November 09, 2010
Gold standard discussion
Posted by James Hamilton at November 9, 2010 07:55 PMdigg this | reddit
Could we get there accidentally?
The Federal Reserve Banks carry gold on their balance sheets at an official price of $42.22. The total amount shown is $11,037,000,000.
At a current market price of $1405/oz. gold is now more than 33 times its carrying value on the balance sheet or a total of ~$370 billion. That represents about 16% of the total assets on the statement (~$2.3 trillion). Of course if the fed shrank its assets back to a more traditional level (~5 or 6% of GDP) of about $900 billion it would be well over a third.
It should be observed that in the pre-Nixonian Bretton Woods era, the Fed was statutorily required to maintain 25% of its assets in gold.
At some point the Fed is well capitalized and its notes would be worth something if it had prudent management.
Posted by: Walter Sobchak at November 9, 2010 08:08 PM
The five largest gold deposits are lying in the vault of the following central banks
World Gold Council (goldresearchstatistics then go to reserves assets statistics)
Historical chart of interest ( Please see 650 years Historic gold price)
After perusing charts and prices history of gold,the parabole story of the old man passing away and calling his two sons seems a better summary.
When remitting to each of them one Thaler of Marie Therese (MMT),he added I will come back to ask you "what did you do of your Thaler"?
More prosaically should central banks be willing to drive their monetary policies with discipline,they since long have tools to perform their duties.
They since long have rules to be complied with.
Posted by: ppcm at November 9, 2010 11:13 PM
A gold exchange standard is not a free market system.
Rather it depends on the worlds major central banks being the buyers of last resort to buy gold at a price well above any foreseeable market clearing price.
That is how the system worked under the 18th century system that many people claim to want to revert to. Under that system the Bank of England stood willing and able to buy all gold tendered to it at $21. The fthat official gold reserves of the major countries gold reserves expanded under this system makes it self evident that the market price exceeded the market clearing price.
Many believe, including Mundell, that the great depression was caused by an inadequate supply of gold at the $21 dollar price and a poor allocation of the world gold supply with France and the US holding too much gold. Roosevelt solved that problem by raising the price of gold to $35.
In the 1960s the problem of inadequate gold at the $35 price reemerged and played a major role in the currency problems of that decade.
Nixon solved that problem by ending the US commitment to buy gold at $35 and allowing the price of gold to float.
1969 when there were essentially no significant central bank purchases of gold was a good base year when gold averaged some $39. I was a gold analyst at that time and estimated that given the relevant price elasticities of supply and demand that the real price of gold would have to rise by some 3% to 5% annually to balance supply and demand. Remember, the price elasticity of south African gold supply -- still the worlds largest supplier -- is negative so that as the price rises south Africa cuts production. If the real price of gold had grow at a 3% rate since 1969 it would now be about $1000.
So the question is if we go back to a gold standard what should be the price of gold under the new system.
I would suggest it should be about $5,000 for the system to work.
Do you think that is what he had in mind?
PS. South African gold supply elasticity is negative because they are trying to maximize the life of the mines so they mine the lowest grade gold they can and still make enough money to just pay their dividend. Remember, they have to mine several tons of ore from several miles under the surface to just get one ounce of gold.
Posted by: spencer at November 10, 2010 06:50 AM
Any view on the deteriorating Ireland situation? Do national defaults threaten the global economy? Is there another shoe to drop?
Posted by: Steven Kopits at November 10, 2010 07:09 AM
After reading your comments in the argument about returning to a gold standard your analysis was exactly backward.
Your wrote: If we had been under a gold standard that required us to maintain a fixed dollar price of gold, that relative price change would have required a 40 percent cut in the dollar wages of a typical American worker, which would be associated with some very traumatic dislocations.
But what you failed to realize is that this "very traumatic dislocation" has in fact happened under a floating currency system. The gold standard is simply an indicator. Under a gold standard the failure of monetary policy would have been clear. Your indictment is not of the gold standard, but of the floating currency regime that gave us such traumatic dislocations. Under the gold standard there were never such huge swings in the currency.
What opponents of the gold standard always ignore is that under a gold standard the exchange value of the currency remains stable but gold flows. Because of this there are less severe variances in prices and so trades are more efficient without currency windfall losses and gains.
Under a floating currency regime the changes in currency value impact price directly and so traders have to spend huge amounts of resources, especially time and labor, just trying to prevent windfall currency losses.
