absolutely correct: "They've never thought about it! Why don't they read it? Here is a copy of mine". (I'm going to read my bank contract, have just been busy the last three or four years.)

            What I would like to learn is what you think should be done by government about the problems created by 99% of the populace thinking that their contract is one thing, and they, the government, declaring authoritatively that it is something inconsistent with that.

        1. Runs & defaults are not necessarily the same. A bank can be solvent but experience a "run" based upon unfounded rumors. Runs are only a problem if demand deposits are loaned (fractional reserve banking).

          A time depositor (e.g. 3 year CD) has no right to get his money back early, so a bank that loans solely on time deposits, wholesale debt and equity will never fail to redeem its demand deposits, nor will it need to buy deposit insurance from the government…

          1. "Runs & defaults are not necessarily the same. A bank can be solvent but experience a "run" based upon unfounded rumors"

            In the strange event that happened, it might be a bad day for the bank, but hardly a problem for the system, since the system would be eager to profit by loaning liquidity to that solvent bank.

            "A time depositor (e.g. 3 year CD) has no right to get his money back early, so a bank that loans solely on time deposits, wholesale debt and equity will never fail to redeem its demand deposits"

            Whether the time deposit is 1 day or 3 years, the bank is still maintaining as reserves only a fraction of its deposits, and upon deposit maturity can still find itself short of liquidity.

          2. Mechanics vs poor banking. Its uncontroversial that lax lending standards and incompetent maturity matching can sink a bank. Point is, runs on demand deposits – even to 100% of demand deposits accepted – are meaningless in terms of bank solvency UNLESS fractional reserve banking is allowed for demand deposits, which are essentially bailments.

            The sole reason a central bank was demanded by the early 20th century bank financiers was to backstop fractional reserve banking of demand deposits. Otherwise, in a 100% reserve system, inept bankers would simply be subject to market punishment by stronger competitors.

            If an industrialist can offload risk on 3rd parties…

          3. Agreed. How can you loan out something of mine that we agree I have the right to immediately take back in part or full at any time (on demand)?

          4. That's fine, but you give up the right to demand it back 24/7 by doing so…

          5. That is entirely up to the parties engaged in the transaction. And when it comes to demand deposits, I've never personally known that right to NOT exist. Although the economists on this blog have written about rare historical examples where that right was not absolute. And, of course, since a deposit is merely a loan, a right to demand payment is no guarantee such payment will be made (even though as far as guarantees in life go, payment of a bank deposit on demand has been shown to be about as good as it gets).

            Same as with a 3 year CD. When the 3 years are up, you can demand to be paid what you are owed, or not. If you don't demand so, then the bank has more funds to loan than it otherwise would. And it is extremely common, the default practice even, to automatically renew CDs. But 3 years or 1 day really makes no difference, aside from the interest you are likely to earn on such a deposit.

          6. So your contention is that it is possible to hold two mutually exclusive positions at the same time:

            1) You can deposit $x with a bank with the right to get all or a part of it back at a moment's notice 24/7 AND

            2) You can give the bank the right to loan out all (ignoring required reserves) or a part of that money on terms while not giving up your rights under #1

            That's logically inconsistent. See your dilemma?

          7. 2) doesn't happen. I don't give the bank any rights. Instead, bank owners, like everyone else, have the right to loan THEIR property. And that right doesn't go away just because they are indebted (to depositors or anyone else).

            There is nothing *logically* inconsistent with a debtor simultaneously being a creditor (obviously, since a logical impossibility couldn't happen even once let alone billions of times all over the world for hundreds of years).

            Nor is there anything unduly risky about the practice, as long as the risk of default is sufficiently low (but not zero, as there is no such thing as a zero risk loan, whether that loan is a deposit or a bank loan).

          8. 2) Deposits are liabilities on the bank's books. T'ain't THEIR property, it's yours. As such they are merely HOLDERS of your deposit. Otherwise, banks would show deposits as income because per your assertion, you've given title to the money over to the bank.

            Don't believe me? Apply for a student loan, get a divorce or get sued. It's not the bank's property that comes into play…

          9. Exactly–deposits ARE liabilities of the banks. But the money a depositor loaned to a bank is the bank's property. Just as the house or car or business or vacation or equities that you buy with a bank loan is YOUR property (and not your income). Just as money a corporation or government gets from a bond sale is THEIR property.

