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