Re: Advantages / disadvantages of the gold standard ?

On Sun, 11 Jan 2009 06:16:58 -0800 (PST), Saggy <gurfinkle@xxxxxxxxx>
wrote:

Thanks for another great post .... but, let me play my favorite
role .... devil's advocate ...

Sure...

On Jan 10, 9:09 pm, RogerDodger <n...@xxxxxxxxxxxx> wrote:
On Fri, 9 Jan 2009 15:18:11 -0800 (PST), Saggy <gurfin...@xxxxxxxxx>
wrote:

On Jan 9, 2:22 pm, RogerDodger <n...@xxxxxxxxxxxx> wrote:
On Thu, 8 Jan 2009 07:33:06 -0800 (PST), Saggy <gurfin...@xxxxxxxxx>
wrote:

<snip>

Consider....

Time 1:   You are happy managing investments for your boss, and
managing your own savings, by investing them in a boom economy by
buying rental homes, the stock of AIG and Fannie Mae,  buying
high-yield corporate bonds, making investments managed for you by Bear
Stearns and Lehman Bros, etc., etc.
     You are reaping profits and reinvesting them as fast as you can!

Time 2:   AIG, Faniie Mae, Bear and Lehman all go *bust*.  The value
of your real estate is *collapsing*. The value of your bonds is down a
full third and falling....

      You think: "Yikes!! If this keeps on my boss is going to fire my
sorry butt, my savings are going to be wiped out, and I'm going to end
up on the street homeless.
      "What is the one thing in the world that doesn't lose value???
      "Money!  Dollar bills!!
      "Sell everything!  SELL!!  Sell the homes, sell the bonds, sell
the stock!!  I can't afford to lose any more!  
       "Sell it all for *cash*.  Get me cash for it!
       "Sell it all for **money** !!!"

What's happened to your demand for money?

You didn't answer.

What happened to your demand for money?

Now multiply yourself by all the investors in the world during the
last six months.  

What's happened in the real world to the demand for money?
Look and see:

Yes. Perfect.


http://research.stlouisfed.org/fred2/series/BOGAMBNS?cid=124


Incredible graphs, however, I don't see how the graph has anything to
do with the demand for money. The graph is bank reserves + monetary
base, so, if anything, it shows an increased supply of money, not an
increased demand.

But: supply-and-demand ... supply-and-demand ...

If one wants to talk economics one must *think* supply-and-demand --
it is the Iron Law of Economics, the Root of All Things.

Fortunately it is very simple:

Price of anything is determined by supply and demand. If...

Supply rises (falls) as demand stays even, price must fall (rise).
Demand rises (falls) as supply stays even, price must rise (fall).
Price stays even as supply rises (falls), demand must rise (fall)
corresepondingly.
"Price stays even as demand rises (falls), supply must rise (fall)
correspondingly."

This has to become second-nature.

It is true of all things, even ideas (which is why intellectual
property laws exist, though I'm not going to digress into that briar
patch).

OK now, look at that graph:
[] Supply of money has risen, exploded!
[] Price of money has stayed the same (as we know from lack of
change in the price level)
[] Therefore, what MUST have happend to demand for money?...

(If you can show that price can stay unchanged as supply explodes and
demand remains unchanged, you can book your flight to Sweden to
collect the very last Nobel in Economics, for refuting it!)

In reality what's happened in the last half year is that demand for US
money has exploded world wide (as the world's investors have become
hugely more risk-averse, and the dollar is the world's safest security
to own).
You can see this both in the fact that the Fed has literally
bought more printing presses to print currency (!) and in how interest
rates on US Treasury securites -- the most freely exchangeable for
dollars -- have plunged to 70-year lows as investors have rushed to
buy them and bid up there price.
Recently the interest rate on T-bills was *negative* -- investors
were willing to *lose money* to hold them to secure the value of their
investment in dollars.
The last time that happened was ... during the Great Depression.

So ... demand for dollars has exploded. Given that, by the law of
supply-and-demand, if the supply of dollars remained unchanged, what
would *have* to happen?

