Practical analysis for investment professionals
12 February 2013

Reframing the Gold Standard Debate: The Fixed-Money-Supply Standard

Posted In: Economics, Philosophy

A debate between those advocating for a fiat money supply and those advocating for a gold standard has been raging for nearly a century. It’s time to reframe this debate in order to highlight some of the intrinsic properties of gold that are germane to this polemic and to inform the discussion of using gold as the philosophical basis for intelligent and prudent monetary policy.

This much is clear: Each side in this debate seems to enjoy insulting the intelligence and wisdom of the other. Consider, for example, the point of view of H. Parker Willis, the first secretary of the Federal Reserve Board:

“Central banks will do wisely to lay aside their inexpert ventures in half-baked monetary theory, meretricious statistical measures of trade, and hasty grinding of the axes of speculative interests with their suggestion that by doing so they are achieving some sort of vague ‘stabilization’ that will, in the long run, be for the greater good.”

On the other side, a frequent dismissal of advocates for a gold standard is that there is no difference between wampum, large rocks, and gold. Yet this statement is a false equivalency. By making a comparison of gold to something that most do not take seriously — wampum or large rocks — critics intend to evoke images of presumably primitive cultures and their presumed naïve beliefs about economics, thus simultaneously dismissing the views of gold standard advocates.

At best, evocation of this kind creates a contextual pit that is difficult for “gold bugs” to climb out of as they try to defend a position made to look foolish from the outset. But far worse is that gold bugs often respond with passionate hue and cry for their precious metal without ever speaking of the intrinsic philosophical value of their point of view.

Despite what is frequently argued, the genius of the gold standard is not that it is based on something of “real” value; as “real” is simply a layman’s way of saying that there is a demand curve for the good. Wampum also had a demand curve at one point. No, the genius of the gold standard is that it implies an important rule:

No money shall exist in excess of the money stock.

Put another way, it implies a fixed denominator in the measure of economic growth and of money supply. The importance of this concept is already accepted. This is why we “inflation adjust” economic growth in recognition that the denominator is plastic. Left unadjusted, our measurement of the true state of the economy is distorted. Just as it is when monetary officials are allowed to create money supply virtually and then the money is made more momentous by the multiplier effect.

So a “fixed money supply” law could substitute for a “gold standard.” Of course it seems to be human nature to incline toward excess. That is, do people truly have the fortitude and discipline to stick to a fixed-money-supply/print-no-money law? Or would another round of over leveraged banks or overleveraged investors in another, unfortunately, all too foreseeable future, beg a monetary authority for inflationary tonic to cure them of debt excesses?

It is all too easy to wave the fiat money hand or pull the fiat money lever until months later measures of inflation register a positive second moment. By comparison, the stock of gold is nearly fixed, limited in expansion by its scarcity and difficulty of extraction. Essentially, gold’s scarcity and difficulty of extraction serves as an artificial law or barrier to the dilution of the intent of a fixed-money-supply law: print no money.

If both sides could look past gold and instead debate what qualities a future monetary framework should entail, they might discover that among the important criteria to be met by a fixed-money-supply standard are:

  • A good that has a nearly universal demand curve
  • A good that has a practically fixed supply

Though I discussed the second criterion above, the first criterion is also important. Why? Because without a nearly universal demand for the good, people will be inclined to switch to another good when convenient. So a nation that wanted to inflate its way out of debt problems would make another good the basis for their fixed money supply regimen. Think: The Chinese declaring the Great Wall as their currency or the United States declaring the Statue of Liberty as the basis of its money supply going forward. Both are large and in fixed supply, however those in Madagascar could give a damn. For a good to be considered viable, its demand curve must be nearly universal.

Because gold meets both of the above criteria, it just so happens to make for a natural candidate to be the central focus of a fixed-money-supply regimen. Alternatives, including wampum in its time and place, have met the two criteria above. Currently, carbon credits meet these criteria, too and, in fact, they have served as a viable way of managing another profligate good: pollution.

Gold bugs are usually forced to defend the intrinsic value of gold as a substance, which just looks silly to those who do not hold their point of view. That makes bugs vulnerable to being dismissed by critics. I argue then that the gold standard debate needs to be lifted from the “gold standard” to its actual implicit core: the fixed-money-supply standard.

 


Please note that the content of this site should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute.

Photo credit: ©iStockphoto.com/mgfoto

About the Author(s)
Jason Voss, CFA

Jason Voss, CFA, tirelessly focuses on improving the ability of investors to better serve end clients. He is the author of the Foreword Reviews Business Book of the Year Finalist, The Intuitive Investor. Previously, Jason was a portfolio manager at Davis Selected Advisers, L.P., where he co-managed the Davis Appreciation and Income Fund to noteworthy returns. He holds a BA in economics and an MBA in finance and accounting from the University of Colorado.

