bradley1719
Full Member
- Oct 26, 2014
- 108
- 41
- Primary Interest:
- All Treasure Hunting
Notes:
I would ask you to read the entire post (rather than simply skimming it) before responding. If you can’t take the time to read and understand what I am truly saying then this post is not for you. If I don’t get a single response from this post due to the fact that it is long winded or hard to understand, then that is fine with me. If you want a quick idea of what this post is about without having to wade through the laborious explanation, then just skip down to the synopsis below.
Thank you for your understanding.
I am open to logical debate. I do not believe that I am 100% right. I may be completely wrong! If you can logically show me to be wrong then I welcome that. I WANT to understand how things work and I am happy to admit when my world view needs an update. But if you can’t give a logical argument then we won’t get very far.
Please do not tell me that all fiat currencies eventually fail. It simply isn’t logical. If you want to debate that point then we can do so in another thread. But suffice it to say that as long as there is at least one fiat currency being used in the world, then you can’t LOGICALLY say that “all fiat currencies have failed” or even that “all fiat currencies eventually fail”. It simply isn’t logical. It is merely an opinion (and perhaps even a correct one), but it is NOT a foregone conclusion that can be proven or even potentially relied upon. Note that I am not saying that fiat currencies have never failed or that fiat currencies are perfect. I’m just using simple logic to debunk the claim that all fiat currencies are destined to fail because of the nature of fiat currencies. If you can’t understand the simple logic of these statements then please stop reading now. This post will just confuse you.
Intro:
There are many reasons why gold standards never seem to last. Some of these reasons are well known while others are rather subtle. I am by no means an expert. But I have spent a considerable amount of time trying to understand why this always seems to happen. I intend to write up a short discussion about my beliefs about some of these reasons. This post is the first in that series.
I believe one of the primary reasons why gold standards often fail is the inherent mismatch related to wealth. This post will talk about that mismatch and why it potentially results in failures of PM backed currencies. Keep in mind that the world is not black and white. I am not saying that this is the sole reason why I believe gold standards fail. I’m just saying that I think this is often an important factor. And I think this factor is largely overlooked.
Synopsis:
Currencies are one of the ways that we store and account for wealth. Throughout history, the net wealth of the world has often increased at a very high rate. Conversely, the amount of gold in the world has stayed rather fixed (or at least has not increased at the near exponential rate that wealth has increased). This makes backing a currency with gold increasingly difficult. Essentially, it becomes impossible to represent something that is constantly increasing with something physical (like gold and silver) whose amounts are relatively constant in comparison. Eventually, a mismatch occurs. And for various reasons, this causes problems in the economy which are very hard to fix with a gold backed currency.
Conclusion: It is very difficult or even impossible to model something that is increasing with something that is fixed.
What is wealth?:
Wealth is many things. Wealth is the computer I’m typing on. Wealth is the spoon I used for breakfast. Wealth is the underground sewage pipes that my local municipality owns. Wealth can also be non-physical items like intellectual property. And… wealth is the amount of currency someone has in a bank account. But it is important when analyzing wealth to NOT get caught up thinking only about cash or your own bank account. Wealth goes far beyond that. There are many ways that we accumulate, store, and account for wealth. Using currencies is one such method but it is not the only method. However, almost all methods of accumulating, storing, and accounting for wealth (other than direct barter) will ultimately depend upon adequate currencies to facilitate at least a portion of the process.
How is wealth created?:
Wealth is created through work of many kinds. When you go to work and get a paycheck, you have created wealth for yourself (and likely your employer). When a farmer plants crops he potentially creates wealth for himself. When solar energy from the sun hits the earth, wealth can be created by utilizing that energy for electricity and plant growth.
There are also multiple reasons why people go to work. Some people are subsistence workers while others work to accumulate wealth and physical things. But regardless, a farmer who can’t increase his wealth by getting paid for an abundance of crops that he doesn’t personally need will likely not plant as many crops in the future. Likewise, a business owner who can’t accumulate wealth by selling goods and services will likely not bother to stay in business. Finally, when inventors can’t get paid for their innovations they will likely stop innovating. When farms stop planting, businesses start closing, and inventors stop innovating, then it is usually a very bad sign for your economy.
