I have been reading Mises on Money, Rothbard's Mystery of Banking, and other similar works. And now I have a question that I have not been able to figure out an explanation for. Hence, this question, defined as carefully as I can:
Assume a 100% gold standard with no fractional-reserve banking. Also assume a government committed to no interference with a free-market.
Now. What would happen if there were suddenly discovered a "Comstock-Lode-type" mountain of gold (not silver!). What would happen when that huge amount of new gold were introduced into such a free-market economy? Would it not cause a kind of inflation in the money supply? What would be the result in terms of prices and productivity, both short term and long term?
I am having trouble explaining the difference between what I think the result would be in contrast to a paper-money inflation.
I'll appreciate any help any of you can give me.
Thank you.
it depends largely on who owns the mineral deposit and what they do with it. If a massive amount of gold were introduced into an economy that used gold as money the exchange value of any given volume of gold would decrease relative to other goods. the exchange value of gold couldnt fall below the value of the industrial value of gold, in fact over the long term a decrease in the price of gold (due to monetary factors) would make marginal uses of gold more prevalent. any product that used gold as a precursor would become more affordable, thus increasing demand for gold and driving the price back up.
OK, I think I understand, but [always wait for the "but . . . ], suppose I am the discoverer of the mountain of gold, and I take it to the mint and have made into gold coins, and then, spendthrift that I am, I go into the free market and start buying up everything I can. Wouldn't that have the same effect on the economy that the a government has when it prints paper money and is the first to use it (before prices go up) and it begins its "step-by-step" movement through the economic system (as Mises says that inflation does not effect everyone at the same time or to the same degree)?
I think it would have the same effect as fiat money printing/counterfeiting.
The effects would depend on these factors unique to using a real commodity as money versus paper or worse electronic fiat money:
1. There are real costs of finding, extracting, and coining the gold. Consequently the lowest the gold could drop to is the price of these activities. And here the coining cost will be the same regardless of the cost of finding and extracing.
2. Alternate uses for gold. Gold is extremely useful so any use of gold other than as money would begin to use gold more as the price drops. Eventually these uses for the gold would reduce the drop in price as it would take gold off of the market.
Understand that this event you are speaking about is exceedingly rare in history. I can only think of the great theft of gold from the Aztecs or Incas to Spain as being examples. Contrast this to the disasters of fiat money in history. The
You could make a machine to does alchemy:turns something in abundance into gold which will effectively make gold useless as money. Understand this is also extremely difficult to do.
That's what I thought -- in the short run. But in the longer run, I would have put something into the economy that is (at least) more valued than paper money., somethng that adds real value to the economy and does not depreciate like paper money. I think the next post by "Bogart" is a good explanation.
Wouldn't that have the same effect on the economy that the a government has when it prints paper money and is the first to use it (before prices go up) and it begins its "step-by-step" movement through the economic system (as Mises says that inflation does not effect everyone at the same time or to the same degree)?
how could it? for some reason you own mineral deposits. lets assume that you didnt acquire them through aggression. in that case you are either lucky or good at business. in order to introduce this gold to market you have to hire people to do useful things. this is different than paying people to do anti-useful things (govt). as this money filters into the economy it is spent by producers on things they deem valuable. these are different things than anti-productive would value and spend non-existent money on. as the real money filters into the market it will affect prices. but its hardly "the same effect."
What if a large hunk of gold fell from the sky into someone's large lot, unbeknownst to anyone else, and this person spent it? On a really basic level, it would have similar effects on prices to a lot of fiat currency being printed. There would be more gold, so it would end up having less value, pushing prices up. Are the objections to the implication that therefore gold is no better than fiat currencies? History shows the inevitability of fiat inflation until destruction, and lack of gold falling from the sky or being transmuted from lead.
You cannot assume both at the same time.
If there's no government intervention there's nothing impeding me of running a fractional reserve bank.
Fractional reserve banks are not stipulated by governments, they are something that happens naturally once people start accepting checking account transfers and other as cash substitutes.
So you either have a 100% gold standard with no fractional-reserve banking activity, which in itself is a very substantial intervention in a free-market, or you accept free banking activity, with the degree of liquidity risks involved when running on fractional reserve.