Ethics Statement

My statement of ethics is very simple, really: I treat others as I would like to be treated. In my opinion, all systems of ethics distill to this simple statement. If you believe I have deviated from this standard, I would love to hear from you: jason@jasonapollovoss.com

16 thoughts on “Reframing the Gold Standard Debate: The Fixed-Money-Supply Standard”

  1. Saeed says:

    Nice thought, fixed money supply standard.
    It seems very difficult or near to impossible that global powers will agree upon on such a system, which you have suggested, in near future. I just want to know your opinion, that how long this current monetary system will last? When do you forsee a collapse or a real need of an alternate more fair global monetary system? Five years from now or ten years? Thanks.

  2. James G. Stoner Holk, CFA, CFP says:

    I think you make a good point in regard to bad rhetoric against gold. The “fixed money supply” framework situates the real issue much better than arguing about intrinsic value. The real issue, I believe, is whether or not what we use for money should be a store of value (as well as means of exchange and unit of account). This seems to be the key divide between “sound money” types and those who advocate for fiat money.

  3. mari says:

    Fixing = creating unbalance, to transfer wealth.

    This debate has been made already +40 years ago in Europe. Distilled out of these discussions a new animal was born.
    The “Euro freegold concept” a split between the medium of exchange and the store of value functions. Just have a look at the ECB balance and you will see how it works ! Spending in Fiat and saving in Physical Gold.
    http://www.flickr.com/photos/70983337@N06/8054909622/in/photostream/lightbox/

  4. Utpal Choudhury says:

    You have given a fresh perspective. And I prefer a fixed-money-supply standard, but cannot find a logic to keep gold against it.

    Secondly, if any nation prints money, then, logically the intrinsic as well as market value of currency should go down immediately in proportion to the access money printed. But that never happens. The argument given by pundits doesn’t sum up to a logical answer. And that encourages powerful economies printing money. If the market behaves rationally, as I understand, there is no need to have a fixed-money-supply standard.

  5. Hell Jason,

    Firstly, this is a very good article (as always) and I enjoyed reading it. This debate is much like the old question – do you see the glass as half full or half empty? Beneath the surface of this century old debate is a much important idea – how you intend to use that water.

    If we are looking at perennial long term inflation adjusted growth (which in itself is unrealistic), both the systems are ‘forced’ to conform/adjust to demand and the naturally limited supply side of resources. However, fiat currency creates a lot more mess when it ‘corrects’ itself if there is excess leverage and money supply. The question we need to ask is: which system is conducive to adjustment as a means of exchange in a way that curbs financial mess? However, it’s ironic to seek this system (whether it’s fiat money or gold) while you still harbour other demand/supply distortions such as subsidies, lobbies, tax codes, policies etc., if at all the intention is to put a lid on the mess we may create in future. The concept of fiat money looks appealing if we are looking at everlasting growth, which is why it’s here. Also, I agree it’s hard (or random?) to assign an intrinsic value to gold. We still need a system that promotes laissez-faire market so we have a balanced demand and an incentive to seek alternatives much before bubbles are created. I think we still need to arrive at the real reason of this debate.

    Regards,

    Jimmy

  6. Hello Jason,

    Sorry about the typo in the first comment.

    Firstly, this is a very good article (as always) and I enjoyed reading it. This debate is like the old question – do you see the glass as half full or half empty? Beneath the surface of this century old debate is a much important idea – how we intend to use that water.

    If we are looking at perennial long term inflation adjusted growth (which in itself is unrealistic), both the systems are ‘forced’ to conform/adjust to demand and the naturally limited supply side of resources. However, fiat currency creates a lot more mess when it ‘corrects’ itself if there is excess leverage and money supply. The question we need to ask is: which system is conducive to adjustment as a means of exchange in a way that curbs financial mess? However, it’s ironic to seek this system (whether it’s fiat money or gold) while you still harbour other demand/supply distortions such as subsidies, lobbies, tax codes, policies etc., if at all the intention is to put a lid on the mess we may create in future. The concept of fiat money looks appealing if we are looking at everlasting growth, which is why it’s here. Also, I agree it’s hard (or random?) to assign an intrinsic value to gold. We still need a system that promotes laissez-faire market so we have a balanced demand and an incentive to seek alternatives much before bubbles are created. I think we still need to arrive at the real reason of this debate.

    Regards,

    Jimmy

  7. Honestly, Jason, you’ll find that in pretty much any debate the debaters love insulting each other. Its just…what, human nature, I guess? Just a fact of life.

  8. Hello all of you that have commented,

    Thank you for your comments – they are as always, insightful.

