Sep 14th 2011, 16:12 by Buttonwood
THREE thoughts on gold and paper money came into my in-box today, all from French banks (which might have cause to be reflective at the moment).
The first was from BNP Paribas which pointed out that an ounce of gold is about the size of a £2 coin. And we all used to use precious metals for our more valuable coinage like a sovereign or a guinea. But of course an ounce of gold is worth $1826 at the moment or around £1100, an indication of how paper money has declined in value. It also means we are never going back to the traditional gold standard, since there wouldn't be enough gold to go round.
However, it is technically possible to revert to some kind of gold exchange standard, akin to Bretton Woods, in which the dollar was convertible at a set rate. (It is not very likely but it is possible to imagine that). So the second thought comes from Dylan Grice of Societe Generale; at what gold price would the Federal Reserve's liabilities be backed by US gold reserves? When he last did this calculation, the answer was around $6,000 an ounce; now it's $10,000.
Thought three is also from Dylan Grice and it's about QE. Since the option is being contemplated again, it is worth quoting him in full as his thoughts explain my worries.
So let me explain why I believe printing money to be a fundamentally dishonest endeavour. Think about how it works. When the central bank, at zero cost, increases the monetary base by 1%, where does that money go? Answer; into the market for government bonds. Since printing the money to buy government bonds costs nothing, government revenues are obtained ostensibly for free. Of course, it buys those bonds in the secondary market rather than from the government directly, and the pretense of an arm's length transaction between government and central bank is thus maintained, with all parties claiming a separation of monetary and fiscal policy. But it's only a pretence.
By issuing bonds to itself, the government seems to have miraculously raised revenue without burdening anyone else. This is probably why the mechanism is universally adopted throughout the world's financial system. Yet free money does not, and cannot, exist. Since there can be no such thing as a government, or anyone else for that matter, raising revenue at no cost, simple logic tells us that someone, somewhere has to pay.
But who? This is where the subtle dishonesty resides, because the answer is that no-one knows. If the money printing creates inflation in the product market, consumers in that product market will pay. If the money printing creates inflation in asset markets, the purchase of the more elevated asset price pays. Of course, if the printed money ends up in asset markets even less is known about who ultimately pays for the government's free lunch. Thus the government has raised revenues without even knowing upon whom the burden falls, let alone telling them.
The Economist welcomes your views. Please stay on topic and be respectful of other readers. Review our comments policy.
You must be logged in to post a comment. Log in to your account.Don't have an account? Register
Sort:
Velocity ? Sterilization ? Back to money as barter ?
Or, to continue to expound on Mr. Grice's point, the money's simply taken from the hordes of cash in business' and consumers' bank accounts. With the M2 multiplier more than halved since the start of the recession, bank lending falling, confidence low and saving skyrocketing it makes perfect sense for some of this excess cash to be "taxed" by government borrowing and spending. In effect, the government and monetary authority are forcing idle savings into productive uses (say, infrastructure).
I suspect that hard-money types like Mr. Grice are upset at the coercive nature of this transfer. But if all actors in the economy are constrained into a negative feedback loop of low confidence, low spending, low employment and high savings then it seems perfectly jusitifed for government and central banks to step in.
It's simply, as Keynes pointed out, saving capitalism from itself.
With globalized financial markets, the burden falls on foreign investors in the money creating country's debt instruments, since the currency will be devalued. And those foreign investors don't vote for legislators, so are irrelevant. Unless you are Greece and those foreign investors now want 25% p.a. to rollover the debt. Whoops - maybe they can vote.
I think the who pays can be a pretty plastic thing and it isn't clear that it's all cost. If I give up some idle labor to earn some money that was generated after the central bank bought a bond that paid for unemployment insurance I no longer need, then we can say wealth was created by QE. My concern is that the virtuous cycle we can hope for is probably only part of the result with the first loosening and less and less important as easing continues.
I think the process is honest precisely because we don't really know the cost or who pays it. But it's dishonest to pretend that we know what will happen.
I believe we have been here before.
May 30th, 1932 http://www.time.com/time/magazine/article/0,9171,769582-1,00.html
An interesting 6 page read. Regards
1. Gold is not money. It's a store of value, one which is convertible to essentially all currencies, a fact that makes it highly attractive when relative values fluctuate. To say that paper money has declined in value is silly because that assumes gold is the same as paper money. 2. The idea of a gold standard doesn't require that gold actually be in vaults to back currency. Give the gold backers at least that credit. 3. The only thing in the long quote I want to pick at is the wording about dishonesty. It's not dishonest to do what you think works - and which history says works. We do lots of things in pretty much every area of life without knowing exactly why it works. Heck, we don't even know what gravity is and it works. We manipulate numbers and we don't know where the constants come from or even why base 10 works. Money is in some ways mysterious but that doesn't mean it's "dishonest" to do things with it as a government. Might as well then say we can't have wheels because the reason why Pi is 3.14 is absolutely unknown so it would be dishonest to roll things around.
