Why the value of gold has nothing to do with your money
This post came about because a certain Mr. Pilkington send a tweet entitled "Something to chew on for my Austrian brothers and sisters. :-D" followed by this link " http://fixingtheeconomists.wordpress.com/2014/05/03/why…" Clearly, Mr. Pilkington has an ax to grind by fixing economists - not economics. Well, so do we... Except we don't take it personal.
Although Mr. Pilkington's article sounds like a condescending lecture to 'uneducated Austrians and gold bugs' at first glance, I shall take it in good spirits. Since he ventured on our field of specialisation, I shall reply in kind and offer him our Sunday Roast for supper.
Mr. Pilkington, who is a research assistent in political economy and apparently belonging to the Post-Keynesian school, intends to do away with the alledged confusion about gold and the gold standard. OK, so he' got my attention. Knowing that a some superficial similarities between the New Austrian School and the Post-Keynesians exist, we differ thoroughly on method. With "we" I mean the New Austrian School. I do not pretend to speak for others. Dissent is the hallmark of a scientist and a communis opinio never advanced science. (Let me add that puberal dissent is not to what I had in mind. Evidence based science has still some meaning).
It may come as a surprise but "Austrians" and gold bugs are not identical. It is regrettable that a man of the caliber of research assistant at Kingston College does not broaden his understanding by following unorthodox economics. To compensate for that oversight, I shall briefly introduce the New Austrian School of Economics. The school has set itself apart from the traditional Alabama centered Austrians and to a lesser degree from those centered around the George Mason University. I leave it to the curious mind to investigate further. The New Austrian School is largely based on Prof. Carl Menger (and to some degree a bit of Mises), Adam Smith, F.A. Hayek, a contemporary of Keynes and of course Prof. Antal Fekete. As for the gold bugs, I suppose they're a breed apart.
Mr. Pilkington reminds his readers that the gold standard of the 18th and 19th century does not operate in the same way as monetary systems today. Sharply observed, indeed. They certainly do not. He refers the reader to the Bank of England for an explanation of the working of the contemporary monetary system. For the benefit of readers, the theory of 'endogenous money creation' is a standard bachelor level semester course and interest rate targeting as a policy or mechanism is equally bachelor level. Nevermind. I shall bear in mind an old adage that preaching to the converted is rather futile. In that perspective, I might just as well do an effort and address the Post-Keynesians as well as anyone interested.
Although standard textbooks use other verbiage, the 'system' repeated at the BoE page can be briefly summarised: a treasury department issues sovereign bonds, puts them up for auction and the contemporary financial institutions purchase them. A Central Bank (in the US the Federal Reserve) bids for these bonds to acquire them and so they end up as collateral for its note issues, either in paper or in an electronic version. To drive this home with students I use the following story: "Yes, M'lord, I did receive a rather large cheque from Mr. Whitehat and after I duly deposited it, I wrote a hundred thousand or so cheques for small amounts, never exceeding the amount of the rather large cheque I was given."
At this point most students realise what I am talking about and it dawns on them that the modern process of money creation is in essence an act of check kiting. Illegal for you and me. Apparently not when you are wearing a White Hat and your name is Mr. Treasurer or Mr. Central Banker. Usualy there is a smart student in the audience alleging that the law allows them to. Is that really so? Small children have a note from their mom relieving them from PT class. Politicians, as the 'representatives' of the people have something similar. In their case they have a law from parliament. "Scientifically" referred to as legal positivism, it is in essence a euphemism for "do as I say, not as I do". I suspect something is afoot with legal positivism, that pretends to invert law with justice. But let us not stray. Prof. Fekete has his own way of driving the above point home. It is a moral or perhaps a legal issue indeed. Now, let it be exactly this point where Mr. Pilkington seems to find reason to classify prof. Fekete as a monetary "crank" for exposing this hypocritical stance and not being scientific about it.
Unbeknownst to Mr. Pilkington prof. Fekete has more than 50 years head start. He is the only professor I know who purchased a seat on an exchange just to study his material in depth. He had a very long time to think and formulate his findings. He already anticipated annoying know-it-alls, usually of the younger generation with only a fraction of his knowledge and experience. He writes in one of his lectures: "To the positivist mind it is cantankerous hair-splitting to drag eleemosynary institutions, widows and orphans - who are dependent on the integrity of the currency for their survival - into the debate. It is not the task of my lectures to enter into a moral argument. It should be possible to establish scientific truth without reference to a value system...." . And so he did.