            What you are missing here is the very meaning of a liability (or loan or debt). The asset loaned and the promise to repay are two different assets owned by two different parties with (usually) two different valuations.

            When you loan someone money, you are making a trade–a purchase. In that trade, the counterparty gets the money (it becomes the counterparty's money–the only reason they are interested in borrowing in the first place). What YOU get, is a promise.

            What happens if the promise is not kept becomes a matter for the creditors to figure out in a bankruptcy hearing. Creditors hope that stipulating collateral in a loan contract will persuade a bankruptcy court to give them priority over other creditors for those assets, but that need not be what actually transpires.

            "Apply for a student loan, get a divorce or get sued. It's not the bank's property that comes into play…"

            Your assets include debt obligations (like demand deposits) to you. Just like if a bank comes under scrutiny its bankloans outstanding count as its property–not the houses or cars or businesses of its customers.

          10. "But the money a depositor loaned to a bank is the bank's property."

            You can say a dog has 5 legs by calling its tail a leg, but that doesn't make its tail a leg.

            Demand deposits are not loans. Neither in fact are time deposits. But with a time deposit, because the depositor has no right prior to the expiry of the agreed upon deposit period to demand his money back, the bank is free to put that money to work and bear the risk of loss.

            Demand deposits are due upon demand, hence not loanable unless you of course are positing loans callable on demand, which are plausible but highly improbable.

            Here's a thought experiment for you.

            ACME Bank opens its doors for business with $0 capital and $0 deposits. I being the supporter of local businesses that I am decide to deposit $1,000 in a checking account. That very same day, you decide to ask ACME for an unsecured loan of $900. The bank gladly loans you $900 of my $1,000 checking account balance for 90 days on your signature due to your great FICO score.

            By coincidence you owe me the sum of $900, which you use the proceeds of the loan to pay me back, and I deposit into my checking account.

            The next day, I decide to close my demand account and withdraw my $1,900.

            Q: Assuming ACME has conducted no other business in that time, how much money does it have to close my account the next day?

          11. “Demand deposits are not loans. Neither in fact are time deposits.”

            Person X trades away her money A to person Y in exchange for Y’s promise to later trade away Y’s nominal equivalent amount of likely different money B plus an amount of C to X.

            Anything fitting this template is a loan of money from X to Y.

            Mortgage:
            (X,Y,A,B,C) = (bank, future homeowner, loan amount, principal, interest)
            Credit card charge:
            (X,Y,A,B,C) = (bank, consumer, charge amount, principal, interest)
            Deposit into demand deposit checking account:
            (X,Y,A,B,C) = (depositor, bank, deposit amount, principal, interest)
            Deposit into CD account:
            (X,Y,A,B,C) = (depositor, bank, deposit amount, principal, interest)

            So opening a demand or time deposit account with a bank is not only undeniably de facto a loan to the bank, it is clearly a loan to the bank from the perspective of all parties involved. No account gets opened without clear discussion of interest payments and, the past century anyway, deposit insurance. That banks loan deposits, I hope we’ll agree, has been common knowledge since before “It’s a Wonderful Life”.

            “But with a time deposit, because the depositor has no right prior to the expiry of the agreed upon deposit period to demand his money back, the bank is free to put that money to work and bear the risk of loss.”

            No, the bank is free (disregarding any arbitrary statutory requirements) to put any amount of *IT’S OWN* money to work, regardless of its relationship to any one depositor. It only needs to ensure, like anyone trying to avoid default, sufficient funds to pay its debts. The funds it uses to pay one depositor can come from anywhere, including other depositors.

            “Demand deposits are due upon demand, hence not loanable”

            Of course trillions of dollars of demand deposits over the centuries have empirically shattered this fallacy. IF someone opens a demand deposit checking account, and then immediately 5 seconds later withdraws those funds, it has no effect on the bank, banking system, or anyone except the psychiatrist of the person who opened the account.

            But, since in reality all demand deposits remain with the bank for some period of time before they are demanded, that period of time makes those funds loanable (and we all well know, loaned).

            A time deposit and a demand deposit both permit the depositor to demand payment at interval T, with actual demand being made at some individually highly variable but statistically regular time W > T. A 3 month CD permits the depositor to demand payment every 3 months, and depositors in reality only tend to do so every 12, 24, or more months. A 1 day CD (demand deposit) permits the depositor to demand payment every day, and depositors in reality only tend to do so every 10, 30, or more days. They are the same thing, with different intervals of permissible redemption, and correspondingly different interest payments.

