A friend of mine who studied neo-classical economics was saying something about how since gold necessarily lowers prices of goods over time it encourages people to save money since the value of gold appreciates and causes bank interest rates to be higher than the rate of growth of certain low risk businesses so it harms these sorts of businesses. I'm looking to read up on this theory. Does anyone know what this is called?
EDITED
The degree to which prices fall depends on the demand for cash. There have been periods in time under a gold standard in which prices rose. It is true however that in the Gilded Age the price level dropped with the massive increases in production. There was a high amount of savings.
How does high savings lead to a high interest rate? It would mean a higher supply of loanable funds and thus a lower interest rate, no? It is also true that in a general shift of preference between consumption and deferrment some consumer goods industries must suffer because of lowered consumer demand. This is reflected by the increase in capital goods industry spawned by higher amounts of investment from bank loans and equities. The dying off of certain consumer goods companies isn't necessarily a bad thing.
The Anarch is to the Anarchist what the Monarch is to the Monarchist. -Ernst Jünger
since gold necessarily lowers prices of goods over time
What? Prices are determined by supply and demand and the quantity of money in circulation. Using gold as money does not magically change any of those three variables.
What it does do is keep one variable from increasing [to some extent, in a modern economy], the quantity of money. So that any increases in production [=supply] that lowers prices is not offset by an increase in money supply that would raise them right back.
it encourages people to save money
This is true. Consider two cases. Case 1. You have money that you know will not decline in purchasing power five years from now, and might even increase. Case 2. You have money that you think is very likely to lose purchasing power in five years. In which case would you feel better saving your money for five years?
since the value of gold appreciates
Again, the value of gold will appreciate if there is increased production
and causes bank interest rates to be higher
Gold is an inanimate object. It does not cause interest rates, which are set by people, to be higher or lower. The interest rate is determined by exactly two people through negotiation, the borrower and the lender. Each of these two people take several things into consideration when deciding what interest rate is acceptable to them personally.
Now he might mean that if those two people are used to the reality we live in when our money is paper, that its purchasing power declines all the time, then the lender will want higher interest because he wants to get back the lost purchasing power. For example, if he thinks he can spend his 100 bucks now and get 5 pounds of lobster meat, but thinks that in a year from now he will only be able to buy 4 and a half pounds, because prices will go up due to money printing, he will tell the lender, "Why should I give you the money for a year and get back less purchasing power than I have right now? To take care of that, I'm going to charge you some interest, an extra 10% above and beyond all my other considerations."
That being the case, if the reverse happens, and the purchasing power of gold went up, he is getting 10% more than anticipated, besides the extra that he gets from the gold itself being more. That might be what your friend means.
But you see the flaw. If gold becomes money, and people understand [as your friend seems to] that the purchasing power will be greater after a year, then the dialogue will be just the opposite. The borrower will say, "I think it's fair to say gold will go up 1% in purchasing power in a year. Therefore by repaying you in gold, I am losing an extra 1%. So I am only willing to pay you 1% less than I would have otherwise."
than the rate of growth of certain low risk businesses
What does he mean by low risk businesses? And what does he mean by rate of growth of those businesses? If he means that those businesses cannot increase production as much as the other businesses did [which increased supply and therefore the purchasing power of gold], so what?
If he means that those businesses have a profit of say 2% a year, and gold goes up by 3% a year, and other businesses have profits of 4% a year, and he's arguing that people will close down the 2% business and buy gold, then he is being silly. Because they will go for the bigger prize, the 4% businesses. And, that will happen whether gold or paper is money.
If he means that the 4% businesses are riskier, and therefore have higher profits, but that very risk is a good reason to avoid them, but gold is safe [unlike paper money], and that is why the 2% business will close down under a gold standard, that is silly as well. Because that fellow should close down even under paper money. His 2% is less than the rate of inflation [since the purchasing power should have gone up 3%, which is what happens under gold, and went up not at all]. He is losing money keeping his place open, no matter what money is used.
so it harms these sorts of businesses. I'm looking to read up on this theory. Does anyone know what this is called?
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Gold only appreciates consistently when all currencies are continually inflating their currencies. Gold itself is not truly gaining value, its price increase is just a measure of gold not losing value relative to the inflation of a fiat currency.
That's not true. Though gold may increase with the devaluation of other currencies, gold does gain value with increased production.
Consider:
100 goods
10 gold coins
Each gold coin is worth 10 goods. We may call its value 10.
The production expands to allow now for 110 goods total. The gold supply, not having changed, will be such that one coin will now be worth 11 goods. Money is the goods-denominator.
^^^True enough.
And that value increase would be accounted for by its use as money, being that it is now being valued more for its exchange value, above and beyond its relatively static commodity value.
There's more wealth in the economy and more demand for money, thus its value as money increases.
Those are two separate causes for the increase in the value of money though. Money's value may increase with either higher production OR a higher demand for money.
Seems to me those factors should be related, as more goods means less money available per unit of goods.
Each year we add much of the value of the GDP to our economy, in terms of wealth, and were the supply of money static that would probably mean deflationary pressure, as the amount of wealth is continually increasing.
This is why I'm looking to read about this in a Neo-Classical book or something. So I can understand what he means.
I thought about it and I want to pose the question another way:
Since the gold standard is deflationary, putting money in the bank is good. So let's say deflation is 1%. The bank might pay you an extra 2% or something.
So if you make 3% by keeping money in the bank, banks, in order to profit have to lend at let's say 5%.
Now, investments that make less than 5% profits per year could not realistically borrow.
This is my understanding of my friend's question. I still have not found a book or something that explains this so I can read it.
Since the gold standard is deflationary, putting money in the bank is good. So let's say deflation is 1%. The bank might pay you an extra 2% or something. So if you make 3% by keeping money in the bank, banks, in order to profit have to lend at let's say 5%. Now, investments that make less than 5% profits per year could not realistically borrow.
Let's look at the numbers again. If there is no deflation, the bank gives you 2%, and lends at 4%. So he has to make 4% a year to borrow.
Enter the gold standard, which magically causes deflation. Then banks will now give you 1% [not 3%] and lends at 3% [not 4%, and certainly not 5%].
My earlier posts explain why in detail.
This makes sense Dave. Thank you.
I asked my friend where I can read about this Neo-Classical theory and he says he doesn't have a source right now, he studied it in school.
As I study Austrian Economics I still don't want to be ignorant of what other schools teach.
Even if what he says makes any sense there are some other really terrible things about paper money that make it. . . terrible. :)
"Those are two separate causes for the increase in the value of money though. Money's value may increase with either higher production OR a higher demand for money."
Higher production of non-money. For example, if gold is money, an increase in the amount of gold will not increase the value of money.
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