Commodity based money

[Lex]

Okay, so we're all here for the gold standard. I've been rereading some Ludwig von Mises articles to try and answer a questions I've been having regarding commodity backed money and can't seem to get a coherent answer so here goes:

We all know the volatility of a government controlled money system, especially when it's just one guy, before it was Greenspan and now it's Bernanke. And we've all kindof come to expect that if we just go back to the gold standard things will be better... but from my understanding of the commodity backed money system is that with things such as gold, which are finite, we will eventually end up with either severe deflation (as the population and the economy grows but the money supply stays the same) or the currency backed by the gold would have to be devalued (so instead of a dollar representing 1 ounce, it would be represented by 1/2 an ounce, etc).

The Great Depression was caused by this exact problem: deflation.

Of course the ultimate solution to this problem is to have lots of competing currencies, etc. But that's not what I think most people are seeing, everyone seems to think that if we just switch to a gold standard everything will be peachy when in fact this would be just as problematic as if we stayed on the fake monopoly money standard.

Ron Paul has stated that he's more interested in a competing currency than merely a switch to the gold standard so it's reassuring to know that at least he's aware of the problems with the gold standard.

Anways, I thought I would get a conversation started on this subject since I think it's an important issue and many people don't fully understand it (including myself).

[John Edward Mercier]

There is no fake monopoly money standard. Interest rates, either market or fed, are largely due to economic factors with GDP being the highest. Its largely been said that the Federal Reserve Board of Governors could be replaced with a simple economic formula... proplem being everyone disagrees as to what that formula is.
People like myself tend to be Strong Dollar advocates.

[Lex]

There is no fake monopoly money standard. Interest rates, either market or fed, are largely due to economic factors with GDP being the highest. Its largely been said that the Federal Reserve Board of Governors could be replaced with a simple economic formula... proplem being everyone disagrees as to what that formula is.

A fake standard for fake monopoly money? No, thanks. 

Under a gold standard interest rates would become irrelevent to a certain degree because it would become prohibitively expensive to borrow money even at 0% interest. The result of deflation is that things are continuously going to get cheaper. So if you buy a house today for $100,000 ten years from now it may be worth $50,000 depending on the rate of deflation. Because of deflation you would also get paid less, which means you would have less money to make payments on your mortgage year after year. So not only would you have lost half of the value of your house you would have also had your salary reduced by half.

That is my concern with a gold standard. It will ultimately lead to deflation. What's needed is something that will keep prices steady. If I saved $100 today it should be worth somewhere in that range 20 years from now. An economic system that could produce such an environment would be ideal from my understanding. So the question becomes what do you base your currency on to keep it relatively stable?

People like myself tend to be Strong Dollar advocates.

What's a Strong Dollar advocate?

[John Edward Mercier]

Strong Dollar advocates are about maintaining the value of the dollar.

The problem with the gold standard was largely the expansion of credit. My father speaks of the old days when one needed a third down and could only finance for three years on a vehicle. For a house, twenty percent was the norm... and a maximum of fifteen years financing with no fixed rate lending.
He remembers taking a pay voucher to the mutual bank and getting cash. After that all his day-to-day transactions were done in cash. Today this is largely unheard of...

[Lex]

Strong Dollar advocates are about maintaining the value of the dollar.

By 'value' do you mean keeping prices the same?

The problem with the gold standard was largely the expansion of credit. My father speaks of the old days when one needed a third down and could only finance for three years on a vehicle. For a house, twenty percent was the norm... and a maximum of fifteen years financing with no fixed rate lending.
He remembers taking a pay voucher to the mutual bank and getting cash. After that all his day-to-day transactions were done in cash. Today this is largely unheard of...

I'm not sure I understand your point. Are you arguing FOR credit expansion or AGAINST credit expansion? Because I would say today we have TOO MUCH credit expansion.

[John Edward Mercier]

I was explaining that in the past credit was limited. Its largely the expansion of credit that has swelled the money supply. The more we 'ease' credit the more the dollar devalues.

In a very broad sense valuation and pricing is related. Competition is more a control of prices, while interest rates are more the control for currency valuation.
When the US$ is devaluing its in comparison to some other format. And it doesn't devalue equally to each of the others.

[Ron Helwig]

I don't see any need for a "standard".

If people think using gold is good, then they should use it.
If people think using silver is good, then they should use it.
If people think using a certificate representing a defined basket of goods is good, then they should use it.

All the talk about interest rates affecting money supply and all that kind of stuff is just a tool for the manipulators. You only need to know how money and interest rates affect each other if you want to manipulate things.

