Gold does not cause deflation

A cornerstone of the libertarian position is having a gold standard. In the 2012 GOP primary Ron Paul championed this position. In 2016, Cruz, Carson, and Rand Paul have all suggested that US adopt the gold standard. A recent piece in the NY Time tries to show how Cruz is wrong for supporting the gold standard.

The writer of the article points to the deflationary spiral as to why we cannot have a gold standard.  The deflationary spiral says that if an economy enters into a recession then layoffs happen. Layoffs mean more people have less money which reduces demand. Less demand means lower prices. As prices for products fall the companies who produce the products will go out of business, starting the process all over again. This can be seen in the image below. Blog post 2

The theory also argues, to prevent this from occurring the government must be able to stimulate the economy with large infusions of money.  A government cannot do this with a gold standard because the amount of money that the government can put into the economy is limited to the amount of money the government takes in taxes. Without a gold standard the government can print dollar bills to infuse into the economy.

The writer of this article cites the great depression as proof of this occurrence. The problem for the writer of this article, is that this did not cause the great depression and the deflationary cycle does not exist.

The problem with the deflationary cycle is it ignores that falling prices will increase demand. As we see above, the falling demand has a downward effect on prices; however what the illustration leaves out is we also see that falling prices will put upward pressure on demand. While there may be some reduction in demand it is not a free fall. Once prices hit a point where people will buy the product for the price offered, then demand will stabilize.

The writer attempts to solve this problem by pointing out that once prices start to fall no one will buy anything. The writer says, “After all, if you believe that the price of, say, shirts will continue to drop, you’ll delay splurging on haberdashery.” But people splurge on things all the time that will drop in price later. Everyone knows that the new iPhone will cost less in 6 months than it will the day it comes out, yet tens of thousands line up to buy iPhones at the full price every day. Some people even sell the iPhone for thousands more online. That means that someone is paying thousands of dollars more on a product then if they bought it in store, they just have to wait a few days to get it.

Also some products are needs, not wants. If I need some milk I will buy it from the store even if it will be cheaper next week. The writer and those who support this theory overlook that people will buy what they can afford when they want it. No one will go hungry today to save a penny tomorrow.

The writer also says that gold is scarce and that the amount of gold is limited, while the number of people increase. While it is true that there is currently a finite amount of gold on earth, gold has kept up with the population. For the past 50 years, there has been roughly 42 grams of gold per person on Earth .Since 1959 gold production has risen by a factor of 2.1 and the population by 2.2. Increases in technology has allowed for more fine gold to be found. There is nothing to suggest that this will not continue. Scientists are already looking to mining asteroids for gold and other sources have been looked at, as well.

The writer’s last point against the gold standard is that it caused, or at least prolonged the great depression. The writer points out that the anti gold standard FDR took office in March of ’33 and the recovery took off. This is not true. For the rest of the 1930’s Americans suffered through a depression and in 1938 the unemployment rate got worse not better. Are we really to expect that FDR’s policies worked so well we remained in a depression that got worse, not better, for another 13 years?

Also the deflationary spiral cannot explain the  depression that occurs in America from 1920-1921. The depression started with a higher unemployment rate than what the great depression started with in 1929. The government did nothing in that depression and the economy recovered quickly. If the deflationary spiral is real, why did this not occur in this depression as well?

What lifted America out of the great depression after WWII was the fact that the rest of the world was in shambles. All of Europe, Japan, China, North African and parts of Russia were still smoldering from the bombs that leveled cities. America made it through the conflict without a bomb dropped on the homeland. While the rest of the world tried to rebuild, Americans were able to sell their products around the world to countries who no longer had the infrastructure to build their own.

The gold standard was one of the reasons Americans was able to achieve the wealth we have achieved. The gold standard limits government, by preventing the government from just printing new money. If we want to rein in the government, impose a gold standard. It will force to government to limit its budget to what it can take in taxes.

Leave a Reply