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The Logic of
Gold Jude Wanniski November 27, 2000 |
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From: Jude Wanniski jwanniski@polyconomics.com
To: Wayne Angell <wangell@* * * * * .com>
Re: The Logic of Gold
MY COMMENTS IN CAPS...
My view is that the Fed Res Act provided a one-way street that not only extended the "1900 Gold Standard Act," but modified it to being a global price support for gold. No one in the world was willing to sell gold for less than $20.67 when the United States Treasury was supporting the price at $20.67. IN ANY OTHER PART OF THE WORLD, PEOPLE WITH GOLD COULD SELL IT FOR THEIR OWN CURRENCY. WHY WOULD THEY WANT DOLLARS? THEY WOULD ONLY HAVE TO EXCHANGE THE DOLLARS FOR THEIR OWN CURRENCY IF THEY WANTED TO BUY GOODS OR ASSETS. AND WHAT DO YOU MEAN BY ONE-WAY STREET? THE FED WAS REQUIRED TO KEEP GOLD FROM FALLING BELOW $20.67 AND FROM RISING ABOVE IT. THIS WAS THE SAME THING THE US TREASURY HAD BEEN DOING FOR THE PREVIOUS 120 YEARS. THE FED WAS CREATED TO DO THE SAME THING AS TREASURY, BUT WITH GREATER 'FLEXIBILITY.' IT REMAINED THAT THE CENTRAL ROLE WAS KEEPING THE DOLLAR CONSTANT IN ITS GOLD VALUE AT THAT RATE. IF GOLD CAME INTO TREASURY, THAT WAS STILL THE TREASURY'S BUSINESS. IT HAD NO MONETARY IMPACT. IT WAS THE SAME AS IF TREASURY BOUGHT NEW FURNITURE, BECAUSE NO NEW MONEY WAS CREATED IN THE PROCESS. IT USED TAX RECEIPTS. NO?As the global price level fell, then more and more gold was sold to the United States further contracting the monetary base abroad. WHAT GLOBAL PRICE LEVEL FELL? AND WHERE DO YOU HAVE STATISTICS ON THE WORLD MONETARY ASE? THE MONETARY BASE THEN AND NOW WAS MONETIZED DEBT OF THE RESPECTIVE GOVERNMENTS.
But, United States gold sterilization prohibited the U. S. monetary expansion which would have necessarily driven up the U. S. price level so that gold would have had a market place value of $20.67 an ounce. Thereby the market clearing price could have fallen to $16 per ounce meaning that the quantity of gold sold would have been just equal to the quantity demanded from non-Treasury sources. But, how could the price fall to a market clearing rate if the U. S. was paying that price.
As a result the proportion of gold in the Fed's balance sheet rose above 40 percent with no Fed Res Act requirement that reserve bank credit be exactly equal to 2.5 times the gold certificate account. The more the Fed sterilized gold the greater the global deflation which was the precursor of protectionism. It was not until the changed political climate of the 1930's raised expectations that 1) the Fed would be forced to inflate and that 2) the official price of gold would be changed that gold was bought from the Fed precipitating a decline in gold certificates and the necessity of changing the gold certificate reserve requirement from 40% to 25%.
Jude, either the price of gold is free to fluctuate as an indicator of monetary policy or we have a fully automatic global gold standard. Under an international gold standard the central bank must be prohibited from sterilizing gold flows--otherwise gold flows are not automatically limited by price level changes.
I detect that you are reluctant to accept the fact that an international gold standard does adjust price levels of trade deficit countries vs. trade surplus countries. It is not that a gold standard freezes price level changes, but that a gold standard prohibits a permanent one-way trend in the price level. Gold is better than managed money in that price level increases or decreases cannot be permanent.