However, I return to the snack offered by Mr. Pilkington, which was about value and gold. He refers to the working of the goldpoints and argues that these are points where money's value divorces from that of gold. Let me not differ just to quibble, but add the following: a gold standard did not "just come about". Neither did any person "agree" to use gold or silver. Rather, gold and silver, evolved to become "money". Mr. Pilkington refers to a text book entitled "Money" by sir Roy Harrod. This author relies on a (legal positivist fiction) theory of 'social contract ' to arrive at his conclusions. Alledgedly, the textbook could be confusing. Well, the interested person could get rid of the confusion haunting this textbook by simply reading prof. Carl Menger's "Geld " (in German) and perhaps available in translation from a good library. Prof. Menger describes the evolution process of how money came into existence. We know precious little about this process, but I venture out and state that it is probably here that the Austrian school earned its nickname of "Psychology" School. "Value" of course has no meaning outside human consciousness. No need to read any metaphysicis in this axiom. Anyone realises that an ounce of gold has no value of its own. No such thing as intrinsic value. Value is all in the mind. But that is rather complex.
It is here where I would like to offer non-NASOE economists some enlightenment on "value". Despite claims to the contrary that value and money are created by some institution or authority by decree, which is only true in a positivist framework for the contemporary situation, the value of goods had its origin in the comparison of utilitiies (In a Mengerian, not a Walrasian sense) to the individual, and under barter there was just no way to measure it, although values could still be compared, subject to the rules of ordinal arithmetic. Later, through the evolution in the marketability of goods (Menger uses the term Absatzfähigkeit ), gold became the most marketable good, money and consequently gold obtained a characteristic of 'least declining marginal utility'. Noteable here is that this social coordination took place worldwide and independent from authorities. It differs from convention or agreement, either in a legal or even a social sense. Stating otherwise just flies in the face of observable facts. Prices (expressed in fineness and weight) emerged in this way, which could be compared as well as measured. They are subject to the rules of ordinal as well as cardinal arithmetic.
Even more : the emergence of money and prices makes for rearrangement and conformity to the constellation of prices that forms over time and space. Since another individual will rearrange his own scale of values to conform to the same constellation, the valuation of individuals becomes universal. Prices harmonize individual values. Thus the standard gold coin is rightly called the unit of value, and the price is rightly called the measure of value. Mathematics is also the science of comparison, besides measuring. A large branch of mathematics called lattice theory also embraces ordinal arithmetic. It is devoted exclusively to the study of comparing (ordering). In a typical lattice one cannot measure for lack of a metric. But then, there are also metric lattices in which both order and metric obtain, and the metric is compatible with the order. In these lattices comparing and measuring are both possible. In the words of Prof. Antal Fekete:
"The mathematician is quite comfortable with the idea that in the beginning there was no metric in his lattice. Later, to his delight, he found a way to construct one, moreover, the metric was compatible with the order. To express this formally:
Let A, B denote goods and let a, b denote their respective prices.
Furthermore, let A d B mean that A is valued less than B.
Then compatibility can be stated as follows: A d B <==> a < b.
If there was a pair of goods A, B such that a < b but A e B (meaning that A is valued more than B even though it is the cheaper of the two) then arbitrageurs would buy A and sell B, and keep doing it until the anomaly in prices disappeared.
This refutes Mises' dictum that it is "unscientific [to] attribute to money the function of acting as a measure of price or even of value". Money does even more. Through the market, money harmonizes individual valuations to become a universal valuation, applicable to all individuals, as manifested by the constellation of prices."
Although "Austrians" are known for their subjectivist approach to economics, the above means that values (under a circulating gold coin standard - not a gold bullion standard) can be compared as well as measured. Due to the nearly constant marginal utility characteristic that circulating full bodied gold coin seemingly possesses, goods prices can be compared in an objective (or least subjective) way, that doesn't invalidate the subjectivist approach. Furthermore, money is not an invention of the State, objections by Prof. G.F. Knapp or any other statist notwithstanding. It is the result of three thousand years of worldwide social coordination. Statist intervention in gold or silver coin is opportunistic and secondary (see: Rejoinder to the Debasement Puzzle of the Middle Ages) although it can have value added under certain circumstances.
