Searching for a Simple Financial Truth

There is something about gold that attracts people.  It became the currency of choice for the Eastern and Western hemispheres before either one knew the other existed. Of course, its attractivness sciews judgement and creates hubris.  Governments have always enjoyed hording the stuff.

In the beginning, Roman coinage was worth the amount of gold it had in it.  As the government spent more than it grossed, they began to put less gold into their coins.  Eventually, the people wised up and realized that the coins weren’t worth as much as they once were.  Inflation began and so did decline.

There was a time when an America could take a dollar bill to the treasury and get it’s value in gold.  No more.  In fact, it’s illegal to own a lot of the stuff because the government wants to protect it’s monopoly on the money supply.  But what does that mean?

Despite reading quite a bit about this stuff, I still don’t understand how the Treasury and the Federal Reserve work.  I know the Treasury manufactures money, which is disconcerting in its own right because if someone forgot to turn the machine off at the end of the day, we’d all wake up and our money would be worthless.  I also know the Federal Reserve ‘regulates the money supply’ by determining interest rates and regulating reserve requirements, I don’t fully understand what they’re doing with treasury bonds?  And who makes sure the Fed is doing it’s job properly?  When did we decide the Fed could spend tax payer money (or am I deluding myself and it’s really government money?) to save one businesses but not the other?  Who regulates the Fed and makes sure they’re doing their job properly?

Basically, the point I’m trying to get at is this. Nothing in this world is free.  When government does something, there is always blow back, somewhere, sometime.  Right now, despite our ‘free market’ the government is influencing the financial markets from countless angles and things are spinning out of control.  If we were still on the gold standard, or a modified version of that system, would that allow the government to play a less significant role in the economy?  Would that create less incentives for financial service professionals to influence government policy? Could that pave the road for more honest regulation?

4 thoughts on “Searching for a Simple Financial Truth”

  1. Your claim that gold was the “currency of choice” among Eastern and Western civilizations prior to contact with each other is patently false. While the Romans did use some gold coinage, it was mainly used to finance large state debts for military incursions. Silver and bronze were the primary coinage for everyday trading and purchasing, as they were vastly more abundant. The Greeks never used gold, but exclusively silver for their mints. The Chinese also used some gold, but were extremely innovative in devising new economic standards, starting with sea shells in the first millennium BC and ending with paper money by 1023 AD. Why is this relevant? Because it demonstrates the historical fallacy that ancient governments had it better with value-based money.

    Precious metals are precious simply because of their scarcity. That scarcity allows them to hold a moderately fixed or increasing value in relation to other commodities. The demand for currency causes the price of precious metals to rise to that point, because of their ability to be minted as coinage. The problem with value currency, as governments found out, was at least two-fold. First, shaving coins became extremely common as it allowed the holder of valued money to remove some of its value while still trading it at face value. This in and of itself caused inflation as the coins in circulation lost value and the amount of currency in circulation decreased. The second problem is that of capital flight. If your economy requires a certain amount of capital to function with liquidity, then value-based currency can never leave – or must leave and enter with the same frequency. Governments can do a decent job of maintaining this system in peacetime, but almost always fall apart during conflicts. As the state tries to finance massive war debts, it may drain its economy of capital to the point where it no longer has liquidity. Ancient civilizations like the Romans, Greeks, and Chinese found that they had to rely on multiple sources of currency in order to prevent this from happening – gold for state debt, silver for market trading, etc. In modern times, at least starting in the 18th and 19th centuries, war debts and taxation operations became so massive that paper money based on the system of “fiat currency” became necessary to ensure liquidity and prevent inflation.

    If you avoid the problem of coin-shaving by creating paper, or valueless, currency, it forces the state to have control over the vast majority of the precious metal. Otherwise, if the metal were to leave the state through international trade, there would be no market liquidity as the currency would be a held value for nothing. During the Great Depression, when American citizens lost faith in the economy and the value of paper money, they attempted to exchange all of their money in return for gold. The problem with this is that it makes the federal government insolvent as it loses its possession of the precious metal and its ability to print more money. Franklin Roosevelt was the one who banned the possibility of exchanging your money for gold precisely for this reason.

    Inflation did rise in Rome prior to its collapse as the center of European and Western Asian power, but there is no concrete thesis as to whether or not this inflation triggered the decline. More likely than their financial system as cause for their fall is their military over-expansion. Somewhat of a relevant difference considering the policy choices (economic, foreign) that voters should consider in the upcoming election.

    You implicitly argue that this inflation-decline scenario could be a factor for understanding the current economic predicament of the United States. The simple fact of the matter is that the economy of the United States is beyond any one individual’s grasp. The complex and hidden trading that occurs at all levels of the American economy makes it impossible for any one idea, like returning to a gold standard, to be either predictable or feasible. Inflation during the Roman Empire could be narrowly defined and adjusted accordingly, because of the relatively small fixed amount of precious metal in the market. This is a luxury the United States no longer has. The global capital markets require fiat currency to function. If you are anti-globalization, then a gold standard makes some amount of sense. However, there are vast drawbacks to creating rigid trade blocs that far outweigh the credit crunch the United States is facing right now. The investment banking paradigm simply is untenable, and I’ve thought that for years. I believe that regulation is what is necessary to prevent companies from financially bankrupting the American Treasury as it retroactively tries to patch holes made by such massively leveraged debts.

  2. That was sort of a mess of ideas, but hopefully my point that both value-based currency and the gold standard are not feasible and are detrimental financial systems as compared to the fiat currency system that the globe currently operates upon.

  3. If one had to pick a single precious metal for currency in the ancient world, gold was that choice. There were many precious metals. For simplicity’s sake, I choice to say gold, which was a mistake because people used a lot of precious metals. Obviously though, my point was that civilization started with value-based money, as you point out.

    I think it’s lazy to say ‘regulation is what is necessary.’ Clearly we need more regulation. What I’m wondering about it the frame (or maybe the ‘foundation) of our economy. The most influential institution in our economy is the Fed. Their power has been steadily growing since their inception in 1913. The organization itself is hardly discussed in the media except for when it makes a ruling.

    My question is this (and please treat it like a question instead of an assertion like you did my previous questions): when a once in a life time financial crises occurs, isn’t it time to reevaluate the most influential institutions within finance?

    Regulating a fundamentally flawed marketplace isn’t going to solve any long term problems. The logical first step is to ask whether or not our marketplace is fundamentally flawed. What would make our marketplace fundamentally flawed? The Federal Reserve System and the Treasury. Aren’t these the two most influential organizations? Shouldn’t we use this as an opportunity to investigate whether their actions and/or existence lead to our current problems?

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