The gold standard and boom-bust cycles

According to some commentators on the gold standard, an increase in the supply of gold generates similar distortions that printing money out of “thin air” does.

Let us start with a barter economy. John the miner produces ten ounces of gold. The reason why he mines gold because he believes there is a market for it. Gold contributes to the well being of individuals. He exchanges his ten ounces of gold for various goods such as potatoes and tomatoes.

Now people have discovered that gold, apart from being useful in making jewellery, is also useful for some other applications. They now assign a much greater exchange value to gold than before. As a result John the miner can exchange his ten ounces of gold for more potatoes and tomatoes.

Should we condemn this as bad news because John is now diverting more resources to himself. This, however, is just what is happening all the time in the market. As time goes by people assign greater importance to some goods and diminish the importance of some other goods. Some goods are now considered as more important than other goods in supporting people’s life and well being.

People have also discovered that gold is useful for other uses such as to serve as the medium of the exchange. Consequently they lift further the price of gold in terms of tomatoes and potatoes. Gold is now predominantly demanded as a medium of exchange – the demand for other services of gold such as ornaments is now much lower than before.

Let us see what is going to happen if John were to increase the production of gold. The benefit that gold now supplies people is by providing the services of the medium of the exchange. In this sense it is a part of the pool of real wealth and promotes people’s life and well being.

One of the attributes for selecting gold as the medium of exchange is that it is relatively scarce. This means that a producer of a good who has exchanged this good for gold expects the purchasing power of his effort to be preserved over time by holding gold.

If for some reason there is a large increase in the production of gold and this trend were to persist the exchange value of the gold would be subject to a persistent decline versus other goods, all other things being equal. Within such conditions people are likely to abandon gold as the medium of the exchange and look for other commodity to fulfill this role.

As the supply of gold starts to increase its role as the medium of exchange diminishes while the demand for it for some other usages is likely to be retained or increase. So in this sense the increase in the production of gold is not a waste and adds to the pool of real wealth. When John the miner exchanges gold for goods he is engaged in an exchange of something for something. He is exchanging wealth for wealth.

Contrast all this with the printing of gold receipts i.e. receipts that are not backed 100% by gold. This is an act of fraud, which is what inflation is all about, it sets a platform for consumption without making any contribution to the pool of real wealth. Empty certificates set in motion an exchange of nothing for something, which in turn leads to boom-bust cycles.

The printing of unbacked-by-gold certificates divert real savings from wealth generating activities to the holders of unbacked certificates. This leads to the so-called economic boom.

The diversion of real savings is done by means of unbacked certificates i.e. unbacked money. Once the printing of unbacked money slows down or stops all together this stops the flow of real savings to various activities that emerged on the back of unbacked money.

As a result these activities fall apart – an economic bust emerges. (Note that these activities do not produce real wealth, they only consume. Obviously then without the unbacked money, which diverts real savings to them, they are in trouble. These activities didn’t produce any wealth hence without money given to them they cannot secure the goods they want).

In the case of the increase in the supply of gold no fraud is committed here. The supplier of gold – the gold mine – has increased the production of a useful commodity. So in this sense we don’t have an exchange of nothing for something here.

Consequently we also don’t have an emergence of bubble activities. Again the wealth producer on account of the fact that he has produced something useful can exchange it for other goods. He doesn’t require empty money to divert real wealth to him.

Note that a major factor in the emergence of a boom is the injection of money out of “thin air” into the economy. The disappearance of money out of “thin air” is the major cause of an economic bust. The injection of money out of “thin air” generates bubble activities while the disappearance of money out of “thin air” destroys these bubble activities.

On the gold standard this cannot take place. On a pure gold standard without the central bank money is gold. Consequently on the gold standard money cannot disappear since gold cannot disappear.

We can thus conclude that the gold standard, if not abused, is not conducive of boom-bust cycles.

51 Comments

  • mrg says:

    The commentators are right. The gold miner is scarcely more praiseworthy than the government money printer.

    You yourself acknowledge that the monetary value of gold is far greater than its non-monetary value.