Eliminate legal tender laws and let people use what they want. Whatever works will win in the marketplace - even if that is multiple currencies such as gold ounces and silver grams.

http://shiresilver.org
http://shiresilver.com

[David]

You raise a good point about the eventual deflation of gold due to the inevitable peak gold, and due to the fact that gold has a limited supply.  The depression was due to rapid deflation that eventually popped the stock market bubble.  This caused a severe scare that led to people holding on to their money which had the same effect as deflation. 
In a deflationary economy money actually becomes very valuable, gold would be no exception.  Its value would go up.  Since most cannot afford to carry a single gold coin worth say...2000 dollars, vendors and mints would intentionally debase it and would openly sell it as such.  It would have the same effect as the gov't in an intentional deflationary economy deciding not to print any more one dollar bills, but would be printing 50cent bills.  They would effectively subdivide the money. 
I am convinced that a deflationary economy would be no worse than any other situation, if it was 1. expected, 2. any corrections that had to be made were done.  The great depression was so bad because it was sudden, unexpected, and the correction took 10 or so years.
All things have an equilibrium point.  That point moves from time to time, but in general not too much.  This is why I am convinced that permanent deflation would not be a bad thing. 

[Jacobus]

The Great Depression was caused by this exact problem: deflation.

The Great Depression was deflationary, but I don't think it's quite correct to say deflation caused it.  I think it was overextension of credit during the booming 20s (caused by Fed policy) that was the root of the Depression.

I agree with David that deflation is not necessarily a bad thing.  I wouldn't mind knowing that the money in my wallet will buy more tomorrow than it does today. 

But I think the most important point is that the government should get out of the banking business.  It is the central planning and control over supply of money, fractional reserve ratios, and interest rates that is the root of boom / bust cycles and provides inflationary incentives.

[David]

Quote<But I think the most important point is that the government should get out of the banking business.  It is the central planning and control over supply of money, fractional reserve ratios, and interest rates that is the root of boom / bust cycles and provides inflationary incentives.>
It wouldn't solve every problem, but it would definitely be a big improvement. 
Think of what permanent deflation would do for retirement and capital savings based investments.   

[Lex]

I think perpetual deflation would be very bad all around. The economy would really slow down because now people have an incentive to put off buying, why buy something today when it's guaranteed to be cheaper tomorrow. I think it would be the other extreme of what we have now. You can forget about loans pretty much outright and despite the debt maddness there are people who make legitimate loans.

I dono, I'm not sold on the idea that perpetual deflation could be a good thing. In the long run it sounds just as bad as perpetual inflation.

[David]

I think perpetual deflation would be very bad all around. The economy would really slow down because now people have an incentive to put off buying, why buy something today when it's guaranteed to be cheaper tomorrow. I think it would be the other extreme of what we have now. You can forget about loans pretty much outright and despite the debt maddness there are people who make legitimate loans.

I dono, I'm not sold on the idea that perpetual deflation could be a good thing. In the long run it sounds just as bad as perpetual inflation.

People can only put off buying for so long.  Needs and wants will still be met.  the interest on loans would be incredibly low, or nonexistent.  Particularly since there would be so much money to loan out, due to the gain on just saving money. 
The biggest problem I see is that of wages.  An employee making the same amount for 10 years straight would have actually seen a pay increase every day he worked due to the increase value of the money.  that would be remedied by an increase of worker turnover, and temporary work, to some degree. 

[Lex]

The interest on loans would be incredibly low, or nonexistent.

Even a 0% loan on something like a house would become very expensive over time. You're monthly payments will stay the same but the value of those payments would increase so eventually you would be paying A LOT of money. Banks would probably have to offer negative interest rate loans. I guess that could work.

Particularly since there would be so much money to loan out, due to the gain on just saving money. 

See, this part troubles me. It doesn't make sense that money laying in your basement would grow in value. There is just something fundamentally wrong with that (just as when money looses value in an inflationary system).

The biggest problem I see is that of wages.  An employee making the same amount for 10 years straight would have actually seen a pay increase every day he worked due to the increase value of the money.  that would be remedied by an increase of worker turnover, and temporary work, to some degree. 

Employees would most likely NOT be making the same amount every year, they would probably be getting pay cuts every year. If you were good that year you would get a smaller paycut than someone working on a fixed salary who would get a paycut to match deflation.

[David]

Particularly since there would be so much money to loan out, due to the gain on just saving money. 

See, this part troubles me. It doesn't make sense that money laying in your basement would grow in value. There is just something fundamentally wrong with that (just as when money looses value in an inflationary system).

It does seem to good to be true.  In theory though it is possible. 
I think what is more likely to happen though, due to demand, is that the existing gold would either become very valuable like platinum or palladium, and silver due to demand would follow.  But due to its overall lower cost silver would become the standard.  Supply and Demand will lead to equilibrium. 

[John Edward Mercier]

Gold and silver have limited inherent commodity value and in a highly deflationary environment would become next to worthless in a very short time. The examples of such are actually near term.
Had you bought an ounce of gold thirty years ago, you would have seen what deflation did to it.
Same thing goes with the Great Depression, it had several parts including the 'dustbowl' which saw farm land values collapse in certain regions. And the Chinese firedrill effect of the Greed/Fear cycle associated with daytrading that when heavily marginalized would result in the collapse. The Fed at the time being largely banker driven would tighten credit, and POOF there goes the economy.