            “unless you of course are positing loans callable on demand, which are plausible but highly improbable.”

            They are not only plausible, but by far the most common type of loan (demand deposits). They are also not uncommon where statues don’t prohibit, as in some business bank loans. It is called loan “acceleration”–a concept almost as old as banking.

            “Here's a thought experiment for you. ACME Bank opens its doors for business with $0 capital and $0 deposits. I being the supporter of local businesses that I am decide to deposit $1,000 in a checking account.”

            Zero capital is a nonstarter. The bank doesn’t get off the ground. A single depositor (local business supporter or not) does not a bank make. For this thought experiment to proceed in any non-misleading way, let’s replace ACME Bank opening its doors, with broke Pete asking you for a $1000 cash loan. That same day, I ask Pete for a cash loan of $900, and Pete hands me $900 from the $1000 stack of cash you handed him. I pay you back the $900 cash that I owed you, and you loan it to Pete. The next day, you demand Pete pay you back the $1900.

            How much cash does Pete have to pay you back? $1000. Pete defaults. Not surprising or enlightening.

            But if Pete understood banking, he might have instead acted like a bank does when it borrows from depositors. He would have borrowed cash from not just you, but several hundred other people. He would not have assumed zero time preference in the lenders, but instead would’ve offered them interest payments to ensure they have an incentive to not want to get paid back. He would’ve had a source of income, most likely using those borrowed funds, from which he would draw those interest payments, and from which he maintains sufficient capital. And most important, he would’ve been doing this successfully for many years, so that he knows historically how much cash he must keep on hand to pay those depositors who actually do want to end their interest payments (the only point of reserves after all is to keep sufficient funds on hand for such day-to-day business). Finally, in the unlikely (meaning had not happened in his long history) event of an unpredictable shortage of liquidity, he keeps apprised of his sound capital situation a list of greedy financiers who would likely compete to sell him the liquidity he would need to maintain his reputation with depositors.

          12. Your basic premise is flawed, rendering everything built on it flawed.

            When a demand deposit is made in a bank, the only thing "traded" are services fees from you to the bank for the following:

            1) security of your deposit
            2) 24/7 access to your deposit, in whole or in part

            At no time do you trade ownership rights of that deposit anymore than I trade ownership rights when I store my goods in a public warehouse. Additionally, the warehouseman has no rights to "use" my property for his gain. At minimum, a warehouse for fungible goods like grain or currency has to give me back an equivalent amount of like goods upon request.

            The rest of your lengthy post is an attempt to add conditions to my simple thought experiment to render it YOUR thought experiment.

            Sorry but that's flawed as well. But at least you admit that my property has been fraudulently cared for….

          13. "Your basic premise is flawed"

            Which is? Do you disagree with my definition of a loan? Or do you disagree that the actions are as I stated?

            "When a demand deposit is made in a bank, the only thing "traded" are services fees from you to the bank for the following:
            1) security of your deposit
            2) 24/7 access to your deposit, in whole or in part"

            "The ONLY thing?" Have you not ever known of a bank account that paid interest?

            "At no time do you trade ownership rights of that deposit anymore than I trade ownership rights when I store my goods in a public warehouse."

            To quote a wise and gracious man: "You can say a dog has 5 legs by calling its tail a leg, but that doesn't make its tail a leg."

            Well, whatever you imagine ownership rights are, you are literally trading away your money to the bank for the bank to make use of as it wishes, with no surprise when upon withdrawal you receive completely different bills, at a different (commonly increased) nominal value. You can call it whatever you like, but giving up forever total control of your property to someone is at least de facto giving up ownership. Of course, you do it because you gain ownership of something more valuable to you.

            "Additionally, the warehouseman has no rights to "use" my property for his gain. At minimum, a warehouse for fungible goods like grain or currency has to give me back an equivalent amount of like goods upon request."

            Interesting. So what is the interest rate attached to fungible warehousing of grain? Because I know of no example of "fungible currency warehousing" anywhere or anytime where interest wasn't a headlining part of it.

            You do know what an interest payment is, don't you?

            "The rest of your lengthy post"

            I regret I lack your discipline to ignore points of argument.

