Thursday, November 10, 2011

First, Let's Get Rid of the Economic Lawyers

I was amused by an exchange between Ron Paul and Ben Bernanke that happened this past summer but I only came across recently:

Paul: Do you think gold is money? Bernanke: (pregnant pause) No. It's not money? It's a precious metal. Even if it has been money for 6,000 years, somebody reversed that and eliminated that economic law? Well, it's an asset. Would you say Treasury bills are money? I don't think they're money either, but they're a financial asset. Why do central banks hold it? Well, it's a form of reserves. Why don't they hold diamonds?Well it's tradition -- long-term tradition. Well, some people still think it's money. In the U.S. anyway, those people are wrong. 
From Daniel Indiviglio's blog at The Atlantic
The economic law that gold is money? I must have missed that. Is it in the Bible or something?

Amusingly, Ron Paul's fanboys think that this exchange somehow displays Paul's fantastic grasp of basic monetary issues and Bernanke's inability to deal with him. Anyone watching the video of their exchange will see Bernanke is clearly bored during Paul's Long run-up to this bit of questioning.

What all of this boils down to is that Paul believes gold has transcendent value. As established by God, no doubt and that value is to be measured only in gold. Or should we say Gold? This is merely arbitrary. An alternative fiat to fiat currency, and a bad alternative for reasons I'll explain below.

And Paul thinks that value itself has to be a transcendent. He offers no reason why this should be so.

Economic value is contingent. It always is. It is less contingent in a developed economy such as ours, but it is contingent. A smallholder brings in 100 bushels of wheat one year, and lives comfortably off the proceeds one year, the next year he brings in 150 and barely scratches a living. How could this be? 150 is bigger, and therefore more valuable than 100, no? But having 150 bushels of wheat in a year when there is too much wheat is worse than having 100 when it is scarce.

The one economic law we should all know well, the law of supply & demand, the basic observation behind capitalism, says "value is contingent." And that law applies to everything, Gold included.

Which means that the wild fluctuations we've seen in the price of gold in USD over the past 40 years or so are NOT just a reflection of the value we put in the dollar, but also a reflection of the contingent value of gold as a commodity. In a flight to quality, gold goes way up and US bond rates way down because there is additional demand for those reputed safe harbor investments, this over and above any implied valuation of the currencies involved.

Now why does gold have a reputation as a "quality" investment? Because the supply is relatively stable and predictable.

So why not tie the value of your currency to gold? Because one of the big reasons you have a currency is the first place is to enable you to manipulate its supply to deal with economic contingency. If you tie the value of your currency to gold, then you've taken this possibility off the table.

And why would you want to manipulate the supply of currency? Because economic value is not measured in Gold, it is measured in human well-being, in people eating, in their having a warm & dry place to stay, in having employment and enjoyment, in having some security in the future. That's "value." And while this definition may sound a little bit nebulous, the fact is that this gets to the real gist of the matter, where merely posited abstract, supposed absolutes, like Gold, just defer the question infinitely--isn't Gold shiny enough to make you stop asking questions?

Value is rooted in perceived human good. Full stop.

Money is an exchange medium which creates a common index to measure value of very different things, because it--money--can be exchanged for many different things--a weight of gold, some barley, a night with a prostitute, a slave, a jug of wine, a pair of shoes, the services of a porter for a day. However, because all of these things are subject to the law of supply & demand, including money itself, the value, as measured in this common index, fluctuates constantly.

Money is a representation of value. Value fluctuates constantly. And the value of the representation itself is subject to change. If the representation is easily counterfeited, it's value will inevitably fall as people do just that.

Hence gold--it is difficult to counterfeit and supply was pretty stable and it thus became a great medium for early exchange. But gold currency had its problems, too. Gold was very scarce and it was difficult to make coinage small enough to represent the value of many many trades. (Most people in the year 1000, say, would never have used a gold coin for any transaction for their entire lives.)

And since weighing coins and calculating for purity was an inconvenient process to undertake at each exchange, coin the clipping and debasing of coinage could be quite profitable enterprises for both governmental and non-governmental entities.

And the supply wasn't always stable. A major strike could wreak havoc on the value of gold as measured in (at the time) more stable commodities. For instance, after the discovery of America, or the California discoveries circa 1850, gold and silver were suddenly much easier to come by in Europe, causing inflation.

And so money was ever a problem, not just in the household economics, but also in any exchange. Coinage was non-standard in every way. The solution to this problem was representational currency. The currency would be essentially valueless in itself, but it would represent and be exchangeable for gold, which represented actual value in a hard to counterfeit way.

But that didn't solve all the problems with Gold. Over the short term, tying your economic policy to gold mean long term price stability, but relatively violent fluctuations over the short term. And since we've all got to put food on the table and pay next month's rent in the short term, this wasn't so good for regular folk. For people who were stashing away large sums of money off of which their grandchildren would live idly, the sub 1% long term inflation rate was great. But near 60% (+40/-20) variations in the annual inflation rate were hardly the stuff that made wage-earners smile and love the gold standard. And they didn't.

In short, a government that cared about wage earners and small holders needed to be able to act to create short-term economic stability, even if that was at the expense of some erosion of long term price stability. This isn't so bad a trade, and the proponents of tying money supply to the gold supple ought to be a bit more honest about what the gold standard brought us--lots of volatility, big increases and decreases in prices that tended to cancel each other out in the long run.

If what you long for is more short-term stability, for your dollar to be worth the same this year as last or two years ago, then Gold is not the answer. In fact, it is precisely the opposite of the answer.

Contingency can't be escaped. Gold is not God--He's said as much. The Gold standard does not bring transcendent truth to our financial transactions, it is only mental children who think so, or even hope for it. Financial transactions depend on other people. There is no guarantor for your wealth or goods against any and all contingencies.

Speaking of children, watching the video of the Bernanke/Paul "showdown" really impressed me with how childlike Ron Paul can be. Paul querying (and wearying) Bernanke is just like watching a toddler trying to find the man inside the TV.

Well folks, there is no man in the TV, there is no ultimate truth behind a dollar bill. Just our collective promise and the likely prospect that others will accept it just as you did. Paul thinks that kind of social trust is a Ponzi scheme. Actually it is life as fully cognizant adults live it.

There is no "law" that says only gold is money, just as there is no "law" that says your parents will always be there for you, or that you will always be the center of the universe. Your parents will die, you are one person among billions, and you will have to face and deal with life contingencies one way or another.

But, hopefully not with tiresome delusions like Gold.