This is a pretty good yarn explaining to the layperson how exactly we moved from a period when the financial markets only ever seemed to go up to the time, now, when there are long queues of anxious customers trying to pull their money out of mortgage lending and savings firm, Northern Rock. Hedge funds have lost money. Weird-sounding entities called ‘SIV-lites’ have lost cash (the absurd jargon of financial markets never fails to amaze me). I do not share the view of some Jeremiads that this saga will bring about a recession – although I do not discount that possibility – but the pace of the UK economy is bound to slow down. Suddenly, this present government is going to find it a lot harder to pay for all those new public sector sinecures it has created over the past 10 years – possibly as many as a million public sector jobs. Slower growth will cut into revenues.
The Northern Rock saga has jolted financial markets so much that the US equity market today fell because of the situation. Normally, the UK stock market takes its lead from the US, not the other way around. By coinidence, meanwhile, Alan Greenspan, the former chairman of the US Federal Reserve, has been plugging his memoirs and airing his views about the current problems. Like a lot of people, I take a less than reverential view of Greenspan, although I can see his many fine qualities too: he is a good economist, pretty sound on markets as such folk go, but he abandoned his old, gold-bug principles a long time ago and was a pretty “seat-of-the-pants” sort of Fed head, making up economic doctrine almost, it seemed, on the hoof. It is a bit rich, frankly, for Greenspan to bash Bush for the tax cuts (one of the few good things that Dubya did as President, actually). Greenspan operated a relatively loose interest rate regime and this fuelled the lending practices that have come back to haunt us, especially the whole sub-prime debt Snafu. Cheap money that is detached from economic reality begets trouble. As a man who once learned his economics in the circles of Ayn Rand and Ludwig von Mises, it is a shame that even he could not understand this, or if he did, act upon it.
I have said it before but I repeat it here: it is high time that the cult of the detached, Olympian central banker setting interest rates for whole land masses was ended. Here is the classic statement of why central banks with monopoly rights of currency issuance keep coming a cropper.
Maybe it is my ignorance, or maybe it is my lack of hang-ups in this matters, but I have never understood why those who oppose the Central-Bank principle have always to propose the Gold-Standard principle instead. If we did not have Central Banks (essentially a government monopoly in the supply of money), why would we need a Gold Standard (essentially another non-economic limitation in the supply of money). Why do we need a reference currency? Why can’t the money value of goods and services be left to fluctuate freely? Could someone explain this: I find this Central-Bank-Gold-Standard dicotomy perplexing?
The theory I was told was that if people were given a free choice without any government backed currency, they would choose exclusively currencies backed by gold. Hence the gold standard. I thought “fair enough, it would be a pretty good thing to base your currency on” but I couldn’t work out why libertarians tend to focus so much on gold. I mean, couldn’t it be applied to just about any precious good that was valuable in small enough quantities? Silver, platinum… diamonds maybe? Particularly since you don’t have to be carrying around these things things, just carrying notes that you own them or have a share in them.
Before long, couldn’t people be swapping shares/vouchers in the goods of any large and stable institutions as a currency?
Easter Island.
Gold is meant to be a shorthand for any kind of commodity backed currency, according to the Mises.org folks.
It’d be interesting to see if a private institution could get away with issuing a fiat currency in a relatively libertarian world.
I think gold standards are a terrible idea and make even less sense in our information rich world where competing private currencies work as easily as any complex derivative product in a sophisticated market.
Why not a currency backed by energy? Or instead of gold, a basket of different precious metals, minerals, energy, etc..?
Frederick, since you ask, I don’t think a modern gold standard would work for the sort of reasons Perry gives. I was not advocating a gold standard, merely pointing to the rather glaring gap between Greenspan’s enthusiasm for money backed by real-world assets and his later conversion to the idea of central banks pumping fiat money into the economy at will.
There is an energy backed economy. It’s in Sid Meier’s sequel to Civilization – Alpha Centauri. It works because it’s a game and energy can therefore be treated rather more abstractly…
Real world energy isn’t an abstraction. If you think otherwise try putting diesel into your petrol car or try powering your laptop with a lump of coal.
BTW, does anybody have a reference to the Italian town which introduced a parallel currency?