    You call the exchange of a printed pound for real goods an exchange of nothing for something, but a newly mined lump of gold is an exchange of almost nothing for something.

    Suppose that for jewellery or industrial purposes a lump of gold is worth 100 eggs, but gold’s monetary function drives its value up to 1000 eggs. A newly mined lump adds 100 eggs worth of real value to the economy, but the miner gets 900 eggs for nothing. He profits at the expense of his compatriots, reducing the value of the gold they already hold, by decreasing its scarcity.

    The reason gold doesn’t tend to cause bubbles is simply that it is harder to mine than money is to print, but unless you subscribe to the labour theory of value, this increased effort doesn’t warrant more praise.

    • Robert Sadler says:

      mrg,

      If your argument is true then an increase in the production of any commodity could feasibly lead to a the business cycle. I think what you are misunderstanding here is that with the process of either money printing by a central bank or fractional reserve banking there is fraud. There is no fraud if a mining company produces more gold than expected.

      I suggest you also consider how money came into existence – it is basically saved production. An increase in gold comes about because of increase in productive activity. An increase in fiat currency requires no productive activity at all. For this reason, it represents a transfer of wealth from the productive to the unproductive.

      • Tim Lucas says:

        “I suggest you also consider how money came into existence – it is basically saved production”.

        Not true. Saved production is the total excess of consumer goods not consumed. Gold not used for industrial purposes is just one part of that saved production as it is just one of all the goods produced that doesn’t get consumed, it being a commodity like any other. However, given that its principal use is monetary – as mrg points out – and its most prized characteristic for this purpose is scarcity, it makes no sense to claim that an increase in gold is a beneficial increase in production. It is rather – a necessary and unfortunate cost to society that uses a gold standard.

        Gold as a money is not perfect and we should remember this. It is just the best that the market has come up with during the time that money has been in existence.

        If a government were genuinely to enforce scarcity of a fiat currency, and keep to its promises, then this currency would surely be better than using gold. Indeed, if there were a free market in which participants could decide between using in using gold or using a government-enforced paper money that individuals were completely confident would be completely inflexible, then the market would surely choose this convenient government currency, rather than suffer the inflation brought about by the gold miners each year. I know that this is the way I would act in any case.

        The problem, of course, is that governments never do keep their promises.

        • mrg says:

          “It is rather – a necessary and unfortunate cost to society that uses a gold standard.

          Gold as a money is not perfect and we should remember this. It is just the best that the market has come up with during the time that money has been in existence.”

          Well said, Tim.

        • Robert Sadler says:

          Tim,

          Is the principal use of gold “money”? I’m not sure that it is.
          I appreciate my definition of money is highly simplistic and crude but if we forget about both gold and fiat currency for a moment how would two parties transact? If I am a baker and you are a shoe maker but I want shoes and you want bread what would we use as money? Let’s say we settle on salt as something we can both use as money. Let’s say one pair of shoes is worth four loaves of bread but you want salt so you can transact for other goods. I produce ten loaves of bread, consume six and save four. Four I sell to the salt maker for four lbs of salt. I sell the salt to you for a pair of shoes. My point is that I needed to save some of my production (as did you and the salt maker) in order to use as “money”. In this way the money is 100% backed by prior production. Bank notes run off a printing press are in no way similar.

          Just on your third paragraph. I am not sure how we could have a free market in which there was a government enforced paper money. Seems like a contradiction? Further, the presence of fiat money would be inflation by definition.

          Is the most prized characteristic of gold its scarcity? Aren’t all goods (except fiat currency, which is why it is not a good) scarce?

          • Tim Lucas says:

            Hi Robert,

            I think differently about this.

            If there is a stock of an existing good, of which it is impossible to create any more, then this stock could equally serve as money. It would not be necessary for it to be incrementally produced in order to serve as money.

            In your example with the shoes and the baker, the baker would sell the shoemaker his bread in return for money that the shoemaker would have to get from elsewhere in return for his shoes. The fact that this money – which market participants have decided to use – has not been produced with labour is irrelevant so long as all market participants are satisfied with its value as money. Economics teaches us that the price of a good is dictated by its marginal demand, not by the cost of its production. In this case, the cost of additional production would be infinte (as no more could be produced). This would not make the value of this money an infinite quantity however. Rather, the value would be what people are willing to pay for it at the margin.