The floating currency regimes in the world since after WWI have been a disaster. From the Great Depression, to the Great Inflation, to what we are now going through, we have had one economic crisis after another and all have been caused by currency mistakes to various extents.
Your example is actually just another example of the failure of floating currencies, lest you forget we were not under a gold standard when these dislocations happened.
Posted by: Ricardo at November 10, 2010 07:14 AM
Sorry Ricardo, we were under the gold standard when the great depression happened.
You are entitled to your opinion, but not your facts.
The reason the central banks, including the US acted the way they did in 1929 -1933 is because that is what the gold system required them to do.
Posted by: spencer at November 10, 2010 07:51 AM
It seems to be a confusion as regards the gold reserves of the USA in in 1932. As reported they were more than enough to cover the paper issuance needed by the federal reserves banks.
According to the Federal act of 1913, the federal reserves banks had to cover with gold reserve 35% of the amounts of deposits in their books.
40% gold reserve as a collateral for their notes issued
As of February 24 1932 the total reserves in gold of the federal banks were valued at 3.140 billion usd, when the federal reserves notes in circulation were of 2.643 billion usd,therefore more than enough.
The same federal act had granted the US Fed banks to print up to 3.5 billion usd paper money, secured by 40% gold reserves and 60% first grade commercial paper.
According to the reports of the time, there was not enough first grade paper to cover the new issuance of paper money.Not enough first grade paper?.The congress promptly amended the Federal act.The federal reserve banks may then guaranty their IOU through 40% gold reserve and 60% first grade commercial paper or US TBs (sounds familiar?).
Credit multiplier obliged,credit multiplier obliges.
Posted by: ppcm at November 10, 2010 08:00 AM
In 1919 there were 3500 labor strikes in the US.
As soldiers were returning from WWI and putting downward pressure on the demand for labor, the demand for food produced in the US was falling too because Europe's farmland was being put back in use. The USDA though encouraged farmers to continue producing at WWI levels for 2 growing seasons. The resulting glut caused the Agricultural Depression of 1921.
By 1929, the percentage of the population being directly supported by agriculture had fallen from 40% in 1921, to 25%. Before the crash of '29, 71% of the population was living below poverty(BLS), but the labor strike problem had been solved.
Labor markets were manipulated into a state of oversupply by removing opportunities and options in agriculture as other labor demand factors, (returning soldiers and massive immigration), combined to end labor strikes, and that is what caused The Great Depression. This manipulation of labor markets left too little purchasing-power in the hands of too many consumers and and traders did not panic due to 'animal spirits', but because it was so obvious that consumers were tapped out. Much the same as in 2007 when it became so obvious that housing costs were not sustainable.
Theories about 'animal spirits', or inadequate gold supply, or in this case, currency value constraints or imbalances, are merely efforts by technocrats to alleviate the blame on themselves and their masters(plutocrats). Zoellick would do well to consider that $1.25 per day equates to about 16 cents per hour based on a 40 hour work week, and then, he should try to see the global economy today as a macrocosm of the US economy in 1929. There is too much global liquidity and too little global purchasing-power.
Gold is nothing more than an expression of human folly. If for no other reason than concern for the environmental damage being done to further this folly, gold should be allowed to find its price equilibrium based on its utility. This could also help to improve capital allocation by removing investment in gold as an unproductive option.
The problems of mankind are caused by greed, exploitation, stupidity, and the resulting conflicts, not fiat currencies.
Posted by: rayllove at November 10, 2010 08:24 AM
After WWI the world went on the gold exchange standard not the gold standard. There was a huge difference.
The gold exchange standard had CBs hold major currencies such as pounds and dollars to back their currencies rather than backing their currencies with gold. The result was the CBs accumulated huge amounts of pounds and dollars. When the UK devalued the pound it actually screwed all the countries holding pounds. France held half of its foreigh exchange in pounds and lost 30% of the value. This value was "taken" by the UK because it refused to pay France the gold price of the pound as it had committed. The Netherlands had it even worse. Their pound holdingss were so huge that they virtually lost all of the value of their foreign exchange.
There has been much made of recovery in the UK after it left gold, but think about it, if you could just refuse to pay your debts wouldn't your financial situation improve? This was not a monetary miracle as gold opponents would have you believe, but a direct theft of value from everyone who had trusted the UK.
When the UK defaulted on its commitment in 1931 there was a run on gold in the US. Investors expected the US to also renege on its gold commitments so they were dumping dollars. Well, the US did just that and everyone holding dollars lost their shirts (not to mention FDR stealing gold directly).