You’ve all heard of this one surely?
http://www.guide-information.org.uk/guidelist.aspx?recid=G19431
Another question for gold-bugs is: who enforces the standard? Isn’t currency pegged to any commodity (or another currency) come to that, just another form of fiat-money?
What we need – and what we largely have, with effective global capital markets and limited exchange controls – are genuinely fiduciary issues, where the worth of a currency depends on how trusted it is. Central banks under such circumstances are much less fearsome creatures, and are become closer to what they were when first invented: guardians of the government’s credit, operating on the understanding that governments do need good credit.
Rob Spear: It’d be interesting to see if a private institution could get away with issuing a fiat currency in a relatively libertarian world.
That is what used to happen on a small scale in London all the time – IOUs from reputable companies were exchanged as if cash.
“Before long, couldn’t people be swapping shares/vouchers in the goods of any large and stable institutions as a currency?”
The touchstone essay here would be F. A. Hayek’s “Denationalisation of Money: The Argument Refined” (1978). I don’t think it’s online anywhere. I have it in my copy of Hayek’s 1991 anthology, “Economic Freedom” (Institute of Economic Affairs). He makes a splendid case for privately issued commodity-based competitive currencies. One of the most remarkable aspects of it is his grasp of the implications of information technology for all this, some time before the revolution really got rolling.
I would point out that gold, per se, is not a “terrible idea”. What’s a terrible idea is government diktat over any of this. Big, crucial, difference.
The “gold base” is mentioned frequently because it was the standard up until the 1970ies.
What we have now is indeed a free, fluid global market in everything: currencies, shares, bonds, vouchers, CDO’s etc., etc..
You use whatever you please as an investment instrument – as a place to put your surplus money, or your debt in.
The pieces of paper you use to buy your groceries with aren’t important at all. The currencies – dollar, yen, pound, euro – have lost their special significance. Cenral bankers are limited in their freedom of money manipulation by the global market.
The essence of why fiat money is considered bad is in Guy Herberts comment – “how trusted it (money) is”. Where does this “trust” come from? Those who are against fiat money are against it because of the necessity of resorting to the likes of dollar diplomacy (in its broadest sense- Google Hussein, oil, euro). The “trust” in a fiat currency, backed by nothing tangible, is brought about by National might alone. The “trust” comes from the same fountain of logic as to why a government can do things that any private enterprise can’t. A truly private entity could not issue anything not backed by something tangible. In short, fiat money only has value because the government has the monopoly on force.
Having said all that, I (as in so many ways regarding libertarian principles) am divided between the ideal and the reality. The fiat money cat is already out of its bag. Just like I think a mass reduction in taxes is proper, to do it all at once would be devastating. So simply cutting back over to a non-fiat backed money would be too. And I have yet to see anyone put forth a plan as to how we could cut back over over a period of time that would not be manipulated by someone. So we will continue on an unhealthful path until it blows. Sometimes you just have to think that Statism cannot be curbed until a huge paradigm shift occurs, and when it does it usually means bad times for many, many people.
The problem with a gold based standard is that gold is inflationary as we keep digging up more of the stuff.
Paul, may I provide an historical example of your argument? When the Spanish Empire was hauling gold and silver by the ton from the New World to Europe, prices went up throughout Europe. A price is nothing more than a ratio of money to goods, so increasing the supply of gold in proportion to other goods inevitably drove up prices.
That may not bother those who practice the Golden Rule (“He who has the gold makes the rules”), but the effect was that Spain, able to import manufactured articles from the rest of Europe, missed out on the Industrial Revolution. European countries who supplied Spain with manufactured goods, such as France, the Netherlands, and England, were the ones who developed productive industries. Meanwhile, in Spain, inflation exacerbated class divisions since the spoils of Mexico accrued primarily to the upper class. Spain had suffered the curse of Midas.
How I hate terms like “gold standard” (or any “standard”) or “based on”.
If gold is what people choose to use as money that is fine.
And if they choose to use silver that is fine.
And if they choose to use several different commodities that is fine as well – as long as the EXCHANGE RATES BETWEEN THE COMMODITIES ARE NOT FIXED.
F.A. Hayek style index money is NOT fine – because such an index will not work.
F.A. Hayek competition monies is fine – as long as there is not government support for any of the banks or other institutions issuing the currency.