            In the example where a currency is universally agreed upon in which no more can be produced, then assuming that good investment decisions are made over time by market participants such that the quantity and quality of goods and services increases over time, all things being equal, the price of this money would rise. Interest rates would be dictated by the preference for goods now relative to goods later and expressed as interest rate in this currency. In short – everything would work as it would do under a gold standard, but without the gold mining industry producing additional gold.

      • mrg says:

        Robert,

        I haven’t really thought about whether increased production of non-monetary commodities could trigger a business cycle, but I suspect not.

        Gold mining may not be fraudulent, but nor is it laudable. It’s as if we were to come up with bank notes that were extremely difficult to forge, and then declare counterfeiting legal (I suppose bitcoin is a bit like this). You can respect the skill and effort of the forger, while still recognising that he profits at your expense, and that transacting with him isn’t the usual sort of value-for-value exchange.

        You say that “An increase in gold comes about because of increase in productive activity”, but my point is that only part of the gold miner’s activity is genuinely productive.

        • Robert Sadler says:

          mrg,

          My view is that it is merely incidental that we use gold as money. What I would say about your bank notes is that they have no value other than being bank notes. Gold on the other hand has many other uses besides being money. I am also not ruling out potential economic distortions due to a sudden massive influx of gold because I have not examined the issue. What I am saying is that “real money” is merely a good that the market has chosen to use as money. Something that someone has produced and saved for transactional purposes. Real money requires prior production. Fiat currency does not.

          Accordingly, would more shoes, bread, salt and grain be a good thing? I would think so. Why then is not more gold a good thing?

    • Speed says:

      mrg said, ” … a newly mined lump of gold is an exchange of almost nothing for something.”

      A “lump” of gold doesn’t appear in someone’s pocket by magic. It is extracted from the ground. Such extraction requires knowledge, work by people and capital for machines. People and/or organizations calculate that their knowledge, labor and capital are best invested in extracting gold rather than building automobiles or some other endeavor. If the value of gold as an industrial product, jewelery or medium of exchange falls, less will be produced and visa versa.

      Gold is no more “nothing” than is a barrel of oil.

      Annual production of gold has gone from about 1200 million tons per year in the late 1970s to around 2500 million tons per year for the past 15 years.
      http://minerals.usgs.gov/ds/2005/140/gold.pdf

      • Speed says:

        “Annual production of gold has gone from about 1200 million tons per year in the late 1970s to around 2500 million tons per year for the past 15 years.”

        Those should be metric tons, not million tons.

      • mrg says:

        “Gold is no more “nothing” than is a barrel of oil.”

        I didn’t say nothing, I said ‘almost nothing’. The monetary value of gold far exceeds its non-monetary value.

        That gold is hard work to produce doesn’t change this.

        • Speed says:

          “Almost nothing” is like the fine print at the bottom of a coupon: Cash value 1/10 cent.

          The value of gold (as determined by its buy/sell price)is the same whether it is used for jewelery, electronic devices, as a medium of exchange or store of value.

    • Craig Howard says:

      You yourself acknowledge that the monetary value of gold is far greater than its non-monetary value.

      Your mistake is to claim a difference between “monetary value” and “non-monetary value”. The price of gold for non-monetary functions (i.e., jewelry) will have to adjust to the value the market places on it as money.

      • mrg says:

        Your mistake is to claim a difference between “monetary value” and “non-monetary value”.

        I agree that it’s difficult (impossible) to say exactly what non-monetary value of gold would be. That doesn’t mean that the difference doesn’t exist.

        You can get some idea from what happened to gold prices in the not-so-distant past. When Gordon Brown sold Britain’s gold at between $250 and $300 an ounce, people had largely stopped thinking of gold as money. These days that thinking has reversed, and the value of gold has soared accordingly. If gold does succeed in replacing fiat currencies, its value (in terms of real goods and services) will go even higher.

