Argument Against the Gold Standard

Alternate to the Gold Standard

Argument: Total currency in circulation should be in equilibrium to total value of goods, services and investments consumed and the net of exports in an economy. Therefore, there should be a “GDP Standard” for backing the currency.

 

Basic Argument: Just like with the gold standard, the currency is backed by real commodities in an economy instead of being backed through no object of wealth as is currently being done on a global level. Money should be tied to economic exchanges of measured value, and not tied to the “predictive” printing of a federal entity or speculators or other regulators trying to manipulate the flow of money into an economy for their own normative economic reasons.

 

Expansion upon the argument: In economics, utility is the representation of one’s preferences of goods, services and interactions. When faced with a decision on whether to go out to a party tonight or stay at home and study for a finals exam the next morning, what is the best decision to do? Obviously, not every person makes the same decision? Why is that? When decision making is done by an individual, they are weighing their perceived benefits against their perceived costs. When B (benefits) is greater than C (Costs) a transaction or interaction is deemed as in one’s self-interest. B > C  = Acting in a logical self-interest. The benefits in the above mentioned example would be the fun attributed to the party, the good memories created that night, the idea of living life to the fullest, and the interactions at the party between others that provide overall happiness… so on. The direct costs associated with going to the party include the price of gasoline to get to the party and the time it takes to get to the party where something else could have been done. Also related is the concept of the opportunity cost. An opportunity cost is what is given up to do one transaction. If the party is attended instead of studying, the opportunity cost is the benefits that would have been realized through studying. If studying is chosen over the party, the opportunity cost is the benefits that would have been realized partying. Through personally analyzing the benefits and the costs, one can determine based on the available information, which decision would benefit them the most.

 

For a basic demonstration see:

 

Every single person in the world has their own utility functions. Functions are relations between a group of inputs against outputs. In a utility function, utility is dependent on variables that impact utility. Not every individual has the same function however. We all have different life experiences, we are genetically different, and we come from different cities and culture and climates… In short, different things make different people happy. One person may have determined it was in their best interest to party instead of studying, while another would have chosen that it is in their best interest to study over partying. Variables that could impact their two utility functions for this specific event would be: Their social interaction ability and how they get along in groups, their emotional feeling that evening based on prior events, the grade they already had in the class, how many hours they had already previously studied, what point they were on a diminishing marginal utility curve for both activities, how they were raised to view each activity, how much sleep they had the previous night…

 

One’s utility is not an easily or directly observable or measureable variable however. It is for that reason that in an economy, interactions should thus be based on “revealed preferences” (Paul Samuelson). Utility is in short, one’s desires. Since it cannot be measured directly, it should be measured as the willingness to pay for what they derive utility from. If partying provides you with utility and you give up your time, studying and the other opportunity costs that are equivalent in (for simplicity sake) today’s US. dollars as “100 dollars” then the party is worth $100 to you.

 

The same goes for when one individual goes and buys a pizza for $10, while another person goes out and pays $13 for a pizza and another individual pays only $8. The 3 individuals have their own utility functions that makes a pizza worth only so much to them.

 

Since one’s personal utility is unique for themselves and they have their own unique benefits gained from each transaction, that also means they are willing to pay up their own unique “prices” or costs. That is the basis for exchanges in a market. The traditional exchange system is the barter system. If Person A has 10 apples and person B has 6 pairs of shoes, and person A needs apples and B needs shoes (specialization of labor), they meet the coincidence of double wants and an exchange can occur. In this hypothetical transaction, person A values 1 pair of shoes at 10 utils (generic measure of utility for demonstration’s sake) and values each apple at 2 utils. Therefore he would be willing to give 1 to 4 apples for the pair of shoes. If Person B values each apple at 3 utils and each pair of shoes at 6 utils, that means he would be willing to give up a pair of shoes in exchange for 3 or more apples.

 

Both individuals have an item the other wants, meeting the coincidence of double wants, and both individuals have utility functions that allows benefits to outweigh the costs, allowing an exchange to occur. Person A would give up 3 apples for 1 pair of shoes. Person A would gain 4 utils, while person B would gain 3 utils.

 

The need for a medium of exchange was quickly realized as it was time consuming to carry apples and shoes around person to person looking for a situation of the coincidence of double wants, the weight of carrying the trade items around was burdensome, and the practice was overall unrealistic. Therefore it was essential to create a medium of exchange for transactions.

 

A medium of exchange is an intermediary that is used in transactions. A medium of exchange must meet the criteria of being and being able to: value goods and services and interactions, have store of value, have little cost for its preservation, be divisible, be recognized as a form of tender, not be easily counterfeited, and have higher value than its size and weight (transportability) . In the current global model, “money” is used as the medium of exchange. Bills, coins, checks, electronic credit cards, Escrow, Paypal… are all forms of money. They are the medium of exchange.

