Sun Sep 8th, 2013 at 12:15:58 AM EST
This diary was prompted by the ongoing discussion in Chris Cook's Credit, Currency and Other Animals and specifically, by Drew Jones' comment below:
How are the outcomes any different from other fixed currency regimes? You're still fixing the currency to a "commodity" whose value is disconnected from your country's macroeconomic needs in the name of achieving some imaginary "true" value.
We got away from fixed currencies for a reason. The Eurozone is currently engaged in a fine display of why we did so.
The problem is that so few people understand money, banking or 'money and banking'. Early 20th century monetary economists such as Irving Fisher, John Maynard Keynes and Allyn Young clearly understood the problems of the gold standard. The UK only really came out of the Long Depression when large quantities of gold started coming out of South African mines. Then prices started rising again. It was the financial collapse of 1873 which led Walter Bagehot to write Lombard Street
, describing how the banking system of the day worked to assure that cash flows were available to meet cash demands.
Part of the problem we have in understanding the current ongoing crisis is that we have taken our eyes off the money. Another perhaps related part is that we have no generally acknowledged set of rules for managing the money supply of individual currencies, let alone rules for managing a global financial system. Still another part is that this lack of rules is loved by some very wealthy individuals and organizations and they have learned to exploit it to their advantage. This all makes solving this problem more difficult and can render even discussions of the subject fraught.
In The New Lombard Street Perry Mehrling describes his view as being based on 'the money view' and notes:
...a fundamental premise of this book is that a "money view" provides the intellectual lens necessary to see clearly the central features of this multidimensional crisis. The reason is simple. It is in the daily operation of the money market that the coherence of the credit system, that vast web of promises to pay, is tested and resolved as cash flows meet cash commitments. The web of interlocking debt commitments, each one a more or less rash promise about an uncertain future, is like a bridge that we collectively spin out into the unknown future toward shores not yet visible. As a banker's bank, the Fed watches over the construction of that bridge at the point where it is most vulnerable, right at the leading edge between present and future. Here failure to make a promised payment can undermine any number of other promised payments, causing the entire web to unravel. (p.2-4)
Mehrling goes on to describe how 'the money view', which was what Walter Bagehot described in the late 19th century in Lombard Street
, has come to be eclipsed over the last six decades, first by 'the economics view' and then by 'the financial view'. These terms are Mehrling's analytical constructions:
On the one hand we have the view of economics, which resolutely looks through the veil of money to see how the prospects for the present generation depend on the investments in real capital goods that were made by generations past. On the other hand we have the view of finance, which focuses on the present valuations of capital assets, seeing them as dependent entirely on imagined future cash flows projected back into the present.
The Institute for New Economic Thinking has sponsored a course in Money and Banking, offered by Perry Mehrling through Barnard College, Columbia University, and online through Coursea in which I have enrolled. The first reading assignment are three topics on the history of banking by Allyn Young, available in PDF through the online course.
When England and the USA were both on the gold standard in the 19th century economists complained of the problem that the money supply depended on mining discoveries. But, none-the-less, gold remained the best reference for value they could identify. And it was one of those commodities, unlike grain, that the wealthy would keep acquiring regardless of how much they already had. The gold standard had limitations but using it made monetary economics and international trade settlement pretty much mechanical applications of known laws. Countries stayed on the gold standard when they could.
Allyn Young described the workings of the monetary system under the gold standard in a series of anonymous sections in The Book of Popular Science by Grolier Society in the 1920s: The Mystery of Money - how modern methods of making payments economize the use of money. the role of checks and bank notes - The enormous edifice of credit; Mobilizing Banking Credits - the drastic reform of the banking system of the United States - Possibilities of the Federal Reserve; and Dear and Cheap Money - The Bank of England and the mechanism of the London Money Market - How the foreign exchanges operate. Together they offer an excellent brief history of money in the US and the world as of 1929, (57 pages total). Allyn Young was a low profile heavyweight in monetary economics in his prime at the time of his premature death in 1929 in London of pneumonia.
