Gold standard?

Will Wilkinson quotes Brad DeLong on Freidman’s monetarism,

In economic reality, “money supply” means not just cash money but also credit entries the Federal Reserve has made in commercial banks’ accounts at the Fed; plus all the credit entries commercial banks have made in households’ and businesses’ checking accounts; plus savings account balances; plus (usually) money market mutual-fund balances; plus (sometimes) trade credit and the ceilings between credit card limits and consumers’ current balances.

No central banker controls all these vast and varied sluices of the money supply – at least not in economic reality. When banks and businesses and households get scared and cautious and feel poor, they take steps to shrink the economic reality that is the “money supply.” Businesses extend less trade credit. Credit card companies cut off cards and reduce ceilings. Banks call in loans and then take no steps to replace the deposits extinguished by the loan pay-downs. Without a single bureaucrat making a single decision to slow down a single printing press, the money supply shrinks—disastrously in episodes like the Great Depression. Thus in emergencies, to say that all the central bank has to do is to keep the money supply growing smoothly is very like saying that all the captain of the Titanic has to do is to keep the deck of the ship level.

Will comments that,

[Brad] seems primarily to be pushing the idea that Monetariasm has to give way to Keynesian fiscal demand priming when monetary responses to recession get tapped out. But I think one could just as easily infer from Brad’s argument that since ideal monetary central planning isn’t really possible, we ought to give up trying and fully legalize markets in privately-issued money.

The link Will offers is to the Cato report, “Is the Gold Standard Still the Gold Standard among Monetary Systems?”

It’s a good article and it makes the important central point: fiat money is subject to considerably worse inflation than money backed by a commodity.

the average inflation rate for the fiat standard observations is 9.17 percent per year; the average inflation rate for the commodity standard observations is 1.75 percent per year. …

A gold standard does not guarantee perfect steadiness in the growth of the money supply, but historical comparison shows that it has provided more moderate and steadier money growth in practice than the present-day alternative, politically empowering a central banking committee to determine growth in the stock of fiat money. …

A gold standard does entail resource costs of mining the gold that is lodged in bank vaults. But so too does a fiat standard entail resource costs, primarily in the form of the deadweight costs of inflation.

Of course, there are still some reasonable objections to the gold standard, in particular the fact that if the U.S. were the only country to revert to a gold standard, we’d lose out on the benefit of fixed exchange rates and we’d see greater instability in gold’s purchasing power. There’s also the risk of shock from sudden shifts in supply.

I’ve never been a real gold bug, although I’m very sympathetic to the arguments they make; inflation–especially hyper inflation–really, really sucks. But inflation isn’t a necessary consequence of fiat money; fiat money just makes inflation easier.

Inflation is the result of bad decisions made by the people who manage money. All regulated monetary systems are vulnerable to inflation. The central cause of inflation is a desire to create value out of thin air, either by printing more bills, entering into greater debt, or devaluing the bills themselves. The U.S. was on a gold standard until we couldn’t be because we’d printed too much money and didn’t have the gold to back it up. That’s not a “whoops,” that’s deliberate manipulation of the money supply to devalue debt: inflation. A gold standard can mitigate the risk of inflation only so long as the government doens’t deliberately undercut the standard.

A gold standard combined with free banking would be largely immune to widespread inflation, but the risk of individual banks deliberately undercutting their own reserves is still pretty high. Banks issuing gold-backed currency would have strong incentive to dilute the value of their bills relative to their competitors and given the recent history of credit default swaps, I don’t think it’s reasonable to expect private banks to always operate with own best interests at heart.

What we need is some way to experiment with different kinds of currencies, some way to test various forms of monetary policy without crippling the economy or punishing real people. What we need is a kind of virtual economy… we need World of Warcraft.

World of Warcraft and other large online games have economies that are sufficiently large and complex to act as informative models for monetary experiments. WoW, for example, struggles constantly with inflation because its currency is backed by fiat. But what if it weren’t? What if Blizzard were amenable to reserving some WoW servers for economic experimentation?

I think such experiments would be enlightening.