April 2013 Bar Bulletin
 
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April 2013 Bar Bulletin

All That's Gold Does Not Glitter

By Christopher Pitts

 

In the last year or so, otherwise reasonable publications have had their pages marred by editorial calls for a return to the gold standard.

Advocates of a gold standard applaud the idea of a "sound" currency backed by gold as opposed to arbitrary, fiat money. Of course, there's nothing magical about gold and it is only an accident of history and human taste that previous societies found it to have any value at all. Indeed, the industrial applications of gold are few and far between. If soundness is to imply an inherent value to human societies, then iron or copper would be far worthier as backers of any currency. As far as its inherent value or particular suitability to back a currency, gold has none - it could just as easily be tiddlywinks.

Currency, commodity backed or not, has utility because societies agree to use it as a proxy for the exchange, transfer and storage of human labor. Prior to currency and credit, economies used barter. In days of old, I would trade a sack of beets for a haircut. Currency simply stands between and breaks the barter into two distinct transactions. Nowadays, I sell my beets to the coiffure and I turn around and give him money for my haircut.

This arrangement has a lot of advantages. However, one drawback is that for all of the potential economic activity to take place, the economy must have an adequate money supply. If I have beets and the coiffure has scissors, but neither of us has any cash, then the exchange doesn't take place. Oh no. The gold standard has no remedy to this problem.

In theory, what gold, or any finite, commodity-backing accomplishes for a currency is long-term price stability. In reality, this is not always the case. The Price Revolution of 16th- and 17th-Century Europe was caused by a massive influx of Spanish gold and silver from the New World (Seville was particularly hard hit as the port of entry for Spanish silver). And the 14th-Century Ghanian King Musa brought and spent so much gold on his Hajj as he passed through Cairo that the local economy collapsed from the ensuing devaluation of the money supply and did not recover for a full decade. As it turns out, gold backing is no guarantee against catastrophic inflation.

Setting aside these admittedly rare instances of gold's devaluation, gold's promise of price stability, even in theory, is ephemeral when looked at more closely. Prices are only half the macroeconomic picture; one also has to look at wages.

When an economic system is out of balance (i.e., its people consume more than they produce), sooner or later either wages must go down or prices must go up to restore balance. If wages go down then the people cannot consume as much, bringing the system back into balance. And if the prices go up, then the people again cannot consume as much, bringing the system back into balance.

They are simply two sides of the same coin. Even assuming that gold offers sterling price stability, a correcting economy would still be subject to wage contraction. Indeed, stable prices mean that the full brunt of the correction must be borne by falling wages. Note that this same logic applies to fiat currency economies; it's just that fiat currencies allow the process to be managed over time.


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