You cannot have the cake and eat it too.
Some Austrians rely on von Mises argument that in a free market fractional reserve banks would collapse in a bank run eventually, and so the system would come back to full reserve.
That argument is entirely speculative and does not seem to explain the history of banking.
The incentive for running fractional reserve is not created by government intervention or by central banking systems, but by profit motives of bankers themselves.
And this is not "a problem". It's a tradeoff between the benefits of having more non-cash liquid assets available and the risks of being caught in a bank run whenever people runaway from these assets and go back to cash.
All business have their sources of risk, and that's the nature of risk in the banking business.
As for the effects of large mineral deposits of gold, that would probably make the price of gold to drop, and consequentially, the price in gold of everything else to increase.
But there are a few differences from printing a bunch of money.
First, it is a hard task to estimate the deposits of a gold mine, even with modern technology.
It's actually a very complicated task of data analysis, and some modern mining companies even offer prizes to people who can find ways to figure their data for them.
And even if the owner of such a huge deposit knew for sure how much gold is in there, he would not necessarily have the incentive to publish this information, or to start dumping gold on the market too eagerly.
He would probably evaluate the market impact of his extraction strategy, and use his private information so to generate an optimal stream of profits on the long run.
He could also overestimate his gold possessions. If for instance he had a vested interest in making his companies shares spike, and them dump them, or if he's trying to get acquired.
This would be a short term strategy, but could backfire if later on he revised his estimates, or even if he was prosecuted for fraud.
Recently, in 2011, a brazilian tycoon named Batista got himself a position among the ten richest men in the world at the time mainly by overstating the oil and gas findings in the plots acquired by his companies.
Later on, these statements were revised and the stock price of his holding fell considerably, and during 2012 his fortune drop from around $30 bi to something like $10 bi.
Still, some will say the whole move netted him significant profits, since he IPOed and followed-on during the boom.
Toxic: Good point about not being able to assume contradictory things at the same time. I was (in making the assumption of 100% reserve banking and no government interference) trying to limit the question to that of an expansion of the gold supply, but maybe that won't work, not in free economy anyway!
I can only think of the great theft of gold from the Aztecs or Incas to Spain as being examples. I read that in 1324-25 in Cairo, Egypt the value of gold 'crashed' due to Mansa I of Mali dumping off tons of the shiny stuff. As a part of his Hajj to Mecca he stopped in at cities and gave gold freely to the poor, and traded it for souvenirs...or so it is said. "Musa's generous actions, however, inadvertently devastated the economy of the region. In the cities of Cairo, Medina and Mecca, the sudden influx of gold devalued the metal for the next decade. Prices on goods and wares super inflated in an attempt to adjust to the newfound wealth that was spreading throughout local populations. To rectify the gold market, Musa borrowed all the gold he could carry from money-lenders in Cairo, at high interest. This is the only time recorded in history that one man directly controlled the price of gold in the Mediterranean." I wonder if this guy AJH Goodwin, who's book this info is sourced from says the Wikipage, was economically literate.
Vanitas Nomen,
Why do you ask if the author is economically literate?
Mainly as a bit of an after thought but, because I haven't read the book by Goodwin I wonder how the author might be able to come to the conclusions he may have come to. Here is the link to the book, any one of us could read it for free online, I just don't have the time right now. http://www.jstor.org/discover/10.2307/3886971?uid=3739560&uid=2129&uid=2&uid=70&uid=4&uid=3739256&sid=21101919493511
Terrill: Toxic: Good point about not being able to assume contradictory things at the same time. I was (in making the assumption of 100% reserve banking and no government interference) trying to limit the question to that of an expansion of the gold supply, but maybe that won't work, not in free economy anyway!
Well, to think in terms of the fractional reserve in banks is only a complication.
The introduction of large amounts of gold in an economy makes the price of gold to fall, at least locally, as now there is more gold chasing the same goods as before.
There are very many examples of these things happening in a local level throughout history, specially in port cities and piracy outposts, subjected to large fluctuations of their balance between circulating gold and other goods.
However, in modern market economies the price of gold is relatively stable globally, since arbitrageurs can operate fast on geographical differentials by buying gold in one market and selling it on another simultaneously through eletronic communications.