  • Richard says:

    What if the gold supply increases and most of it goes into the loan market – surely this will artificially lower interest rates to create the boom-bust cycle?

    • John says:

      I wonder if Holland’s Tulipmania would fit that description, though there were probably other factors at play.

    • Craig Howard says:

      What if the gold supply increases and most of it goes into the loan market – surely this will artificially lower interest rates to create the boom-bust cycle?

      It will lower interest rates, to be sure, but it won’t be artificial. It will be real. When Ben Bernanke declares that interest rates are .1% and summons the electrons to back it up, that’s an artifical lowering.

  • Jonathan M.F. Catalan says:

    Contrast all this with the printing of gold receipts i.e. receipts that are not backed 100% by gold. This is an act of fraud, which is what inflation is all about…

    This is confused. Inflation is not about fraud; inflation is an economic phenomenon, not a legal issue. An increase in the supply of gold is the same thing as an increase in the supply of money. An increase in the supply of gold in circulation will lead to a general rise in prices. This is theoretically true, and we have historical examples of this occurring (i.e. the great European price revolution that Rothbard blames on the huge gold and silver imports from the Americas).

    If new gold enters the market through consumption then what will happen is a temporary increase in consumption. If gold enters through the loanable funds market then it may cause intertemporal discoordination. What is good about gold is that its introduction is largely naturally regulated:

    1. It’s total unmined supply is limited;
    2. It costs time and capital goods to mine and mint, which means that its production is largely tied to time preference.

    But, that gold is a good commodity because its naturally limited in its availability and it is more difficult to produce than paper notes has nothing to do with the theoretical possibility of intertemporal discoordination or even inflation.

    • John says:

      Does that mean a Friedman monetary rule could potentially work better?

      • Jonathan M.F. Catalan says:

        I don’t think that there is an ideal degree of inflation. There are market forces of discoordination and there are market forces of coordination; these are natural to the market. Some type of monetary “rule” — i.e. policy — is not natural to the market; it’s not part of this pattern of discoordination and coordination.

        I think, though, that under free banking (the Selgin/White model) inflation would actually fall. What an increase in demand for banknotes does is decrease demand for outside money, meaning the demand for gold production falls (other than jewelry). So, while many (wrongly) accuse the Selgin/White scheme of being inflationary, it is actually probably the exact opposite — it would probably do more to stabilize the supply of money.

        • John says:

          Would you support quantitative easing to keep MV constant during this time like some of the free-banking advocates do?

          My view is that quantitative easing is only a secondary measure. To “restore” monetary velocity, so to speak, confidence needs to be restored and that could imply debt write-downs and more orthodox policy making.

          • Jonathan M.F. Catalan says:

            No, I don’t support quantitative easing. There is an article of mine on this site from some time ago explaining my position against quantitative easing within the framework of monetary equilibrium, actually.

            • John says:

              I’ve read it. It reminded me of a discussion at Coordination Problem, but I don’t side with you on this issue. I agree that it is impossible to know how to “reflate” correctly (c.f. Hayek’s knowledge problem), but that doesn’t mean it cannot cushion the effect of a monetary deflation.

              • Jonathan M.F. Catalan says:

                My view is that a rise in the demand for money is, in effect, the cushion itself. It represents an increase in savings in an environment where there is, effectively, a shortage of savings. It, in other words, lessens the degree of monetary contraction necessary in terms of loan defaults.

        • Ingolf Eide says:

          Jonathan, agree with your first paragraph but not with the notion that inflation would fall under Selgin/White style free banking.

          Indeed, in a brief piece at freebanking.org entitled “Is Fractional Reserve Banking Inflationary?”, Selgin himself wrote:

          “The move to fractional reserves results, in other words, in a permanent, once-and-for-all price level change, but not in any permanent change in the inflation rate.”

          http://www.freebanking.org/2011/09/02/is-fractional-reserve-banking-inflationary/

          That seems entirely reasonable. Earlier in the piece, he makes a related point that’s far too often downplayed or entirely ignored:

          “Generally speaking, an economy’s rate of inflation is mainly a function, not of the reserve ratios kept by its banks or of whether banking is a free or heavily regulated industry, but of the nature of it’s base money regime.”