In short if a bank plays fractional reserve games (or any other game to try and get the amount borrowed greater that REAL savings) it must be allowed to go bust and those who trusted in it must be allowed to starve in the streets (at least as far as the government is concerned).
This will mean that people are not likely to trust a fractional reserve enterprise.
And, of course, if an enterprise plays fractional reserve without saying it is doing that (i.e. it pretends that its notes are 100% “covered” by whatever commodity it says they are covered by – and they are NOT) then that is fraud and the managers responsible should go to prison.
Even if no commodity at all is money (say government fiat notes and coins are the money) borrowing should still be 100% from real savings – otherwise there will be credit expansion distortion of capital structure (via malinvestments) and boom-busts (which will be used as an excuse for all sorts of statism).
“Gold Standard”.
In Britain the Bank of England issued more notes than it had gold from the day it was founded (back in 1694).
True it do not do this MUCH (other than in wartime – indeed as late as 1914 few people in England had “white fivers” or other such and most buying and selling was done with coins) – but it still irritates me (to put it mildly) that certain politically connected people got wealth at the expense of the general public (for, no mistake, this is NOT a “victimless” custom).
As F.A. Hayek was fond of saying. Increasing the money supply is NOT like gushing water running everywhere at once (as the Chicago School seem to think) – for example if there is a “ten per cent increase in the money supply” that does not mean that everyone just finds that they have ten per cent more money in their wallet.
Increasing the money supply is like treacle (not water) – it piles up in certain places (such as the stock market and the real estate market) and wealthy politically connected people end up with sticky, sweet smelling fingers.
“Gold Standard” in America.
Even before 1913 there were plenty of credit bubble games.
Under the Civil War National Banking Act private banks were encouraged to play games and they did.
Although it is true that the Civil War “Greenbacks” were got rid of (these Greenbacks were NOT a harmless alternative to bank bubbles, as some people to think, they were a bloody mess). Sadly the second Greenback Case declared that the Greenbacks were not unconstitutional (even though paper money clearly is unconstitutional – read the the Constitution of the United States if you do not believe me), in spite of the first Greenback case declaring that they were unconstitutional.
Chief Justice Salmon P. Chase wrote for the majority – even though he had been the Civil War Treasuary Sec who had issued the Greenbacks (basically the government added more judges and ran the case again – Chief Justice Chase being in the dissenting minority).
Anyway fiat money went away for awhile (end of the 1870s) but bank bubble money remained – hence there were boom-busts.
These boom-busts were used as a excuse to set up the Federal Reserve system in 1913 – which made them worse.
Any real gold standard (how I hate that term – either gold is the money or it is not, there should be no f…… “standard”) ended in 1933 (indeed privately owned gold was stolen and private contracts voided).
The “gold standard” of 1933 – 1971 in the United States was an utter absurdity (no connection to anything real at all), which is why I do not dislike Paul Volker as much as other libertarians do.
See next comment – this one is getting too long to read.
Alan Greenspan is a bad man. Ayn Rand was right to fling her dinner in his face all those years ago. Mr Greenspan is not wrong about everything (for example he is quite correct to attack the Bush Administration for wild spending), but he is not a man who should be trusted.
I use the words “bad man” on purpose. If a man does not know that he is pumping up a credit bubble for special interests then he is badly informed, but he is not bad. If a man does know what he is doing then he is bad man – and this should be stated.
The reason that Ayn Rand flung the plate in his face was NOT because Mr Greenspan supported both fractional reserve games and Federal Reserve credit money expansion (to support the bubbles), but because he UNDERSTOOD what he was supporting (most people involved in this have not got a clue what they are involved in – they may be millionaries but they are as innocent as new born babes).
Alan Greenspan was directly responsible for the credit money expansion that led to the .com bubble and he is directly responsible for the credit money expansion that has led to the present bubble.
And he understood in advance that expanding the money supply would lead to such bubbles (although no one can totally predict in advance WHERE the bubbles will be) and he did it anyway – because he wished to support financial special interests.
Nor is it ture that a Federal Reserve Chairman has to be like this.
Take the case of Paul Volker (spelling alert).
Many libertarians hate P.V. because he was the man in the Treasuary Department responsible for “taking America off the gold standard” under the Nixon Administration in 1971.
