I'm sure this question has already been debated to death around here, but I used the search option and couldn't find a thread on this particular question, so I'll start a new one.
Could an influx of new gold cause a business cycle under a 100% gold coin standard?My understanding of ABCT is that when there is an expansion in circulation credit, it makes it seem to investors as though there are more saved funds available for investment than there actually are (effectively, more consumer demand for longer processes of production). Investors then overinvest in longer processes of production, when in reality there is not enough demand (resources saved up) to make these investments profitable. Once the new money trickles down and spreads out across the entire economy, people reassert their correct savings-consumption ratio, the malinvestments are exposed as unprofitable, and the economy adjusts.
Now, if an economy were under a 100% gold coin standard, gold miners happened upon a large amount of gold in a cave, minted it into coins and put the coins into circulation, wouldn't this increase in the money supply also make it seem to investors as though real savings (demand for longer processes of production) had increased, causing them to overinvest in processes requiring more savings? And, once that new gold money spreads itself across the entire economy and consumers reassert their correct consumption-savings ratio, wouldn't these overinvestments be exposed as unprofitable and cause a recession?
AustrianAntitheist:So, then, is the Austrian case for gold merely an empirical one? Namely, that experience has shown us that gold money is far harder to mine, and therefore the supply of gold money is far more difficult to increase in large quantities, and therefore only causes minor (perhaps, almost unnoticeable), relatively contained booms and busts?
Google "price specie flow mechanism"
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Esuric: AustrianAntitheist:So, then, is the Austrian case for gold merely an empirical one? Namely, that experience has shown us that gold money is far harder to mine, and therefore the supply of gold money is far more difficult to increase in large quantities, and therefore only causes minor (perhaps, almost unnoticeable), relatively contained booms and busts? Google "price specie flow mechanism"
Well, my question really didn't have to do with international balances of trade, or gold flowing from one country to another, but rather the amount of gold in one country increasing (without decreases in the amount of gold in other countries) due to gold mining. My question was, wouldn't a large gold find increase the money supply in a country, fool investors into thinking market participants' time preferences had lowered (and hence, that effective demand for longer processes of production had increased, when in fact, it hadn't), and cause overinvestment in longer processes of production that resulted in a bust, once the new money spread out over the entire economy and the correct time preference rate was reasserted, exposing these overinvestments as unprofitable.
However, I think a previous poster might have answered my question, since, without a fractional reserve banking system, the new gold discovery would not be lent out and pyramided upon by banks, and hence would not affect interest rates on bank loans, and hence would not fool investors into thinking market participants' time preference rate had actually lowered. At least, that's the way I think I understand it now.
What it comes down to is the difference between the natural interest rate and the market interest rate.
Caley McKibbin: What it comes down to is the difference between the natural interest rate and the market interest rate.
Could you elaborate a little on this, for me?
AustrianAntitheist:Well, my question really didn't have to do with international balances of trade, or gold flowing from one country to another, but rather the amount of gold in one country increasing (without decreases in the amount of gold in other countries) due to gold mining.
I understand your question. The answer is that new discoveries of gold would indeed set off an inflationary boom and then the eventual bust. But the inflation wouldn't be as severe since gold serves two functions under a gold standard (industrial use and monetary use). As inflation increases, and as the value of gold falls, the demand for gold for industrial purposes increases, having a stabilizing effect. Furthermore, I mentioned the price specie flow mechanism because it is the main reason why Austrians support a gold standard. When one nation inflates, under a gold standard, it is hit with a deflationary shock, and elevates the market rate back towards the natural rate. There are self-correcting forces restoring equilibrium. Our international monetary system has no self-correcting market mechanisms and must inevitably lead to perpetual inflation.
Smiling Dave:I refered to Spain after the discovery of America in an the previous post, and cited the wiki.