          • Jonathan M.F. Catalan says:

            Ingolf,

            Right. In the Selgin model, gold is base money. But if there is little demand for gold as currency then there is less of an industry for gold production towards this purpose. Selgin, in fact, says as much in his book Free Banking (arguing that more resources can be moved to other industries).

      • Jonathan M.F. Catalan says:

        And, sorry, when I say “other than jewelry” I don’t mean to restrict the value of gold only to jewelry. I only mean that the demand for gold will be for its value as a commodity, rather than as a medium of exchange.

    • Robert Sadler says:

      Jonathan,

      I think you have taken Dr. Shostak’s quote out of context. When we extend it thus:

      This is an act of fraud, which is what inflation is all about, it sets a platform for consumption without making any contribution to the pool of real wealth.

      We can see the difference between an increase in the supply of gold and a difference in the money supply. An increase in gold (as an industrial and consumption good, as well as money) results from an increase in productivity leading to an increase in wealth. A central bank adding zeros to a virtual account is not increasing productivity or wealth. Inflation (by which I mean increasing the money supply without 100% backing by a real good) whether by a central bank or a fractional reserve bank is fraud. It has tangible economical effects which is also why it is an ethical issue. An increase in the supply of gold is no more inflation than an increase in the supply of grain or leather.

      • Jonathan M.F. Catalan says:

        Robert,

        How is increasing the number of gold coins adding to our wealth? What is the difference between having $10 in gold or $10 more in banknotes? I don’t understand the distinction you’re trying to make.

        If we define inflation as an increase in the money supply (which is the economic definition), then it doesn’t matter whether that money supply is composed of bank notes or composed of gold coins. The catallactic laws of money don’t change based on what type of money it is.

        Finally, the economic problem of inflation has nothing to do with fraud. Otherwise, we are constantly defrauding each other. Prices fluctuate. The value of your money in terms of other goods is constantly fluctuating.

        • Robert Sadler says:

          Jonanthan,

          I didn’t say an increase in gold coins – I was referring to an increase in gold which is a good.

          You seem to be changing your definition of inflation. Your second paragraph defines it as an increase in the money supply whereas your third paragraph implies your working definition is that inflation is a rise in prices. Can you clarify? Note that neither definition is the same as the one I am using.

          As for the distinction I am trying to make: gold is a good, zeros added to an account are not. This is a firm and clear distinction between gold and fiat currency. To understand why this is important I encourage you to read some of Dr Shostak’s earlier articles where he discusses capital theory (Dr Huerta de Soto also provides an excellent summary in his recent book).

          I say this because a good basic understanding of capital theory (which is all I have alas) is crucial to understanding why inflation of fiat currency leads to serious economic distortions and why an increase in gold is unlikely to have the same effect.

          • Jonathan M.F. Catalan says:

            Robert,

            We’re talking about money (and so is Shostak; not sure if you missed this). Who cares about the production of gold for non-monetary use? My point has to do with gold money, not gold in general.

            You seem to be changing your definition of inflation. Your second paragraph defines it as an increase in the money supply whereas your third paragraph implies your working definition is that inflation is a rise in prices. Can you clarify? Note that neither definition is the same as the one I am using.

            The point of defining inflation as an increase in the money supply is to emphasize the causal relationship between changes in the amount of money and changes in prices.

            But, ultimately, the exact definition is irrelevant. As long as we’re talking about the same concept, then it’s fine.

            But, you’ve failed to actually address my point. We’re talking about money. Why is an increase in gold money (which is what Shostak is talking about) better than an increase in fiat money? What’s the catallactic difference between these different types of monies as far as the relationship between amount of money and prices goes?

            Regarding capital theory, I suggest you read some of my own work on this topic.

            • Rob Thorpe says:

              Jonathan, Robert,

              Mises and Rothbard sometimes have quite different views on what causes an unsustainable boom.

              In Mises the answer is account falsification, which is a generalisation of Fisher’s money illusion. People continue to believe that money has it’s old value while it’s value is deteriorating. When they begin to discover the problem they must adjust their plans.