            "is an attempt to add conditions to my simple thought experiment to render it YOUR thought experiment."

            What condition did I add? Really, all I did was change the name of one of the parties. I even still came up with your numerical answer. Are you saying that your argument depends not upon the actions of the parties involved, but rather upon how they are named?

            "But at least you admit that my property has been fraudulently cared for…."

            Where did I do that? Pete defaulted. Default is not necessarily fraud. Furthermore, I explained how Pete could have avoided default by *instead* acting the way banks act.

          14. Your basic premise that a demand deposit is a "loan" is flawed, rendering everything that follows moot. Reread my last reply for the explanation.

            It used my money to make a loan to a 3rd party while insisting to me my money was still available 24/7 – crime #1

            The bank has fraudulently told me I have $1,900 on deposit which I can demand at any time 24/7, when in fact it has only $1,000 – crime #2

            Per your suggestions, it can only pay me back by fraudulently accepting the money of 3rd parties under the guise of investing funds received to generate a return for them. Instead it takes their funds and then gives them to me – crime #3

            I close my account, never to return. The bank has knowingly committed 3 crimes as a matter of business under the guise of fractional reserve banking….

          15. "Your basic premise that a demand deposit is a "loan""

            I've defined "loan". I've shown that a deposit meets that definition. I haven't just presumed. Instead, you are the one making the repeated unsubstantiated assumption that it isn't a loan. And every time I ask you to address a glaring fault in your argument, you ignore it. Let's try again:

            1. Do you know what an interest payment is?
            2. Do you know what banks do with deposits?
            3. Do you know at which declining redemption interval a time deposit ceases to be a time deposit?
            4. Do you know what loan acceleration is?
            5. Do you know what de facto ownership means?
            6. Do you know which party in a rendered service gets paid?
            7. Do you know the difference between fraud and default?
            8. Do you know what the whole entire purpose of reserves are?

            "It used my money to make a loan to a 3rd party while insisting to me my money was still available 24/7 – crime #1"

            It is common knowledge that you are factually incorrect. Instead, the bank uses its OWN money (money that you are well aware upon deposit that the bank will do with as it pleases–aka, the bank's property).

            If you personally are a net debtor because of, say, a large home mortgage, that doesn't mean that the money you use to buy groceries or electronic goods or books by Murray Rothbard isn't YOUR money.

            If you believed that the cash you handed over to the bank remained YOUR property, then instead of the bank telling you that it will pay YOU more the longer you maintain the deposit, the bank would be telling you that you would be paying IT more the longer you maintained the deposit. The deposit pays an interest rate–i.e. it is a loan.

            A deposit is ALWAYS everywhere and at all times advertised by the bank as a loan, because deposits are inextricably linked to an advertised interest rate (even if advertised as zero or negative). Depositors are unable to avoid be informed that the bank considers it a loan. The bank treats it as a loan. The physical mechanics of it are identical to a loan. George Bailey has even been repeatedly explaining it to generations of Americans that it is a loan.

            "The bank has fraudulently told me I have $1,900 on deposit which I can demand at any time 24/7, when in fact it has only $1,000 – crime #2"

            Wrong. The bank has correctly told you that you have a $1900 deposit, because you DO in fact have a $1900 deposit by mere fact that you deposited $1900. That has NOTHING to do with how much cash the bank has in its vault, just as my $100,000 debt to my business loan holder has nothing to do with how much cash I have under my mattress. A deposit is not cash. Deposits, being loans, always have interest rates. Cash or storage never do.

            A bank does not need to have cash holdings equal to its total deposits. It only needs to have cash holdings equal or exceeding withdrawals.

            "Per your suggestions, it can only pay me back by fraudulently accepting the money of 3rd parties under the guise of investing funds received to generate a return for them."

            Of course, you know that wasn't at all my suggestion. INSTEAD, a good bank loans out every penny that it can from the loans that it receives from depositors (so that it can pay the depositors the interest they are expecting from the money they loaned the bank), keeping only enough liquidity on hand for expected withdrawals. The deposits of 3rd parties aren't pyramid scheme transfers. Rather, it is a large number of diverse depositors that allows the bank to accurately predict how many withdrawals to expect.

            More depositors means the depositors can earn more interest because withdrawals are more predictable, so less cash is unproductively lingering in some vault.