Answer: ... the price of dollars would have to rise sharply...
*deflation*. Just like during the Great Depression.

Now as it happens, Bernanke is maybe the world's greatest expert on
the Great Depression and he has openly vowed that whatever happens, he
is *not* going to repeat the same mistake the Fed made in 1929-32 by
letting a deflation --> reduces GDP -- > reduces money supply -->
creates more deflation -- -etc. etc., economy-destroying feedback loop
get started. (He's going to make his own brand new mistakes!)

So as demand for money has exploded, he's in response exploded the
supply of money -- as seen in that chart -- to keep the price of money
stable. (Which is what the Fed did *not* do 1929-32).

"Price stays even as demand rises (falls), supply must rise (fall)
correspondingly."

Plus, you indicate later in the post that the
increase is due to the Fed injecting reserves, so the significance of
the graph may be nothing more than that Ben Bernanke had a bad night,
and decided to pump up the reserves the next morning.

But supply and demand says that is impossible. If...

"Supply rises (falls) as demand stays even, price must fall (rise)."

If Bernanke rocketed money's supply up after having a bad dream, and
demand for it stayed the same, its price *could not* stay the same.

We'd have a nasty bout of inflation.


Everyone wants money all the time, so it's hard to imagine a lack of
demand for money.

Everyone wants and needs housing all the time, so it's hard to imagine
a lack of demand for housing.

Does that mean the demand for housing doesn't vary -- so home prices
don't vary up and down?

I'm not sure about this. I think the demand for housing is pretty much
constant or a function of demographics, and that doesn't account for
the current runup (there is a good video on this subject at the online
Khan academy).

Supply and demand!

The supply of housing changes only modestly year-to-year (it takes
time and commitment to build a house).

Year 1: With supply basically unchanged, price zooms up!
What must have happened to demand?

Year 2: With supply basically unchanged, price plunges!
What must have happened to demand?

Note that as the total supply of housing changes only at a modest
rate, is fairly inelastic, a small change in demand for it has a *big*
effect on its price.

If an item has an elastic supply, so that an increase in demand
increases supply, the price change will be more modest.

Say a company makes widgets on an automated assembly line. If demand
for its widgets goes up it can set the assembly line to "faster" and
puit an a suffieciently increased supply so that no price increase for
then occurs -- puts out Supply and demand rise together. Similarly,
if the demand for its widgets drops it can set the assembly line to
"slower" to reduce their supply suficiently to keep their price
unchanged.

OTOH if the supply of an item is totally inelastic, like collectibles,
1957 Mickey Mantle baseball cards, the price of the item will be
highly *volatile* because supply can't change at all -- so the effect
of a change in demand lands 100% on price.

Housing is on the relatively "inelastic" side of the scale. Especially
to the extent housing price includes the price of the land it is
located on, as land supply is very inelastic.

BTW, a common sense check on demand for housing:

Do you hear realtors saying "Homes are selling like hotcakes, just
like two years ago!" or "Homes are listed far longer than two years
ago to get sold, with sellers making price concessions..."

If the latter, what's that tell you about what's happened to the
demand for housing?

Supply stays basically the same, price plunges, what *must* have
happened to demand?


Off of recent experiece, I think they do!

<

It is "the law of supply and demand" applying to money.


Here again, applying the law of supply and demand to money is not
intuitive, it's like applying the law of supply and demand to wood
fairies. Money, as we've known it, is generated out of thin air,
so ...... there is no production cost ..... just like wood fairies ..

Wood fairies don't exist.

Currency does exist, in finite supply.

Same with T-bills and T-bonds, and the components of M2.

Production cost is irrelevant. Price is set by supply-and-demand, not
production cost.

I'm trying to get this, however.

You'll get there. ;-)

<snip>

The basic monetary equation is MV=PQ.

I.e.: M (quantity of money) * V (velocity, the rate of its use, the
number of times it turns over in a given period) = P (price of goods
and services) * Q (quantity of goods and services).