              Rothbard on the other hand comes close to making the same arguments as Lucas and the rational expectations school. To him the public can see through some changes in the value of money, but not through others. Rothbard puts changes due to creation of fiat money in the later category, the public can’t see through these and they’re fooled by them. However, the public can see through the effect of changes in the demand for money, or through the effect of a rise in the supply of money as would be caused by a rise in supply of gold in a gold standard. The final conclusion of this analysis is that when the private sector or state sector create money in ways that Rothbard doesn’t approve of, such as fiat money or fractional-reserve money, then that leads to an unsustainable boom, But, when money is created in ways he does approve of, such as by mining gold it doesn’t.

              I don’t agree with Rothbard, if the public can see through changes in the demand for money then why can’t they see through changes in it’s supply?

              • Jonathan M.F. Catalan says:

                Rob,

                Those are not Mises’ views on the “unsustainable boom” at all, sorry. In Mises’ views the unsustainable boom is a product of malinvestment, caused by a change in relative prices. It was Mises’ account that inspired Hayek’s work on the same topic.

                Rothbard’s account is a union, to some degree, of Mises and Hayek, where Mises probably integrated the subjective element to a much greater degree than did Hayek.

                It has nothing to do with a general change in the value of money. In all cases, it has to do with the change in the price of capital goods of different orders.

              • Rob Thorpe says:

                I don’t agree. I’ll post at the bottom of this thread though so I have more space.

            • Robert Sadler says:

              Jonathan,

              If you are discussing money backed by gold then discussing gold for non-monetary uses is crucial. It is this backing that makes it valuable. This is why gold was used as money in the first place. Because it had value. It is a good and people would accept it as payment. Ask yourself if you think gold money came first or jewellery. Did bank notes come first or gold money?

              Where does the supply of gold for coins come from if not from gold mining? Will the market value of a gold coin increase if the demand for gold’s primary use jewellery, increases? What about the steadily increasing demand for gold for industrial purposes (cell phones, computers, iPods, etc.)? Will this affect the value of a gold coin? I would think so. Would an increase in the gold supply be a good thing? Cheaper electronics, jewellery, medicines etc. sound pretty good to be. I think it would naïve to ignore these effects and assume they would have no effect on the market value of gold coins.

              Would increasing zeros on a bank account at the Fed achieve the same thing? The Fed would like to think so…

              I don’t think you can divorce the non-monetary uses of gold from the monetary. There are alternative uses of gold coins. I can buy a bunch of gold coins, melt them down and make a necklace. Can you do this with zeros in a computer account?

              I think your definition of inflation is incomplete. I would define inflation as an increase in the money supply that is not backed 100% by gold (or a suitable good). Looked at this way, clearly an increase in gold cannot be inflationary while an increase in mere bank notes clearly is.

              Jonathan, I would be happy to read your work on Capital Theory. Would you mind supplying me with some links? Thank you.

              • Robert Sadler says:

                Just on your note to R. Thorpe, Jonathan:

                You say that Mises’ view is that the unsustainable boom is a product of malinvestment caused by changing relative prices. What causes these changing relative prices?

              • Jonathan M.F. Catalan says:

                I’m sorry Robert, but that simply isn’t the case. It isn’t the non-monetary value of gold that gives gold money its value. You are misunderstanding Mises’ regression theorem. The origins of money, or the value of the first money, was derived from the value of the same commodity’s non-monetary value, but upon the initiation of monetary value these two values are completely separate.

                So, the value of gold as currency is set by past prices in gold, not the price of gold in terms of some other economic good.

                And the demand for gold as money has nothing to do with the demand for gold as jewelry. Gold will continue to be mined for other purposes, but whether it enters circulation as money depends on demand for it as money.

                Now that we know what we’re talking about, the fact is that there is no catallactic difference between an increase in the supply of gold in circulation as money and the supply of banknotes. Money is money; what type of money makes no difference in terms of laws of catallactics (economic laws).

