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

[vulturesrow]

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The "gold standard" was abandoned because the gold supply does not grow at a fast enough pace to keep up with the growth of the economy. It is therefore inherently deflationary, and economically unsustainable.

q/q

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At this point I think I'd probably rather see deflation than inflation for a while. Why is deflation more evil than inflation?

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John,

Check the link I posted earlier on in this thread, it addresses this issue.

[John Kilduff]

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The "gold standard" was abandoned because the gold supply does not grow at a fast enough pace to keep up with the growth of the economy. It is therefore inherently deflationary, and economically unsustainable.

q/q

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At this point I think I'd probably rather see deflation than inflation for a while. Why is deflation more evil than inflation?

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John,

Check the link I posted earlier on in this thread, it addresses this issue.

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OK, thank you. I've excerpted the statements that article makes about deflation (since my question was about deflation specifically, not about the overall concept of a gold standard):

"The third is that deflation is also bad, and at the lower percentage values, often even worse than inflation. "

The author is saying that most economists have "settled" or agreed on this. I can't quite be convinced by that because a "majority consensus" among economists used to be trumpeted as reason to support Keynesianism. I don't find appeal to authority or expert status fully convincing and especially not in Economics.

"This surprises/offends/meets with the frank disbelief of many "sound money" types, who think that, barring local shortage, in an ideal world everything ought to cost the same or less than it did when Grandpa was a boy. (These sorts of opinions are cemented further by the fact that Grandpa, who is often the source of them, is usually living on a fixed income, and therefore feels that he would make out better in a deflationary economy.) The problem is, deflation does rather devastating things to anyone who has debt, since they now have to repay what they borrowed in more expensive dollars."

So deflation is bad for those in debt. It also must be conversely good in the same sense sense for those who are debt-free and holding money. Is debt a thing to be encouraged? Generally speaking I would think probably not. Rather, savings and investment are the basis of future prosperity, so if anything should be encouraged I would think that those things should be encouraged rather than debt.

Deflation means that, thanks to the abovementioned sticky wages, the economy has to deal with demand shocks by lowering output.

The operative effect of supply and demand. That's the way it works and no amount of tinkering is going to change that; the effect can only be artificially mitigated to some extent and the mitigation must carry its own cost as well.

"Deflation can result in what's known as a liquidity trap, a concept pioneered by liberal economist John Maynard Keynes and best elucidated by liberal economist Paul Krugman back before he left economics writing to focus on his hatred of George W. Bush. Deflation is what made the Great Depression so memorable. Deflation is so bad that almost everyone agrees that moderate inflation, in the range of 1-2%, is better than risking even a small amount of deflation."

Again an appeal to authority/expert status/"consensus".

So while the article touches on the subject of deflation it doesn't do much to truly explain or convince why deflation is bad.

Thanks for reading and for any responses.

[adanthar]

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So deflation is bad for those in debt. It also must be conversely good in the same sense sense for those who are debt-free and holding money. Is debt a thing to be encouraged? Generally speaking I would think probably not. Rather, savings and investment are the basis of future prosperity, so if anything should be encouraged I would think that those things should be encouraged rather than debt.

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You'd certainly get your wish in a deflationary economy, because one of the first and surest outcomes of a prolonged period of deflation is that the entire lending cycle would completely collapse. Forget the wave of both personal and business bankruptcies crashing into everyone above the consumer on the food chain and let's just focus on the basic economics. If the future value of money becomes *greater* than the present value of money, why would you ever make a loan - especially at a low interest rate - when you could hang onto the cash instead? Even if you were willing to make that loan, what kind of sucker would it take to accept it?

The real issue with your statement is that

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Is debt a thing to be encouraged? Generally speaking I would think probably not.

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this simply isn't true. Properly leveraged debt in an economy with free lending is an asset, not a liability, and results in far greater economic growth than the same amount of money sitting in a mattress. Further, what do you think 'investment' means, other than some individuals lending money to others in exchange for some kind of asset? And why would you assume that a deflationary economy would encourage investment?

[NeBlis]

How to know that you are at least 98% correct in your political / economic assumptions.

Midge and Q over Q both think you are wrong.

[PLOlover]

one question:

why do the central banks have hundred of tons of gold?

[John Kilduff]

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So deflation is bad for those in debt. It also must be conversely good in the same sense sense for those who are debt-free and holding money. Is debt a thing to be encouraged? Generally speaking I would think probably not. Rather, savings and investment are the basis of future prosperity, so if anything should be encouraged I would think that those things should be encouraged rather than debt.

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You'd certainly get your wish in a deflationary economy, because one of the first and surest outcomes of a prolonged period of deflation is that the entire lending cycle would completely collapse. Forget the wave of both personal and business bankruptcies crashing into everyone above the consumer on the food chain and let's just focus on the basic economics. If the future value of money becomes *greater* than the present value of money, why would you ever make a loan - especially at a low interest rate - when you could hang onto the cash instead? Even if you were willing to make that loan, what kind of sucker would it take to accept it?

The real issue with your statement is that

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Is debt a thing to be encouraged? Generally speaking I would think probably not.

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this simply isn't true. Properly leveraged debt in an economy with free lending is an asset, not a liability, and results in far greater economic growth than the same amount of money sitting in a mattress. Further, what do you think 'investment' means, other than some individuals lending money to others in exchange for some kind of asset? And why would you assume that a deflationary economy would encourage investment?

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Thanks for your response.

You seem to be explaining why a prolonged and strong deflationary trend would be bad. OK, I accept that would probably be the case. And debt isn't necessarily bad in an absolute sense but rather can sometimes depending on conditions be beneficial. Generally speaking though, having hard assets > being in debt. Investment > being in debt; it's generally better to be the one lending or investing than the one borrowing. At the very least, it's better to be in a position where you have enough assets to be able to lend or invest. And you can't invest as much as long as you are in debt (same with countries: how much of the U.S. GDP now goes entirely to service the debt? And I think that debt service percentage keeps growing...)

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?

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

[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.

[PLOlover]

interesting greenspan interview.
http://prisonplanet.com/articles/sep...7Greenspan.htm

he said a central bank not necessary when on the gold standard, but by the 1930's it was felt that the gold standard was bad. well no duh, since fed was 1913-14.

I mean wouldn't a central bank want to get rid of the gold standard?

logicians, if central bank not necessary when on teh gold standard, what is "gold standard not necessary when there is a central bank"?

[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.