A conversation about inflation

[MrMon]

Okay, here's the problem with a hard money system and why it can't possibly work in today's economy. What are you going to base it on? Gold seems to be the favorite of the hard money advocates, but let's see what happens when we do that by looking at historical data.

Note: All $ terms are in Year 2000 US dollars

In 1820, US Real GDP was 12.5 billion dollars or 1.8% or world share. In per capita terms, this was $1,328 per person. World per capita gold production was about .5 ounces, and total world population was about 1.1 billion people, for a total annual gold production of 550 million ounces. The US gets 1.8% of that, or 9.9 million ounces. US population was about 9.6 million, so each person gets 1.03 ounces of gold, representing a GDP/gold production ratio of $1,287/ounce.

So what does this all mean? Let's assume we want to a maintain constant price of gold - hard money. Gold backs up the money supply. Now, of course we don't need as much money in circulation as there is GDP, people do consume their GDP after all, usually on a pretty constant weekly basis, but it provides a hand measure that we can all understand. We'll also assume that there is no spare gold in the world in 1820 - all prior stocks back all world's wealth at a certain ratio, and that new gold production in 1820 covered the new wealth created at that same ratio. (Note that 1820 is arbitrary, it just happens to be a year I have data for, as are all the following years.)

By 1870, US Real GDP was $98.3 billion, 8.9% of world GDP. Per capita was now $2509. World gold production was now .54 ounces per person, world population was 1.35 billion, for total world production of 729 million ounces. US share is approximately 65 million ounces, US population is 40 million, so gold per capita is 1.625 ounces per person, working out to a GDP/gold ratio of $1,544/ounce. Not bad, but we need more gold to get back to our $1,287 price of 1820. But, since our numbers may be a bit off, let's just say it's close enough.

Now let's move up to 1913. US Real GDP is now $530 billion, 19.1% of world share, per capita is now $5,462. World gold production has increased all the way to .65 ounces per person, world population is 1.75 billion, for a total world gold production of 1.138 billion ounces. US share of that is 217 million ounces, US population is 97 million, or 2.23 ounces per person. GDP/Gold Ratio is now $2,444/ounce. Ooops! Looks like that little gold shortage back in 1870 has turned into a real crisis if 1820 is our benchmark. No surprise that the world economy started abandoning the gold standard at about this point, as things are only going to get worse.

By 1950, after seeing half the world's economy destroyed through two World Wars and a Great Depression, US Real GDP was $1.78 trillion, or a whopping 27.3% or world share. Per capita was $11,752. World gold production per capita peaks at .82 ounces per person, world population is 2.6 billion, total world gold production is 2.13 billion ounces. US share is 582 million ounces, US population is 151 million, or 3.84 ounces per person. GDP/Gold ratio is now $3,053/ounce. Damn those lazy gold miners, can't they produce more, can't they see what they're doing to our economy?

Now for 1973. US Real GDP is $4.34 trillion, per capita is $20,541, US share is 22.0% of world GDP. World gold production drops to .75 ounces per capita (hello Mr. Nixon), but total world population is 4 billion and total production is up to 3 billion ounces. US share is 660 mliion ounces, US population is 211 million, or 3.12 ounces per person, less than what was produced in 1950. Yet with GDP up, the GDP/Gold ratio is now $6,578/ounce. Yikes!

We'll finish this off in 1998. US Real GDP is $9.07 trillion, still 21.9% of world GDP, and $32,868 per capita. World gold production has stabilized at .75 ounces per capita, world population is 6.1 billion, total world production is almost 4.6 billion ounces. US share is just over 1 billion ounces, US population is 276 million, so gold is 3.63 ounces per person. GDP/Gold ratio is $9,049, over seven times what is was is 1820.

Look back over the numbers. GDP outstrips gold production every time. We simply can't produce enough gold to keep up with a modern industrial/service/information economy. So add in other commodities. I have no doubt we'll outstrip those as well, not to mention the problem of maintaining ratios. What happens if those silver miners get a little too good, producing too much silver. Going to shut down the mines to maintain the proper gold to silver ratio? The more commodities you add, the more problems you are going to add in managing the commodity basket. But if you add in all the commodities, say the whole GDP, then you have what we have today, fiat currency. No problem maintaining production of anything, the economy as a whole backs the currency. Problem solved.

[GoodCallYouWin]

Base it on uranium.

[frizzfreeling]

MrMon,

Its even worse than you state, because world gold production is much less than you have said. You are missing something in your weight conversions, because gold production peaked at ONLY about 85 million ounces per year around 2001. Total gold ever mined is estimated at around 5 billion ounces, but a good portion of this is lost.

At the current production rate of 80 million oz per year, and 20% world GDP for U.S., thats 16 million oz per year for about 12 trillion GDP, or $750,000 per ounce.

[adios]

[ QUOTE ]
[ QUOTE ]
And if we're talking about switching to a full reserve system where the currency is backed by a commodity, I think we could expect to see loans a lot harder to come by than they are now or have been. Could be convinced on that though.

