Explain to an idiot the benefits of going back to the Gold standard

[adanthar]

Yes, being the debtor is worse than being the creditor. However, a proper lending economy requires both of those statuses to be present in order to work [img]/images/graemlins/tongue.gif[/img]

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Prolonged and extreme inflation is bad also. What I don't understand is why mild or temporary deflation is so terrible. If mild inflation isn't so bad then why is mild deflation so bad?

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Mild deflation still crashes the lending cycle.

Think of it this way: inflation is simply another factor to be subtracted from the future value of money, and is therefore factored into the interest rate of any given loan. If a proper interest rate would be 5%, a 2% inflation rate makes that rate 7%. That's basically all that (mild) inflation does.

Now let's assume we have a deflationary economy and *add* a deflation % to the future value of money, thereby making it worth more than the present value. (Again, I want to emphasize that the very first thing that would happen in a deflationary economy is a cascade of bankruptcies all the way up, but we're speaking solely about basic economics here.) Theoretically, because I'm now guaranteed some return on a loan by simply putting it under my mattress, there is almost no risk to the lender and interest rates should be zero. However, a zero interest rate means there is no incentive for the lender to loan money at all, while an interest rate substantially above zero is a usurious rate that only a sucker would take. The actual percentage of deflation doesn't matter.

(Now, take this one step further. In the real world, most loans are given out for two reasons: for consumer spending and for business growth. If consumers are discouraged from spending, what happens to businesses? If businesses are already in a crunch from the former, and now cannot take out new loans at reasonable rates because it's far less risky to put the money in a mattress, what happens to them?)

Moreover, although IIRC you did say you weren't crazy about the gold standard, a deflationary economy caused by a return to the gold standard would by no means be mild.

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edit: or how about neither inflation nor deflation; my guess would be that that would be better than either.

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Mild inflation is more or less simply a side effect of the lending economy/business cycle/population and GDP growth (for example, a nation that has doubled in population in fifty years should, for a variety of reasons - some obvious, some not - certainly have more money supply available than it did fifty years ago). I'm not well enough informed on modern economic theory to know whether a small amount of inflation is currently seen as a necessary evil or beneficial on its own (both views have been widely held in the past), but any sort of present value > future value equation can already adapt to account for it and the market easily adjusts to any reasonable number.

[John Kilduff]

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Yes, being the debtor is worse than being the creditor. However, a proper lending economy requires both of those statuses to be present in order to work

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Agreed, but you usually would prefer to be in a position to be the lender. Wouldn't the USA be better off as a net lender nation than as a net debtor nation, internationally speaking?

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Think of it this way: inflation is simply another factor to be subtracted from the future value of money, and is therefore factored into the interest rate of any given loan. If a proper interest rate would be 5%, a 2% inflation rate makes that rate 7%. That's basically all that (mild) inflation does.

Now let's assume we have a deflationary economy and *add* a deflation % to the future value of money, thereby making it worth more than the present value....

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In which case a 5% interest rate adjusted for 2% deflation would be 3%?

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...Theoretically, because I'm now guaranteed some return on a loan by simply putting it under my mattress, there is almost no risk to the lender and interest rates should be zero.

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Why zero? The use of money now can be turned to profit in a good business at a rate higher than interest paid.

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However, a zero interest rate means there is no incentive for the lender to loan money at all, while an interest rate substantially above zero is a usurious rate that only a sucker would take. The actual percentage of deflation doesn't matter.

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Not sure how or why we get from 3% (which is 5% - 2%) to 0%.
Why wouldn't there some middle ground for interest rates if the rate of deflation is low?

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(Now, take this one step further. In the real world, most loans are given out for two reasons: for consumer spending and for business growth. If consumers are discouraged from spending, what happens to businesses? If businesses are already in a crunch from the former, and now cannot take out new loans at reasonable rates because it's far less risky to put the money in a mattress, what happens to them?)

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I'm finding it hard to see why there couldn't be some area in between or room to work within as long as the rate of deflation is very low.

[adanthar]

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Agreed, but you usually would prefer to be in a position to be the lender. Wouldn't the USA be better off as a net lender nation than as a net debtor nation, internationally speaking?

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Internationally speaking, every major nation except Canada (which has reserves of every major commodity and little population) is a net debtor because the indebtedness is largely to its own citizens. But that's neither here nor there, because that has nothing to do with inflation or deflation - except in the sense that since we're debtors, deflation would make us worse off. I'm honestly not getting what you're trying to say with this.

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In which case a 5% interest rate adjusted for 2% deflation would be 3%?

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It doesn't work like that. You can add inflation to the interest rate, but you cannot subtract deflation from it. Again, the reason is because inflation is merely one factor in an equation in which the future value of money is less than the present value. When future value > present value, interest rates, which are a measure of rewarding the risky behavior of loaning out money, stop functioning, because there is now no reason to loan it out at all; you can just sit on it.

If you still don't get it, try the Wiki (http://en.wikipedia.org/wiki/Deflation). It's a good summary.