From: "Angell, Wayne (Exchange)" <wangell@* * * * *.com>
To: "'Jude Wanniski'" <jwanniski@polyconomics.com>
Subject: Date: Mon, 27 Nov 2000 12:14:25 -0500
Re: The Logic of Gold
Date: Mon, 27 Nov 2000 12:14:20 -0500My view is that the Fed Res Act provided a one-way street that not only extended the "1900 Gold Standard Act," but modified it to being a global price support for gold. No one in the world was willing to sell gold for less than $20.67 when the United States Treasury was supporting the price at $20.67. As the global price level fell then more and more gold was sold to the United States further contracting the monetary base abroad. But, United States gold sterilization prohibited the U. S. monetary expansion which would have necessarily driven up the U. S. price level so that gold would have had a market place value of $20.67 an ounce. Thereby the market clearing price could have fallen to $16 per ounce meaning that the quantity of gold sold would have been just equal to the quantity demanded from non-Treasury sources. But, how could the price fall to a market clearing rate if the U. S. was paying that price.
As a result the proportion of gold in the Fed's balance sheet rose above 40 percent with no Fed Res Act requirement that reserve bank credit be exactly equal to 2.5 times the gold certificate account. The more the Fed sterilized gold the greater the global deflation which was the precursor of protectionism. It was not until the changed political climate of the 1930's raised expectations that 1) the Fed would be forced to inflate and that 2) the official price of gold would be changed that gold was bought from the Fed precipitating a decline in gold certificates and the necessity of changing the gold certificate reserve requirement from 40% to 25%.
Jude, either the price of gold is free to fluctuate as an indicator of monetary policy or we have a fully automatic global gold standard. Under an international gold standard the central bank must be prohibited from sterilizing gold flows--otherwise gold flows are not automatically limited by price level changes.
I detect that you are reluctant to accept the fact that an international gold standard does adjust price levels of trade deficit countries vs. trade surplus countries. It is not that a gold standard freezes price level changes, but that a gold standard prohibits a permanent one-way trend in the price level. Gold is better than managed money in that price level increases or decreases cannot be permanent.-----Original Message-----
From: Jude Wanniski [SMTP:jwanniski@polyconomics.com]
Sent: Monday, November 27, 2000 10:47 AM
To: Angell, Wayne (Exchange)
Subject: RE: logic of gold
I don't understand your comments. The price of gold was constant at $20.67.
I don't see any record of it rising in the postwar period. The "deflation" you cite is a fall of the prices of other commodities to realign with gold.
Did you ever read Roy Jastram's "The Golden Constant"? He calls it the "Retrieval Phenomenon." Von Mises also distinguishes between "cash driven" inflations and deflations and "goods driven" inflations and deflations. In our discussions, I try to keep the two separate, because our disagreements arise out of failing to do so.
At 07:50 AM 11/27/00 -0500, you wrote:
Jude, I appreciated your sharing a good economic lesson in your interchange with Steve Conover. A good piece.
I would point out that the Federal Reserve Acts of 1913-14 did not require that the Federal Reserve expand credit until the price level rose in the U.S. relataive to the price level in Europe. Without a rise in the price level which would have encouraged a growth rate of imports to match the growth rate of exports there was no limit on gold inflows. There was no automaticity. Instead, the Federal Reserve became such a huge player while European central banks were so ravaged by war and post war monetary promise breaking, that the inflow of gold at first moved the price of gold up until the U. S. price was the global price plus shipping and the world price became the U. S. price less shipping costs. But, the Federal Reserve Act gave the Fed an increasing ability to sterilize the gold inflow and thereby permit global deflationary forces to at first impact Europe and then, eventually, the United States.
-----Original Message-----
From: Jude Wanniski [SMTP:jwanniski@polyconomics.com]
Sent: Sunday, November 26, 2000 3:11 PM
To: Steve Conover, Sr.
Subject: Re: logic of gold
At 08:00 AM 11/26/00 -0600, you wrote:
Thanks, Jude.
A few more questions...
JW... Money growth should only increase within the constraints of the dollar/gold price. The economy can grow at 10% a year within this constraint, but only until it reaches full employment at the potential of the work force.
STEVE: But entrepreneurs equipped with liquidity can increase the economy's real capacity, via creative destruction. (Create new work, new jobs, export the crummy jobs to China, import talented people, and better-educate all people. Maybe at a sustained growth rate of 10%.) If liquidity is limited by the supply of gold, would that not deprive them of the liquidity they need to continue expanding at a 10% rate?
