Responses to Blog 13: The Modern Money View of Gold and Gold Coins

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Now you will notice the date—2008—and you might think it is all outdated.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.

18 Responses to Responses to Blog 13: The Modern Money View of Gold and Gold Coins

  1. The notion that currency is an IOU does not fly for me. Currency issue is an act of sovereignty.The relative assets of the soverign, such as control of a geographic territory as a nation state, is a base for that issue. Any State money is fiat, e.g., ordained by law, regardless of its composition. The State government which represents the territory can issue money to buy goods, services and infrastructure construction because it has authority over that territory, by the consent of the governed or their silence, which is agreement. The presence of currency enables exchange of goods and services. The economic activity of citizens builds the collective value of the State's territory and justifies a proportionte increase in currency. To trade outside the State's territory, currency exchange is required to receive or pay in the currency of other soverigns as may be required by the trade itself. In the absence of currency, straight barter is used.Gold and silver, precious metals, are an asset class people go to when soverign money is debased by debt-IOU's in excess of the underlying assets and currency issuance to pay the IOU claims. Real money would have the abiity to satisfy IOUs and lead to a statement that says "Paid in Full."

    • Tom Christoffel
      “The notion that currency is an IOU does not fly for me”

      When people say money is debt they are speaking from an accounting perspective.

      What gives some problems is the assumption that
      1) Federal spending necessitates the simultaneous issuance of interest bearing debt. It does not.
      2) the dollar is not a debt. It is.
      The dollar is a non-interest bearing debt of the Federal Government.

      What they mean by “debt free money” is for government to stop issuing interest bearing debt (which they should do).

  2. You say gold is not money. But surely money is whatever we use as money, whether a commodity or a unit of nominal value. Governments require that taxes be paid in legal tender, but legal tender is not what defines money.You say gold is in a bubble, but all the fiat currencies are collapsing except the Swiss Franc.You speak with great confidence, and I'm loving this blog series, but all the sources I trust disagree with you on the future of gold.

    • “But surely money is whatever we use as money, whether a commodity or a unit of nominal value.”

      No.
      A medium of exchange is a function of money not a definition of.
      Money, whatever is used to represent it (gold, paper, wood, bits & bytes, etc) is debt, it is the debt in which other debts are denominated, ie; the unit of account.

      Gold is gold.

      William.

  3. Tom: think a little more deeply about your claim. OK so you've got some green paper Dollars. US government assets "stand behind those"? Go try to claim your local airforce base. Or the Rocky Mountain National Park. Matslat: think a little more deeply about your claim. So all fiat currencies are collapsing except the Swiss Franc? Really? Collapsing against what? The Swiss Franc? The Franc might be rising, and other currencies are jockying against one another. Some rising against a basket of currencies; others falling. You cannot have all currencies collapsing. I suppose you might mean that gold and Swiss Francs are trending upward against major currencies. OK, so what. What goes up will come down. You need to find other sources to trust on gold. Most self-designated authorities on gold have a dog in the hunt, you know. LRWray

  4. matslats,You speak with great confidence, and I'm loving this blog series, but all the sources I trust disagree with you on the future of gold. Dude, no. In the long run, gold tends to return to a relatively constant purchasing power against a basket of basic staples, like wheat. It's way over that right now. Other things equal, the price of stuff in general tends toward the cost of production over time.So if the traditional role of gold persists…you're going to lose money if you buy and hold at current prices. If the traditional role of gold doesn't persist, and the price becomes a product of the cost of production and its value as an industrial and decorative material…you're going to lose even more money. If you expect all currencies of the world to fail, that's still not a compelling reason to buy gold: you might see it rise in terms of the failing currencies as things fall apart, but you have no idea what the purchasing power of the metal will be after the fact. If one really were such a super pessimist, there must be more practical things to put one's resources toward.

  5. "I was the only economist they could find willing to say “it is not supply and demand”"Ha! Krugman was a culprit of this rubbish for ages. He had no idea how the commodities markets operated and when he discussed it he used to trot out the old 'supply and demand-cross from undergrad textbooks to 'prove' his point. Whenever people ask me why I dislike Krugman I direct them to that post — doctrinaire, much?More seriously though, I doubt I'm the only one who would like to hear about that escapade you spoke about. Maybe a blog post on NEP sometime or something?Finally, although this is typically an impossible call: what do you think caused the 1980 bubble and what do you think popped it? I've looked into it and I've always thought the cause was crazy Volcker era monetary policy inducing general nervousness — but then, it was trending before that; inflation hysteria, maybe? No idea what popped it. Thoughts?

  6. @ matslats"You speak with great confidence, and I'm loving this blog series, but all the sources I trust disagree with you on the future of gold."When ALL the sources you trust agree that rapid price increases in a good are not the inflation of a bubble… it's probably a bubble.Remember housing? ALL the trusted people, from the banks to the realtors simply 'knew' that the prices wouldn't stop even when they passed the moon. And who turned out to be right? Dean Baker and a few other random economists.There's a lesson in there somewhere: never trust your mechanic!

