Friday, December 19, 2008

Inflation, manias, and gold, oh my!

On a rare hard money post on the Reason blog, a pointed question was asked of the commentariat, by domoarrigato:

I've never gotten a decent answer from Austrians on this site as to why they prefer the arbitrary inflations and deflations which would inevitably caused by fluctuations in the supply and industrial demand for soft yellow metal over those tied to the state of the economy. Or, how a metallic standard would cure the primary cause of bubbles and crashes (human psychology and extension of credit to dubious actors for uneconomic means.)

This latter isn't impacted one whit by being able to convert currency into specie.

I decided to man up to the task and offer my own response:

I think you're just setting up a straw man. It doesn't have to be gold, gold is merely a good candidate. The whole point is that one should be free to choose whatever means of exchange one desires.

Also, manias and panics cannot be solved other than through a totalitarian state which tells you what to buy and sell. People are sheep and will plow into retrospectively dumb "investments" like beanie babies. Reducing the scope of government will prevent many manias by taking away the easy credit punch bowl, and by removing fool-hardy government schemes and mandates. If you research manias throughout history, the worst ones initiated by the government sticking its phallus in the middle of private contracts (Tulips, Mississippi River Valley, Railroads, and finally, Real Estate). Government *could* quell some manias by pursuing cases of fraud, but since governments were making money hand over fist through real estate taxes, nothing happened.

...inflation and deflation aren't intrinsically bad (in moderation), they just benefit debtors in the former and savers in the latter. *Both* extreme deflation and inflation are bad because they distort people's rational expectations as to what their money is worth and aggravate herd like behavior ("Never put your money in banks, they can't be trusted!" or "Houses always go up in value!")

Well, apparently my reply was somewhat satisfactory as domoarrigato riposted:

If I've been effective enough in pointing out the difficulties of a gold standard that it is viewed as a strawman on a libertarian website, then I have been sucessful indeed. I put it out there, because I generally get a lot of flack for busting on the gold crowd. I see I've attracted the attention of the free banking crew instead today. I actually have a lot less of a problem with that concept than you might think. Free banking is a concept that I like a lot - in fact I support efforts like e-gold etc. I do take issue with the idea that USD are somehow a monopoly currency in this country. There are many counter examples that argue otherwise - mostly local barter arrangements. The big more visible ones tend to run afoul of the laws (like money laundering statues) but that doesn't stop people from saying it's because of "legal tender laws" - which it's not. In fact, we have free banking in the US, and these currencies exist peacably beside the dollar. It's just that money - like telephones - has a lot of network effects that determine it's success. You can only use wildcat currencies where they are accepted voluntarily.

Well put. I would only add that moderate deflation can much more easily turn into extreme deflation, and is always accompanied by much worse economic outcomes than moderate inflation. Which is why every mainstream economist that I am aware of views a couple of percents of inflation as "price stability"

Then he offered a concrete example of how a gold/silver standard is just as inflation prone as fiat currency. And soon we were off on another tangent:

I did an interesting calculation on the oft cited roman debasement and inflation example. Very good records exist, and I was able to compare the value of silver denari(common unit of money that were debased from being solid silver to solid bronze with just a silver wash) to that of solid gold aureus (corrected for weight and purity) which were commonly used as stores of wealth. Over the 200 odd year time period that I looked at, inflation averaged a remarkably un-remarkable 6%.

Also during this time period, the roman empire expanded enormously in size and citizenry and wealth/capita. The money supply increased many times faster than the 6% would indicate because of this. The romans inflated their currency through debasement because of the raw demand for more currency in an expanding economy.

Another poster name HAL-9000 offered his analysis of Rome's inflationary period, which put things into perspective:

What was the 200-year period you looked at? Most of what the Roman Empire was built during the Republic...at least the big-money "acquisitions" if you will. Your time-frame sounds more like the late Republic than the Empire.

You know, sitting here thinking about it, there's another big caveat in looking at money and collective social behavior with ancient societies - especially the Roman transition from Republic to Empire - and that's slavery.

In the late Republic and especially the Empire, most people's participation in money transactions was as the commodity the monies were being exchanged for. That also would have a significant impact on "assets" in a society that practiced a high form of ledger accounting like the Romans did.

I wonder, what was inflation like when Rome was still a Republic, before rampant slavery set in, and a permanent underclass became dependent on socialism bread and circuses in Rome? Was there a monopoly on metallic currency, and was it subject to inflation?

Much ink has been spilled on the matter. Even if a government chooses gold over fiat currency, it could still debase it, though with much more difficulty. A recently written book attempts to analyze the use of money in that time period. It seems one problem the authors had, was trying to measure the amount of money floating around. Apparently, Roman coins were valued, but many other means of exchange were used during the Republic. Rural farmers used wheat and cattle, some used foreign coins, and still others just used unminted bullion. It becomes ambiguous as to what money is--and how does one measure the other means of exchange used? It seems the number of coins used simply met the demand for coin. It wasn't until the Roman empire spanned the whole mediterranean, and the grain shipments converged on the gargantuan city of Rome, that the emperors achieved a de facto monopoly on money. The larger the government, the more official coin it needed to pay its functionaries and military. Also, it's more convenient for the government to request payment for taxes in its own coin. Eventally everybody had to use coin, as governments needed to buy grain for the proletarians and the army--even though traders and farmers initially preferred not to use the official coinage. It seems Gresham's Law was already in effect.