The Gold Standard

I’ve been trying for a while now to figure out why I dislike the gold standard — that is, pegging currency against the price of gold. I think currencies are fundamentally arbitrary — they’re a convention that needs to be (roughly) agreed on, but whether that’s $1 for a ham sandwich or $1000 for a ham sandwich doesn’t make much difference, as long as everyone agrees which of the two it is. By that argument, saying $1 is worth 23 miligrams of gold should be fine. Now sure, that breaks down if you suddenly get a huge increase in supply of gold — if someone posts a video on youtube how to turn grass clippings into pure gold, you’re going to get some pretty serious (and worse, uncontrollable) inflation and it’ll cost more than 230 miligrams of gold (or a mower load of grass, or $10) to get a big mac and coke. But worries about vast new sources of gold is probably not a realistic objection, at least until we have asteroid mining.

So I think there must be something else to justify opposition to the gold standard, and in particular that at some point you have to argue that not being able to inflate your currency whenever you want is actually a bad thing.

To some extent the consequences of being unable to devalue your currency/inflate you money supply is playing out in Greece now, and depending on whose explanation you believe, was a cause of the Great Depression.

In both cases, the theory goes that crushing debt (war reparations, too much spending) and an inability to actually pay that debt can’t go on forever, and inflation is an easy way to get out of that. At any rate, easier than bank failures, easier than government defaults, and easier than going to war. Basically, inflation turns into a way to force everyone to forgive their debtors by a given percentage, rather than having to pick some people who get nothing back, while others get everything.

On the other hand, inflation only “really” helps with long term debt — if you have to pay someone a million dollars in ten years time, a 15% annual inflation rate lets you pay it all back by doing the equivalent of $135,000’s work in each of the last two years, even if you do nothing for the first eight years. But if you owe someone a million dollars in two years time, and can only earn $135,000 each year, you’d better hope for inflation of over 540%, or you’ll want to start bankruptcy proceedings now.

That’s essentially what happens with debt that has a variable interest rate (or rolling debts) — the lender guesses what inflation’s likely to be, and says “ok, I won’t send the boys around to collect my $1M today, but next week you owe me an extra 1%”. Which of course means inflation isn’t going to do you much good if your debts are all short term (135B euros of Greek bonds due within the next five years, a five year fixed rate mortgage, credit card debt, etc) — the people loaning you money have been clever enough to factor in the possibility of inflation and still make you pay what you owe.

In theory, all that’s fine and proper: you shouldn’t borrow more than you can pay back, and there should be some negative consequences to living off promises you never make good on.

In practice, people get into situations where it’s simply impossible to pay back a debt. Whether that’s a thin veneer over slavery in the form of debt bondage, or managing to spot a bunch of uncovered short sellers who were willing to commit to selling (in effect) more than 100% of a company, or something else.

There’s probably no simple solution to that — people are always going to want to buy now and pay later, people are always going to try making that “pay later” part as expensive as possible, and people are always going to make mistakes in estimating what’s possible: all of which leads to people getting into more debt than they can actually pay. In that view going to the gold standard to stop government getting themselves out of debt by printing money just makes it harder to get out of too much debt, it doesn’t actually decrease the factors that get people (or governments) into debt in the first place, and thus actually makes things worse, not better (at least overall: people holding long term government bonds whose worth might be inflated away have every reason to like the idea).

Of course, the main resolution surely has to be liquidation/bankruptcy proceedings, where creditors only end up getting a percentage of what they’re owed adjudicated by some trusted third party, the debtor gets put on a list of bad people who don’t pay their debts reliably, and otherwise everyone goes back to living their lives, usually including the bankrupt individual. That approach seems a lot better than the pure debt-market approach of having risky debts become increasingly short term and increasingly expensive until either someone rich comes along and provides a bailout, or there’s a global recession.

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