 

In a gold standard, gold is not the medium of exchange; it is what the medium of exchange is backed up by. The concept relates to limiting the amount of currency in circulation to the total value of one commodity (gold). Gold like every single good, item, service, investment and other interaction receives its value from the same source. As stated above, we have our utility preferences. Gold derives its value from this source as well.

 

When used in terms of making exchanges on specifics, the utility function  can be converted down into a demand function. Example: A demand function is the amount of a product demanded for each combination of price and the other factors.

Quantity Demanded = D(price, contributing factors)

Example:  If demand of pizza is affected by its price, the price of hamburgers, the price of tacos and the consumer’s income, then the demand function will be like this:

 

 

 

Qd of Pizza = 5    –   3P*pizza     +         5P*hamburgers       +            2P*tacos          +      .0002*M

Where:

Qd is quantity demanded

P is price (utils)

M is consumer’s income

5 is the constant utility for the individual if all prices were zero

 

The price of pizza has a negative sign because as price goes up it has a negative correlation on the amount demanded. The price of hamburgers and tacos has a positive sign because as they price of the alternative products to pizza goes up, the amount of pizza demanded is higher because its comparative price changes. Consumer’s income is positive because the more income the consumer makes, the more money they have to spend on pizza.

 

The same concept applies towards gold. Since gold is scarcer, people tend to value it more. A potential demand function for gold could be:

Qd of Gold(ounce) = 100    –   4P*gold  +         5P*platinum       +            2P*diamonds        +      .0031*M

–Essentially, the demand for gold is a function of income, the price for platinum, diamonds…

Other variables factor into demand functions just as they do utility functions because the relative benefits received from other items determine which purchase provides the most benefits to the individual. When we go out to eat at a restaurant and see a steak dinner costing $50, but a grilled chicken costing only $20, even though we as a society as a whole may prefer the taste of steak over chicken, depending on our income and the price of its complement goods (chicken) we may determine the benefits gained from chicken as a function of taste, price and health outweigh the benefits gained from steak against the same variables.

 

Example of a demand function plotted on a graph as a demand curve:

 

As previously stated, gold is not the exception. Nothing in existence has a default value. They are all functions of demand/utility.

 

Of course in an exchange there must be at least 2 individuals or components exchanging. The opposite side is known as the supplier, hence where their utility is converted to a supply function.

 

Quantity Supplied = S(Price, Contributing factors)

 

Supply Function Curves are generally upward sloping.

Example: If the supply of pizza is affected by pizza’s price, the price of tomatoes and the price of cheese, the supply will look like this:

QsPizza =       10        +     6Ppizza               –    3Ptomatoe           –                    2Pcheese

 

Where:

QsPizza = Quantity supplied of pizza

P = price

10 = Number of pizza supplied if all prices are zero

 

Quantity supplied goes up as the price of pizza goes up and it quantity supplied goes down as the price of cheese and tomatoes go up.

Example of a supply function plotted on a graph as a supply curve

 

 

In a market where individuals seek to maximize their well-being/utility the demand curve and the supply curve are brought to equilibrium. By plotting individual’s supply and demand functions on a graph the equilibrium level can easily be viewed as the place where the 2 intersect.

Notice the horizontal dotted line. The triangular shape above it is the utility that is derived for the consumer. The triangular shape below it is the utility for the supplier.

 

We all know though that an economy consists of more than 2 individuals. To derive an aggregate supply and demand curve we simply horizontally sum.

 

 

 

So now we have determined why exchanges occur, how items receive value (including gold), what a medium of exchange is, what money is, how to convert utility functions into manageable monetary units , how to account for individual and aggregate supply and demand.

 

GDP:

GDP is the total number of monetary units summed up for the total consumption, investment, government expenditures and net of exports. Let’s remove government since the government artificially creating demand and making purchases is immoral at best. So that leaves GDP as:

GDP= C + I + X

 

As stated previously, the total value of goods and services and other market interactions can be transferred to a medium of exchange. In addition, transactions only occur where both sides based upon their own preferences are acting to make themselves better off as their benefits outweigh their costs.

Example:

In a market where person A purchases pizza for a gain of utility that is equatable to10 money units, Person B purchases Gold for 50 money units, Person C  purchases labor hours for 15 units, Person D purchases shoes for 15 units,  Person E invests in savings an amount of 10 units. The sum is 100 units. For simplicity’s sake, let’s assume all of these transactions are enough to satisfy each person’s desires for an entire year.  That means literally only 100 units of money was needed that year for all transactions to make every person the best well-off they could be. The GDP is 100 units and it only took 100 units to obtain exactly what every person needed and desired.