If currencies are used as a means to conduct business and represent wealth, then the economy needs an adequate supply of currency to fuel growth of the economy. A shortage of currency hampers the development of wealth which results in many economic problems. Sure, an economy can struggle along with a deficiency in currency. People may turn to bartering or may just stop buying things they don’t really need. But this cannot go on for too long before the economy and the country starts to reach a breaking point.
What is net wealth?:
Wealth is both created and lost. The difference between the amount of wealth you create vs what you spend/lose is your net wealth. Keep in mind though that even if your net wealth is negative, you can still be creating wealth for yourself (and your employer) if you have a job. For example, if you earn $1000 a week but spend $2000 a week on expenses, then you are still creating $1000 worth of wealth for yourself. Your net wealth is -$1000. But if you hadn't worked and made that $1000 then you would be even more in the hole. You are also potentially creating wealth for your boss and wealth for whoever you pay that $2000 to (the banker who services your loan, the restaurant you eat at, etc.). In the end, wealth is created and lost such that at any given time there is a net wealth equation. But if you look at history you will hopefully see that the net wealth of the world has been increasing.
How fast is wealth increasing?:
First off, net wealth can be increasing one day and decreasing the next. But overall, the net wealth of the world has been increasing at a very high rate for several hundred, if not thousands of years. A very interesting mental exercise is to think back to the earliest days of the European settlement of the United States. Take a snap shot and try to imagine how much wealth there was in the United States just before the first pilgrims got off of the boat in Plymouth Rock. At that point, all wealth in the country was owned by the Native American Indians. The average Indian may have had an axe, some furs, a spear, a teepee, and so on. The collective wealth of all of the Indians at that point was rather small. And after those first Europeans stepped off that boat, the collective wealth of the United States went up by a very small blip.
Now fast forward and think about the amount of wealth in the United States today. Again, don’t just think about bank accounts. Think of everything… the spoons and forks in your drawer; your clothes; your TV’s; every square foot of carpeting in your house; your money; your cars; your air conditioning; pens; pencils; flashlights; batteries; guitars; silver and gold; food; grass; lawnmowers; and on and on. Every square inch of your house is wealth that you have accumulated. You may not have paid for all of it yet, but chances are that you eventually will if your net wealth is positive.
But this is just you. Now think about your neighbors: their grill, grass, dog, house, car, light bulbs, clothes, and so on. Now think about your government, but not just your national government. Think about your local government too: police cars, bullets, Glocks, sidewalks, sewer systems, stop signs, street lights, street sweepers, pencils, chairs, bolts, paper, committee rooms, and on and on. Finally, think about your national government: think about every building; every aircraft carrier; every bullet; every hammer; every phone; and every soldier’s uniform. And of course, we haven’t even talked about businesses or other countries yet.
When you stop and actually consider how much wealth there is in the world today and how much it has increased in the past few hundred years, it is absolutely mind boggling! And this wealth (along with the population of the world) is almost always increasing. If the population of the world is increasing but the amount of the wealth in the world is not, then there will eventually be a very serious problem. The amount of wealth in the world continues to increase because people keep working. People keep creating. Governments keep building. Standards of living keep increasing. And so on.
The impedance mismatch:
So how do we represent something that is constantly increasing at such an alarming rate with something that is increasing at what seems to be a snail’s pace? Well… you can’t. And that is the problem. Sure, you can play tricks and mess with the price of gold to get a temporary match. But eventually, the creation of wealth far outstrips the amount of gold you have and terrible things happen.
What kinds of things happen? Your economy goes into a depression because there just isn’t enough currency around to pay employees or invest in new opportunities. Your infrastructure ages and collapses because there is no currency to pay for materials and workers. Basically, any civilization that wants to continue improving their standard of living and whose population is increasing will benefit by having a net wealth that is increasing. If the net wealth is decreasing or staying the same, then EVENTUALLY, there will be a mismatch and things will come to a halt. When the number of people in the world goes way up, and the net wealth in the world goes down, very bad things happen.