                And, what makes the investment unsustainable in both Hayek’s and Mises’ views is this change in relative prices. The change in relative prices is brought about an increase in the supply of money in the loanable funds market, without an increase in the available quantity of capital goods. but, if the loanable funds market was composed entirely of gold money and not banknotes, and there was an increase in the supply of gold coin in the loanable fund markets then the same problem would occur.

                Again, I point to the empirical evidence provided by the European price revolution of the 16th and 17th Centuries (which caused an industrial fluctuation in Sevilla, for example).

                And you can read most of my work at Mises.com.

          • Jonathan M.F. Catalan says:

            And just so that we know the problem isn’t a lack of reading: http://en.wikipedia.org/wiki/User:Catalan/Library#Libertarian_Studies_and_Economics

          • Rob Thorpe says:

            Robert,

            Why do you think money must be a good?

            If you are opposed to people spending what they have not yet earned then why aren’t you opposed to debt contracts too, since they do the same thing?

  • It is sad that in 21 comments only Craig Howard and Richard have rememebered of interest rates.
    The reasoning of Shostak – like the most of current Austrians’ – is always biased by underrating the role of interest rates while focusing only on “money” (with no further steps into comprehending how credit is money too); interest rates are determined by the market for funds, and if a greater deal of money is available it is highly feasible it will turn into a greater supply of funds, which lowers the interest rate and re-allocates wealth along the time-dimension of capital; it is the biasing of time dimension which creates cycles (i.e. boom and bust phenomena depending on each other in sequence) as the flow of wealth (and savings) gets dis-aligned from the time-development of production.

    A sudden increase in gold supply, within a gold-money system, will create business cycle as it will immeadiatly push interest rates down. It is a genuine monetary distorsion: no new real savings are now available but just a greater deal of monetary medium which chases the same amount of real wealth as before!
    The advantage of gold as a money is (some comments got this point) “just” that its rate of creation is out of control by central authorities and is really low indeed, so its bias onto the economy is present but absolutely negligeable, while fiat money supply is discretionary and – as we see – too fastly increasing thus lowering interest rates a lot.

    • Rob Thorpe says:

      I agree. But, I would argue that what you describe happens because of account falsification. It occurs because people regard the monetary unit as being worth a similar amount of real goods while the number of those monetary units is increasing much more quickly than production is. If people realised that the monetary unit was declining in scarcity then the effects you describe wouldn’t occur.

      For that reason the “narrow” interest rate paid on current account and short-run bonds isn’t so important. The “broad” interest rate, the interest-like portion of profits paid on all investments is what’s important.

      • It is account “falsification” as the supply of the monetary instrument increase, which is a illusion of a greater availability of savings; there is actually a change in the numeraire. Of course people think it is similar to an occurred increase in the available goods, as price have not yet reflected the new money/goods ratio of the economy. As new exchanges take place, prices will rise and reflect the actual devaluation of the higher amount of money in circulation (as money is less scarse, as you say, it will “value” less goods).

        No cycles will occur “If people realised that the monetary unit was declining in scarcity” immediately, so prices should immediatly step up proportionally i.e. the numeraire would perfectly in zero time incorporate the lower scarcity… which is impossible in the real world because of the Cantillon effect (unless you subscribe the homogeneous rise in prices of monetarist theories, which I am sure you do not *smile*).

  • I add: Spain and Portugal increased a lot the supply of gold-money when America was discovered: a lot of new mines where opened and a lot of gold imported to Spain and Portugal. This led the economies to crack up. Is there someone here who deems this happened perchance?

  • Rob Thorpe says:

    Those are not Mises’ views on the “unsustainable boom” at all, sorry. In Mises’ views the unsustainable boom is a product of malinvestment, caused by a change in relative prices. It was Mises’ account that inspired Hayek’s work on the same topic.

    Rothbard’s account is a union, to some degree, of Mises and Hayek, where Mises probably integrated the subjective element to a much greater degree than did Hayek.

    It has nothing to do with a general change in the value of money. In all cases, it has to do with the change in the price of capital goods of different orders.

    Jonathan, I don’t agree with you on this. I’ve been very busy recently, but if I get the time I plan to write a reply to your article on prices and the demand for money.

