Our closing comment yesterday dealt with the possibility of returning to a gold standard. The answer, of course, is yes, it is possible. But how likely it is involves more insight into the inner mechanisms of politics, central banks and future goals than we’re likely to dig up here. But we can offer some thoughts to help us watch for possible signs.
Before we continue, however, I wanted to point out an article that presents a typical example of logical fallacy. Just because yellow grass burns doesn’t mean that yellow grass causes fire. But that’s just as logical as the arguments presented by some contemporary economists. They fail to see the forest for the trees and attempt to establish a macro perspective while only using a portion of the information needed to arrive at a veritable conclusion.
For instance: As we’ve noted, some sort of asset based currency helps provide stability because of its limited availability. Gold has shone forth as the most natural candidate for the position, historically. However, writing for BBC, Robin Banerji presents the following argument.
The problem is that in practice, things do not always work out like that – from 1919 to the 1930s, US prices were anything but stable.
The problems with this statement are manifest. The early 20s saw Federal Reserve intervention that actually exacerbated the economic condition. It was only after they backed off that the economy began to surge again. But then something happened that changed the landscape of stock markets. Brokers began lending. And stockholders began borrowing, sometimes very heavily. In some instances they could borrow 90%, thus increasing their holding potential by 1000%.
Now, what happens when you have a $500,000 loan for a house in a busted housing market? Let’s say your house is now worth $200,000. That’s what happened with stocks in the ’29 crash. The brokers had loaned out so much money for stocks that they’d created a false supply. With that false supply came higher stock prices. The animal was soon feeding up on itself and eventually succumbed to its own insatiable desire to consume its own flesh.
In such a case it doesn’t matter what kind of currency was in place. The creation of false supply will inevitably come back to bite someone. And that’s exactly what fiat currencies do. They create a false supply of currency. In fact, the entire system is a false supply of currency. In such a situation your wealth, insofar as it’s held in dollars, is only as good as the promises of the U.S. Treasury and the Federal Reserve. You’re only able to trade as long as that promise is recognized as good by those you’d trade with. As soon as that sentiment dissipates, so does dollar denominated wealth.
One more point and then we’ll put off our discussion on the viability of moving to a gold standard until tomorrow. In the BBC article, Harvard Professor Kenneth Rogoff agrees with the author’s comment:
“The price of gold fluctuates a lot and therefore the price of your currency would fluctuate a lot,” he says.
Rogoff points to the fluctuations of the dollar in the 19th and early 20th centuries when the dollar was tied to silver and gold.
We have two problems here. We discussed one yesterday. Today gold is denominated in dollars. It’s not the instability of gold that’s represented in the price fluctuations, but the instability of the dollar. A quick check of how much gold will purchase versus how much dollars will purchase makes this point abundantly clear. Jeff Clark does exactly that in his excellent article on inflation.
The final point to make is in regard to fluctuations in the dollar during the 19th and 20th centuries. I’m curious as to what he valued the dollar against. It’s certainly true that there were fluctuations. But his blanket statement simply isn’t helpful.
For instance, when there’s a large gold or silver strike somewhere, there’s new supply of gold and silver. During such times, the local economy experiences inflation due to the increased money supply. The further you get from the source, the less impact such supply has on the economy. However, if it’s big enough, it’ll affect the entire country. This was experienced during some of the gold rushes of the 1800s.
However, when the government attempted to intervene with controls, it led to prolonged and unnatural corrections. Whenever natural forces of supply and demand were allowed to work, the economy found equilibrium and the gears continued turning.
There will always be exceptions. But that’s what they are, exceptions. And even in these exceptions, natural forces will inevitably bring normalcy sooner than any form of manipulation. At this point our entire economy is based on an exception that will inevitably come crashing down. Nature has a way of doing that. And when it happens our economy will likely be rocked like none other in the history of man.
What do you want to be holding when that train comes in?
For your prosperity,
J. Keith Johnson
The Gold Informant