Cato Unbound

Free-Market Money

I read John Tamny’s letter to the editor of Cato Unbound yesterday. Even though I enjoy reading letters and essays about free-market publications from intelligent people this one hit me wrong. I have an Economics degree (BA) from UCSD but I skipped post-graduate academia in favor of the business world. While working my first job, I went on to earn a Certified Public Accountant designation to learn the “language of business”. While I am not qualified to debate many in academia,  I do believe I can shed some light on why a return to a commodity standard for money is ill-advised.

John Tamny, who has excellent credentials, wrote this letter to the editor of Cato Unbound explaining why he felt a return to the gold standard would be optimum. Mr. Tamny makes some excellent points about money, many of which I agree with. He quoted some world-class economists (including Mr. Keynes) about the need for a stable measuring rod to be used in the exchange of goods.

Mr. Tamny’s argument is that money, if not backed by a stable commodity such as gold (the most stable commodity ever according to him), will never be an optimal measuring rod of value. I would argue that there can be only one optimal determinant of the value of money and that is the market.

Money needs no proxy to help the market determine its value. Money’s value is what the market settles on based on its supply and the general confidence in the government issuing it. The US dollar is not backed by a stable commodity for the very reason that unless the supply of that commodity can expand ad infinitum and the government can acquire it ad infinitum, as money can and must, it will eventually drag on the economy.

Gold is a finite commodity and the potential size of the world’s economy is not. If I would like to sell my cows to a butcher, I could accept just about anything of value in exchange although the most efficient would be money. Money is the chit that goes on the left side of the ledger in place of my cows. Do I really care if it is backed by gold? It makes no difference to me because in a market economy with a stable central government I know that when I need feed for my cows I can take the chits I got from the butcher and use them at the feed store.

If we tie the chits to gold, what happens when the need for money increases (because commerce is growing along with population etc) beyond the supply of gold? We then have to devalue the currency relative to our cache of gold. Government intervention to devalue money will, most likely, be problematic. It raises too many questions.

By example, suppose today we have dollars backed by 1/1000th of an ounce of gold. In several years, we will need more money to conduct more commerce (because GDP growth depends on money growth), and so we either buy it or we devalue the dollar dropping its worth  to 1/2000th of an ounce of gold for example. Regardless of how much gold we can buy today, we will eventually have to devalue. Taken to the extreme our money, after many devaluations,  will effectively not be backed by any commodity because it will be backed by 1/200,000,000th or some other tiny fraction of an ounce of gold which, for all purposes, is not far from zero. In addition, we endured numerous shocks along the way as our government intervened (without the help of the market and global economy) to devalue the dollar thereby allowing us to increase the supply of money to accommodate more commerce.

What is surprising is that many free market proponents such as the Cato Institute,, and many of the Austrians (including Ron Paul), do not have faith in these markets they adore to set an optimal currency value; a value on currency backed by the full faith and credit of the participants in the economy. They lack faith in currency supported by the robustness of the free market whose supply is assured by a stable government.

These “free-market” advocates see a number of problems with “unbacked” currency stemming from the evils of government and including imminent inflation. Apparently they believe folks will wake up one day and say “Damn I thought I had gold in my pocket and it’s only really paper” and perhaps they believe the butcher will suddenly say, “since this is only paper and I thought it was gold or I think it should be gold, I want $100 for this pound of beef instead of my usual $10”.  This thought process and behavior seems inconsistent with a market understanding and free market ideology.

I say, if you’re free-market, believe in the market. The gold standard is ancient history. It is like training wheels on a bike; we don’t need them. Let’s do business and let the market stabilize the value of a dollar while we grow the economy through that very same market.