    The question here is slightly separate from Monetary Disequilibrium theory, what we’re concerned about is ABCT.

    I think we agree that the scenario described by ABCT begins with an injection of money. We normally consider an injection of money into the banking system, let’s use that case here.

    Now, what happens to the interest rate if there is an injection of money depends on your view of rational expectations? The view of many of the rational expectations school has been that short-run interest rates may change but long-run interest rates will remain unaffected. I believe Fisher Black pointed out that this isn’t really consistent, and that even short-run interest rates should not change from the natural rate. I take the view that we can’t expect expectations to be perfect, and therefore an injection of money will reduce the short-run interst rate (and probably longer run interest rates too). I expect you would agree with me there.

    Now, the question is how do we get from this point to malinvestment and from there to crisis? In “The Theory of Money and Credit” Mises refers to Bohm-Bawerk’s “average period of production”. That concept may be invalid in general but toy models can be created where it is valid. We can talk about an evenly-rotating economy where there is an average-period-of-production of 1 year. When there is a monetary injection into the banking system the short-term interest rate falls, this makes more roundabout processes of production more profitable and the average-period-of-production becomes longer.

    This change though doesn’t gaurantee a crisis. The average-period-of-production may increase and remain longer for long periods of time, even permanently. In ABCT though we’re talking about an *unsustainable* rise in roundaboutness. A large part of the theory is about why the rise is unsustainable. One simple answer that’s often given is that the percentage of output used for capital goods and the percentage used for consumer goods do not follow the aggregate wishes of the public. In think this explanation is a cheat, we must go further and explain why the wishes of the public even matter.

    The conventional view here is that the injection of money will eventually have an effect on the price of consumption goods. I generally agree with this view. Roughly speaking there are four things that can be done with the newly injected money. To begin with it can be held, if we look into that case monetary disequilibrium rears it’s head. I don’t want to talk about that now, let’s talk about it in the future. The other three possibilities are that it can be spent on consumer goods, producer goods or existing capital assets. I think we should discuss the latter case more, but generally ABCT concentrates on the effect on producer and consumer goods. Generally the fall in interest rates that a money-injection causes is seen as causing demand to rise for producer goods. Garrison suggests it could be more complicated than that and demand for consumer goods could rise quickly too. I agree with him, but again, that’s a discussion for another day. Let’s just say that demand for producer goods rises as the new money is spent on producer goods.

    Does a rise in demand for producer goods mean that demand for consumer goods falls? Not necessarily. If expectations cause no complications then there is no reason for demand for consumer goods to fall. Since we are assuming that actors can’t come to unbiased conclusions about the long-run interest rate(or at least can’t perfectly), it makes no sense to argue that expectations can help much here. We can’t really assume that people have perfect expectations about the future price level if they don’t have perfect expectations about long-run interest rates. There will be account-falsification. So, the total demand for output, consumption goods plus producer goods, rises. That leads to a temporary rise in production (while buffer stocks are used up) and then a rise in prices. Price rises in producer goods gradually lead to price rises in consumer goods as the injection of new money spreads through the economy. In traditional ABCT this then leads to a situation where worker/consumers see their costs (consumption goods costs) rise more quickly than their incomes. That then leads them to suddenly reign in their spending on consumption and this causes a recession. A variant of this may be closer to the truth, it may be that as prices begin to increase consumers see that as a sign of a future rise in prices and that the real change happens slightly in advance.

    Notice how the above paragraph works, here I’m talking about relative prices and price levels. I need both to make the theory work, one alone can’t do the job. Sometimes people talk about money spreading out from an injection as though that process can explain everything by itself. If you can explain it without any reference to aggregates or price-levels then I’m all ears.

    If you read Mises even in “The Theory of Money and Credit” he gives the ABCT theory I’ve described here.

  • btcbase reno says:

    Great Articel. I hope Bitcoins will get more popular in the future – imagine Amazon payments through such an easy payment method like bitcoin. We run a German Bitcoin Blog since the early days of Bitcoin and we’re happy about all awareness Bitcoin is getting lately.

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