For those interested Nixon screwed the holders of dollars in 1971 in the same way the UK screwed holders of pounds in 1931.
Posted by: Ricardo at November 10, 2010 11:06 AM
My opinion - if the U.S. international debt ever becomes completely and obvious unmanageable, we may wish that we had had something like the gold standard to keep international imbalances from reaching that point. And from the look of things, we will get close enough to that point to experience real crisis before needed remedial action is taken.
Posted by: don at November 10, 2010 02:30 PM
Gold has appreciated 40% because of the flight from depreciating fiat--ie, gov't decreed--money. Were our money defined as a certain weight of gold, both would be stable.
As for the our recovery when we left the gold standard, that event was in fact the gov't defaulting on its previous bonds & the all the existing contracts made in gold. In other words, it represented a forced "renogotiation" of debts. To the extent this renogotiated bad debts, which is the best thing that can happen in a bust, it helped recovery. But the gov't defaulting represents a tragic lie to the people who in good faith lent it money. Similarly money printing allowed by leaving the gold standard facilitated screwing creditors generally. This is what you champion?
My reading of history is that no country recovered more slowly from the Great Depression that the US. Tho' there were a plethora of factors, it is hard to claim much from the episode for fiat money.
Having said that, let me be the 1st to acknowledge that increasing the supply of money can have powerful short-term effects. But those effects are all negative in the long run because of the havoc they create with false relative prices.
Posted by: Bryce at November 10, 2010 06:58 PM
Bryce "My reading of history is that no country recovered more slowly from the Great Depression that the US."
Krugman's chart suggests you may want to read better history books:
Ricardo You're making a very strange argument. First you argue for a gold standard both as a way to ensure price stability as well as presenting it as some kind of moral imperative to protect creditors from being "screwed." Then you proceed to catalog a long list of historical episodes in which countries that were on the gold standard ended up "screwing" certain economic classes by going off the gold standard. If we're to believe your historical account, then it sounds to me like it's only a matter of time before a country facing depression will abandon the gold standard. In other words, your version of history tells us that a gold standard is not credible in the face of strong pressures to devalue or abandon the standard. By your own account a gold standard is only credible when it's not binding. So what's the point? If you're worried about inflation, then go buy TIPS bonds.
Posted by: 2slugbaits at November 11, 2010 05:44 AM
Krugman's chart ends in 1937, right before the 2nd leg down in the Great Recession for the US. Again, I want economists to not merely study the short-run effects, which are all fun with money printing.
US economic growth & unemployment from 1929-39 hardly implies that any of what was done then was beneficial.
Posted by: Bryce at November 11, 2010 06:56 AM
Rather than scratching your head about the history I quote why don't you look it up.
I have been concerned that you do not really understand the gold standard but I have been hesitating to insult you by explaining it, but it appears that I must. I have never argued that a gold standard would ensure price stability, but that it reveals when there is no price stability. The cataloge of historical episodes is to show how incompetent the monetary "wizards" really are.
And a country that abandons the gold standard during a depression is like a race car driver disconnecting his speedometer when his accelorator gets stuck thinking that if he doesn't have to acknowledge the problem it will go away.
The gold standard is not a technique for holding a currency stable. The gold standard is just that, a standard. Just as the Commerce Department has a standard for a meter but does not tell manufacturers how to make rulers, the gold standard tells monetary authorities when they are failing not how to correct the problem.
The gold standard is very simply a system where anyone is allowed to exchange currency for gold or gold for currency. If more currency is being exchanged than gold then the monetary authorities know that too much currency is in circulation and must act to reduce it. If more gold is exchanged for currency then the monetary authorities know that too little currency is in circulation.
Now the methology used to either remove or increase the currency in circulation is up to the monetary authorities and depending on economic circumstances could be different between countries or different within a country at different times. Countries have tried fixed legal gold reserves, they have tried measures of money supply such as M1, M2, etc, and they have tried price systems such as CPI, CPE, etc. Any of these are perfectly acceptable with a gold standard because it only measures the results.
If you look at the how the Bank of England operated with the gold standard the actual people working it had no education and did virtually nothing all through the 19th Century. The gold standard simply took care of itself. This is one thing the FED does not want because then they would no longer be the most powerful people in the world.
Those who oppose the gold standard want the freedom to manipulate the currency to generate windfall profits for themselves or their countries by cheating other counries (see the comments by the US monetary authorities about China) without having a standard reveal their nafarious actions.
