A Gold Standard Can work Just Fine

September 21, 2002

Summary

  • For standards of living to rise, it is not necessary for Gross Domestic Product to rise faster than population growth rate.
  • The very idea that we can "control" the long term economic cycle via short term management of interest rates and money supply is a nonsense.
  • Therefore, it is not necessary for money supply per capita to grow.
  • Therefore, a Gold Standard can work just fine
  • When the underlying drivers of the economy are well understood, it becomes clear that the economic cycle known as the "Long Wave" is a phenomenon of Nature which cannot be avoided or "managed". The best we can do is save during the boom years to see us through the hard years.

The following is a quote from an article published by David Chapman on September 19th 2002 on Gold-Eagle (www.gold-eagle.com.): "In August 1971 President Richard Nixon suspended US$ convertibility to gold. With US$ sloshing around the world because of the Marshal plan and the Vietnam War the US was forced to suspend convertibility when a large institution (central bank?) came to the US demanding gold for dollars. Effectively the US defaulted and rather than pay, changed the rules."

The conventional wisdom arguments that have been subsequently used to justify this self-serving decision by the "Tricky Dick" Nixon Administration - which effectively took the world off a Gold Standard - have been:

  • "Money supply" is the grease required to keep the economic wheel from seizing up. When times get tough it is necessary to offer the markets large quantities of low priced money to encourage spending.
  • A relatively inelastic supply of gold inhibits the ability of a Central Bank that is subject to constraints of a gold standard to provide the grease in sufficient quantities when the economic wheel starts to squeak.
  • With World Population growing at a faster rate than we can pull gold out of the ground, gold has become a "barbarous relic".
  • Free floating exchange rates will provide an external discipline sufficient to ensure that any country which "irresponsibly" raises its money supply to unrealistic levels will find its currency depreciating relative to other countries' currencies.

Quite apart from the conventional counter-arguments relating to market manipulation and speculation, it is relatively easy to demonstrate that this conventional wisdom is flawed.

Let us try to be as basic as possible in our level of communication.

A formula to define profit can be simply stated as:

Income - expenses = profit

The argument that underpins conventional wisdom regarding "improved standards of living" is this:

  • Increasing standards of living flow from increasing profits per capita across the economy as a whole.
  • In turn, increasing profits per capita flow from increasing volume of overall trade (income) - ie Gross Domestic Product.
  • With this in mind, it is critically important to ensure that GDP not only rises, but that it rises at a rate that exceeds population growth rate.
  • Central banks need the ability to stimulate GDP growth (or suppress it when overheating occurs), by expanding and/or contracting the money supply as the need arises and/or by lowering or raising the level of interest rates.

It is interesting how conventional wisdom never seems to focus on the expenses side of the equation. Arguably, if you were to keep a country's income constant, and you were to reduce the totality of expenses in relative terms, then profits per capita (and standards of living) could still rise.

There is evidence to suggest that this is not at all an unrealistic view.

In World War II, arising out of the manufacture of combat aircraft, a phenomenon called the "Experience Curve" was discovered. Every brilliant idea contains a simple truth, and the simple truth of the Experience Curve was discovered to be that "the more you do something, the better you get at doing it".

Years later, an organization called the Boston Consulting Group latched onto this idea and tested it across many industries. They discovered, to their delight and amazement, that regardless of what you do, you not only get better at doing it but the RATE at which you improve is actually quantifiable. i.e. The Experience Curve is quantifiable and is not "Industry Specific".

Arising from this discovery, an entire generation of Strategic Consultants was born, as the BCG's theories came to form part of the syllabuses of Business Schools world-wide.

From memory, the formula goes something like this:

"Every time the accumulated output of any product or service doubles, the real (inflation adjusted) cost per unit of output declines by a predicable amount" and, if memory serves, the amount was found to be 18%. (Eighteen percent)

By way of illustration: Do you remember when electronic Light Emitting Diode (LED), hand-held calculators first came onto the scene in the early 1970s? Their cost was quantified in hundreds of dollars.

Today a Liquid Crystal Display (LCD) calculator with the same functionality can be purchased in your local supermarket for under five dollars, and the FOB price in Shenzhen Province - or wherever in China they are now produced - is probably close to $1, including the solar powered battery.