JUDE: When the central bank supplies liquidity to its member banks, the member banks are prepared to make loans to customers who are credit worthy. An entrepreneur does not walk into a bank with plans for a perpetual motion machine and ask for $50,000 to see the project through, unless he is willing to put up the necessary collateral and pay the interest rate the bank asks. If the central bank supplies more liquidity than the bank desires, the bank must make loans to customers who are not creditworthy. Only then are the reserves translated into currency, as the borrower draws down his credit line. This is the inflation process. The customer must bid for factors of production that are no longer restrained by the dollar's gold price. If an entrepreneur can't get bank credit, he must either use sweat equity to move his project along, or borrow from family and friends. This process has no inflationary effects, because his sweat equity adds to the capital pool and his borrowing from family and friends subtracts their cash from the common pool, so somewhere in the system a less promising enterprise is stuck for capital.
JW: The 2 1/2% annual rate that Milton F fixes on is the rate of advance of the leading country in the world, which is operating at a maximum given its capital base and education level of its population. Growth is not a function of the money supply, per se.
STEVE: But can't a lack of growth be caused by an insufficient money supply?
JUDE: No. If the central bank is vigilant in keeping the dollar/gold price constant, it eliminates the monetary risk in a transfer of capital from a lender to a borrower. The central bank MUST supply the reserves demanded of it as long as the price of gold does not change. It does so by preventing the dollar/gold price from falling below the lower gold point. IT HAS NO CHOICE. Once it has committed to prevent the gold price from falling below a specific price -- say $299.99 -- it has to add liquidity to make gold more demanded than dollars. If gold gets to $300.99, it has to make dollars scarce relative to gold, by selling bonds that pay interest to the banks in exchange for cash, which it then extinguishes. The Fed either "monetizes debt" or "demonitizes debt." The Fed can do nothing else when it is on a gold standard. If there is unrealized potential in the economy, the Fed cannot worry about that. The government itself must decide how to change the tax, regulatory and spending programs it administers in a way that encourages more growth.
JW: If the government issues more liquidity than the market is asking for at a specified gold price, either gold will leave the country or the price of gold will rise in dollars.
STEVE: Isn't that the inflation scenario even with fiat money?
JUDE: Not at all. Once Nixon broke the link between the dollar and gold, telling the world we will no longer give it gold for dollars when they demand it at a specific price, FORT KNOX was closed down. We have the same tonnage of gold today as we had in 1971, with the exception of the small amount of gold we auctioned off when Jimmy Carter was President.
JW: Insofar as "monetary policy" is concerned, the economy works at an optimum when the government does not inflate or deflate, taking the monetary risk out of private finance.
STEVE: Yes, I agree 100%. But how to measure inflation is problematic. If we could measure inflation & deflation more accurately with more timeliness, what would be wrong with allowing the money supply to expand for as long as it could do so without inflation?
JUDE: The first breath into a balloon begins its process of inflation. The first teenie-tiny increase in the dollar price of gold also begins the price of inflation. That's what Alexander Hamilton was talking about when he persuaded the first Washington administration to define the dollar in terms of gold. If the Fed is FORCED to keep the dollar/gold price constant -- which was the intent of the Federal Reserve Act of 1913 -- then the money supply can grow or not grow at high rates or low rates as long as the dollar were kept as good as gold, to the last gram. This occurs through the fractional banking system. Do you know what that is?
STEVE: As you can see, I am still having difficulty understanding how inflation in the price of gold is an accurate proxy for inflation in the price of goods & services at a given quality. If it's not an accurate proxy, then basing the money supply on the price of gold seems to me just as error-prone as basing it on Greenspan's flawed judgment.
JUDE: If gold isn't, what is a more accurate proxy? If you think there is no accurate proxy, then you leave us and the whole world population with no way of reducing monetary risk, forever consigned to monetary crises. I can sympathize with your reluctance to see gold as the best proxy, but I submit that mankind decided that issue long ago, after thousands of years of trial and error. Silver ran neck and neck until 1873, when it got the boot. Nothing is left but gold.