            "I close my account, never to return. The bank has knowingly committed 3 crimes as a matter of business under the guise of fractional reserve banking…."

            Not a single crime. Not a single misunderstanding. Not a single problem. Not a single conspiracy. Not a single lie. Not a single fraud. Merely the aggregations of loans (from deposits to bank loans) through an expert intermediary. Exactly as advertised in every major language in the world. That is all that banking (sometimes redundantly called "fractional reserve banking") is.

          16. LOL, you have yet to show how a DEMAND deposit qualifies as a loan under the common definition of the term:

            "A loan is the act of giving money, property or other material goods to another party in exchange for future repayment of the principal amount along with interest or other finance charges. A loan may be for a specific, one-time amount or can be available as an open-ended line of credit up to a specified limit or ceiling amount."

            http://www.investopedia.com/terms/l/loan.asp

            A checking account does not conform to that because there is no principal to be repaid, interest to be charged or "other finance charges". The deposit made to the bank is an amount to be held subject to withdrawal at any time in whole or in part. Checking (demand) accounts typically do not pay interest and instead charge numerous activity or account fees as well as over-draft fees which by definition can not exist on time deposits.

            As I said before, you can say a dog has 5 legs by calling his tail a leg, but that doesn't mean his tail is a leg…

          17. Well, of course I did show you, but I can't make you read my posts, just like I can't make you answer my questions, least of all the ones that make you uncomfortable.

            However, the quote you gave works fine as well. Same thing.

            A checking account meets that definition precisely. You are giving money to another party (a bank) in exchange for future payment (withdrawal) of that amount (principal) along with interest.

            "Checking (demand) accounts typically do not pay interest"

            In my decades as a bank customer, I have never had a checking account that did not pay interest, and I use 5 different independent banks–4 among the largest in the country. And upon opening each account, I was presented in paper a summary of the account description with a big colored box showing what interest I would be paid on those checking accounts.

            Do you have a checking account?

            However, given that your argument now seems to depend upon whether or not interest is paid, is it fair to say, that *if* I could prove to you that a particular bank deposit pays interest, that you would then agree with me that that particular deposit is necessarily a loan to the bank?

      1. No, runs are only a problem with insolvent banks. A 100% reserve bank whose net worth falls below zero will face a rune, while a 10% reserve bank with positive net worth will survive a run. Customers, knowing this, will not run on the bank.

        1. Wrong. A "run" on a 100% reserve bank is a non-issue since the bank always has the funds to redeem all demand deposits. The only banks for which runs are a problem are those that lend out demand deposits…

          1. Note that I was talking about insolvent banks. For example, a bank might hold 100 oz of silver as backing for 100 paper dollars it has issued. That is a solvent, 100% reserve bank. But all that has to happen is that the bank gets robbed of 1 oz, and it becomes insolvent. A run will happen, since all the silver will be gone after $99 have been redeemed, and nobody wants to be #100 in line.

          2. Remember 100% reserves applies ONLY to demand deposits since a bank is able to lend based upon its combined time deposits, wholesale borrowing and equity.

            Runs cannot occur on non-demand accounts, though as discussed, lending to deadbeats or incompetently matching yields & maturities can certainly render a bank insolvent…

      2. I agree. I read through this thread and tend to agree with you. I'll point out that technically back in the days of gold some banks actually broke their own rules and suspended withdrawal of deposits when there was a bank run, out of necessity. It totally contradicted their contract with their customer but in a fractional reserves system, be it gold or fiat, it was necessary to temporarily stop a liquidity crisis that was not a solvency crisis.
        Bonus trivia: in a 100% reserves Chicago Plan system, the interest rate on loans would be much higher than today's fractional reserves system, which would favor equity more than debt.

    2. Not even close to true. If the bank "goes off the gold standard" the market will value its dollars at whatever it thinks they will buy. That's a function of the bank's financial strength and a host of other factors. In all probability after such an event the market will value those dollars at _far_ less than 1 oz.

      1. Example: when the Bank of England suspended in 1797, the value of its pounds was unaffected. The reason is that the boe's assets and liabilities had not changed from the day before, so the suspension of gold convertibility meant relatively little, compared to the bank's assets and liabilities.

