Commentary: Interim piece on monetary standards

I am no economist, but it occurs to me the multitude of articles and countless economists deriding metallic and bimetallic standards do not understand what was being attempted previously in doing so. The way I see it, every previous attempt to ‘standardise’ any monetary unit (by whatever means, using whatever commodity) was an attempt to cap or somehow limit its own devaluation as caused by increasing its volume of issue (base). One aspect of this increase is due to interest rates – since interest is rent, and rent seeking diminishes the working capacity of any currency unit by effectively reducing the circulation of money stock. No mechanism could and/or would prevent the devaluation of a currency when stock replenishment is required frequently to account for the proliferation of rent seeking. Monetary standards attempt to preserve the value of the monetary unit – period. Real entrepreneurs (not the flashbang 21st century IPO schemers, known as the bubble factory) seek to create ‘enduring value’, a fading tradition that is almost extinct. Measured in quanta of monetary units, fiat money is simply a number, and by no means is it any store of value in and of itself. It’s capacity to purchase is forced to diminish with time.

For me, the establishment of monetary standards was an attempt to prevent (or at least control) this destruction in the value of the ‘fiat’ that it sought to protect, by backing it with something tangible. A noble gesture perhaps, but it is the next best option to free and unrestrained (unsecured) currency issuance (profligacy, as we see today) that without a tangible value of reference (of something, anything) would accelerate the destruction of that monetary unit. (Recent exhibits: Weimar republic, Zimbabwe, Mexico – in no particular order or preference)

The early gold standards (of 1900 to 1930) fixed the price of gold against an increasing supply of money stock. This meant that the reserve value of sovereign gold held against that rising money stock could only increase by increasing the volume of reserves. This meant pressuring gold producers to maintain margins against the rising pressures THAT WERE INDUCED by this rising money stock. Eventually (it should be obvious) gold producers HAD TO get squeezed out of supply due to diminishing returns on lower gold grades, rising production costs and lower revenues due to lower volumes and still, a fixed sale price for their gold.

What the early gold standards imposed was to force gold producers to cherry pick the richest, most easily accessible gold reserves in order to satisfy margins imposed by a fixed gold price. Held against the reality of rising monetary stock (fiat), this was only ever going to fail. Moreso, it failed to prevent the devaluation of the fiat paper. This is because NOTHING can prevent it. Money is a number, and is not a measure of enduring value – except for diminishing value. The gold standard using a fixed gold price had to fail, since the money stock (and levered credit market) it was attempting to protect kept it’s ever upwards issuance (replenishing ever more rent seeking from increasing debt issuance) while sources for gold dried up. Maintaining a gold reserve ratio became futile, but only until the upward growth of unsecured monetary credit became unsustainable. Only then, was something done.

The conditions that we have today, with a competitive open market gold price, does not mean we do not still have a gold standard. It is possibly how a gold standard was always meant to be, since it allows greater flexibility in maintaining gold reserves backing a monetary unit. Historical valuation of the US gold reserves serves as a benchmark for how the gold standard continues to satisfy the best interests of the US Treasury. The stock of US sovereign gold remains to be a measure of credit worthiness of the US, and this presents only an advantage for the US Treasury. Since fixing the quantity of gold reserves from about 1980 (post 1971 with open market gold trading) – the value of the US Treasury gold reserves has raised in accordance with the increase in monetary stock of US fiat (being otherwise worthless, nonredeemable Federal Reserve notes). It is only by virtue of these gold reserves, that the US Treasury maintains the increasing issuance of USD denominated debt to foreigners, in honouring the obligations of the US as measured against the amount of US debt issued.

Without other legal recourse available to foreigners to claim US debts via the transfer of some other inalienable property rights, it is only the perceived worth of the USD fiat currency that prevents a collapse in foreign interest in purchasing ever more US debt. In this modern era of globalisation and open market access, the idea of holding paper reserves is taking a back seat to risk and short term opportunity, since holding any paper currency only ever depreciates in its purchasing capacity in the long term in the presence of any positive nominal rate of interest (rent).