 

If 100 units of money satisfies every single market transaction and is based upon the free market exchanges, why should there be 101, 102, 105, 200, 300, 1000 units of money existing? If it took 100 units to satisfy every single market transaction, how could 90 money units suffice?

 

The Federal Reserve does not print money based on transactions, but rather it prints on monetary policy to “grow” or contract” the economy and to lead to their desired market results.

 

The Gold Standard is based on saying that gold is worth a set amount and only that much money units can be made. If all of the gold in existence was valued at 80 money units, then in the case of the above simplified economy, it would have been unable to account for 20 money units required for exchange. One or  more people WOULD  NOT have been able to make a free market and free-willed transaction based  upon the regulatory action of  limiting money supply not to the level that supply and demand requires,  but to the level of one commodity in an economy.

 

As the GDP example above the total market equilibrium level of money units was 100 units. Many gold standard proponents argue that gold’s value is constant, which as demonstrated above it is not, but if we were to assume it was. How could the gold standard thus adjust for changes in utility functions, demand functions and supply functions? If a famine occurs, food is now worth more as it is scarcer. If the population grows and more individuals are interacting in the market, more units are needed. A constant variable such as gold cannot make adjustments for constantly changing variables.

Some argue that that means one should simply make more money on gold, but if you make the dollar divisible into more units, that just means the units are smaller. Dividing the dollar 100 times is the same as 1 penny. The same applies for gold. Dividing its value into smaller units just means more smaller units.

 

With a GDP standard, if the GDP in month 1 was 100 units, that means 100 money units should be in circulation. If the population grows and it now requires 110 money units for all transactions to exist, that means 110 money units exist. If diminishing marginal utility occurs and thus price goes down and only 80 money units are needed, then units are removed and only 80 units exist.

 

Money units just like everything else has a supply and demand curve. They are representations of the aggregate supply and demand curves of all of the transactions in a market. When money units are not spent, but rather invested it is done so because just like all transactions, they are done because the benefits outweigh the costs. The benefits of investing or saving outweigh the cost (what could have been purchased if spent instead of investing). We invest money in return for additional benefits often times known as interest. Going back to the equilibrium demonstration for supply and demand:

 

Or

The concept is the same. So what would happen if money supply was not set to the equilibrium level where supply and demand intercept? Let’s assume that by controlling the money supply by using gold instead of by using the free market functions that supply of money units is higher than what is required to equal the total of money units required in a market for a given period. Therefore the supply curve would shift up. Bringing the new supply curve in equilibrium with the unchanging demand curve results in:

Note how the equilibrium is now at a different location than what exists naturally in a free market. In money supply terms it would lower real income (money is now worth less) and raise the interest rate (there is too much in circulation so to force itself back to the natural equilibrium level it encourages holding onto money).

 

The shaded blue area is the difference in the true market equilibrium and the artificially created equilibrium due to placing monetary units on something of higher value instead of based on the aggregate true market value. The blue area is known as dead weight loss, it is economic inefficiency and the inefficient allocation of resources. In short, it takes away utility by cutting into producer and consumer surplus. Thus it makes people worse off.

The gold standard however is just one of millions if not billions plus items of value in an economy. So in reality it would fail to account for the total number of money units that is needed, thus shifting the supply curve down.

 

Once again, the free market equilibrium no longer exists. Supply artificially lowers by using the gold standard. This creates fake and excessive spending power that decreases the incentive to save and invest money – instead of being at the free market level of spending and saving/investing.

Once again the blue shaded area is the difference between the free market  equilibrium level and the artificially created equilibrium level created through a regulatory practice of artificially limiting money unit supply to just the value of one item. And once again you cut into people’s and society’s well-being making them as a whole worse off. Essentially you are forcing them to act a way against their will.

 

When having an economy based on money unit supply being equal to money unit demand based on the aggregate free-willed (free market) transactions of all individuals (summed up by GDP) then you get this:

And after never interfering and having money unit supply equal to the market desires you get this:

No dead weight loss. No change. No regulatory interference. No loss of utility. Society is at the highest utility it can be in its market conditions.

 Alternate to the Gold Standard

Conclusion: A gold standard does not account for the total demand desires for a population and therefore acts as a regulation that decreases social utility by underproviding for its population. A GDP standard where supply is equal to demand accounts for society’s total utility preferences leading to maximized social welfare. The practicality of implementation of both forms of money circulation is the same and the measurement of value in both systems is the same. Since all variables in determining which model to be used are the same with the exception of one, and that exception is the decrease of people’s well-being when the gold standard is applied, it is logically and morally correct to use a GDP standard.

 

 

 

 

 

 

 

 

 

 

 

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