The role of gold in currencies:
There are multiple ways to use gold with currencies. One very common way is to back your currency with gold such that a “currency for gold exchange” can occur. This means that someone can potentially exchange currency for an equivalent amount of gold. Note that this does NOT mean that a government has to maintain a one to one ratio of gold in their vaults to dollars of currency. They can use an idea that is similar to that of “fractional reserve banking” where they try to figure out how much gold they should keep on hand to back the amount of gold exchange they will likely need to facilitate. If they guess incorrectly though, the result could potentially be a bank run. This has happened countless times in the past.
Another option is simply to peg the value of your currency to gold. You do not provide the ability to exchange your currency for gold. You simply declare your intention to let the value of your currency float such that it matches a certain amount of gold per dollar. Many would argue that this is not really a true “gold standard”, but frankly, that doesn’t matter as we will see next.
Either way, the same impedance mismatch will eventually occur. The problem arises when the amount of currency available is insufficient to cover the increase in wealth being experienced in a system. In the case of an exchange backed currency, the government wants to increase the amount of currency but because they would also need to increase their gold holdings to back that currency, it becomes increasingly difficult to maintain their gold standard. They simply don’t have enough gold available. And due to the costs of acquiring gold (which I’ll cover in the next post), they really don’t have too many options beyond something as drastic as confiscation (which I’ll also cover in the next post). Essentially, they are stuck. They can only increase the amount of currency in the system if they either somehow acquire more gold or reduce the gold-to-currency backing ratio. The latter will eventually fail as you cannot continue to back your currency with less and less gold for eternity.
In the case of a currency that is simply pegged to the value of gold, a government can potentially just print the additional currency they need without acquiring more gold. But at that point the gold is really just fiat. It doesn’t represent anything other than an agreement on a value of your dollar. And if people don’t agree on the value of your dollar then the gold standard is pointless and provides no benefit.
One thing that can happen when pegging your currency to gold is that the value of the currency and the value of gold diverge. When there isn’t enough currency available, the value of the currency tries to go up because it is rare (a form of deflation). But because the government has pegged the value of the currency to gold, this also means that the value of gold wants to go up too. Eventually, people will balk at this because gold is a physical thing and they won’t allow that physical thing to have a value beyond conventional beliefs. For example, if today I can buy a cow with one gold coin, that same rancher is not going to let me buy 1000 cows with one gold coin tomorrow. You can’t arbitrarily change the value of gold because it is a physical thing and people will therefore give it a perceived value that can’t fluctuate drastically. It can fluctuate by small amounts, but you can’t arbitrarily say that gold is worth 10 times as much today as it was worth yesterday. So eventually, you run into the same problem. The amount of currency isn’t sufficient to cover the growth in wealth because the perceived “value” of gold is holding it down.
The same thing happens in the other direction. If you print too much money, then the value of the currency goes down due to inflation and tries to take the value of the gold with it. But people won’t let you take the value of gold down arbitrarily because it is a physical thing with a value based on conventional beliefs. So at this point, a currency that is pegged to the value of gold is really just another fiat currency based on convention. And if that is all it is, then why get gold involved in the first place? Eventually, when the currency gets either over inflated or over deflated, the general populace will not let you arbitrarily change the value of gold to match and a serious problem occurs. Eventually, the relationship between the value of your currency and the value of gold breaks and the currency dies.
Now admittedly, it looks like pegging the value of your currency to gold gives you more wiggle room than trying to back your currency with gold that can be exchanged. And I would agree that this is probably true (for a while). But you could argue that simply pegging your currency to gold doesn’t provide much value because it just turns gold into fiat. You aren’t REALLY backing your currency with anything other than a declaration that your currency is worth a certain amount. And that usually doesn’t work for long (especially in the face of economic hardship). Finally, throughout history the majority of attempts to use a gold standard have consisted of the option to allow the exchange of currency for gold which probably explains why these attempts have always failed so miserably.
Summary:
So in the end, gold backed currencies always suffer from the problem of the physical nature of gold and the virtually unlimited nature of wealth. Eventually, the mismatch causes destructive forces in the economy such that the government can’t continue to back the currency with gold. This leads to the other common problems related to gold standards which eventually doom the attempt to back a currency with a precious metal.
It is simply not logical to try and model something that is constantly increasing with something that is relatively fixed. At some point, your model breaks.
What’s next:
In the next post I’ll talk about the downsides of “costs” and why backing your currency with a physical item that has significant costs can lead to similar problems.