Perhaps it is for this reason that the US Federal Reserve is experimenting with an extended and sustained Zero Interest Rate Policy (ZIRP). However this only reduces the interest on base money stock available to its member banks. The primary bank market remain as rent seekers in collecting a premium interest rate that still reduces the working capacity of the total monetary stock. So nothing further will change until the structure of these (mostly private) member banks change. They are still collecting the overhead of excess interest rate, however it may be justified. Only now, there is no benefit to being able to collect this interest by the Government responsible for issuing and circulating the currency.

From an opening passage on monetary standards, by R. G. Hawtrey (1919)
WHEN we speak of a monetary standard we mean that which regulates the value or purchasing power of the monetary unit. The monetary unit is the unit for the measurement of debts. A debt is an economic relation which requires to be expressed as a number or quantity, and, in order that it may be so expressed, it must be expressed in terms of some unit.
Now the subject matter of debts is wealth. They arise out of transactions in wealth, and are extinguished by transactions in wealth. A sale of goods or a service rendered makes a debtor and a creditor. The debtor can extinguish his obligations, the creditor can satisfy his claims, by another sale of goods or service rendered. Such goods and services are wealth, and have value. The unit for the measurement of debts must be a unit for the measurement of values.
The monetary standard is therefore commonly called, and quite rightly called, the standard of value. But it is a mistake to suppose that it is merely a standard of value, no more than a unit for the comparison of different items of wealth. Such a standard of comparison would be in itself something conventional and non-essential, for, so long as the same unit were chosen within the limits of each comparison, it would not matter what the unit might be, or whether different units were used for different comparisons.
Debts, on the other hand, are the very foundation of the econo- mic system, and the existence of a network of debts, calculated in a certain unit, is an important and substantial fact. The true function of the monetary standard is so to regulate the unit in which debts are measured as to maintain the stability of that system. Prices, which measure the value of commodities in terms of the unit, and inversely therefore the value of the unit in terms of commodities, are themselves potential debts. The quotation of a price is an offer, the acceptance of which completes a contract and gives rise to a debt.
The characteristic of the ideal unit for the measurement of debts is that it should have the same meaning when the debt is discharged as when it is contracted.

Agreed. As an Engineer, it is easy to consistently think of systems in terms of capacities, abilities and mechanics. The monetary system is no different. Its ‘capacity’ is measured a number of different ways, but it has output, efficiencies and inefficiencies. To me, the raw capacity of money (cash/fiat/credit) to do real work for the benefit of the sovereign is not tied to any monetary/metallic base. However the endurance of that capacity to be maintained in an environment where MORE money (base) is constantly issued, is most certainly underpinned/underwritten by something else that is tangible and of enduring value. Without being underwritten, the fiat currency must eventually succumb and collapse due to a lack of faith in its capacity to measure any realistic value.

Inflation is a result of an oversupply of monetary credit (including circulating currency), not caused by the amount money in circulation. Inflation is a measure of lending standards, that promotes and enables the use of money but also accelerates it’s demise in the absense of some other appreciating backing medium – whatever that happens to be.

This is saying nothing of fluctuations in the the demand side by Governments in replenishing/adding to reserve stock. Also, given the often combatant and competitive historical relationships between nations, supplying or selling as an export trade would have been subject to the whim of foreign policy of the day. So the capacity of gold to sufficiently stabilise economic prosperity in an era of advancing monetary systems and growing GDP’s would have been hampered. But I doubt that was ever the stabilisation mechanism many have derided. Any monetary standard has nothing to do with how that monetary unit is utilised, circulated and leveraged (for credit), since having a standard is merely a measure of reserve capacity and credit worthiness I believe.

Regards,

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About atradersrant

Self-employed private trader of equities, commodities and FX for income and investment; Follow me at your own risk! I provide analysis of major market & economic trends .. with too much commentary on fraud and corruption that is rife in the open market.
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One Response to Commentary: Interim piece on monetary standards

  1. Pingback: The reality of inflation, deflation, currency, and credit | power of language blog: partnering with reality by JR Fibonacci

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