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Why zero? The use of money now can be turned to profit in a good business at a rate higher than interest paid.

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You're still ignoring the immediate real world impact on consumer spending. What are these "good businesses" in a deflationary economy with no consumers spending any money?

Check out Japan in the 90's for a good example of just this effect in action.

[PLOlover]

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You're still ignoring the immediate real world impact on consumer spending. What are these "good businesses" in a deflationary economy with no consumers spending any money?

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what's the difference between people "investing" their money in stocks, etc, to keep their savings from being eroded by inflation, and people saving hard currency like gold under their mattresses because it will keep it's value,

other than who is in control of the asset?

I mean, in either case, the consumer is not "spending" it.

[adanthar]

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what's the difference between people "investing" their money in stocks, etc, to keep their savings from being eroded by inflation, and people saving hard currency like gold under their mattresses because it will keep it's value,

other than who is in control of the asset?

I mean, in either case, the consumer is not "spending" it.

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I'm sorry, but if you don't get the difference between someone putting their money into the stock market and therefore keeping it circulating in the economy as a whole vs. keeping it in their mattress, you're not competent enough to talk about economic theory.

This question is like someone wandering into HSNL and asking what the benefits of raising preflop are.

[PLOlover]

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I'm sorry, but if you don't get the difference between someone putting their money into the stock market and therefore keeping it circulating

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a) well if you buy 1 share of stock and hold it versus buying one gold coin and keeping it, how is the share of stock "circulated".

b) if it's so simple, just explain it.

c) my main point of course is that both activities are "investment", not "spending".

I mean, even today one can invest in stocks or invest in stuff like gold coins, are you saying the guy who invests in stocks is more likely to spend extravagently?

[adanthar]

Oh okay, you meant buying gold. My bad, I misread your answer. That said,

1)while there's nothing "wrong" with someone hoarding bullion*, our economy/all developed economies are built on people not hoarding *anything* and maintaining spending patterns;

2)The main point of buying gold is for its perceived stability vs. a weak currency (hence why it's going up these days.) A deflationary economy, especially, say, one based on gold, would first necessitate a devaluation of the metal. Therefore, anyone hoarding gold prior to a major deflationary event (such as a return to the gold standard) would very probably lose their shirt.


*there is an exception in that, since the US is kinda short on gold mines at the moment, an investment in specifically bullion results in a trade imbalance. This matters a lot more in a deflationary economy than a regular one.

[PLOlover]

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You're still ignoring the immediate real world impact on consumer spending. What are these "good businesses" in a deflationary economy with no consumers spending any money?

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this is what i mean.

[tolbiny]

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When future value > present value, interest rates, which are a measure of rewarding the risky behavior of loaning out money, stop functioning, because there is now no reason to loan it out at all; you can just sit on it.

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What? As long as a person can gain more by lending than by simply holding money then they have an incentive to lend/invest.

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You're still ignoring the immediate real world impact on consumer spending. What are these "good businesses" in a deflationary economy with no consumers spending any money?

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This totally ignores reality, since if no one was spending money then prices would drop so low that anyone who had money saved (everyone) would start buying since their purchasing power had hit the point that they were waiting for it to hit. Since individuals have different thresholds for when spending > consuming, and the fact that current consumptions is preferred to future consumption, your hypothetical non consumption economy never comes about. Every lowering of prices due to deflationary pressure adds another group of people who now meet their requirements for spending.
To your point about investing in businesses in the future having a population with large amounts of savings built up means that there is a large incentive to produce newer and better products sine there is a huge market to tap into. Target consumers for businesses are the ones with the most to spend, the more is saved the more can be spent.

[adanthar]

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in inflation, the money is becoming worth less, in deflation, the money is becoming worth more. (in reality I don't think this would occur as mining gold would free market be more appealing and thus keep the balance).

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O rly?

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One of the main disadvantages of the gold standard is that it artificially inflates the value of gold. The total amount of gold that has ever been mined is estimated at ~125,000 tonnes.[1] At the current gold price of around USD $640 per Troy ounce, or around $20,000 per kilogram, the value of this entire planetary stock would be USD $2.5 trillion, which is less than the value of currency circulating.

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It's gonna take a whole lot of extra gold mining to get there from here.

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This totally ignores reality, since if no one was spending money then prices would drop so low that anyone who had money saved (everyone) would start buying since their purchasing power had hit the point that they were waiting for it to hit. Since individuals have different thresholds for when spending > consuming, and the fact that current consumptions is preferred to future consumption, your hypothetical non consumption economy never comes about. Every lowering of prices due to deflationary pressure adds another group of people who now meet their requirements for spending.
To your point about investing in businesses in the future having a population with large amounts of savings built up means that there is a large incentive to produce newer and better products sine there is a huge market to tap into. Target consumers for businesses are the ones with the most to spend, the more is saved the more can be spent.

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This is all well and good, but that's not at all what happened in Japan (edit: and, I should say, every other deflationary economy ever, although Japan is the only really recent one).