What Are Our Stable Money Alternatives?

(This item originally appeared at Forbes.com on April 6, 2017.)




Let’s say that you wanted a currency that was stable in value – one that did not go up or down in value. This is good, because then you don’t molest the economy with the various distortions that happen when currencies go up and down in value. By doing so, you explicitly abandon all the many funny money ambitions that involve, one way or another, purposefully manipulating an economy with a currency that is unstable in value. For this, you need a floating currency.

Once you have a goal, then you naturally look for ways to achieve it. The traditional means to achieve this goal is a gold standard system. The value of a currency is linked to gold. Over many centuries of experience, it has been found that gold is a pretty good real-world approximation of this ideal of stable currency value. It has always worked very well.

At this point, someone usually complains that gold is not quite a perfect expression of stable monetary value. How could it be? Such perfection does not exist in this world. You might think that this would be a good time to stop looking for such perfection, because you have already determined that you won’t find it.

Nevertheless, it seems that some people want to try something new. I would caution against this. The gold standard has an awesome track record. The Netherlands ruled a global empire and became the world’s financial center with a gold standard system. Britain ruled a global empire and became the world’s financial center with a gold standard system. The United States ruled a sort of global empire and became the world’s financial center with a gold standard system. Usually, this sort of thing is what you want to imitate. Do you say: “I want to become a better basketball player than Michael Jordan, because, although he had a great track record, it wasn’t perfect. And, I want to do it by playing basketball completely differently than he did.” Good luck with that.

All right then. Let’s try to achieve Stable Value in our monetary affairs, but not use a gold standard system.

At this point, there is really only one proposal that is on the table. It is a commodity basket of some sort.

This proposal has been on the table a long time. People were making this proposal back in 1816, when the British pound was a floating fiat currency, and the political impetus was building to return to a gold standard system, which was achieved in 1821.

The commodity basket idea is based, from first principles, on a fallacy. Typically, the people who embrace this idea simply assume that a commodity basket is a perfect representation of Stable Value. There is no argument for or against.

Now, once you assume that a commodity basket is a perfect representation of Stable Value, then of course it seems to be superior to a gold standard system, because it is Perfect, and gold is not, because … you assumed so.

I know what you are thinking. You are thinking that it is hard to imagine that anyone could be so stupid. When there is a shortage of wheat, due to bad weather perhaps, doesn’t the market value (the price) of wheat rise? And when there is a bountiful harvest and more than people want, doesn’t the market value fall? Of course. You cannot get more obvious than this. And what if there is something like a major war? The Napoleonic Wars, perhaps, which consumed all of Europe, or World War I? Certainly that might cause an increase in commodity market values?

This is obvious, right? It is supposed to be obvious. So why do people “just assume” that a commodity basket is a perfect representation of stable monetary value, and that any variation in the ratio of commodities to gold represents changes in gold’s value exclusively?

Now, let’s say that you did not make this assumption, and actually tried to get an idea of whether a commodity basket was a better representation of stable value than gold. People have often done this, and to summarize, they have concluded that gold is better. When there is a change in commodity prices vs. gold, you have to ask: “was that due to some change in the market value of commodities, due to the supply and demand for commodities, or was it due to some change in the value of the money, which is gold?” This is a little difficult, because we really don’t have some perfect scientific standard by which we can precisely measure the two side-by-side. But, with some thought, you can come to a reasonable conclusion.

I do not know of one single person, in the last two centuries, who made this kind of careful side-by-side comparison, and concluded that a commodity basket would be better than gold. The only people who come to that conclusion are those who “just assume” that it is true – whose conclusions are based on fallacious initial assumptions.

Let me show you what I am talking about. In 1816, the great economist David Ricardo wrote:

It has indeed been said that we might judge of [a currency’s] value by its relation, not to one, but to the mass of commodities. …

To suppose that such a test would be of use in practice, arises from a misconception of the difference between price and value. …

Nothing is so easy to ascertain as a variation of price, nothing so difficult as a variation of value; indeed, without an invariable measure of value, and none such exists, it is impossible to ascertain it with any certainty or precision. …

Commodities generally, then, can never become a standard to regulate the quantity and value of money; and although some inconveniences attend the standard which we have adopted, namely, gold and silver, from the variations to which they are subject as commodities, these are trivial, indeed, compared to those which we should have to bear, if we adopted the plan recommended.

Here’s Ludwig Von Mises, a century later in 1912, dealing with the same fallacious ideas:

In investigations into the nature of changes in the value of money it is usual to distinguish between two sorts of determinants of the exchange ratio that connects money and other economic goods; those that exercise their effect on the money side of the ratio and those that exercise their effect on the commodity side. This distinction is extremely useful; without it, in fact, all attempts at a solution would have to be dismissed beforehand as hopeless.

Among the commodity-basket people are also a few who are basically soft-money devaluationists. They don’t really want a currency of stable value. They want to be able to apply an “easy money” devaluation solution to some economic problem. But, they can couch their arguments in the language of “stable money,” because “I want to devalue the currency” is a hard sell. Typically, this arises in two situations. One is when the economy is good, but commodity prices are low. This is because, although commodity demand is expanding due to the strong economy, commodity supply is expanding even faster due to new investment, and prices are falling. Commodity users are enjoying the unexpected bounty, but commodity producers – in the past, this included family farms, a huge political bloc – complain that they are unable to pay their bills. Pressure builds for a currency devaluation. This was common in the 1890s.

The other common situation is where commodity supply is not expanding so much, but commodity demand is collapsing due to a broader economic downturn, leading to lower prices. This was common in the early 1930s. Currency devaluation becomes a way to attempt to resolve the broader economic issues.

Now, it should be obvious that neither of these two situations arise because a commodity basket is some kind of perfect representation of stable value. Rather they arise because commodity prices are going down (not remaining stable), because of excess supply in the first instance, and collapsing demand (a recession) in the second.

“Aha,” you say, “but certainly, there must be some kind of other option, some kind of creative statistical what-have-you, that might produce an even better representation of stable monetary value than gold?”

No, there is not. I’ve never seen one. And, I’ve looked. There is nothing. Not even in the form of a back-of-the-napkin scrawl. There are a million and one variants of some kind of soft-money floating fiat currency arrangement – Taylor Rules, nominal GDP targeting, CPI targets, etc. etc. and more etc. These appear endlessly. But, I have never seen one proposal that attempts to do what gold does in a gold standard system, in some kind of improved fashion.

Not one central banker, as far as I know, has ever attempted to create a currency that is even more stable in value than gold, without using gold. Not one has ever achieved it. And, I think it is pretty safe to say that they never will, because, after four decades of having pretty much carte blanche in these matters, it does not seem to have ever crossed their mind. Anyone want to make a bet on the next forty years?

So, those are your options: one based on a fallacy, and an “option” that does not actually exist, even in the form of a proposal. Neither has any kind of real-world track record.

When people are ready to abandon the idea of funny-money economic manipulation, they are ready to finally understand why gold has always been the money of humanity. The Russians and Chinese are there, I think. The Americans and British mostly still want to try the old funny-money tricks, which have never worked, and aren’t going to start working now. If they persist in this silliness, they will eventually be brushed off the world stage, to make way for people who are serious, the way they too were serious, once.