[/ QUOTE ]

Full reserve system isnt necessary and this would make loans much harder. Actually something that is necessary to take place in the US economy under given circumstances since loans are likely to get uncontrollably more difficult due to creditors lacking confidence. One way or another they need to up their credit and the tax payers/fed are losing the trust of the public and since fed isnt willing to raise rates then the legislators must further back up their currency.

More importantly, the anarcho capitalist perspective is that of free banking though. Where transparent fractional reserve and full reserve banking coexist and compete.

Either way the benefit is that loans are restricted by the wealth of the society to satisfy said loans. Economic consequences and rewards are properly placed. Increased savings allows for increased investment while decreased savings will force a decrease in investment.

Since investment would be tied to commodity savings, investors are much wiser and will not have the means to malinvest the limited resources and production of a society. "Credit systems" like Exsub's do the opposite and hit the bust phase when the limited resource fact becomes public knowledge.

The largest damage of inflation is the distortion of economic calculation for the enduring period so there is always a serious waste in resources that cant be turned back.

[/ QUOTE ]

One thing I want to make clear, I'm not saying that making loans harder to come by is necessarily a bad thing. Just showing that changes in the economic system will change economic behavior.

[adios]

Good post. There's no doubt that trying to save money by depositing it in a bank savings account is the worst option to choose for accumulating wealth in our current monetary system.

[pvn]

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GDP outstrips gold production every time. We simply can't produce enough gold to keep up with a modern industrial/service/information economy.

[/ QUOTE ]

So what? Why do "we" need to produce X amount? And who's "we"?

[Borodog]

Of course inflation benefits debtors. Duh. A huge part of the reason that governments favor inflationary monetary policy is that inflation favors debtors, and government is always the largest debtor in society.

This does not make it good, or magically make its deleterious effects vanish.

[Borodog]

[ QUOTE ]
Okay, here's the problem with a hard money system and why it can't possibly work in today's economy. What are you going to base it on? Gold seems to be the favorite of the hard money advocates, but let's see what happens when we do that by looking at historical data.

Note: All $ terms are in Year 2000 US dollars

In 1820, US Real GDP was 12.5 billion dollars or 1.8% or world share. In per capita terms, this was $1,328 per person. World per capita gold production was about .5 ounces, and total world population was about 1.1 billion people, for a total annual gold production of 550 million ounces. The US gets 1.8% of that, or 9.9 million ounces. US population was about 9.6 million, so each person gets 1.03 ounces of gold, representing a GDP/gold production ratio of $1,287/ounce.

So what does this all mean? Let's assume we want to a maintain constant price of gold - hard money.

[/ QUOTE ]

Let's not. Why would you want to assume this. It's a ridiculous assumption. The price of gold will vary according to people's varying demand for cash holdings. There is no reason at all to "assume that we want to maintain a constant price of gold." What would this even mean? If gold is the money, then gold has nearly an infinite number of prices, one for each good or service sold in the market. Constant relative to which good or service? Are you claiming that it is somehow desirable that NO prices change relative to each other?

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Gold backs up the money supply.

[/ QUOTE ]

No, gold WOULD BE the money supply, ideally, at least under a 100% reserve system. A fractional reserve system hard money system is actually NOT backed by gold EXACTLY to the extent that titles to gold are inflated relative to actual gold. This is why we had business cycles even when we were supposedly on a gold standard; we still had FRB artificially inflating the money supply.

[ QUOTE ]
Now, of course we don't need as much money in circulation as there is GDP, people do consume their GDP after all, usually on a pretty constant weekly basis, but it provides a hand measure that we can all understand.

[/ QUOTE ]

What does this even mean? People get paid for their production in money (at least any production that would be included in the GDP). Whether they spend that money on consumption or save it simply changes the demand for money.

[ QUOTE ]
We'll also assume that there is no spare gold in the world in 1820 - all prior stocks back all world's wealth at a certain ratio, and that new gold production in 1820 covered the new wealth created at that same ratio. (Note that 1820 is arbitrary, it just happens to be a year I have data for, as are all the following years.)

[/ QUOTE ]

What's the purpose of this assumption? Gold is gold. People will either use it for money or some other use, like jewelry or industrial uses. This just goes into the total demand for money.

[ QUOTE ]
By 1870, US Real GDP was $98.3 billion, 8.9% of world GDP. Per capita was now $2509. World gold production was now .54 ounces per person, world population was 1.35 billion, for total world production of 729 million ounces. US share is approximately 65 million ounces, US population is 40 million, so gold per capita is 1.625 ounces per person, working out to a GDP/gold ratio of $1,544/ounce. Not bad, but we need more gold to get back to our $1,287 price of 1820.

[/ QUOTE ]

No, we don't. Why? Because you say so? There is no way to define "the" price of gold; it has a practically infinite number of prices. Furthermore, why are you calculating historical gold prices in modern inflated dollars? Why not calculate modern devalued dollars in gold? A dollar is SUPPOSED to be a unit of gold, a fixed weight of gold, 1/20th of an ounce.

[ QUOTE ]
But, since our numbers may be a bit off, let's just say it's close enough.