However, the “gold standard” of 1933 to 1971 was a total farce (even before 1933 it was a “gold standard” not proper gold as 100% of money – so the United States was left open to the vast credit-money expansion of the late 1920’s that led to the Great Depression, by the way the rigged exhange rate British “gold standard” of 1925 to 1931 was a farce as well and supporting it was directly connected to the expansion in the American money supply).
As Fed Chairman Paul Volker did not bend over whenever the financial interests wanted more funny money (as Alan Greenspan did).
Milton Friedman said that Paul Volker cut off the extra funny money supply too harshly – making the cold turkey of 1981-1982 too harsh.
But I do not agree (with the greatest respect to the late Milton Friedman). Politically something is either done at once – or not all.
Either one cuts off the extra funny money or one does not – gradually cutting down will not play. It is cold turkey or nothing.
I do not believe that the Federal Reserve system should exist. Nor am I a supporter of Paul Volker’s general political or economic opinions.
But Paul Volker proved there could be SOME honour in the system (it does not have to be a prostitute for financial interests).
Alan Greenspan does not compare well.
Apologies for picking nits, but …
The Civil War National Banking Act is hardly the example you want to choose. It is an example of a “credit bubble game” only in the sense that it was the US’s first flirtation with fiat money (well, not counting the disastrous Confederate currency experiment, I mean). So this isn’t an example of a national gold (actually, silver) standard’s inability to prevent credit money games. Rather, it is an example of how quickly people will indulge in credit bubble games when they are allowed to go off the standard.
Just to be clear – I’m picking bones with Mr. Marks’ choice of example, not with his argument. I myself am agnostic about commodity-based currency. I haven’t read enough to take a firm position.
For general trivia – there is a local “independent” currency here in the Midwest: the Liberty Dollar. I haven’t bothered to participate, and the Fed is already looking for ways to shut it down(scroll down).
Lots of talk, but no clear answer!
On the one hand we have the people who support the Gold Standard and want a currency pegged to a single or set of commodities. I can see the problem in this system in that it will only work smoothly as long as the commodity is either tightly controlled by governmental power (banning the private extraction of gold as in some countries) or tied to a commodity that is stable (betting against human inventiveness not finding a better way to mine something valuable is just asking for trouble).
On the other hand we have the people proposing a fiat currency, where the value (exchange rate) of a currency is set dynamically and depends on the confidence people have in the issuing institution. What I do not understand is that if you propose a fiat currency, why do you need Central Banks? Why not have the fiat currencies on their own?
“That may not bother those who practice the Golden Rule (“He who has the gold makes the rules”), but the effect was that Spain, able to import manufactured articles from the rest of Europe, missed out on the Industrial Revolution. European countries who supplied Spain with manufactured goods, such as France, the Netherlands, and England, were the ones who developed productive industries. Meanwhile, in Spain, inflation exacerbated class divisions since the spoils of Mexico accrued primarily to the upper class. Spain had suffered the curse of Midas.”
Oh, dear. While dating the Industrial Revolution can be a daring enterprise, it’s pretty safe to point out that the impact of gold on the economy of Spain predates it by at least two centuries. And none of this can be seriously examined without accounting for horrendous war with England and the Netherlands. “The curse of Midas” actually has very little to do with it.
If citizens are not allowed to own the commodities that their paper money is backed by then in what way is the money “backed”? It doesn’t matter if the government has a trillion tons of gold in Fort Knox backing the paper in my wallet if I can never lay hands on the gold. The whole point of a backed currency is that you can exchange it for a physical good should you desire.
This whole thing about the gold supply’s “stability” is strange. It seems that the two arguments are “People would mine gold causing inflation” or “Gold is too rare to allow expansion of the money supply”.
It is safe to say that gold is not being destroyed in any appreciable amounts today. No treasure galleons are sinking to the bottom of the Atlantic, and natives aren’t dumping tons of it into the volcano to appease the gods. So if the supply isn’t shrinking, only growing through mining, then “price” should be dropping as long as demand stays constant. Of course demand doesn’t stay constant because economies tend to grow. More and more people are being born and those people want gold.