The goal is to keep PQ rising at a healthy sustainable rate, or at
least stable.

If M is stable and V declines then obviously PQ will decline
(recession and/or deflation occurs).

Increasing demand for money reduces V, as people keep money in vaults
and mattresses (figuratively and literally) rather than spend, lend,
invest it.

Thus, increasing demand for money, by reducing V, causes
recession/deflation unless M is increased by an offsetting amount.

The Fed's huge mistake during 1929-32 was that when V fell and the
money mutliplier collapsed, it *didn't* increase the monetary base by
an offestting amount, so M2 collapsed

To see how the money multiplier has collapsed in the last year just as
it did during the Depression, tale a look:

http://research.stlouisfed.org/fred2/series/MULT?cid=48


Here again, the money multiplier MM equals M2 divided by M0 (monetary
base + reserves), and the precipitous drop in the MM is probably
(without doing the math, but eyeballing it) due to the run up in M0,

???

i.e. the increase in the denominator, which, as indicated, could
signify nothing more that a Ben Bernanke hangover.

How would increasing the monetary base act to reduce the multiplier??

Bernanke greatly increases supply -- and if there is no change in
anything else (i.e. demand) then the multipliers stays the same, M2
rockets up, and we get a hefty surge in inflation.

MV=PQ. Bernanke shoots up M, V stays the same, PQ must shoot up.

QED.

OTOH, if an external shock to the system reduces the multiplier by
increasing demand for money and reducing V, then M2 will plunge and
we'll be heading for deflation *unless* Bernanke shoots up the money
base to keep M2 stable in spite of the collapsed multiplier.

M is increased to offset the fall in V, keeping PQ the same.

That's what's happened.


.... there were two stages to the Depression.  

The *collapse* was 1929-33, and ended promptly when the US left the
gold standard. (Yes, the US then started "printing money" with the
explicit purpose of ending the deflation, and succeeded.)

The *recovery*, from the low point of the 30% GDP decline, ran from
1933 into WWII.


Well, now, I'm sure someone will challenge this ! I think the current
wisdom, at least in the Austrian school, is that the depression lasted
till the late 30's. But, that's a whole nother subject.

Yes, the Depression lasted until 1940 or thereabouts.

That is, it wasn't until then that GDP got back up to above 1929
levels, which is where its "end" is defined to be.

But the *great collapse*, GDP plunging 30%, deflation of 25%, was all
1929-33, while on the gold standard.

The slow intermittent recovery, as GDP rose back towards where it was
before, was 1933-1940 or so.

No Austrian will deny that, them's just facts.

The two periods were dominated by very different economic processes.
Deflation wasn't an issue during the post-'33 period. FDR's policies
were -- and they are a different story, discussed here ...

http://newsroom.ucla.edu/portal/ucla/FDR-s-Policies-Prolonged-Depression-5409.aspx?RelNum=5409


...
OK, first, why could they not print money when on the gold standard?
If the demand for money was so great, and it was, people would have
used the money to buy goods and services and not made a run on the
govt's gold window. So, money could have been issued even while on
the gold standard.
...

See previous question about increasing money to supply increased
demand while maintaining the gold standard.

You mean this:
.....>OK, first, why could they not print money when on the gold standard?
If the demand for money was so great, and it was, people would have
used the money to buy goods and services and not made a run on the
govt's gold window

......

You can't beat the law of supply and demand.  Printing money with that
idea certainly would cause a run on the gold window.

Starting point...

...
By supply-and-demand, one once of gold has a commerical value equal to
a given amount of everything else in the economy, a pound of A, a gram
of B, an hour's worth of labor at C ... etc. etc.  If the gold is
worth $20.67 then they are all worth $20.67

If you then inflate the currency by about 25% so any of them are worth
$26 they will *all* be worth $26.  Clear enough.

But if in that situation you then price-fix the price of gold at only
$20.67, and maintain that by the government selling its gold stocks at
that price, then *everyone in the world* will rush to the gold window
to buy gold at $20.67 that they can swap for *everything else* that is
worth $26.