If you made it this far, thanks for listening!
I would ask you to read the entire post (rather than simply skimming it) before responding. If you can’t take the time to read and understand what I am truly saying then this post is not for you. If I don’t get a single response from this post due to the fact that it is long winded or hard to understand, then that is fine with me. If you want a quick idea of what this post is about without having to wade through the laborious explanation, then just skip down to the synopsis below.
Thank you for your understanding.
I am open to logical debate. I do not believe that I am 100% right. I may be completely wrong! If you can logically show me to be wrong then I welcome that. I WANT to understand how things work and I am happy to admit when my world view needs an update. But if you can’t give a logical argument then we won’t get very far.
Please do not tell me that all fiat currencies eventually fail. It simply isn’t logical. If you want to debate that point then we can do so in another thread. But suffice it to say that as long as there is at least one fiat currency being used in the world, then you can’t LOGICALLY say that “all fiat currencies have failed” or even that “all fiat currencies eventually fail”. It simply isn’t logical. It is merely an opinion (and perhaps even a correct one), but it is NOT a foregone conclusion that can be proven or even potentially relied upon. Note that I am not saying that fiat currencies have never failed or that fiat currencies are perfect. I’m just using simple logic to debunk the claim that all fiat currencies are destined to fail because of the nature of fiat currencies. If you can’t understand the simple logic of these statements then please stop reading now. This post will just confuse you.
Intro:
There are many reasons why gold standards never seem to last. Some of these reasons are well known while others are rather subtle. I am by no means an expert. But I have spent a considerable amount of time trying to understand why this always seems to happen. I intend to write up a short discussion about my beliefs about some of these reasons. This post is the first in that series.
I believe one of the primary reasons why gold standards often fail is the inherent mismatch related to wealth. This post will talk about that mismatch and why it potentially results in failures of PM backed currencies. Keep in mind that the world is not black and white. I am not saying that this is the sole reason why I believe gold standards fail. I’m just saying that I think this is often an important factor. And I think this factor is largely overlooked.
Synopsis:
Currencies are one of the ways that we store and account for wealth. Throughout history, the net wealth of the world has often increased at a very high rate. Conversely, the amount of gold in the world has stayed rather fixed (or at least has not increased at the near exponential rate that wealth has increased). This makes backing a currency with gold increasingly difficult. Essentially, it becomes impossible to represent something that is constantly increasing with something physical (like gold and silver) whose amounts are relatively constant in comparison. Eventually, a mismatch occurs. And for various reasons, this causes problems in the economy which are very hard to fix with a gold backed currency.
Conclusion: It is very difficult or even impossible to model something that is increasing with something that is fixed.
What is wealth?:
Wealth is many things. Wealth is the computer I’m typing on. Wealth is the spoon I used for breakfast. Wealth is the underground sewage pipes that my local municipality owns. Wealth can also be non-physical items like intellectual property. And… wealth is the amount of currency someone has in a bank account. But it is important when analyzing wealth to NOT get caught up thinking only about cash or your own bank account. Wealth goes far beyond that. There are many ways that we accumulate, store, and account for wealth. Using currencies is one such method but it is not the only method. However, almost all methods of accumulating, storing, and accounting for wealth (other than direct barter) will ultimately depend upon adequate currencies to facilitate at least a portion of the process.
How is wealth created?:
Wealth is created through work of many kinds. When you go to work and get a paycheck, you have created wealth for yourself (and likely your employer). When a farmer plants crops he potentially creates wealth for himself. When solar energy from the sun hits the earth, wealth can be created by utilizing that energy for electricity and plant growth.
There are also multiple reasons why people go to work. Some people are subsistence workers while others work to accumulate wealth and physical things. But regardless, a farmer who can’t increase his wealth by getting paid for an abundance of crops that he doesn’t personally need will likely not plant as many crops in the future. Likewise, a business owner who can’t accumulate wealth by selling goods and services will likely not bother to stay in business. Finally, when inventors can’t get paid for their innovations they will likely stop innovating. When farms stop planting, businesses start closing, and inventors stop innovating, then it is usually a very bad sign for your economy.