Even history shows us that demand has always outstripped supply for precious metals. That’s why they’re “precious” in the first place. The reason man has always coveted gold, a nearly useless metal before the advent of electronics, is because of it’s relative stability in supply and demand. You can always dig up more, but someone will buy it from you as soon as you pull it out of the ground. I’ve never heard of anyone complain that they had a warehouse full of gold they couldn’t get rid of.
Iron based money would not make a good standard. It has a huge supply, but highly fluctuating demand. Iron is more valuable when a war is going on (swords and all that) or massive amounts of construction are taking place. Such instability is useful for speculators, but not so good for people that need to buy bread.
My overall point is that if the “problems” associated with a gold standard are so severe then why has man used it since the dawn of recoded history? Answer: because those problems are imaginary! Our ancestors knew a good thing when they saw it. It is only in the last hundred years that anyone has questioned the usefulness of gold in commerce. The people most against a commodity backed currency are the ones who make butt-loads of money from counterfeiting (central banks).
Personally, I like the idea of competing private currencies. Why can’t we have Microsoft Dollars [Bill Gates’s Bills?] running alongside Sterling, Yen, US$, Euros… ?
They’d find their natural exchange-rates depending on circumstances and perceived market-trustworthiness.
Joshua please.
It must not be a commodity BASED currency – that opens the door to the late 1920’s and endless other examples.
Either the commodity is the currency or it is not.
Ditto private currencies.
Government fiat money “works” because the government demands you pay your taxes in it.
A “Bill Gates money” would not have that factor.
So Bill Gates (or who, or what ever) would have to say WHAT they were claiming was the currency.
They would have to be SPECIFIC.
And I doubt “these bits of paper with my face on them” would do. Although, sure, if people want to use those in trade with each other I do not believe anyone should stand in their way.
One of my comments has still not turned up – oh well it will in time.
As for Mr Davies question.
Of course you can have a government fiat money without a central bank Mr Davies.
Fiat money “works” (in so far as it does) because government demands that people pay their taxes in it (and because most fiat currencies did not use to be fiat currencies).
There is no reason that this should be tied to the moral hazard, corporate welfare of central banks or other government or semi government institutions.
However, please do not imply that I want a currency “based on” a commodity or “tied to it”.
What people choose to use as money evolves over time (many different commodities have been used and money is older than government – coinage may have been a government invention, but money was not).
Different commodities can and have been used at the same time and in the same area – there is no problem as long a the exchange rates are NOT fixed (if they are “bad money drives out good” or some other problem) and everyone is clear about what their contracts require payment in.
“But say the contract says payment in gold of certain purity and then people find a lot of new gold mines”.
Bad luck for the creditor – but not a boom-bust in the classical sense.
Alan Greenspan.
I have just done a short post on his interview with Neil Cavuto on F.N.C.
No doubt people will write in and say “you were unfair, Mr Greenspan also attacked the wild spending of Congress and warned about the future burden of the insane entitlement programs”.
Yes and, no doubt, Mr Greenspan is kind to children and animals as well.
What interests me in the context of monetary policy (which is what he was in charge of – if he had been a Congressman or Senator then I would have examined his VOTES against government spending, otherwise talk is cheap) is his replies to questions in that area.
He supported all his credit-money expansion in the past, and he supported the rate cut today.
Also, in reply to the most recent bubble Mr Greenspan said that a lot of debt paper is in trouble because it is linked to the real estate market – his solution was “prevent default” in the housing market (if the powers-that-be can – it was clear he was NOT talking about private agreements between lenders and the people they lent money to).
This is the mentality of the man.
Bail out, bail out, bail out. For everything and everyone.
And this is why he as much the “Goldwater Republican” he claims to be, as he is a cat.
I missed a point.
I repeat that index monies (i.e. a currency that is supposed to be more than one commodity) will not work.
I know that F.A. Hayek (at times) thought they would, but they will not.
In fact even two commodities (let alone a “basket” of them) will not work.
For example, the Pound had to be silver OR gold (it could not be both).
And the Dollar could not be BOTH silver and gold either.
If people do not understand the logical reasons that it will not work I advise them to look up the history.
Last point:
Let us say we had Mr Davies suggestion of a fiat money without a central bank (or other credit-money expanding institution).
This would, of course, NOT mean “stable prices” (price indexes are a bit of nonsense anyway, but I am too tired to get into that).
Prices would tend to decline over time as better ways of doing things were worked out.
