Stability of Gold Standard and
its Selected Consequences
Michal Kvasnička
Masaryk University Brno, Faculty of Economics
qasar@econ.muni.cz
http://www.econ.muni.cz/˜qasar/
Rationale for Presentation
Sound money is of key importance for good performance of the free
market system.
Austrians prefer gold standard and free banking.
most difficult for the government to manipulate
historically very stable
low price inflation / deflation
mild trade cycles
Question
Does the historical stability guarantee its present stability?
Answers:
Rothbard, Hülsman, Hoppe, Selgin, White, . . . —Yes, without
questioning
Me: No—we need an analysis
This is the analysis.
The message to be delivered is simple, but sad.
Structure of Presentation
Rationale for the presentation
Model of gold standard
Dynamics of gold standard
Selected consequences
for fractional free banking
for monetary reconstruction
Model of Gold Standard
Many standard models:
Barro (1979)
Dowd–Sampson (1993)
Chappell–Dowd (1997)
White (1999)
We will use White’s simple graphical model.
Assumptions
We assume:
stationary economy
closed gold economy or international gold standard—gold can
flow without any cost
money is piece of gold or redeemable claims on banks
bank money is money substitutes or fiduciary media
money multiplier is unity or higher
money measured in troy ounces
gold used as money and for non-monetary use
gold can flow between these uses freely
(free coinage, free melting down)
purchasing power of gold is the same everywhere and in every
use
purchasing power of gold is ppg = 1/P
Purchasing Power of Gold
Purchasing power of gold (ppg = 1/P ) is determined by the demand
for money and supply of money.
Or: by demand for monetary stock of gold and supply of monetary
stock of gold.
Md = Ms,
d
s
Gm
= Gm
ppg
ppg∗
(1)
s
Gm
E
d
Gm
tr. oz.
Demand for Monetary Stock Gold
Demand for money is
M d = P · Φd (Y , π , . . .)
(2)
(+) (−)
Demand for monetary stock of gold is derived from the demand for
money
d
Gm
= M d /µ = P · Φd (Y , π , . . .)/µ
(3)
(+) (−)
Demand for monetary stock of gold
rises with price level (decreases with ppg)
rises with aggregate product
decreases with inflation
Demand for Non-monetary Stock of Gold
Demand for non-monetary stock of gold is demand for its nonmonetary non-consumptive use.
Gnd = Gnd (P , . . .)
(4)
(+)
Demand for non-monetary stock of gold
rises with price level (decreases with ppg)
(may depend on aggregate product, . . . )
“Supply of Monetary Stock of Gold”
There is stock of gold Ḡ at the economy at a moment.
The part of the stock of gold that is not demanded for stock nonmonetary use is supplied for monetary use:
s
s
Gm
= Ḡ − Gnd (P , . . .) = Gm
(P , . . .)
(+)
(5)
(−)
“Supply of monetary stock of gold”
decreases with price level (increases with ppg)
Changes of Total Stock of Gold
Total stock of gold Ḡ is not constant over time.
New gold is mined at every moment:
g s = g s (P , . . .)
(6)
(−)
and some gold is consumed at every moment (production of computer circuits etc.; wear and tear of coins):
g d = g d (P , . . .)
(7)
(+)
Changes of Total Stock of Gold (continued)
If more gold is mined than consumed, the surplus is added to the
total stock of gold Ḡ; in opposite case it is subtracted from it.
ppg
ppg∗
gs
e
gd
tr. oz./year
Stationary Equilibrium
Under our assumptions there exists a stationary equilibrium.
ppg
g
ppg∗
s
ppg
s
Gm
e
E
d
Gm
gd
tr. oz.
tr. oz./year
“Stock market” determines the actual price level.
“Flow market” determines the stationary price level.
At the stationary equilibrium one price level clears both “markets”.
Change in “Stock Market”
A change in the “stock market” changes price level only temporarily.
Let us assume a decrease of the demand for monetary stock of gold.
✓
g f h
Change in “Flow Market”
A change in the “flow market” changes price level for ever.
Let us assume an improvement in mining technology.
✓
g f h
Dynamics of Gold Standard
We are interested in the speed of the transition from one equilibrium to another one.
The speedier the transition, the higher problems caused.
Speedier transition is associated with
higher price inflation
higher relative (percentage) change in the stock of money
⇒ more severe trade cycle
Determinants of Speed of This Transition
Determinants of the speed of the transition form one equilibrium to
another one are many (price elasticities, . . . ).
Nothing can be said in general in most cases—it is an empirical
question.
One determinant is systematic—the size of the monetary stock
of gold.
We will concentrate on it.
Why Size of Monetary Stock of Gold Matters
It is important because it is independent of the surplus (or deficit)
of gold at the “flow market”.
ppg
g
ppg∗
s
(g s )0
e
ppg
s
Gm
s 0
(Gm
)
E
d
Gm
gd
tr. oz.
tr. oz./year
The lower the monetary stock of gold, the higher the percentage
change of the stock of money (ceteris paribus).
Numerical Case
Let us assume a non-monetary shock that causes a surplus of newly
mined gold over its consumption 1 mil. tr. oz.
gs − gd
Gm
%∆Gm (aprx.) π (aprox.)
1 mil.
1 mil.
100 % (less)
100 % (more)
1 mil.
1 bil.
0.1 %
0.1 %
Monetary stock of gold acts like a cushion—it stabilizes economy
against non-monetary stocks.
Formal Analysis (For Those Who Like It)
Price level at a moment is
P =
µ · Gm
Φd (Y, π, . . .)
(8)
Then rate of inflation is
Ṗ
g s − g d − Ġn Φ̇d (Y, π, . . .)
π= =
− d
P
Gm
Φ (Y, π, . . .)
(9)
The lower the monetary stock of gold, the higher the price inflation.
(The second term destabilizes price level further.)
Conclusion
The higher the monetary stock of gold, the higher the percentage
change of the stock of money caused by an imbalance at the “flow
market”.
The higher is the percentage change of the stock of money the faster
is the transition form one equilibrium to the other.
And
the higher price inflation / deflation
the more severe trade cycle
Consequences
Let us explore consequences for
fractional reserve free banking
monetary reconstructions (attempts to resume the gold standard)
Mature Fractional Reserve Free Banking
Free banking of the Scottish type proposed by White and Selgin
economizes on gold reserves.
It lowers reserve ratio from 100 % to 2 % or smaller (White, 1999).
It cannot make permanent inflation when the final reserve ratio is
attained.
It can undermine stability of the gold standard (if widespread)
because it lowers the monetary stock of gold (50×).
⇓
Historical evidence from time with much higher reserves is not sufficient to prove this kind of banking would be stable enough.
Monetary Reconstruction
Rothbard, Hülsmann, . . . proposed plans to reestablish the gold
standard. (Hülsmann: independently.)
Finding the first stationary equilibrium may be painful problem—we
will neglect it.
Problem: If the gold standard is reestablished only in a small open
economy, it would be horribly unstable—its monetary stock of
gold would be tiny in comparison to the world gold flows.
It would be even worse nowadays because
central banks have a lot of gold—they may sell it
non-monetary demand for gold stock includes foreign private
reserves to hedge against inflation—it can be highly unstable
Monetary Reconstruction (continued)
Monetary reconstruction must be done at once in many countries
of a significant economic power.
(Which makes it even more improbable in the near future.)
Thank you for your kind attention.
Any questions, comments, or hints?
Michal Kvasnička
qasar@econ.muni.cz
http://www.econ.muni.cz/˜qasar/wp.html