Spain had a long period of inflation due to the influx of American gold and silver. But the thing that really killed the Spanish Empire was taxation. The English who went to fight in Spain in the 1930's couldn't believe how backward and primitive once mighty Spain was.
chloe732:Why wouldn't your scenario (a large and sudden increase in gold, no fractional reserve banking, no central bank) simply cause prices to rise? Why would a long term project that was not profitable prior to the gold injection, now appear to be profitable? If the gold is borrowed from a 100% reserve bank, the interest rate would reflect the time preference of the depositors (ie, long term deposits; since demand deposits are not loaned out). On the other hand, if the gold is from investors, then again, why would they suddenly choose long term projects that weren't profitable before, and across all industries, simultaneously? It could be that the investors see higher prices, and are motivated toward the project, but wouldn't they also be able to forecast the higher costs of production too since prices are rising? The project could fail, and the injection of gold would disrupt the economy, but what would cause the simultaneous cluster of errors of investment in long term projects across all industries? Without fractional reserve banking and / or a central bank, would time preference change simply because there is more gold? Prices would rise, yes, but would time preference necessarily fall?
It could be that the investors see higher prices, and are motivated toward the project, but wouldn't they also be able to forecast the higher costs of production too since prices are rising? The project could fail, and the injection of gold would disrupt the economy, but what would cause the simultaneous cluster of errors of investment in long term projects across all industries? Without fractional reserve banking and / or a central bank, would time preference change simply because there is more gold? Prices would rise, yes, but would time preference necessarily fall?
Esuric: Could I get your opinion on my comment, above? I read your comment about international gold flows, to paraphrase: In the OP's scenario, monetary inflation would result from finding a large quantity of gold. Prices would rise, foreign goods would become more affordable, imports would increase, gold would flow out of the local economy. Also, industrial use would increase since gold is more plentiful. These effects would tend to bring prices back down. But, would time preference be affected by any of this?
"The market is a process." - Ludwig von Mises, as related by Israel Kirzner. "Capital formation is a beautiful thing" - Chloe732.
AustrianAntitheist:Could an influx of new gold cause a business cycle under a 100% gold coin standard?
At the micro level--and by this I mean in the area local to the mine where the gold was found--it is possible to create a boom-bust cycle of some sort, but gold is both labor and time intensive to produce. The news of the find would probably spread more quickly than the actual gold itself, so investors would be aware of the find and its effects on price levels. Also, the amount of gold that would be required to disrupt investment and/or the prices of goods and services would not appear instantaneously (except possibly locally), so the effects of the find would be dampened further--you would need thousands of tons of gold to affect national price levels.
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The short answer is no. The long answer is as follows:
Any influx of new money will initially create some distortions in relative prices, so in theory, an influx of a large quantity of new money can give rise to bubbles, however, such bubbles are likely to be intratemporal in nature. ABCT is not a theory of intratemporal distortions, or a theory of just any bubbles.
ABCT is a theory of intertemporal distortion in the structure of production caused by a mismatch between the amount of loanable funds made available by the banking system and the amount of real savings. At the heart of the problem is the practice of maturity mismatching. Banks issue short term liabilities in order to invest in long term assets. Zero-term liabilities in the case of demand deposits.
The influx of new gold can be used in one of only three ways:
1. The additional new gold would be spent on consumers goods.
2. The new gold would be saved by holding it (hoarding)
3. The new gold would be saved by making it available for investment.
Under a true gold standard, banks would not be able to inflate on top of any influx of new gold that may make its way into the banking system. The gold would be either held as demand deposits or made available to the bank for investment as time deposits. The crucial point to understand is that under no circumstances, can there arise a maturity mismatch under a true 100% gold standard. There can be no Austrian business cycle.
AustrianAntitheist:My understanding of ABCT is that when there is an expansion in circulation credit, it makes it seem to investors as though there are more saved funds available for investment than there actually are (effectively, more consumer demand for longer processes of production). Investors then overinvest in longer processes of production, when in reality there is not enough demand (resources saved up) to make these investments profitable. Once the new money trickles down and spreads out across the entire economy, people reassert their correct savings-consumption ratio, the malinvestments are exposed as unprofitable, and the economy adjusts.