Now let's move up to 1913. US Real GDP is now $530 billion, 19.1% of world share, per capita is now $5,462. World gold production has increased all the way to .65 ounces per person, world population is 1.75 billion, for a total world gold production of 1.138 billion ounces. US share of that is 217 million ounces, US population is 97 million, or 2.23 ounces per person. GDP/Gold Ratio is now $2,444/ounce. Ooops! Looks like that little gold shortage back in 1870 has turned into a real crisis if 1820 is our benchmark. No surprise that the world economy started abandoning the gold standard at about this point, as things are only going to get worse.

[/ QUOTE ]

Worse? Huh? Because the cost of a good has changed over time from one number X to another Y? Why is this "wrong"? What do you presume to assume is the "correct" price of anything, and how do you arrive at this magic number?

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By 1950, after seeing half the world's economy destroyed through two World Wars and a Great Depression,

[/ QUOTE ]

All three of which fueled by inflation.

[ QUOTE ]
US Real GDP was $1.78 trillion, or a whopping 27.3% or world share. Per capita was $11,752. World gold production per capita peaks at .82 ounces per person, world population is 2.6 billion, total world gold production is 2.13 billion ounces. US share is 582 million ounces, US population is 151 million, or 3.84 ounces per person. GDP/Gold ratio is now $3,053/ounce. Damn those lazy gold miners, can't they produce more, can't they see what they're doing to our economy?

[/ QUOTE ]

Why do you imagine that gold production has to "keep up with" other production? This is the underlying assumption to your "analysis", and it has no basis in the real world. Money is a medium of exchange, it's absolute quantity does not matter. If money production outstrips other production, then prices will rise. If other production outstrips money production, then prices will fall. There is NO aggregate problem in either case, UNLESS money can be counterfeited and injected into credit markets and artificially lowers interest rates.

[ QUOTE ]
Now for 1973. US Real GDP is $4.34 trillion, per capita is $20,541, US share is 22.0% of world GDP. World gold production drops to .75 ounces per capita (hello Mr. Nixon), but total world population is 4 billion and total production is up to 3 billion ounces. US share is 660 mliion ounces, US population is 211 million, or 3.12 ounces per person, less than what was produced in 1950. Yet with GDP up, the GDP/Gold ratio is now $6,578/ounce. Yikes!

[/ QUOTE ]

Yikes? Who cares? I repeat, why is this bad?

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We'll finish this off in 1998. US Real GDP is $9.07 trillion, still 21.9% of world GDP, and $32,868 per capita. World gold production has stabilized at .75 ounces per capita, world population is 6.1 billion, total world production is almost 4.6 billion ounces. US share is just over 1 billion ounces, US population is 276 million, so gold is 3.63 ounces per person. GDP/Gold ratio is $9,049, over seven times what is was is 1820.

[/ QUOTE ]

WHO CARES. Gold-denominated prices have fallen. Your gold can buy more goods and servies. THAT'S WHAT HAPPENS IN A GROWING ECONOMY. Increasing productivity makes every wealthier. Your alternative is an inflationary system that makes a small number of people wealthier, prior recipients of inflated money, but only at the expense of everyone else, who are made relatively more poor than they would have been without the credit expansion.

[ QUOTE ]
Look back over the numbers. GDP outstrips gold production every time. We simply can't produce enough gold to keep up with a modern industrial/service/information economy.

[/ QUOTE ]

Why do you presume that gold production must "keep up with" an economy. There is nothing wrong will falling prices. We had decades of increasing productivity, growing economy, and a generally falling price level at the end of the 19th century. By the end of the 19th century real interest rates had fallen to less than 3%. The business cycles we had were not due to falling prices or a hard money, they were due to fractional reserve banking inflating the money supply.

[ QUOTE ]
So add in other commodities. I have no doubt we'll outstrip those as well, not to mention the problem of maintaining ratios.

[/ QUOTE ]

Huh? Production of commodities will always outsrip the production of all commodities? Surely you can see this is wrong, right?

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What happens if those silver miners get a little too good, producing too much silver. Going to shut down the mines to maintain the proper gold to silver ratio?

[/ QUOTE ]

What? Why do you insist that prices cannot change relative to each other?

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The more commodities you add, the more problems you are going to add in managing the commodity basket.

[/ QUOTE ]

Why does a "commodity basket" need to be "managed"? If there is more than one metal in use as money, then there will be a market derived exchange rate between them that will fluctuate just as any other price in the market.

[ QUOTE ]
But if you add in all the commodities, say the whole GDP, then you have what we have today, fiat currency.

[/ QUOTE ]

Uh, no. You have barter.

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No problem maintaining production of anything, the economy as a whole backs the currency. Problem solved.

[/ QUOTE ]

There is no problem to be solved. There is no problem maintaining the production of anything that should actually be produced with a real money standard, and there is a HUGE problem mainting the production of the things that should actually be produced under an inflationary fiat money system; it's called the business cycle.

[tomdemaine]

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[ianlippert]

Another point to clarify is that we are not for a hard gold monetary system. We are for a free banking system. If fiat money is the best for industrial production then it will out compete gold in the free market. If you were interested in any sort of scientific experimentation you would be for a free banking system.