All the talk you hear about the gold standard being a constraint on monetary policy is bull. The constraints were placed on monetary policy by governments not by the gold standard. There are more constraints on the currency today than there were under the gold standard: banks have strict reserve requirements both international and domestic, there requirements from the FDIC, requirements from the FED, requirements from congress, and on and on. The FED is even tasked with creating employment by using money. What a joke! Employment is created by jobs not by money.
The monetary gurus have pretended something very easy is very hard, so that they can demand huge salaries to play sudoku with other people's money.
Posted by: Ricardo at November 11, 2010 07:29 AM
Bryce "which are all fun with money printing."
So what are you saying? That after 1937 the Fed went crazy with the printing presses? Take a look at M2 growth. It actually dropped after 1937.
"US economic growth & unemployment from 1929-39 hardly implies that any of what was done then was beneficial."
Translation: ignore historical facts...they tell us nothing. Just believe in gold. Long live King Midas.
Posted by: 2slugbaits at November 11, 2010 08:07 AM
I am shocked at the level of ignorance about the gold standard and the gold market. For one, while the Fed claims a certain amount of gold on its balance sheet the accounting rules allow it to keep leased gold on the books even though that gold may never be returned by the borrowers. We also have no idea about how the swaps are accounted for and will never know until there is a full audit as proposed by Ron Paul. Then there is the issue of the gold standard itself. It is not incompatible with the free market because privately issues money backed by gold will be able to compete with any fiat money issued by individuals, businesses, cities, states, or federal governments. The central banks are not the buyer of last resort as claimed above. In fact, it is central banks that are incompatible with the free market because the free market would grant no bank the monopoly status and special privileges tha central banks have now.
Posted by: Vangel at November 11, 2010 08:59 AM
Ricardo "I have never argued that a gold standard would ensure price stability, but that it reveals when there is no price stability."
What? Why don't you just look at price indices like PPI or CPI or PCE if you want something that will "reveal when there is no price stability"? Gold hasn't been a good predictor of anything except people's gullibility in listening to whatever Glenn Beck tells them. Here are gold prices over the last 35 years:
You might want to try matching that up with any of the conventional measures of price stability.
"The gold standard is very simply a system where anyone is allowed to exchange currency for gold or gold for currency. If more currency is being exchanged than gold then the monetary authorities know that too much currency is in circulation and must act to reduce it. If more gold is exchanged for currency then the monetary authorities know that too little currency is in circulation."
Or simpler yet, observe inflation/deflation directly by looking at something like core CPI.
You seem to be going through an awful lot of intellectual gymnastics to argue for something that isn't a good predictor of anything.
Posted by: 2slugbaits at November 11, 2010 10:30 AM
If this gold standard is so awesome, then why are liberatarians waiting for the government to institute it instead of doing it themselves? No one is stopping some Randian genius from issuing deposits redemable in gold, these deposits being then usable as mediums of exchange.
Why bother forcing the rest of us adopt to your currency system when you simply can do it on your own?
Posted by: clone12 at November 11, 2010 03:06 PM
It is amusing that you insist that the dollar is more stable than gold. I think most people here are smarter than that.
Also I would suggest that you compare the amount of gold relative to real goods and services versus your beloved currency relative to real goods and services.
Price is what one good will exchange for another. If one apple that will exchange for one orange then the cost of an apple is one orange and the cost of one orange is one apple. Take a look at the exchange value of the dollar to any good over the past 100 years, then come back and we will talk.
Posted by: Ricardo at November 11, 2010 03:51 PM
At some point the Fed is well capitalized and its notes would be worth something if it had prudent management.
If you think Federal Reserve note are worthless now, I invite you to send me thirty or forty pounds of them. Denomination doesn't matter. Hey, I'll even pay the shipping!
Posted by: Jeff at November 12, 2010 07:20 AM
I don't know what your definition of "stable" is, but when I'm thinking about stability I usually have in mind less volatility.
I have no idea how you would get reliable and meaningful data going back 100 years...particularly since gold prices were fixed up until 1971. In any event, most people's active economic life doesn't span 100 years; but it does span 35 years and we do have 35 years worth of reliable data. Just for kicks, let me suggest that you take the log differences of annual gold prices over the last 35 years and compare that to the log differences of the CPI over that same timeframe. Gold's volatility is something on the order of ten times that of the CPI.