This is not a bad thing.
True lenders would get more buying power back that they gave (even if interest rates were zero – which they would not be, because otherwise no one would be likely to lend out money), but gently falling prices over time (as opposed to a price crash as a credit money bubble bursts) is something that people can adjust to.
There is no reason why everyone should expect “more money” in their wallet every year.
If they can buy more and better stuff they are getting better off – even if their “income” has not risen.
Forget Industrial revolution and think commercial revolution. There is a good case that the United Provinces of the Netherlands had an essentially modern economy (that is to say the limiting factors for growth lie on the demand not supply side – i.e. malthusianism no longer applies) by about 1610, which then spread to England and others. 60% of the northern Dutch lived in towns and, while most of Europe suffered from rising grain prices as population outstripped production, tulips were being traded on the Amsterdam stock exchange and middle class Dutchmen were buying paintings for their homes. By 1700 or so England was well on the way to a similar scenario. It was this sophisticated, for it’s time, market economy that produced the industrial revolution
The idea that machines made capitalism rather than the other way round, is a Marxist one, not to be taken seriously.
Meanwhile, Spain went from being a relatively rich country to a complete economic basket case with chronic food shortages and eventually it couldn’t even produce enough wool (its primary export) to supply the home market. Silver (gold imports were insiginifcant from about 1550) was not the sole cause, one must also take into account a lunatic legal system, price controls on agricultural produce (not even balanced by price controls on, say, farmer’s tools) and heavy taxation. Nevertheless the relatively high inflation of spain did undoubtedly contribute to destroying its export industry.
(Italy’ economy also fell apart from 1590 onwards, but this is sufficently explained by the collapse of mediterranean trade routes after the Portugese opened up the Cape and then the Dutch took over and injected a dose of competence ito proceedings.)
Billy Beck, if you read my post closely, you will notice that i didn’t say the Industrial Revolution came during the height of Spanish gold and silver extraction in the New World. I said the influx of gold had deterred Spanish manufacturing by allowing Spain to import goods rather than make them. By the time the Industrial Revolution began, Spain was too poor to take advantage of it.
While the good times were still rolling, the most important strategic material was gunpowder. You’d think the world’s richest empire would ensure itself of its own supply, especially when they launched so many wars. But, the Spaniards thought they would always have enough gold that they could import it.
The economic joyride without economic development had to end someday. Unfortunately, by then the Hapsburgs had anticipated Louis XIV’s attitude of “apres moi, le deluge.” They kept right on spending in the face of declining revenue by selling so many bonds that by the time of Philip II’s death, two thirds of government revenue was going to pay only the interest on public debt. They had vastly expanded the powerful rentier class and sold titles of nobility which included exemption from taxes. The Spanish crown finally declared bankruptcy in 1557. The country needed manufacturers but it produced rentiers and the beginning of this was all that Mexican gold.
Sudden, unearned wealth is often disastrous for a person. The misfortunes of many lottery winners shows on the personal level what Spain showed on the imperial one.
As you may well know Mr Olson the Spanish government (even before Philip II wars in the Low Countries) was actively undermining both manufacturing and farming (farming being more important at the time) by its taxes and regulations (especially in Castile).
Castile when from the relatively (nothing is perfect) free and tolerate place it was under Henry IV to worse times under Ferdinand and Isabella (if only the other side had won the Civil War on the death of Henry IV – but there we go) who were plundering the Jews (and other people) before old Chris even got to the New World.
Under later rulers taxes and regulations got worse and worse (to give just one example farmers could not keep hurders off their property, because of the money the hurders paid to the government).
These endless regulations became known to the English as “Spanish practices” (especially in labour market situations).
The Dutch part of the Low Countries (the Netherlands – the part that fell being known now as Belguim) managed to get by with a lot less regulations and taxes than Spain had (although the guild restrictions in the Dutch Republic undermined long term development) – and it was Holland that was attack.
Religious toleration and economic liberty went hand in hand.
Holland had far less persecution of Roman Catholics than Spain (and so on) had persecution of Protestants. Indeed the elite Blue Guard of the Prince of Orange was mostly Catholic – the Blue Guard faught in Ireland in 1689 in defence of William III and against the (Louis XIV of France supporting) James II. Something that would confuse both sides in Northern Ireland today.