And before you can say "WOOOOSH!", Fort Knox will be empty and your
gold standard will be busted.

This is exactly how you get the crises that bust commodity-money
standards and fixed-exchange rate regimes.

You can't inflate a currency on the gold standard. Forget it.


Of course if the economy is in equilibrium, not growing, on the gold
standard, and you pump up the money supply, then inflation will result
and there will be a run on the gold window. This is the case you have
presented.

However, if the productive output of the economy is increasing at a
rate of 5% per year,

We were talking about the Great Depression, remember. But anyhow...

then I would think you could increase the money
supply at rate of 5% per year while keeping prices stable and staying
on the gold standard.

Only if the supply of gold is increasing 5% a year.

Gold supply sets the maximum growth of paper money in a gold standard
system, that's the *entire point*.

And, in the case of deflation, the goal of increasing the money supply
is to prevent the downward slide of prices, to stabilize them, and
until prices are stabilized, again, I would think that you can print
money while staying on the gold standard.

I am at a loss as to how you imagine you can increase money supply on
a gold standard without an increase in gold.

1) The amount of gold sets, fixes, the maximum amount of money.
2) You'd increase the amount of money beyond that point.

How?

Supply and demand again. By it, one gold oz = $20.67. Next you
increase the supply of money. Now, by supply and demand, the market
price of gold *can't* be $20.67, it *must* be more. You've busted the
gold standard.

The gold standard says you can't do that -- you can't print that
money. The entire purpose and function of the gold standard is to stop
you from increasing the money supply to raise prices. So how can you
do it?

Once more, this is the scenario you are proposing:

Initially, by supply and demand, any number of things have a price of
$20.67: an ounce of gold, a week's worth of groceries, a barrel of
oil, a subscription to Collier's. etc.

Next you decide to boost prices by increasing the money supply by
printing paper money until the price of all these things equals $26 --
*including* the price of gold, of course!

But you decide to also price-control the price of gold *below* its new
market price, at only $20.67, by the means of having the Treasury
provide one ounce of gold to everyone who shows up at its door with
$20.67 of paper money to buy it.

What happens when something is priced well below its market value?
It sells out immediately!

You are going to have a stampede of people bringing their paper money
to the Treasury to buy gold that they will then swap for other stuff
at a profit of $5.13 per once of gold they buy.

Fort Knox will be emptied of gold before before you can say "Where'd
all the gold go?" And that's the end of your gold standard.

You simply *can't* inflate the currency on a gold standard without a
corresponding increase in the quantity of gold. The entire purpose of
the gold standard is to stop you from doing just that.

They just couldn't do it back in 1929-32.

I mean, if they could have, they *would* have!

I confess I think the whole idea of a 'money supply' is a gross and
probably misleading oversimplification

Ha! Tell that to the people who enjoyed the Great Depression, and the
Weimar hyperinflation, and Mugabe's hyper-hyperinflation today.

of what is really important,
and that is the distribution of money in the populace.

Distribution of money "among a populace" doesn't have much real
meaning.

Distribution of income, and distribution of wealth, have real meaning,
and are studied endlessly.

It wouldn't do
to study that subject in the universities, I imagine. Deliberate
obfuscation? Probably, now that I think about it.

Never confuse "I haven't studied a field and so don't really
understand it" with "The professionals in that field must be
obfuscating things from people like me, because I don't understand
it".

Hey, I'm an engineer in real life, and we tend to be a bit hard headed
and, when in engineering mode, we do have to know what we know and
what we don't know, and we really have to know what we know, so, it
can sometimes take a lot of convincing. Finance is like quicksand to
the engineering mind.

I have degress in law, econ and finance. So I'm a smart and
well-educated guy -- but I don't understand engineering at all! Not a
bit!

My unavoidable conclusion is that you engineers must be intentionally
obfuscating things from all us non-engineers to take advantage of us.
Shame on you. ;-)

I'll sue you!
.

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