Buttonwood, you and Mr Grice are missing a key point. Consider what fiat money, backed by no gold standard or collateral of any kind, really means. Fiat money has no intrinsic value whatsoever; a dollar is worth a dollar only because we all agree to accept that dollar in exchange for a certain amount of goods and services. Thus, as long as we all consent to it, government can print as many dollars as it wants to.
This isn't as crazy as it sounds; all money is in effect a unit of exchange in a complex barter system. Its all relative to supply and demand and perceptions.
This doesn't work very well for Zimbabwe, because the world will not consent to it. Indeed if any one country tries this unilaterally it invites inflation. The US is unique because its currency and debt is so integral to the system that everyone is willing to accept it. Even so there are some who don't buy into it which is why they are buying gold and tormenting the Swiss.
I predict fiat money will triumph over gold. No-one wants to go back to gold or to bartering turnips for sheep. Though I am curious; how many turnips would Facebook be worth?
Printing is a tax levied by banks. However, not all of it goes to the public sector, as much of the tax is siphoned off by the financial sector as their "fee" for mediating the transaction. When the central bank prints to subsidize unlimited loans at ZIRP to hedge funds, the bank is taxing anyone who buys things (including the public sector), and redistributing the purchasing power to hedge funds. Hedge fund managers and their clients can now buy more, and the non financial sector can now buy less. In this transaction, the bank is taxing government, and loaning out the goods to hedge funds.
In effect, the bank taxes goods/services away from voters, and loans out the confiscated goods. Unfortunately, printing credit (debt) this way is ultimately counter productive for nations. When printing credit (debt) drives the debt to GDP ratio over 90%, the economy slows. The non financial sector experiences a gradually declining standard of living over time, especially fixed income retirees. Capital is also misallocated due to price distortion, which lowers the rate of productivity improvement. Printing is a very bad way to raise funds, as John Maynard Keynes put it:
"There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose."
Printing engages all the hidden forces of economic law on the side of destruction. Recent events are a textbook example of this.
debasing is stealing from thr virtuous who saved, if you are a good politician you will buy influence with it- there is no difference between rewarding the teachers union (obama) or giving (well, to be exact, mainly german money, to greece (sarkozy)), beware of the wrath of the population, they might discover the truth. we tend to get the governments we deserve- the only problem is the state media, unfortunately today a state can allways threaten with new regulations and get a compliant media.
And of course every time you effectively bail out a Greek bond holder at the implicit expense of someone who chose not to make an unsustainable investment in the Greek economy. Or when you keep interest rates at an all time low to protect the balance sheets of banks over invested in over priced property and thereby prop up the balance sheets of leveraged buy to let speculators at the expense of first time buyers and those who did not leverage. Or when you raise the debt ceiling without meaningful cuts or taxes in order to pay for vast Medicaid entitlements that would be the dream of an equally deserving Chinese man who is helping to finance them, well then you inch increasingly further away from a reality that must at some point and inevitably will reassert itself - that's why Gold, as well as the supply side restriction too of course!
And let us not forget that government expenditures, funded as described above, are included in GDP...and the band played on.
I don't know if I necessarily buy the argument that currency with no backing is inherently dangerous. It depends on the circumstances of course, but there are deep flaws in the gold standard as well, mainly the fact that countries scramble for gold reserves and that the standard can constrain growth. This may be the goal of it, but from what I have seen it makes prices of goods and services extremely volatile and more open to speculative attacks.
But, free floating regimes also have their issues obviously. It's really a choice between excepting trade offs when debating the merits of all systems and which ones people will accept.
Plus, the introduction of computer trading and high leverage in currency markets surely doesn't help either, but how do you control money that has no boundaries, that can move across the world with a click of the mouse? A gold standard would only work if all countries use it properly--and that is the true challenge in it's implementation.
In this blog, our Buttonwood columnist grapples with the ever-changing financial markets and the motley crew who earn their living by attempting to master them. The blog is named after the 1792 agreement that regulated the informal brokerage conducted under a buttonwood tree on Wall Street.
Advertisement
Read comments on the site's most popular topics
Over the past five days
Over the past seven days
Advertisement
Subscribe to The Economist's free e-mail newsletters and alerts.
Subscribe to The Economist's latest article postings on Twitter
See a selection of The Economist's articles, events, topical videos and debates on Facebook.
Advertisement
Read Full Article »