  4. "Here I want to propose an alternative hypothesis, which complements
    rather than replaces the employment-incentive hypothesis. I propose that
    many mainstream economists today instinctively oppose the idea of the
    self-regulating gold standard because they have been trained as social
    engineers…They are experts, and an automatically self-governing gold
    standard does not make use of their expertise. They prefer a regime
    that values them."

    Still sounds like an employment-incentive; "What will the common folk do without us experts doing our job?"…

  5. "Milton Friedman once hypothesized that monetary economists are loath to criticize central banks because central banks are by far their largest employer." Yes, here, Milton Friedman, with his characteristic insight, explains why so many doctors favor science-based medicine over witch doctors, and why so many teachers are in favor of schools. It's all just the rent-seeking, self-aggrandizing, market-distorting monopolization tactics of people who actually know things. (You will note that this is also the exact argument proving the existence of the climate-change-myth conspiracy. The tyranny of the intellectual elites – a group defined entirely in negative terms vis a' vis the ignoramuses who groan beneath its heel – knows no bounds.)

    1. The actual number of economists employed by central banks is actually MINUTE compared to the total number (employed by universities, banks, etc) strikes me.

        1. It would be worth looking, not just at the raw number of positions, but also at the pay and prestige of those positions, too. You can WANT a particular job and do the things you think will get you that particular job WITHOUT ever having because there's just the one job and 500 applicants.

  6. Sorry to have to tell you this, but if you set a "gold standard" then your economic growth is tied to how much gold you can find! It is ludicrous!

    1. I'm afraid Michael Kendall is right, Rcoutme: your's is one of those things people know that just ain't so.

  7. Certainly, the monetary economics profession can get into a rut, possibly due to professional needs (getting a job). Today all salute a 2% IT. Why? Why not a 3% IT, or an IT band of 1.5% to 2.5%?

    And why so few discussions of the role of property in bank landing, and property zoning?

    Was there a single Western monetary economist who said, "Japan's central bank can buy back half of the nation's gigantic national debt, force interest rates on 10-year JGBs to zero, pay negative interest on reserves, have almost no unemployment, and still have deflation." ?

    If orthodox monetary economists could be so wrong on Japan, yet not change their views…well, I call that being in a rut. Ideology and dogma top empirical results.

    As for ruts—why not a silver standard? Why always a gold standard? Silver was a monetary metal before gold. Gold was considered gaudy, for jewelry and baubles and fops.

    Silver has the gravitas needed for a monetary metal.

    Hooray for the silver standard!

    1. There of course were silver standards and bimetallism standards. The U.S. was on a gold and silver standard from 1792 until The Gold Standard Act of 1900 established gold as the only standard for redeeming dollars.

      Why did this happen? Through a trial and error process over millennia, gold proved itself as the most monetary of all commodities. This is due to gold's unique properties which are solely monetary. (Its limited industrial use does not negate this role.) Gold holds its value and remains the monetary Polaris.

      I recommend my series on Understanding Gold for detailed background on this subject.

      http://manonthemargin.com/category/uncategorized/understanding-gold/

      1. In fact, the victory of gold over silver was to a considerable extent inadvertent. Think of Newton's overvaluation of the guinea, or of the discovery of gold at Sutter's mill, or of the dropping of the silver dollar from the 1873 Mint Act. "Trial and error" doesn't really describe what happened very well.

      2. Because bimetallism always results in a difference between relative redemption and relative market prices of the commodities, Gresham's Law should always tend to produce effectively a single (if alternating) metal standard, regardless of how many commodities are in the statutory standard. If the effective standard under bimetallism turned out to be gold, then gold probably was the commodity whose set redemption price was too high compared to the relative market prices of gold and silver.

        1. That's true vikingvista. And if Gresham's law works, then long term fiat money is also largely neutral. If inflation is 10%, people will, over time, adjust their prices by 10%. People respond to incentives… And some evidence (Bernanke's FAVAR 2002 paper) show money is largely neutral, short term-ish, having very little effect. Ergo, fiat money is just fine.

          1. "And if Gresham's law works, then long term fiat money is also largely neutral." This strikes me as a complete non-sequitur.

          2. You got me again by George! I guess Gresham's law is working on the 'unit of account' aspect of money, rather than money neutrality per se given a particular unit of account (that is, you cannot have two units of account, that's two too many).

          3. "Ergo, fiat money is just fine."

