Reply To: Why is gold falling?


The argument of your Keynesian friend is illogical. He is saying that the volatility in the dollar price of gold, which is not money, is due to the vagaries of the valuation people make of gold but not the value they make of the dollar, which is money. But if the value of money cannot be the source of the volatility of the prices of goods, then in a gold standard, i.e., when gold coins are money, the valuation of gold coins cannot be the source of volatility in the prices of goods either.

As to the “prediction” that the Fed’s expansionary monetary policy in the wake of the crisis would cause price inflation, the jury is still out. The Austrian theory of money explains that the purchasing power of money is determined by the Total Stock of money and the Total Demand to hold money, just as the price of any other good is determined. The money stock in our economy is money proper (i.e., Federal Reserve Notes printed by the Fed) plus money substitutes (i.e., on demand, at par redemption claims for money proper) issued by banks and other financial institutions. In the wake of the crisis, the Fed bought assets from banks and paid with reserves (cash and demand deposits at the Fed). In normal times, the banks would issue a multiple of fiduciary media on top of their reserves. But instead, banks have held excess reserves. Thus, the money stock has not expanded as some anticipated it might. Moreover, the demand for money has increased, as it often does during a downturn. This has moderated the reduction of money’s purchasing power. The jury is still out on whether the potential for monetary inflation in the form of excess reserves in the banks and a reduction of money demand will yet result in a significant monetary inflation when economic normality returns. That it hasn’t happened yet may be a strike against the historical acumen of those who predicted it would, but it doesn’t bear at all on the efficacy of the theory of money held by Austrians.

Finally, the claim that the economy cannot reach its highest production potential without continuous monetary inflation, which cannot occur under the gold standard, is both theoretically dubious and historically false. The fastest sustained period of economic growth in American history was during the latter part of the 19th century under the classic gold standard. The basic theoretical problem with this claim is that production depends not on prices of output, but on the spread between output prices and input prices. Such price spreads depend not at all on total spending in the economy.