Young described how the US banking system developed the capability to expand and contract the money supply in order to deal with large seasonal requirements for credit at harvest time and how any but trade imbalances persisting over several years were dealt with by the London Money Market - on the gold standard. While all combatants during The Great War but the USA abandoned the gold standard they felt compelled to return to gold when possible. This again failed in the 1930s.
My view is that the limits of the gold standard increasingly bit as the market system spread into all aspects of various societies and as subsistence agriculture ceased to be a reliable fall back for all but a tiny portion of the population. The problems with the gold standard emerged during downturns. Subsistence agriculture played a significant role in the US during the Great Depression of the '30s. It fed people who could not otherwise have afforded to buy food and allowed them to use what money they could earn to pay the rent. But, even so, it became necessary for all countries to abandon the gold standard during the 1930s in order to have the flexibility to deal with the pressing needs of their citizens by expanding the money supply without respect to the supply of gold available. This consideration became even more pressing as WW II approached and, with it, the need for rearmament.
The gold standard was finally abandoned because it became unsustainable and because a minimally acceptable alternative emerged. At Bretton Woods Keynes proposed a technically workable system of international settlement that was based not on gold but on a mechanism to enforce balanced trade, but the USA shot that system down for reasons of power politics. The USA had financed the successful prosecution of WW II and wanted to continue to dominate the world economically. The USA had the largest gold reserves in the world and so a gold based settlement system was adopted for international trade, with the gold price being US$35 per ounce, other currencies were denominated with respect to the US$ and trade balances continued to be 'netted out' where possible.
This worked acceptably into the 1960s, in large part, as Yanis Varoufakis has noted, because the USA recycled its surplus through aid and foreign investment. International trade balances turned against the USA, in no small part due to US expenditures both on the Vietnam War and Great Society social welfare programs - LBJ's 'guns and butter' policy, and, in 1971 President George Pompidou, seeing that soon the USA would not be able to settle trade deficits in gold, sent a French warship to New York to retrieve French gold. This led Nixon to close the gold window, or end gold convertibility, on August 15, 1971. Other countries didn't like this, but world trade did not collapse. And the US dollar went from being the gold backed reference standard of monetary value to being the de facto world currency even though it was a US fiat currency. Needless to say this was acceptable to the USA. The communist 'Second World' had their own arrangements and some 'non-alligned' countries, notably India, dealt with the situation by minimizing their involvement with the USA.
Fortunately for the USA oil was priced in dollars and was the single most important item of international trade. In addition European countries had accumulated large quantities of US Dollars or Eurodollars and Japan Europe were starting to export significant amounts of manufactures to the USA a trade that was denominated in dollars. This hasn't 'solved' the problem in any fundamental sense and the world economy has been in a prolonged 'muddle through' ever since.
We have developed a practical framework for international settlements through the Bank of International Settlements but we have not developed any widely acceptable means of controlling the world money supply or verifying the integrity of 'systemically important' banks and other financial establishments, let alone resolving 'systemically important' insolvent banks and financial establishment in the face of an international monetary crisis.
Our money supply is no longer bound by the limits of the gold standard and the amount of available gold yet we continue, in many important ways to act as though we were still on the gold standard. And we have disaggregated monetary inflation into consumer price inflation, however defined, on which governments focus compulsively, especially when it involves 'wage push' inflation, and asset price inflation, variously defined but typically including real estate, stocks, bonds and other financial instruments, especially derivatives, most of which are studiously ignored by governments and left largely unregulated or 'self regulated' as a playground for the enrichment of the already wealthy and the despoliation of the rest.
The current global system of finance is poorly understood and much abused by those who do understand it. Keynes' system of settlements by forcing individual nations to have balanced trade over time retains its practicality and appeal but adoption is and will be opposed by a wealthy few who benefit from the existing mostly unregulated global system of finance and by countries such as the USA, Germany and China who are current beneficiaries, though for different reasons. Transcending this impasse remains our biggest challenge.
Update [2013-9-8 11:11:20 by ARGeezer]:Changed De Gaulle to Pompidou