            The question of whether or not fiat money performs better than non-fiat is entirely a matter of the incentives and capabilities of the fiat authorities. In other words, ignoring incentives and knowledge availability, it is easy to imagine a monetary authority whose actions do anything, including mimicking or even outperforming any gold standard, and including producing a steady predictable long run inflation.

            But commonplace as it is, it is nowhere near reasonable to ignore such important realities. Nor is it reasonable to ignore historical examples, particularly the disappointing ones of America's own central bank both before and after the fiat regime developed.

    2. Projections by the famous Ben Cole noted. "And why so few discussions of the role of property in bank landing, and property zoning"- why change the subject? First, it's well known most banks lend to property at the retail level, it's probably 80% of their business. Second, studies have shown property zoning is irrelevant except to drive up the cost a bit. In Houston TX there's no zoning laws yet gas stations are always near busy intersections, not at the end of quiet cul-de-sacs. As for your monetarist fantasies…well that can't be helped, gobble gobble 😉

      1. Ray, Ray, Ray:

        Property zoning does drive up the "cost a bit." Try buying a house in San Diego vs. Houston.

        I bring up property zoning due to this sentence by Larry White:

        "I have elsewhere suggested that career incentives give monetary economists a status-quo bias."

        The status quo in macroeconomic circles is to fret constantly about inflation, the minimum wage, "free trade" and lately, "labor shortages."

        The topic of ubiquitous state-enforced property zoning and the heavy outpouring of bank loans onto zoned property is rarely discussed, although Adair Turner gives it a go and I advise to read a lot by him.

        Even the inflation-fetishists go mute on property zoning, although housing is a large component of the CPI.

        The Fed's latest Beige Book howls about "labor shortages," but not one word on "housing shortages."

        Odd, isn't it, when there is no government limit on the supply of labor that can be provided in any city, but there government limits on the supply of housing?

    3. Half of silver mined goes to industrial uses vs only 10-15% for gold. That means there are a lot more companies bidding on silver which makes silver prices somewhat more volatile.

      And looking at charts, while silver and gold mirror each other pretty well silver has higher highs and lower lows than gold and that would suggest that out of the two metals gold is the best choice for a commodity standard.

  8. Excellent analysis! Worth noting that our 'gold standard' was severely hampered by extremely perverse Federal regulation of banks–creating unstable pyramiding–and in one period by the govt. requirement re silver, by itself generating the terrible recession Pres. Cleveland inherited.

    Better than a gold standard would be a Constitutional amendment that placed "a wall of separation" between govt. and money & banking. Make banks operate under the same rules as other businesses.

  9. Digital money supports gold certificates, and there is enough gold for each outstanding certificate.

    So we have gold vaults in all the major cities with an input and output window. But the gold company needs to move gold between cities.

    So the company has its own delivery service for customer pick up and delivery. The company declares delivery in 3 days, pickup in 2 days. Then the company can observe the queue of deliveries and has time to move gold overnight between cities to balance flow.

    But it is not 100% backed because the queue sizes vary If my neighbor gets his gold in one day, but I have to wait three days because of congestion, then the trade possibilities for me and my gold are less than my neighbor who got his gold early. So gold runs are still possible.

    1. Exactly why, historically, even an attempt at maintaining fee-for-service 100% reserve business still results in a bank occasionally extending credit to its depositors, since one of the inevitable services is to save the customer the task of hauling his own gold, and not require him to wait.

    2. The gold would only have to move if accounts don't balance in whatever number of days is specified. It doesn't have to be daily or weekly for sure.

      Also why shift gold if you can shift other assets instead? If the other entity agrees, transfer title to bonds or stocks or other paper.

      Anyway this it what clearinghouses do, you can just shift gold within the same building or even just do it in a ledger and therefore no metal ever moves.

      Of course every now and then you might want to set up a situation where you do move metal just to keep folks on their toes. But if you're aggressive about auditing the clearinghouses you use you can maybe not even bother with moving the gold.

      Runs would be rare. According to Selgin, during the Scottish Free-Banking era banks that got out of balance by too much had their membership in the clearinghouse suspended until they corrected the issue. This imposed discipline on the banks. Also the other banks stood willing to buy up the outstanding currency of a failed bank and this was a source of calm for the general public. And there were no major crises during this period (after a certain point, but I don't remember when but early in the period.)

      So I don't think runs would be a problem.