In very simplistic terms: Subject to the reasonable assumption that successive doublings of the totality of all accumulated experience within an economy will give rise to successive 18% reductions in real unit costs across the entire economy, we can draw the following conclusions:

1. If GDP were to grow naturally at around the same rate as population growth then, given continuously falling costs on a per unit basis, standards of living will continually rise. Under such circumstances it would be absolutely unnecessary to have any mechanism at all for "encouraging" or "discouraging" GDP growth.

2. The arguments against gold as the ultimate anchor currency are without foundation. i.e. It is an irrelevancy that above ground stocks of gold grow relatively slowly.

Unfortunately, one compelling problem is that if we were to envisage the World Economy as a gigantic game of Monopoly, then all of us who have ever played the game understand one simple fact: When you have a finite amount of cash in the pot, the winner is always the guy/gal who lands up with all the cash.

It follows that any monetary system that we may conceive will not only need to have the ability to exert a discipline on Central bankers' predisposition to get carried away, but it will still always need flexibility to provide "some" slack. Both of these objectives are eminently possible to achieve under a Gold Standard.

If the total world "fiat" money supply were to be frozen at any given point in time, then each unit of available currency would buy a defined fraction of an ounce of gold based on the then prevailing exchange rates and gold price.

The "money supply" would thereafter be limited to increasing at the rate of extraction of gold from the earth. This fact in itself will provide some slack.

Perhaps the world-wide ground rules could be further tweaked to include an adjustment for increases in population. i.e. perhaps the value of gold per ounce should automatically rise at the rate of population increase to facilitate an increase in paper money supply by that amount. This logic could be justified as "non-inflationary" on the assumption that the additional members of the population would eventually add value from their incremental efforts.

Of course, the thorniest problem lies in the implementation.

For one thing, the politicians will never buy into such a simplistic idea. Apart from the hard fact that there is "leakage" throughout the world (to use a polite euphemism), politicians absolutely need to pork barrel in order to get re-elected. (This is the main reason why cost of Government has been rising disproportionately to GDP growth overall). Unless the Electorate moves to INSIST that its elected leaders behave with pristine integrity, it will never be possible to "cap" expenses, let alone see them fall at a predictable rate.

Further, we cannot argue the fact that some people are born with more ability than others and are therefore likely to accumulate wealth at the expense of others in a world of relatively finite supply of money.

But that is happening anyway. It's an age-old phenomenon that the rich get richer and the poor get poorer. We have a choice: We can attempt to disguise this fact or we can accept it and act appropriately with the objective of addressing it.

And so, the circle is closed. A world driven purely by self-interest will certainly benefit the strong at the expense of the weak which, in the end analysis, is precisely why the imposition of some form of external discipline is imperative.

There are two thoughts that arise from the above:

1. In a previous article I demonstrated - by means of findings from some inspired research by Cesare Marchetti - that the long Kondrat'eff wave is fundamentally driven by the commercialisation (and ultimate market saturation) of successive waves of technologies which, in turn, are associated with the emergence and growth (and subsequent waning) of new waves of energy sources. (The sequence from the Industrial Revolution to date has been wood, coal, oil, natural gas). In the context of "accumulated experience", standards of living will eventually begin to fall as markets saturate, and will only begin to rise again as the unit costs of new technology products fall quickly in absolute terms when markets for these new products are penetrated. With this in mind, an economic winter is unavoidable and politicians/economists must be restrained from tinkering with money/credit supply in their attempt to avoid that which is unavoidable. All that happens when such tinkering occurs is that asset price bubbles emerge, and this eventually causes more economic dislocation than would otherwise occur if no interference at all were forthcoming.

2. Politicians who are motivated, ultimately, by self-interest have the capacity to wreak enormous damage on Society at large if they are allowed to make decisions based on popularly accepted conventional wisdom. A new form of political structure needs to be devised which has sufficient checks and balances so as to preclude any individual from leading Society as a whole down the path of destruction. The world is now facing the real possibility of War. Why is this so?

Well, when you pierce the veil of all the obfuscation and misinformation, it becomes clear that politicians are attempting to justify their existence in an environment where it is physically impossible for them to deliver on their "pork barrel" promises. So they create new problems, which they then move to solve.

All of which again begs the question: "Why is the US Electorate prepared to accept such sub-optimal decision making from its elected leaders?"

The total world's holdings of gold could be transported by a single solitary oil tanker.

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