The danger of setting the new gold parity too low (too few dollars per ounce of gold) is exemplified, as Selgin (2012) notes, by Great Britain’s choice in 1925 to restore the old parity. At discussed above, because the price level had risen sharply, a return to the old parity required a sharp deflation to return to the old price level. The danger of setting the parity too high is, conversely, a transition inflation to reach the new equilibrium price level. Eichengreen (2011) summarizes the problem this way:
Envisioning a statute requiring the Federal Reserve to redeem its notes for fixed amounts of specie is easy, but deciding what that fixed amount should be is hard. Set the price too high and there will be large amounts of gold-backed currency chasing limited supplies of goods and services. The new gold standard will then become an engine of precisely the inflation that its proponents abhor. But set the price too low, and the result will be deflation, which is not exactly a healthy state for an economy.
To avoid transitional inflation or deflation, the new parity must be the one at which monetary gold supply and demand are equated at the current price level. If we could assume that the supply and demand for monetary gold were unaffected by the reinstatement of the gold standard, the solution would be easy: choose the current price of gold. But that is unlikely be exactly true. As I earlier argued, the demand for gold bullion and coins today is an inflation-hedging demand that would be absent under a gold standard. On the other hand, because a gold standard lowers the mean and medium-term variance of the inflation rate, the demand to hold currency and demand deposits for transaction purposes, against which banks would hold gold reserves, would rise. As Selgin (2012) notes:
The problem here is, not that there is no new gold parity such as would allow for a smooth transition, but that the correct parity cannot be determined with any precision, but must instead be discovered by trial and error. Consequently the transition could involve either costly inflation or its opposite … .
Tyler Cowen (2008) cites the same problem: “One five or ten percent deflation is enough to crush the economy and indeed the whole gold standard idea. Given the socialist calculation debate, can we really know the right transition price?”
Choosing a new parity is indeed a problem. There are two approaches to estimating the new parity that would avoid transitional inflation or deflation. Note that new parities need to be chosen simultaneously by all participating currency areas in order to agree to return to the gold standard simultaneously so as to create the broadest possible international gold standard. The first, more conventional approach is to use econometric studies of recent inflation-hedging demand for gold, and of transactions demand for zero-yielding bank reserves at gold-standard-type expected inflation rates. The second approach, which calls for further study, is to derive guidance from market signals, in particular from the gold futures market or some new kinds of prediction market, in which market players put money on their own estimates of what the real purchasing power of gold will be following a return to the international gold standard.
In a world where prices and wages exhibit greater downward that upward stickiness, playing it safe in the choice of a new parity means erring on the side of a small transitional inflation rather than a deflation.
So as not to overstate the relative size of the problem, however, we should note that the same problem attends any significant change in the inflation path, or significant change in other policy (such as the rate of interest on reserves) under a fiat standard. The switch to a lower inflation rate target, for example, will cause the path of transactions demand to hold money relative to the volume of spending to jump upward (will shift the velocity of money downward). Underestimating the increased demand, and failing to offset it with a one-time increase in the stock of money, will cause the policy to create an excess demand for money and will thus create a recession with unsold inventories of goods and unemployed labor services. The Bernanke Fed’s switch from zero to positive interest on bank reserves in October 2008 sharply increased the banking system’s demand to hold reserves, swamping the money-supply-expanding effect of the accompanying “Quantitative Easing 1” expansion of reserves. The result was seven months in 2009 (March through September) in which the year-over-year inflation rate was negative. The downturn in real output already underway was amplified. Curiously this “bad” deflation – and the first deflation of either kind in more than five decades – occurred on the watch of an expressly deflation-averse Fed chairman.
Will America start prospering again — as it has not prospered for over a decade? Likely yes. But not without a fight. Now that Jim DeMint has raided Steve Moore from the Wall Street Journal that card might be Heritage Foundation vs. the White House. Could be big.
John Holdren, now Obama’s White House science advisor, 40 years ago termed America “overdeveloped.” Holdren co-authored a 1993 book, Human Ecology: Problems and Solutions, with Anne and Paul Ehrlich reportedly saying that, “A massive campaign must be launched to restore a high-quality environment in North America and to de-develop the United States….” (Emphasis supplied.)
As a soldier of France, no one knew better than Professor Jacques Rueff, the famous French central banker, that World War I had brought to an end the preeminence of the classical European states system and its monetary regime, the classical gold standard. World War I had decimated the flower of European youth; it had destroyed the European continent’s industrial primacy. No less ominously, the historic monetary standard of commercial civilization had collapsed into the ruins occasioned by the Great War. The international gold standard -- the gyroscope of the Industrial Revolution, the common currency of the world trading system, the guarantor of more than one-hundred years of a stable monetary system, the balance wheel of unprecedented economic growth -- all this was brushed aside by the belligerents.
Publisher's Note: Originally released in June/July of 1991, this detailed report discusses Jacques Rueff's economic theories and applies them to modern economic events.
By John D. Mueller
LBMC’s Growth Model
In L’Ordre Social, Rueff constructs a theoretical model of the world economy. In it, output is the flow of goods and services produced by the stocks of labor and capital. His analysis includes the interaction of market prices and costs of production (net of taxation); markets for goods claims and foreign exchange, which are integrated through internal and external trade by purchasing power parity (and disparity), including transportation costs and tariffs, a monetary system which may be either gold-convertible or inconvertible, with or without reserve currencies, with or without adjustment lags (which produce overshooting effects in the price level and exchange rates); a theory of how economic policy operated through incentives and disincentives, including not only taxation but also price- and other regulation; alternate methods of financing budget spending (taxation, borrowing, monetization) and their effects – among other things.
"Commercial banking grew out of the desire (inspired by the profit motive) to conserve cash (gold) and by means of credit to provide financial elasticity and growth in the commercial process of exchange. That is, all producers (sellers) who desired true money (gold), instead of the short-term secured credit bills – promissory notes of their customers (the buyers) – could, through the mediation of goldsmiths-turned-bankers and bill-merchants-turned-bankers, obtain real money by discounting their bills of exchange for gold with the emerging commercial bankers of early modern Europe. The combined institutions of stable money and secured credit enabled commercial civilization to make of the entire world the only closed economy."
Argentina is floundering. Brazil is struggling. Colombia is growing. Colombia is now the third largest economy in Latin America, according to Capital Economics. The Wall Street Journal’s Darcy Crowe and Taos Turner wrote recently: “After Argentina’s economy dwarfed Colombia’s for decades, economists say the trend reversed in January as the...
One of the themes for the Akan gold counterweights is the electric mudfish.
Image courtesy of AfricanMasks.info
Spark From The Deep by William Turkel has this to say about the fish upon which this counterweight is modeled:
The electric catfish also played an important role in the west African kingdom of Benin, which...