      And you wouldn't have to wait three days for your gold. you'd be sent some information via e-mail directing you to a local gold seller who would fix you up, then that person would settle with the bank.

      From what Selgin and White have taught us about free-banking the system would be a lot more flexible and robust than you think.

      1. Gold, one of many ledger systems.

        We can also do interest charges in our gold delivery business, pay a positive or negative fee for pick up and delivery. Then we compare incoming and outgoing queues, establish the random queuing process promised in a gold standard that allow some 3-10% delivery variance in support of price discovery. An integrated system. And gold movement does, or did, test the transportation system which is very dependent, as is the whole economy, on the movement of metals securely. I could see the gold companies getting 10-20% of the total currency market, compete well with bitcoin.

  10. Although the 'Gold Standard' was able to keep the inflation rate close to zero (due to gold holding its value well) and made the price level more predictable, it prevented the central bank from fighting recessions by outsourcing monetary policy to how much gold we have. Which is basically determined by how much gold we can dig up from the ground.. Countries that rejected the 'Gold Standard' soon began to recover from their losses.

  11. I've come to believe that the 1929-33 deflation was just the belated undoing of the 1914-1917 Europe-caused global inflation of gold prices. During the war, most belligerents used their gold coin and reserves to buy war materials from neutrals like the US. This substantial decrease in the global demand for gold reduced its value in terms of goods and, since the US was still on gold, reduced the value of the $ in terms of goods. When Europe finally scrambled to restore the prewar gold standard in the late 20's, the increased D for gold necessitated a global deflation of prices in terms of gold, and therefore of $ prices.

    So the Depression was monetary as per Friedman and Rothbard, but it wasn't the Fed's fault per se, but rather Europe's. A well-known drawback of any fixed exchange rate system is that it requires the countries that fix to import whatever inflation or deflation is going on in the foreign currency being fixed to. So the US imported a gold inflation, and then a gold deflation as Europe went off and then back on gold. The US M supply therefore decreased to accommodate the "exogenous" deflation.

    A smoother landing would have been achieved if Europe had followed the US Civil War example, and had just frozen their currencies (perhaps after devaluation) until their price levels came down low enough to resume the desired gold parity. It would also have helped if they had realized that 100% gold reserves for notes and deposits were not at all necessary for gold convertibility. But the US had no control over what Europe decided to do. The Fed did aggravate the global deflationary pressure by holding substantial excess gold reserves over and above the 40% "requirement".

    Doug Irwin has documented the scramble for gold in the late 20's by France and others in Cato Papers 2012. France went nuts accumulating gold reserves, apparently shooting for 100%.

    Only 100% reserves will guarantee that a bank will never fall short of your "reserve requirement." However, there should be no shame in a reserve shortfall, and in particular it should not be used as an excuse for suspension. Rather, deficient banks and central bank should simply not be allowed to extend any new credit (or to roll over maturing old credit) until the statutory reserve target is met. As long as they have some reserves, their primary obligation should continue to be to redeem notes and deposits on demand.

    That said, as Friedman pointed out in his "Monetary Mischief", the post-Civil-War deflation would have been softened if silver had not been demonetized in 1873. With silver in the wings, the US would probably have come back down on silver around 1876, rather than on gold in 1879, and the economy would have sailed more smoothly in the late 19c. Gold could then have been brought back in for large denominations by an appropriate devaluation with respect to future debts but not existing debts. The US would have had a floating exchange rate vis a vis Europe, but as we have seen since 1973, that is not the end of the world.

    The Fed did engineer a US-specific inflation on top of the global inflation during 1917-19, which was abruptly liquidated during 1919-22. But this still left the US price level (and therefore gold prices) on too high a level for the day when Europe would be back on its historic gold standard.

  12. Is it not time to think of a Gold Plus standard that takes in Platinum and very precious rare earth (RE) metals as a kind of basket reference standard, instead of making it look as a pure run on Gold alone as the U.S. has most of it topping the list? Of course the Fed will never allow that because Chinese have control over 95 pc RE’s but not over Platinum. Ultimately the entire debate on Gold as standard is subject to the arbitrary chance possession of the metal by any country with total disregard to the innovative labour moving economy as a whole around Globe. Gold does not move an economy. Ideas and labour do.

    George Chakko, Vienna, Austria.
    10/ 07/ 2017 03:04 hrs CET

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