  7. Hey Philip and also Anon: thanks and i agree with your points.On my "bit part" I do not want to make it more than it was. There were commodities mkt experts who were telling the staffs of both Lieberman and Stupak that it was NOT supply and demand. The most important voice was Mike Masters–who gave a series of testimonies. The problem was that all the academic economists were trotted out to say he did not understand basic econ: it is all supply and demand. I had met Mike through Warren Mosler, and had actually started to Stupak offices also supplied important info (I cannot divulge more). Armed with what they needed, Lieberman and Stupak were prepared to go after the speculators–and pension funds got scared. No legislation followed because the mkt collapsed. Anyway, that is the short story. Maybe I will write a longer version–but I really recommend you look at Mike's stuff (cited in my paper).

  8. Sorry: I lost a line in the post above: should read something like: I had met Mike through Warren Mosler, and had actually started to write a piece on the commodities bubble back in 2004 but could not get the data. Meanwhile, Mike collected terrific data on pension funds (mostly) flowing into futures contracts. That supplied what I needed, so I began again in early 2008. Stupak offices also supplied important info (I cannot divulge more).

  9. @ LRWrayMaking my way through the paper now. Very comprehensive.Do you think the commodities boom will require substantial bailouts when it busts?And any chance you could have a quick look at my 'gold in the 80s' question in my first comment?Thanks.

  10. RandallDo you know Greenberger for University of Maryland? He points out commodity speculation took off in 90s largely due to deregulation. I didn’t realize it was a problem during the 1929 collapse and FDR instituted rules for preventing speculation in the futures market. And I would add in addition to de-regulation, this speculation has been inadvertently aided and sustained by declining/low interest rates the Fed pursues (or must pursue to keep interest servicing costs low). This is a recent interview he gave. http://www.youtube.com/watch?v=t3Xl0L21PjUAlso Dan Dicker an ex future trader book “oils endless bid” talks about the speculation problem in commodities.

  11. Phillip I believe the 80s bubbles was initially aided by negative real yields (nominal – inflation rate) much like we have today. The 80s had both higher nominal and inflation rates but the spread was declining and negative like today. There were supply shocks in 80s but you might want to check out Summers (ex Treasury secretary) thesis on Gibson Paradox. Gold Bugs use that paper as proof that gold is manipulated by government. But it more important to note that a declining real rate makes bonds present value decrease (negative real yields mean a negative NPV). Bonds in these conditions are less attractive option for wealth preservation as inflation erodes the value of the bond. So commodities become a hedge for inflation (but the correlation tends to be greater when real yields decline so it maybe more accurate to think of commoditities as a store of wealth than an inflation hedge).At some point as price climbs, everyone jumps in and leverages up the commodities. And in 80's Volker increased the nominal rates beyond inflation which brought real yields back to positive collapsed the speculation/bubble.But inflation/hyperinflation scares makes a more simple to understand and effective wall street fear mongering pitch to get investors into commodities bubble. Rather than a more pragmatic pitch of during declining or negative real yields, some commodity exposure may make sense as a "store of wealth"

  12. Randall I tend agree with the outlook on Gold.I do believe that politicians/fed are scared what would happen if people truly understood monetary policy (print prosperity). And therefore put forth this game of deficits/debt misinformation to obscure reality. Maybe I’m reaching but this helps to explain why the fed/treasury retains its horde of gold. That is, it is an unnecessary security blanket.I also think gold has a bit to go. I'm looking for sufficient consumer leverage to be applied like we saw during Nasdaq (stock on margin) and housing bubble (ponzi mortgages) before we have our Minsky moment in gold. That is when people start buying gold with their credit card….

  13. It seems particularly generous for Prof. Wray to entertain even massively ill-informed statements, though in this particular topical domain several of these entries seem to be more ideological than having any serious interest in the content, history or application. If I recall correctly, matthew slater is a programmer whose income derives from promoting debt based community currencies through CommunityForge, particularly in Europe. As such little interest in comprehending MMT etc can be expected because of a basic conflict of incentives in favor of pop level economics. Ie I expect that there is more of a contrarian motive than a serious interest than not. Perhaps the Pauls and Thomas Greco will show up as well to refute MMT. Thank-you Prof. Wray, impeccable as usual even to an insertion of dysinformation posing as an opinion earned through education.

  14. Thanks for comments, not much more to add. I have not studied the 1980s commodities boom at all. Probably were some dynamics as discussed by Jeff. Goldbugs out in full force pitching gold as inflation hedge. Plus Hunt Bros running up silver–so demand would move to gold, too.Greenberger was one of the heroes leading the charge against Goldman, et al, speculators. And at least some of that time, he was an insider (regulator) trying to do something but stopped by an administration that had no interest in regulating. Yes, I know him and I also recommend all of his testimonies.Let me just say that LETS (local currencies) and MMT are compatible. The LETS people just need to get some taxes behind their local currencies.

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