Monday, August 22, 2011

Is Ron Paul Crazy? Part I

I certainly used to think so.

I admired him during the debates for the Republican nomination for President in the summer of 2007 because of his strong commitment to limited government, the Constitution, and bringing troops not out of just Iraq, but from all over the world. But then he would go on rants about returning to the gold standard and how Federal Reserve policy was going to lead to a financial disaster.

Let's start with an analysis of the gold standard.

On the surface Progressives (Democrats) usually hate the gold standard because it is "old" and "ancient", while Conservatives (Republicans) hate it because Ronald Reagan and Milton Friedman didn't support it. Business people don't like the gold standard because their "economics" teachers told them that the gold standard impedes economic growth and prevents governments from emerging from depressions.

The economic theories dominating the Democratic and Republican parties are deeply flawed because they do not understand the most important aspect of a market economy; indirect exchange. Rather than barter for goods directly people choose to trade indirectly using a medium of exchange. It is this medium of exchange that is referred to as money.

It is important to note that people do not acquire money for the sake of having money. They acquire money so that in the future that money can be used to acquire a good. People do not work and earn a paycheck because they want money. People work and earn money in order to purchase other goods. It is irrelevant whether these purchases are for current or future consumption, what matter is that, in the end, people always obtain money in order to purchase goods.

Various societies at various times always used different commodities as money but eventually one commodity, gold, became the dominant form of money. The reasons for this are obvious. Gold is shiny, durable, divisible, and most importantly rare and difficult to duplicate. Additionally, gold has little use for industrial purposes other than electronics and jewelry.

Gold has one disadvantage, however. It is heavy and can be difficult to carry on long trips. This fact led to what became known as banking. People began to deposit their gold in banks in exchange for bank notes. Then the depositor was able to travel with the bank notes and use them to purchase goods. The new owner of the bank note could then go to the original bank and redeem the gold that was entitled to him. These bank notes are what are today referred to as cash (dollars, pounds, euro, etc).

This is why mainstream economic theories are wrong. They mistake bank notes (dollars) for the actual commodity that is backing them, usually gold, and it is this commodity that is money. Money is not a store of value. Money is a medium of exchange. Because mainstream economic theories have no real explanation of money, they are not economic theories at all. They are the works of crackpots and know-nothings. Mainstream economic doctrines believe that you can just print more currency (bank notes) and magically generate wealth (to be discussed during the next post).

It was the responsibility of each bank to determine the ratio, the standard, between the note and the corresponding amount of gold. The value of gold was determined by its ability to purchase other goods (its purchasing power), not by the exchange ratio (the standard) in relation to the bank note that the bank set it at.

When someone objects to the gold standard as a form of government price controls they are wrong. The government is not setting the price of gold. It is merely determining how much gold can be redeemed for its bank notes and it is exactly this power that was given to the Congress in the Constitution. When an alleged "Constitutionalist" dismisses the gold standard they only prove that they have no understanding of the Constitution at all.

Another objection is that why must gold be used for the commodity? Isn't this another form of government force? These critics often forget to point out that supporters of the gold standard also support the elimination of legal tender laws which force people in the US to use government issued currency. Absent legal tender laws US money would compete directly with the currencies of other foreign governments, state banks, local banks, private banks, and private mints. The government does not have to use gold. It is only recommended because throughout the entire history of the world gold (and sometimes silver) has always been the money of choice.

Ron Paul isn't so crazy after all.

In a society of honest money, bank notes are backed by an actual commodity. Today all bank notes are backed by the nothing more than the "good faith" of the governments that back them. This is called fiat money which leads to another problem; inflation. A gold standard alone cannot prevent inflation. The subject of inflation, the Federal Reserve, and fractional-reserve banking will be dealt with in the next post.

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