If currencies are used as a means to conduct business and represent wealth, then the economy needs an adequate supply of currency to fuel growth of the economy. A shortage of currency hampers the development of wealth which results in many economic problems. Sure, an economy can struggle along with a deficiency in currency. People may turn to bartering or may just stop buying things they don’t really need. But this cannot go on for too long before the economy and the country starts to reach a breaking point.
What is net wealth?:
Wealth is both created and lost. The difference between the amount of wealth you create vs what you spend/lose is your net wealth. Keep in mind though that even if your net wealth is negative, you can still be creating wealth for yourself (and your employer) if you have a job. For example, if you earn $1000 a week but spend $2000 a week on expenses, then you are still creating $1000 worth of wealth for yourself. Your net wealth is -$1000. But if you hadn't worked and made that $1000 then you would be even more in the hole. You are also potentially creating wealth for your boss and wealth for whoever you pay that $2000 to (the banker who services your loan, the restaurant you eat at, etc.). In the end, wealth is created and lost such that at any given time there is a net wealth equation. But if you look at history you will hopefully see that the net wealth of the world has been increasing.
How fast is wealth increasing?:
First off, net wealth can be increasing one day and decreasing the next. But overall, the net wealth of the world has been increasing at a very high rate for several hundred, if not thousands of years. A very interesting mental exercise is to think back to the earliest days of the European settlement of the United States. Take a snap shot and try to imagine how much wealth there was in the United States just before the first pilgrims got off of the boat in Plymouth Rock. At that point, all wealth in the country was owned by the Native American Indians. The average Indian may have had an axe, some furs, a spear, a teepee, and so on. The collective wealth of all of the Indians at that point was rather small. And after those first Europeans stepped off that boat, the collective wealth of the United States went up by a very small blip.
Now fast forward and think about the amount of wealth in the United States today. Again, don’t just think about bank accounts. Think of everything… the spoons and forks in your drawer; your clothes; your TV’s; every square foot of carpeting in your house; your money; your cars; your air conditioning; pens; pencils; flashlights; batteries; guitars; silver and gold; food; grass; lawnmowers; and on and on. Every square inch of your house is wealth that you have accumulated. You may not have paid for all of it yet, but chances are that you eventually will if your net wealth is positive.
But this is just you. Now think about your neighbors: their grill, grass, dog, house, car, light bulbs, clothes, and so on. Now think about your government, but not just your national government. Think about your local government too: police cars, bullets, Glocks, sidewalks, sewer systems, stop signs, street lights, street sweepers, pencils, chairs, bolts, paper, committee rooms, and on and on. Finally, think about your national government: think about every building; every aircraft carrier; every bullet; every hammer; every phone; and every soldier’s uniform. And of course, we haven’t even talked about businesses or other countries yet.
When you stop and actually consider how much wealth there is in the world today and how much it has increased in the past few hundred years, it is absolutely mind boggling! And this wealth (along with the population of the world) is almost always increasing. If the population of the world is increasing but the amount of the wealth in the world is not, then there will eventually be a very serious problem. The amount of wealth in the world continues to increase because people keep working. People keep creating. Governments keep building. Standards of living keep increasing. And so on.
The impedance mismatch:
So how do we represent something that is constantly increasing at such an alarming rate with something that is increasing at what seems to be a snail’s pace? Well… you can’t. And that is the problem. Sure, you can play tricks and mess with the price of gold to get a temporary match. But eventually, the creation of wealth far outstrips the amount of gold you have and terrible things happen.
What kinds of things happen? Your economy goes into a depression because there just isn’t enough currency around to pay employees or invest in new opportunities. Your infrastructure ages and collapses because there is no currency to pay for materials and workers. Basically, any civilization that wants to continue improving their standard of living and whose population is increasing will benefit by having a net wealth that is increasing. If the net wealth is decreasing or staying the same, then EVENTUALLY, there will be a mismatch and things will come to a halt. When the number of people in the world goes way up, and the net wealth in the world goes down, very bad things happen.
The role of gold in currencies:
There are multiple ways to use gold with currencies. One very common way is to back your currency with gold such that a “currency for gold exchange” can occur. This means that someone can potentially exchange currency for an equivalent amount of gold. Note that this does NOT mean that a government has to maintain a one to one ratio of gold in their vaults to dollars of currency. They can use an idea that is similar to that of “fractional reserve banking” where they try to figure out how much gold they should keep on hand to back the amount of gold exchange they will likely need to facilitate. If they guess incorrectly though, the result could potentially be a bank run. This has happened countless times in the past.