Your understanding is correct.
AustrianAntitheist:Now, if an economy were under a 100% gold coin standard, gold miners happened upon a large amount of gold in a cave, minted it into coins and put the coins into circulation, wouldn't this increase in the money supply also make it seem to investors as though real savings (demand for longer processes of production) had increased, causing them to overinvest in processes requiring more savings? And, once that new gold money spreads itself across the entire economy and consumers reassert their correct consumption-savings ratio, wouldn't these overinvestments be exposed as unprofitable and cause a recession?
1. Who is to say that the newly minted gold money would go into credit markets? Consider this: The gold miner extracts the gold. The gold miner then sells a portion of that gold to a money-minter. The money minter pays the gold miner some newly-minted gold coins in exchange for the raw gold. The minter then mints new coins with the raw gold, and proceeds to spend/save it at their discretion. So yes, there would be some distortions along the way, but nothing serious enough to cause a full-blown business cycle the way we normally perceive it.
2. How much money do you think would be minted a year? Remember, in a free market, private money producers would compete among each other in providing alternative currencies. So there might be a "gold standard," when in reality there could be three or four different "gold standards" competing with each other, each separate standard bearing the stamp of its mint. And since every minter would want to attract as many customers as possible while still making a profit, they would have to keep inflation under control. I would venture so far as to say that minters would very rarely expand the money supply at all, since people would want to use a naturally appreciating currency.
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chloe732: But, would time preference be affected by any of this?
Maybe, maybe not. If it does change, it will be in the positive direction; but even if it doesn't change, there will still be an inflationary boom, that is, inter-temporal disequilibria (market rate below natural rate). The deflationary shock/correction after the initial boom will adjust prices, and restore equilibrium. But the deflationary correction may go too far and elevate the market rate above the natural rate causing "secondary shocks." This is/was the main argument against the gold standard--of course, we see how well the alternative system worked out.
Either way, the key is this self-correcting mechanism which prevents perpetual inflation. In our current system, nations can continuously inflate, making their goods more appealing on the international market, increasing exports. Furthermore, the reduced interest rate, caused by inflation, will put additional downward pressure on the currency, leading to runaway inflation. Of course, if all nations are doing this (which they are), then individual currency fluctuations are concealed (because every currency is being devalued). This is why gold, even to this day, is the most stable unit of account.
Assuming there were an economy without even 100% backed bank deposit notes--an economy in which everyone just used physical gold coins directly even--wouldn't a simple increase in the gold money supply (due to a large gold mining discovery) make it seem to investors as though market participants had suddenly started saving more (i.e. effectively demanding longer processes of production), even though they hadn't?
No. The ABCT is predicated on a boom instigated by means of credit expansion, i.e. artificial creation of loans depressing the interest rate, sending false signals to entrepreneurs who then engage in more lengthy productive processes. News of a gold influx would be akin to an open announcement that more notes are being printed. It might cause prices to rise, but that is all.
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Jon Irenicus:No. The ABCT is predicated on a boom instigated by means of credit expansion, i.e. artificial creation of loans depressing the interest rate, sending false signals to entrepreneurs who then engage in more lengthy productive processes. News of a gold influx would be akin to an open announcement that more notes are being printed. It might cause prices to rise, but that is all.
Banks would pyramid additional credit on top of their new reserves. Even if the influx of new gold (discovery of a mine) went directly to consumers, it would automatically put downward pressure on the structure of production. But it always finds its way to both consumers and the banking system. This happened to Spain after they discovered large gold supplies in South America, and it happened during the latter part of the 19th century when large gold reserves were found in Australia and California. An additional supply of money must necessarily lead to a recession insofar as the ratio between the demand for present and future goods changes.
I can see where this is going. You have to specify whether there is FRB in this hypothetical "gold standard".