I thought I offered the above insight and I shall assume that a research assistant worth his salt will take his research serious so that when the occassion presents itself, one can talk more authoritatively-even when disagreeing.
I admit that I was somewhat bedazzled with Mr. Pilkington's concept of the 'price of gold'. The issuing banks redeemed their notes against standard full bodied coin. So the price of gold is still expressed as a measure of itself. Is there such a thing as a price of gold under a gold standard, where a standard gold coin is both the metric and the measure of value? I think what Mr. Pilkington ought to have written, was that worn coins were melted as soon as they became "legally" underweight. What do I mean? A coinage act by Parliament, like the note from mom, declared the upper and the lower boundaries in weight, before the coins lose their legal tender status. Enter the Edicts of Rulers or acts of Parliament and suddely a layer of complexity is added to an otherwise simple weighing excercise. There is a debate possible on the question whether coin circulated by weight or by tale, bringing us to the very interesting subjects of brassage, seigniorage, Greshams' 'law' (sic) and of course gold import and export points, which are the result of the combination of measuring by weight and calculating transaction costs by tale. We offer the serious researcher or interested student a balanced list of historical research material to be found in the writings of J. Bolton "Money in the Medieval English Economy", P. Spufford "Money and its Use in Medieval England", H. Van der Wee, R. De Roover, J. Munro and I. Kirzner, all distinghuished professors of which Kirzner is the only "Austrian". To be sure, there are many more.
Since gold and silver coin circulated simultaneously, the "price" of the one could be expressed in terms of the other. I do not deny that an authority could add value and diminish transaction costs by the excercise of assaying and standardising, in the process assuming the burden of maintaining the quality (weight) that it has taken upon itself. It has happened before in history. But we digress. Mr. Pilkington describes the flow of gold to and from the Mints and gives what I think must be the goldpoints as a reason for this flow. Let us immediately observe some quirky human behaviour, namely the innate ability of humans to hoard. It is prof. Fekete who offers a theory of hoarding in economics, which is rather absent from monetarist theory and, yes, very sketchy in Keynesian theory. I add that precious metal flows to and from the Mint could equally have come about as a reaction to the rate of interest or the rate of discount, expressed by hoarding and dishoarding behaviour.
I refuse to equalise the rate of interest with the rate of discount since it can be readily observed that both can and did go their own way, oftentimes in opposite directions. The flow of precious metal to the Mint is however, an important prerequisite for a functioning gold or silver coin standard. Could it be the economic discoordination (by debasements, seigniorage, fixing a bimetallic ratio, etc.) that has resulted in evasive action? Did people's behaviour overide the whishes of their lords? (Gresham politely tried to convey that message to her Majesty). Referring to people's hoarding behaviour as 'barbaric, criminal or pathologic' is disingenious in the context of a metallic standard. It is the decentralised mechanism of setting interest and discount rates. The silence about this characteristic is deafening in economic textbooks.
Next, Mr. Pilkington touches upon the Bullionist vs. Banking debate and sets out to prove that the Quantity theory is wrong. Well, he could have saved his efforts. We concur. The QTM can easily be disproved and Mises is not to be followed on this point. Better yet, under a gold coin standard, an argument can be made that whenever new precious metal discoveries took place, discount rates would drop without a trace of inflation and bill arbitrage would dispense with the discount differentials over time and space. New gold discoveries would not necessarily increase price levels, rather, the discount rate lowered by social coordination (not agreement or consensus) and the wealth of nations increased, because the Social Circulating Fund increased, commensurate with the increase in gold coin volumes. It is the great merit of the gold standard that it stabilised interest and discount rates, not necessarily prices. Even Keynes admitted that stable rates meant stable prices. Perhaps a lesson for policy makers? But that is another story.
Regarding the famous Banking vs Bullionist debate in England, Mr. Pilkington takes the side of the Bullionist camp. Right. We don't. This famous debate took place because England had run into some unexpected issues regarding its silver standard pound defined in gold terms as one sovereign. But around that time, there were several high level International Monetary Conferences with France, Germany, Italy, Spain, India and the Americas. We know that silver had been effectively demonetised from around 1870 onwards, which forced England, willy nilly onto a gold standard, not int he least because their stock of silver coinage was in a dreadful state. And not only England. The German Kaiser found it opportune to raid France in 1870 for some loot in gold, before Bismarck put Germany on a gold standard a year later.