Another option is simply to peg the value of your currency to gold. You do not provide the ability to exchange your currency for gold. You simply declare your intention to let the value of your currency float such that it matches a certain amount of gold per dollar. Many would argue that this is not really a true “gold standard”, but frankly, that doesn’t matter as we will see next.
Either way, the same impedance mismatch will eventually occur. The problem arises when the amount of currency available is insufficient to cover the increase in wealth being experienced in a system. In the case of an exchange backed currency, the government wants to increase the amount of currency but because they would also need to increase their gold holdings to back that currency, it becomes increasingly difficult to maintain their gold standard. They simply don’t have enough gold available. And due to the costs of acquiring gold (which I’ll cover in the next post), they really don’t have too many options beyond something as drastic as confiscation (which I’ll also cover in the next post). Essentially, they are stuck. They can only increase the amount of currency in the system if they either somehow acquire more gold or reduce the gold-to-currency backing ratio. The latter will eventually fail as you cannot continue to back your currency with less and less gold for eternity.
In the case of a currency that is simply pegged to the value of gold, a government can potentially just print the additional currency they need without acquiring more gold. But at that point the gold is really just fiat. It doesn’t represent anything other than an agreement on a value of your dollar. And if people don’t agree on the value of your dollar then the gold standard is pointless and provides no benefit.
One thing that can happen when pegging your currency to gold is that the value of the currency and the value of gold diverge. When there isn’t enough currency available, the value of the currency tries to go up because it is rare (a form of deflation). But because the government has pegged the value of the currency to gold, this also means that the value of gold wants to go up too. Eventually, people will balk at this because gold is a physical thing and they won’t allow that physical thing to have a value beyond conventional beliefs. For example, if today I can buy a cow with one gold coin, that same rancher is not going to let me buy 1000 cows with one gold coin tomorrow. You can’t arbitrarily change the value of gold because it is a physical thing and people will therefore give it a perceived value that can’t fluctuate drastically. It can fluctuate by small amounts, but you can’t arbitrarily say that gold is worth 10 times as much today as it was worth yesterday. So eventually, you run into the same problem. The amount of currency isn’t sufficient to cover the growth in wealth because the perceived “value” of gold is holding it down.
The same thing happens in the other direction. If you print too much money, then the value of the currency goes down due to inflation and tries to take the value of the gold with it. But people won’t let you take the value of gold down arbitrarily because it is a physical thing with a value based on conventional beliefs. So at this point, a currency that is pegged to the value of gold is really just another fiat currency based on convention. And if that is all it is, then why get gold involved in the first place? Eventually, when the currency gets either over inflated or over deflated, the general populace will not let you arbitrarily change the value of gold to match and a serious problem occurs. Eventually, the relationship between the value of your currency and the value of gold breaks and the currency dies.
Now admittedly, it looks like pegging the value of your currency to gold gives you more wiggle room than trying to back your currency with gold that can be exchanged. And I would agree that this is probably true (for a while). But you could argue that simply pegging your currency to gold doesn’t provide much value because it just turns gold into fiat. You aren’t REALLY backing your currency with anything other than a declaration that your currency is worth a certain amount. And that usually doesn’t work for long (especially in the face of economic hardship). Finally, throughout history the majority of attempts to use a gold standard have consisted of the option to allow the exchange of currency for gold which probably explains why these attempts have always failed so miserably.
Summary:
So in the end, gold backed currencies always suffer from the problem of the physical nature of gold and the virtually unlimited nature of wealth. Eventually, the mismatch causes destructive forces in the economy such that the government can’t continue to back the currency with gold. This leads to the other common problems related to gold standards which eventually doom the attempt to back a currency with a precious metal.
It is simply not logical to try and model something that is constantly increasing with something that is relatively fixed. At some point, your model breaks.
What’s next:
In the next post I’ll talk about the downsides of “costs” and why backing your currency with a physical item that has significant costs can lead to similar problems.
If you made it this far, thanks for listening!
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