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(This item originally appeared on Forbes.com on March 8, 2012.)
http://www.forbes.com/sites/nathanlewis/2012/...h-demand/
Let’s think of a useful gadget, like a blender, the thing you make margaritas
with.
These blenders are a little special, because they never wear out. You can use
them indefinitely. Also, the government has a monopoly on blenders. You can
only buy them from the government.
The government has a fixed price for its blenders – let’s say $100. You can
buy as many blenders as you want, for $100 each. The government will also buy
the blenders back from you, for $100 each. Thus, the price of a blender is
fixed at $100.
In this way, the government fully satisfies the demand for blenders, at $100
each. If people become more wealthy, or the population increases, or there is
a fashion for owning lots of blenders, the government will be happy to sell
you as many as you want. Some people will own none at all. Some may have
dozens.
At the same time, if people find that they have too many blenders, the government
will buy back as many as you have to offer, for the same $100. We can see how
the blender supply could increase and decrease, depending on whether people
wanted to buy more or sell them back to the government.
At any time, there may be some people who want to buy blenders, and some
people who want to sell them. Thus emerges a private market for blenders. The
private market price is also $100, for the simple reason that nobody would
pay more than that and nobody would sell for less than that, since the
government is ready to buy or sell at $100.
On any given day, there might be people who have more blenders than they
need, and who would rather have $100 to spend on something else. Let’s say
the sellers have 100 blenders for sale. There might also be people who have
$100 and want to buy a blender. The buyers want to buy 105 blenders. The
sellers and the buyers meet, and 100 blenders change hands in the private
market. This does not change the blender supply. However, that would leave
buyers for five blenders, but no sellers. These people would end up going to
the government and buying five blenders, and thus the aggregate blender
supply would increase by five blenders.
Conversely, if there were 100 blenders for sale, but buyers for only 75, the
government would end up buying 25 blenders, thus shrinking the aggregate
blender supply by 25.
Maybe some foreigners want our government’s blenders. The government is happy
to sell them as many blenders as they want, for $100 each. Likewise, the
government will buy them back for $100, just as they would do for a domestic
citizen.
Thus, the aggregate blender supply could be much larger than the number of
blenders actually held by domestic citizens. The blender has now become an
international blender. The aggregate blender supply will grow or contract,
responding not only to domestic demand but global demand.
It’s a pretty simple system. Shouldn’t be hard to understand.
A “currency” is also a useful gadget like a blender. We don’t use it to make
margaritas, but rather as a tool of commerce. It’s a useful tool, which is
why we all have some. However, we don’t want to have too much – at some
point, we would rather have some sort of good or service, or other asset,
instead of a bigger pile of paper banknotes. We have a certain demand for
currency – we each hold a certain amount. It might be a lot or a little,
depending on a lot of factors, and people’s personal decisions. There is no
currency that is not owned by someone.
A lot of people are confused by how a gold standard system works. They think
it has something to do with mining, or gold imports and so forth. Nope.
Instead of selling a blender for $100, the government sells a dollar for a
certain amount of gold, perhaps 1/20.67th of an ounce, as was the case in
1900. Maybe fractions are confusing, so you could use “grains of gold.” There
are 480 grains per troy ounce, so 1/20.67 would be 480/20.67 or about 23
grains of gold.
It’s very simple. The government will sell you all the dollars you want, at a
price of 23 grains of gold. The government will also buy your dollars back
from you, and give you 23 grains of gold in return.
We can see that the amount of dollars in existence will expand and contract
depending on whether people come to the government to acquire new dollars, or
sell their dollars back to the government. If people are getting wealthier,
and the economy and population is expanding, it is quite likely that more and
more people will come to the government and acquire more and more dollars.
However, perhaps people don’t want to hold as many dollars anymore. So, they
go to the government and give their dollars back, and get gold in return.
You can see that this system would provide exactly as much currency as people
need and want, and not one dollar more or less. We can also see that the
dollar’s value is fixed, at 23 grains of gold per dollar.
Let’s say that, on a given day, there are people who want to disacquire
$1,000,000, and people who want to acquire $500,000. What I mean by this is
that people have $1,000,000 of currency, either paper banknotes or bank
reserves, and they would like to trade this for something else, like goods
and services or other assets. They want to end the day with $1,000,000 less
currency.
Likewise, the acquirers want to hold more currency. Maybe there is only $20
in their wallet, which they feel is not enough for their daily needs, and
they take some sort of action (selling goods, services or other assets) that
results in their having $120 in their wallet. The acquirers want to end the
day with $500,000 more currency.
Obviously, there is a mismatch. In this case, $500,000 would end up at the
government’s doorstep, to be sold for gold.
However, the government may be aware of this mismatch, particularly if it has
been persistent for weeks or months, and instead of waiting for someone to
show up asking for gold, they do something else. For example, the government
could sell a government bond for $500,000, and in the process take $500,000
in payment. The government thus takes $500,000 out of circulation (they can’t
spend it again because that would put it back in circulation), in this way
balancing acquirers and disacquirers without having to make any gold
transactions.
This is the way gold standard systems actually worked. That is why they
produced the kinds of statistics we looked at recently, which many people
find bewildering. Look at the statistics again and see if they make sense to
you now.
There are even academics who have spent their whole careers as supposed
“experts” on monetary history, who don’t understand how this worked.
Actually, they were never really interested. Their real goal has been to
provide justifications for today’s Keynesian floating currency system, by
making the gold standard system seem ridiculous.
Ignore what the munchkin economists say. You can figure this out on your own.
It’s actually a target="_blank" very simple
system. The only strange thing is that people find it so confusing.
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