Originally published August 31, 2011 on the New Economic Perspectives blog.
Thanks for the comments, which were very tightly focused on gold and gold coins. I want to reiterate my summary: gold coins are not an example of a “commodity money” such as the sea shells supposedly chosen by Friday and Crusoe. Rather, they were a “fiat money”, government IOU that happened to be stamped on precious metal. These coins almost always circulated far above the value of the embodied metal; however, that value set a minimum below which the coin’s value could never fall.
That proved handy when a crown was overthrown; or when the coins circulated beyond the crown’s reach. I argued it is not a coincidence that the gold standard, precious metal coins, Mercantilism, wars for foreign conquest, and internecine European wars evolved together. The rise of the modern state, with its ability to conscript warriors and enforce taxes made all of that oh-so-Medieval. Precious metal coins were banished to the dustbins of history.
Yet, today’s goldbugs want to bring it all back. Presumably they love the outfits—anyone for the Society for Creative Anachronism? You too can wear tights and pursue damsels in distress with all the accouterments.
OK more seriously, on to the questions and comments.
Q1: It appears that markets do behave as if gold is money. Is this irrational? Does it reflect rational concern with the stability of fiat money? What is gold if it is not money? Is all this speculation just a “greater fool” theory? And what determines the price of gold, anyway?
Answer: All good questions. First, let me remind you that gold is only one of 25 commodities going through a tulip-bulb type speculative hysteria. Indeed, since 2004 we have lived through the greatest commodities bubble in human history—bar none. Please see my Levy Institute piece http://www.levyinstitute.org/publications/?docid=1094.
Now you will notice the date—2008—and you might think it is all outdated. From 2004 to 2008 we had the previous all-time biggest bubble. Then Lieberman and Stupak initiated an investigation into Goldman Sachs (oh, you know it had to involve Goldman) and pension funds (say what?). Yours truly played a walk-on part (I worked behind the scenes with their staffs). I was the only economist they could find willing to say “it is not supply and demand” (it never is—and butlers never commit the murder, either). I wrote the piece you can read at their invitation. Pension funds got scared sh*tless. Their members would blame them for the $4 gas at the pumps. They pulled one third of their funds out. Commodities’ prices collapsed (remember oil fell from approx. $150 to $49 a barrel). Then the financial crisis and the government deficit hysteria and Frank Dodd and all manner of other diversions diverted Congress’s eye away from the ball. Given that real estate was no longer a good speculative cake walk, Goldman induced pensions and other managed money back into commodities. And there you go. $4 gas. They boomed. They bubbled. They exploded. The mother of all tulip bulb hysterias.
And gold is dragged out (again) as the hedge against Chairman Bernanke’s helicopters that will surely induce hyperinflation. (If there was ever a sure bet, the bet against USA inflation has got to be it. But that is a topic for another day.)
The gold shoe will drop. Remember, inflation adjusted gold is still below 1980 levels. Gold has never been a good “investment” against inflation. It is a purely speculative bet because gold has no inherent return. Sure, it is somewhat limited in supply and industrial demand (as well as the demand for bright shiny stuff to attach to bodies) grows. But, still, like all other commodities it suffers from a dangerous predicament: mining technologies improve. OK, maybe not enough to halt rising (nominal) prices over time. But enough to make gold a sucker bet.
Besides, governments have locked a huge portion of the world’s gold supply behind bars. They can let gold out anytime they damned well please–for “good behavior” or just to screw the gold bugs. Whether they will is all political. Betting on politics is a fool’s bet, too. Our gold bug in chief (Greenspan) has been put out to pasture. Don’t count on the Bernanke-Geithner team to continue to boost gold prices. (I won’t go into the rumors that Greenspan helped to stabilize gold prices—using the President’s stabilization fund, yes the same one apparently used to bail out Euro banks so that the money market mutual funds wouldn’t “bust the buck”—as that is a bit too close to UFOs and alien abduction. But I can report that reputable commodities markets experts believe it.) The point is that gold is a tiny market and governments are big players. Remember silver? A bigger market that the Hunt brothers managed to almost corner. Those were two Bush W-like cowboy offspring of a Texas oilman. Do you really want to bet that the world’s central bankers have the interests of gold bugs at heart as they make decisions about the proper price of gold? The US government crushed the Hunt brothers as if they were ants. End of silver boom.
So, no, gold is not money and never has been money. It is a commodity, like Tulip bulbs. Remember what happened with tulip bulbs? Think USB drive sticks. They multiplied. Production costs fell. Prices collapsed. Everyone sold, sold, sold. Yes, central banks will end up with egg on their faces. For most of them, it will be no worse than the Fed’s purchases of toxic waste MBSs. Paper losses, covered by Treasury.
If you’ve got some unused gold, sell it now. You will never regret the decision. (Disclaimer: I do not provide investment advice. If you want investment advice, go to Goldman. They can professionally advise you how to lose your life’s earnings. To them.)
Q2: Didn’t use of gold coins reduce forgery?
Answer: Undoubtedly. But it then led to clipping, weighing, Gresham’s Law dynamics, and so on as discussed last week.
Q3: Can you pay taxes in gold?
Answer: Seriously doubt it. Give it a try. But I’ll give you $32 an ounce and you can use the dollars to pay your taxes. Ship it to me, c/o UMKC (better insure it). And, yes, a dollar is always worth a dollar in tax payment. Much better than gold—you never know what that will be worth when it comes time to pay. So ship gold today!
Q4: Was crying down coins inflationary or did it lead to hoarding and thus was deflationary?
Answer: As discussed, there would be some Gresham’s Law dynamics: you hoard heavy coins and push the light ones in payment. Any coins cried down would be pushed (not hoarded). At the public pay offices (where you paid fees, fines, and taxes) you would experience inflation (deliver more coins to pay your tax debt). From what I understand, the impact on prices in “markets” would not be quite one-to-one. In other words, prices would not necessarily rise fully to take account of the lower value at the public pay offices. But I would say that these historical reports are not conclusive. Still we can surmise that the coins that were cried down probably would fall in value so we’d see some market price inflation in terms of these coins. And “velocity” of them would probably increase as everyone tried to offload them. Coins that were not cried down would get hoarded. But that effect was probably not huge—the historical reports are that crying down was well-understood and even more-or-less accepted as a legitimate means of increasing the tax burden. The story is that the population accepted it so long as it was not done too often. Finally recall that coins had no nominal value printed on them—so the crown had to announce the value at which they’d be accepted. And recall that entire coinages would frequently be called-in for recoinage. It is highly misleading to focus on coins. They were rarely important. Most taxes were paid in tallies (which could not be cried down since the nominal value was cut into stock and stub) and most private transactions took place in bills of exchange or as credits and debits (bar tallies, for example)—again all nominal.
Thanks, again, for comments. Next week: IOUs denominated in the domestic currency: government and private.