    Above, Utpal Choudhury wrote, “If the market behaves rationally, as I understand, there is no need to have a fixed-money-supply standard.” In response I would write…

    For the market to be able to re-price a currency it relies upon several important things: liquidity, and more importantly, a currency that is not being distorted by a monetary authority. On the first issue, liquidity, there are very few truly global currencies: US dollar, Euro, Yen, and to a lesser extent the yuan/renminbi. It is not a small matter to re-denominate all of your assets in a preferred currency. Further, look at those four ‘reserve-type’ currencies and in all four cases there is massive monetary stimulus in those economies. So the ‘rational’ market folks who would re-price a currency can only do so on a relative basis. There is no ability to re-price a currency on an absolute basis…and that is the problem which is why folks advocate for a gold standard.

    I am not necessarily advocating for a gold standard so much as I am advocating that the discussion actually focus on actual merits and not on the ‘intrinsic value’ debate which is, in my opinion, the wrong argument to have.

    With smiles to all!

    Jason

  9. Roger Lindsley says:

    I guess I don’t understand how this would work. If you make an option on a short sell you have to borrow the equity, it seems like the same would be an issue with the money itself in lending, it would be an end to fractional reserve lending. As a bank you no longer could hold a reserve say 10 to 1, you would be “creating” money- as is done now. A CB could “lend” cash options to cover a bank’s lending? So this would require the CB to hold cash in reserve all the time to cover lending, reducing the amount of money in circulation by an amount equal to credit. You also have problems when you trade securities, an MBS for example represents cash equivalent and the value changes. If it goes to zero is that amount credited back to the CB?

    It seems that the finance market would leverage the entire money supply through credit transactions, it being so much larger than the rest of the economy. People would in fact have incentives to both sequester money into credit agreements and take deflationary positions. It seems to be a very instinctive and simple form of arbitrage.

    What if you secured currency (not all, but a private electronic currency) with commodities and other forms of value. Your personal account would fluctuate in standard currency value based on the underlying assets, you would trade actual ownership like an ETF, with a fee for transacting out of the system. It would be a little floating basket that represented a liquid exchange outside of the fx world.

    1. Hi Roger,

      Very enjoyable commentary on the idea, especially about fractional reserve banking. Here the asset securing the increase in money supply would be the security on whatever loans/investments the banks made. I think the point of the gold standard/fixed money supply folks is to eliminate the creation of money supply as secured by nothing more than monetary authority’s personal policy preferences and to have it rooted in actual preferences about real capital (i.e. K, if you are a Marxist).

      With smiles,

      Jason

      1. Roger Lindsley says:

        This discounts services and prefers commodities. How could an economy expand beyond physical capital values?

        What is the creditworthy value of financial services? How do you secure a loan based on services that have yet to be performed?

        And in a commodity preference world you have arbitrage by possession and or ownership, is there a commodity futures market allowed in these schemes? It seems to be easier to game real capital markets if you greatly discount the less tangible service sector.

        Paralleling this discussion is the Skidelsky “Rise of the Robots” discounting of human labor through technology discussion. A fixed monetary based secured by real capital would accelerate wealth concentration because a primary and growing means to income for the masses is service related employment.

        1. Hi Roger,

          To your last points about real capital…I can see by saying ‘K – if you are a Marxist that you took that literally. Fully acknowledged: services are backed up by something demonstrably quantifiable. Namely, human labor or ideas and innovation by that same human labor.

          The idea is that money describes a real value and not a chimera, that is the essence of a gold standard. Just as a balance sheet relies upon the real value of an asset as opposed to the management simply inventing cash flow by changing the value to suit its purposes. This latter example is analogous to quantitative easing.

          The point I am trying to make is that for numbers to be valued they have to relate to something other than monetary legerdemain. Unfortunately, the gold bugs get tripped up when forced to defend the intrinsic value of gold. Yet, that is not the essence of their argument.

          Jason

  10. KAMAL KHAN says:

    It has been proven that the world’s current system has Failed and that is why everyone is Calling for the Gold Standard being Re-Introduced. It has also been Observed that The Gold Standard has been Very costly and in-efficient so now what ? . There was a Good system or thinking about the SDR’s but that system has not been updated for 5 decades. Thus everything is STALE and out of current norms.. The Countries Like America and UK especially at this point of Time have defaulted (Because they are not able to meet their Expenses from Their Revenues and Top Cover that They Keep Raising The Debt Ceiling and Changing laws).. The effect would be disastrous as we all will see in future. but Coming Back to the Point of Standards. Whatever the pros and cons for Both One has to realise That Both These standards were NOT Followed. I personally would follow the GOLD Standard as whatever is backing the Currency can be seen/felt and should be there .. others are just bookish figures which can be changed easily..

  11. Hi Kamal,

    Thanks for sharing your point of view with the audience.

    With smiles,

    Jason

  12. Scott says:

    Bitcoin – the very defition of a fixed money supply 🙂

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