Gold News

Does a Gold Standard Constrain Growth?

Well? Does it...?

WE LOOKED yesterday at Federal Reserve chairman Ben Bernanke's wrong interpretation of the gold standard, his hazy recollection of the financial history of the inter-war years, writes Greg Canavan for the Daily Reckoning Australia.

We neglected to mention another hoary old 'golden' chestnut he banged on about.

This chestnut is that there's not enough gold (which is money) to satisfy a growing economy. Therefore, a gold standard can restrain economic growth because of the tight rein it imposes on the money supply. Most people instinctively agree with this.

But when you think about, you'll realize such an interpretation is one-dimensional.

Let's start with the concept of money.

Money is simply a representation of wealth. It is not wealth itself. Most people derive wealth from their labor. Money is a way for them to disperse (spend) their wealth in many different ways (via consumption) or defer consumption by saving.

The creation of wealth in an economy happens irrespective of the amount of money circulating. If real economic growth rises by 10 per cent, and the money supply increases by just 2 per cent, then the price level adjusts to reflect the change.

In this case the price level would adjust downward (deflate) to reflect a greater relative increase in wealth. If on the other hand money grows faster than wealth then the price level will rise. An increasing money stock divided by a stable pool of wealth is just another way of expressing inflation.

It doesn't matter if the money stock grows slower than the rate of real wealth creation. 'Money' is just a numerical representation of that wealth.

But here's why central bankers and statists don't like it: it causes deflation. Not bad deflation, like the type you get when an asset bubble bursts. We're talking good deflation, where an economy's natural tendency to innovate and make technological improvements lowers the price level over time.

Such deflation is great for consumers because it puts a little more purchasing power in their pockets year after year. But it's bad for...guess who?

Politicians, bankers and whoever else relies heavily on debt.

Under a gold standard, where the money supply grows very slowly (usually around 2 per cent per annum) there is a tendency toward mild deflation. In such a scenario households gain a little purchasing power – via the advances of technology – each year.

But a monetary system that bestows minor benefits on a broad swathe of society cannot benefit special interest groups. And a government hamstrung by such a system finds it difficult to buy votes.

In short, a gold standard – except in rare times of major gold discoveries – prevents an inflationary outbreak of the money supply. It tends towards deflation instead.

Inflation is the monetary policy of the 20th and, so far 21st centuries. It is favored by bankers (it encourages people to get into debt), central bankers (it justifies their existence) and politicians (it provides them with the funds to selectively bribe the electorate).

Unfortunately, the general population also favors inflation because it provides the illusion of wealth. People fall for the fallacy that money equates to wealth.

Thanks to Bernanke and the central bank brigade, there is now more 'money' in the world than at any other time in history. Yet our 'wealth', or living standards, has not kept up with the recent historic surge in the money supply.

But for some reason the world continues to look at Bernanke as the font of all monetary wisdom. We're not suggesting the world should immediately return to a classical gold standard. That will probably never happen. Not at least until there is a crisis so bad that the clowns still running the show are completely discredited.

But gold still plays a very important role in the financial system whether Bernanke wants to recognize it or not. Despite the absence of an official gold standard, humans are still digging gold up in all parts of the world and redepositing it in a vault somewhere.

In a monetary system completely abused by special interests and the banking elite, gold remains in more demand than ever. It is the monetary North Star for an idling and listless system.

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Greg Canavan is editorial director of Fat Tail Investment Research and has been a regular guest on CNBC, ABC and BoardRoomRadio, as well as a contributor to publications as diverse as and the Sydney Morning Herald.

See the full archive of Greg Canavan.

Please Note: All articles published here are to inform your thinking, not lead it. Only you can decide the best place for your money, and any decision you make will put your money at risk. Information or data included here may have already been overtaken by events – and must be verified elsewhere – should you choose to act on it. Please review our Terms & Conditions for accessing Gold News.

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