I would’ve finished this post last night, but two things got in the way:

1. I had somewhere I had to be in short order.
2. The post was getting too long, so splitting it wasn’t a bad idea.

That said, if you haven’t read the first post, you can do so here.

Continuing on…

I’ll start by pointing out that, even with our current currency system, it’s quite possible for hostile countries to affect the value of our money. In fact, China has been buying T-Bills for years, which has caught some people’s attention. What I was getting at, however, was that, in a commodity-based or metal-based currency model, there’s no good way to get control of your currency when someone acquires enough of what your currency is based on. In fact, it was due to China indirectly buying a large amount of silver from Britain (what the Pound was based on at the time) that led to the Opium War. Coincidentally, this helps show that China has a long history of getting large trade balances on its side and picking up the wrath of the prevailing powers of the time in the process.

With that out of the way, it’s now time to explain what our current currency is based on - us! Simply put, our currency is based on the economic production of our country. If our economic production and our money supply increase at the same rate, our currency will retain value. However, pulling that off is rather tricky - there are numerous variables at play. So, what the federal government usually does is shoot for mild inflation - they do this by loaning money to banks at very favorable rates, which encourages banks to loan more money. If the government was unable to loan money due to a shortage of gold, banks wouldn’t be able to loan as much money, which would stunt growth since businesses wouldn’t be able to borrow money to increase capital.

So, why am I touching this? Because, though I’m libertarian-minded, I don’t agree with the entirety of the Libertarian Party platform. Take the following from the LP’s Family Budget section:

During those same years, the government has increased the money supply — producing inflation. Whether the inflation rate is 12% or 3%, the result is the same: groceries cost more; clothing costs more; your car costs more. You work harder every year for less purchasing power.

The solution, from the LP’s perspective, is to eliminate inflation. However, doing so would cause the millions of Americans on credit cards extreme hardship - banks, to maintain profits, would increase interest rates, causing undue hardship on American people. One way that some in the LP would like to fix inflation is by bringing back the gold standard. Unfortunately, bringing back the gold standard would cause extreme deflation (gold is currently selling for $668.90/ounce, so basing the dollar on gold would require fewer dollars on the market), which, as the article notes, would cause severe hardship - since the price of everything would go down, profits would go down, people would lose jobs, and anyone that’s borrowing money would be in dire straights.

I have other issues with the Libertarian Party’s platform as well… stay tuned.

This post is inspired by the following article on TCS Daily titled “What Roosevelt Didn’t Know”. The crux of the article is about how policy makers and economists reacted to the Great Depression in the early 1930s and how, if they had the same access to economic indicators that we have today, they would have behaved very differently. One section, however, that really caught my attention was the following:

The Meaning and Effects of Deflation

Inflation is a general decline in the purchasing power of money. Deflation is a general increase in the purchasing power of money.

It is easy to confuse general inflation or deflation with a change in the relative prices of goods. Thus, a spike in gasoline prices might be mis-labeled as inflation, while a drop in the price of wheat might be mis-labeled as deflation. A genuine inflation involves rising prices in most goods and services.

Inflations tend to be good for borrowers and bad for lenders — at least at first. In the early 1970’s, mortgage rates of 8 percent looked pretty steep to homebuyers. However, inflation accelerated later in the decade, and mortgage borrowers did really well, paying back their loans in much-cheaper dollars. Lenders, on the other hand, were crushed, with many going out of business between 1978 and 1982.

Conversely, deflations tend to be bad for borrowers. The farmer who borrows today to plant a crop for harvesting in six months cannot repay the loan if prices fall during the meantime.

Lenders can protect themselves from inflation, but borrowers cannot protect themselves from deflation. When lenders see inflation taking place, they can charge higher interest rates, and they can make loans for shorter periods of time. When borrowers see deflation taking place, they do not have the ability to demand appropriately low interest rates, because the appropriate interest rate might be less than zero. Lenders will hold onto money rather than lend it at negative interest rates.

Irving Fisher understood this. Even today, among economists, the relationship between inflation and interest rates is known as the Fisher effect.

So, what does this have to do with metal standards and why do I feel compelled to touch on this issue? Before I answer that question, let’s clear up something:

What is a metal standard?

Some of you may already know this - a metal standard is when you base your currency on metals, usually gold or silver. Back in the day, this meant that you could take a dollar (or pound, franc, mark, whatever) and get a predefined measure of gold or silver from a bank; the British Pound got its name because 1 British Pound used to be worth precisely 1 pound of silver. There are some benefits to a metallic standard:

- Conversions between metallic standard currencies is relatively easy; simply convert between currency A to the mineral it’s backed on, then convert from that metal to the equivalent worth of currency B, which is also based on the same metal.
- A government cannot simply print more money, thus preventing extreme inflation. Since the currency is based on a particular tangible product, the government can only print enough currency to buy the amount of that tangible product that the government has.
- It’s easy for people to understand and relate to. People trust gold a lot more than they trust the government, and they understand that gold has value because it’s gold. Why is a dollar worth something? It’s just a colorful piece of paper, right?

However, there are some big problems with metallic standards. The big two are:

1. A currency based on a metallic standard is basing its worth not on the value of the economy in which it’s used, but instead on the value of a metal which may or may not be produced in that economy.
2. A government cannot simply print more money.

To fully understand these two issues, let’s pretend the United States decided, for whatever reason, to base the dollar on oil. Oil has a tangible value - there’s a finite amount of it, it has economic worth (we use it for fuel), it’s portable (I wouldn’t want any in my pocket, mind you), and everyone understands oil. However, as everyone knows, the value of oil can go up or down, often at the whim of countries quite hostile to the United States. Consequently, if the United States decided to enact an oil standard, the dollar would be at the whim of regimes with hostile intent that could inflate or devalue the dollar (by increasing or decreasing the supply of oil, respectively), which could severely disrupt the economy, and there would be nothing the United States government could do about it. If a hostile country started buying all of our currency to increase the value of the dollar, thus making our exports cost more overseas, could we print more money to counteract that, thus stabilizing prices? No - the amount of dollars we produce would be fixed to the amount of oil those dollars are worth. The only way we could print more dollars would be if we produced more oil, which would not be economically feasible if the cost of producing that unit of oil on which the dollar was based was greater than $1.

More on this tomorrow.