We can speculate about the reasons for the silver demonetisation, which - notwithstanding the lack of academic attention from the economics profession- was an epic catastrophe. A forensic analysis may suggest that this demonetisation of silver did not 'just happen'. Too many parties with high stakes were involved. It is a fact that the Rotschild Banking establishment actively seeked to establish note issuing banks (or what is the same : central banks) worldwide and they controlled mining interests in both gold and silver. It can also be observed that the note issuing banks had progressively lesser commercial bills (self-liquidating credit, maturing into gold coin) only to be replaced with government bonds in portfolio. This had a noteable destabilisation effect on the discount rate and the bill market, which the New Austrian School argues is the world wide Social Circulating Fund from which labour can be financed. We note that social unrest and Marxism coincided with the gradual expansion of note issuing banks and the commensurate shrinking of the bill market. We don't think of it as a coincidence.
We have independent and unsuspect corroboration for this view on the bill market as the social cirulating fund in the works of Adam Smith (describing the spontaneous bill circulation in Liverpool) and later Heinrich Rittershausen (Arbeitslosigkeit und Cirkulationskredit). No, none of them are "Austrians". George Selwin, if you prefer an Austrian, has written a very readable exposé on coin issue in England and treats the Bullionist vs Banking Debate in his well researched book "Good Money, Birmingham Button Makers and the Mint".
Mr. Pilkington disagrees with the Banking School on the grounds that the silver pound can still be measured in terms of gold. True, but he dismisses the demonetisation of silver and its effects. The job of gold and silver circulation had to be done by gold alone now. Note that this is not a Quantity Theory argument, it is a simple observation, corroborated by the Banking School. Surely that is what the Banking School offered in their argumentation. The worldwide silver demonetisation gave rise to this debate, to the worldwide establishment of issuing banks, to International Monetary Conventions. It can even be argued that the ensuing discoordination had a direct relationship with the Long Depression and perhaps even the many wars of that period. Too much happened to be coincidence. Life is not linear indeed, but there are consequences. At the very least, it deserves further investigation. For a balanced argument, this should not be excluded.
Mr. Pilkington rightly mockes the attitude of people that still adhere to the QTM. He refers to modern monetary systems as systems by convention. This is where I take exception. 'Convention' does not suffice to characterise the modern monetary system. Money in all its forms emerged as a spontaneous social coordination. It was never the result of a convention. The contemporary monetary disposition, however, is not the result of social coordination, but the result of private enterprise and political lobbying. The world only arrived at fiat currency after series of monetary discoordination disasters that flowed from dirigist efforts, such as the French assignats or before that, John Laws' experiment in France, which was a repetition of a failed earlier experiment in Sweden. Even the Chinese experimented and failed with silk money before the Swedish tried their luck.
One would have thought that by now, authorities would have learned from the failures and would hesitate to experiment again at the expense of a hapless population. Fiat currency came about by the force of law. Should anyone disgree with my use of the word 'force' than it should be explained why 'nominalist' laws, 'forced circulation laws' or 'tax laws' (purposely designed to make one pay in the currency of the realm- no foreign exchange will do!) exist at all. Surely there would be no need for these laws and their penalties if we all happily "agreed" without reservations to use fiat currency?
There is more though. I would have thought that a serious research assistant would have greater depths of knowledge of Austrian economics. For his enlightenment, perhaps his entertainment, there exists also a Mengerian disequilibrium school of economic thought. Yes that's us. Most of us have standard or advanced economic training. And rejected it. Furthermore, science does not need to refer to morality or metaphysics to make a point. But the application of science is not free of morals. Surely political economy is such an application. If you disagree with me, Mr. Pilkington, than I look forward to your gracefull and equanimous acceptance of Mr. Buiters' Zero Lower Bound solution(s), when he advocates to marginalise everyone's money, bank balance and savings account - including yours.... I know, radical uncertainty reigns. Or not.
Frank Van Dun, Economics and the Limits of Value Free Science.
Lawrence Officer: Between the Dollar-Sterling Gold Points, Exchange Rates, Parity and Market Behavior
Antal Fekete: When Atlas Shrugged-Part 2: Gibsons Paradox and the Gold Price