Posted by: 2slugbaits at November 12, 2010 07:24 AM
slug, you are the one ignoring facts. The unemployment rate was double digits still in 1939. What a recommendation for years of money printing & expansive gov't!
All I'm arguing for are honest prices that express supply & demand. Most gov't interventions distort & crimp that process.
Posted by: Bryce at November 12, 2010 07:27 PM
tj I don't know about your facts, but what I read says that in 1938 unemployment spiked and M2 fell relaitive to 1937. That is, after FDR made the mistake of listening to folks who were worried about "honest prices" so too did the macroeconomic indicators turn south. The 1939 numbers, while bad enough, represented a significant improvement over 1938.
We're in a liquidity trap. What that means is that the market is trying to tell us the "honest price" for money ought to be a negative interest rate of something like (-4%). In other words, that's what the short term rate should be if we wanted to have a NAIRU target that would clear the labor market. But some basic laws of arithmetic won't let the market arrive at negative nominal interest rates. Put another way, the idea of an "honest price" for money when you're in a liquidity trap is meaningless gibberish.
I don't give a fig about "honest prices" in and of themselves. Prices are only useful to the extent that they are efficient tools for increasing output. But for a lot of reasons price signals are not infallible, and when they take us down a dead end it's time to "man up" (to use a favorite term of the Tea Party types) and recognize that government intervention is required. Governments distort prices, but so do real world markets. The only thing that doesn't distort prices are the kinds of fake markets you often find in undergraduate micro textbooks.
Posted by: 2slugbaits at November 13, 2010 05:57 AM
Oops. Post addressed to tj. Should have been Bryce.
Posted by: 2slugbaits at November 13, 2010 07:35 AM
I think I am misunderstanding the arguments for a gold standard.
A monetary system in which gold is directly used as currency slaves economic growth to an essentially fixed supply of available metal. An economy that can experience real growth without proportional currency growth seems in danger of starving its expansion for lack of money. We have the opposite problem right now (money growth with little real growth), but that doesn't make a pure hard-metal currency more desirable in the long term than a fiat currency.
What am I missing? Is the appeal of gold just that it can't be printed?
Posted by: Anonymous at November 15, 2010 08:13 AM
If gold is priced in dollars you cannot insist that a fluctuation in the dollar price of gold means that gold is unstable. That is like saying that the inflation that we have experienced since 1970 is because the value of goods has changed but the value of the dollar has stayed the same. Give me a break!
Do you really not understand?
Posted by: Ricardo at November 15, 2010 08:54 AM
You are falling victim to the propaganda of the opponents of the gold standard. There is a significant difference between a gold STANDARD and requiring gold to be money. If you were building a house would you require someone from the Commerce Department to bring their meter bar to make all your measurements? Of course not because that bar is the standard against which meter substitutes are measured.
A gold standard does not eliminate money substitutes such as paper dollars. What the gold standard does is tell you when the right amount of money substitutes are in circulation. If paper dollars are being exchanged for gold then there is too much paper out there. If gold is being exchanged for paper dollars then there are not enough money substitutes out there.
This is easy to see in action in the 1920s. All the countries of the world, with the possible exception of the US had too much paper money in circulation becasue they left the gold standard to use inflation to finance WWI. Prices in all countries exploded upward and the value of currencies relative to the dollar, which was still on the gold standard at $20/oz, plumetted.
But France recognized the problem and after the franc had run up to 50:1 against the dollar Finance Minister Moreau pull the franc back to 25:1 where he stabilized it (before the war it was about 4:1). At that point gold began to pour into france.
The UK on the other hand did not control its currency instead attempting to support union wages and inflated prices by not reducing the supply of pounds in circulation. Gold flowed out of the UK.
Something that you seldom hear is that when the UK went back on the gold standard the gold flow reversed for two years and the UK gold supply increased, but Norman and the BofE feared deflation and recession and so engaged in their own form of Quantitative Easing. The result was that gold began to flow out of the UK once again.
France remained steadfast in the value of the franc and in so doing became the strongest economy in Europe during the latter part of the 1920s.
The contrast between France and the UK during the 1920s is a great lesson on the gold standard, but you must do the research on your own. The opponents of the gold standard have perpetuated the mercantilist myth that Franc held the franc too tight and the UK returned to the gold standard at the wrong parity. If you look at the situation in the UK, whether on the gold standard or off of the gold standard their bad monetary policy is what caused gold to flow out of the country.
Posted by: Ricardo at November 16, 2010 07:51 AM