Gold standard discussion

My apologies - I head meant to add this as a comment to the question on Monday about the gold standard, but since I can't find it, I'll just start a new thread.

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Let me start by saying that I'm not what you'd call a "gold bug"; yes, I own some physical gold and silver but will not hesitate to liquidate it if I need to eat or heat my home or get a doctor to look at a wound. Gold and silver are money, but can't really be used for anything else in your daily life.

Money. Money is a hard term to understand. Sometimes money means currency, sometimes it means purchasing power and sometimes it means store of wealth. But one thing money definately is: it's whatever people think it is. This is true of gold or silver or big rocks or paper, the thing only has value if people think it does. The reason people like gold so much is because it has the longest run as "money" in human history and it's somewhat rare and impossible to manufature or duplicate. In the discussion of the gold standard, many people talk about it as a store of wealth, and some talk about it as a currency, but few talk about it in terms of purchasing power. For example: one ounce of gold at the turn of the 20th century could buy a nice suit, a hat, a fine cigar, a good meal, a night of drinks at the tavern and still leave you with change in your pocket. Today, an ounce of gold can buy you a nice suit, a hat, a fine cigar, a good meal, a night of drinks at the club and still leave you with change in your pocket. The purchasing power of gold hasn't varied much in the last few thousand years. I wanted to talk about purchasing power and how inflation works against it, both with a gold standard (historically) and under our current fiat system.

I'd like to start by printing a short history of currency in the US. The dates have been borrowed from a variety of sources, including the Federal Reserve:

1775 - The first "United States" currency was issued - the Continental Currency (was fiat and used to pay for the Revolutionary War. Went inflationary so fast, we needed a loan from France to actually pay for stuff towards the end of the War.)

1785 - The US Dollar is established as the unit of currency for these United States, issued by individual banks (the end result of the Continentals inflation and eventual worthlessness was incorporated into the Constitution as Article 1, Section 10, "...coin Money; emit Bills of Credit; make any Thing but gold and silver Coin a Tender in Payment of Debts...")

1861 - First Federally authorized currency created, the Greenback (used to finance the Civil War, has the distinction of still being redeemable as face value if you happen to find one in circulation.) Currency revaluation #1

1913 - The progressive income tax is instituted as part of the Federal Reserve Act (originally stated as never more than 1 or 2% of yearly income.)

1916 - The Federal Reserve opens it's doors for business (which is neither Federal nor has any reserve.)

1934 - Private ownership of gold made illegal (gold bullion and coins were taken and federal reserve notes issued instead with the promise to redeem them for lawful money.) - Currency revaluation #2

1963 - Federal Reserve notes were issued with no promise to pay in “lawful money” (but were still redeemable internationally for gold.) Currency revaluation #3

1965 - The US Mint gave us these copper sandwich things in place of silver coins (but they still kinda looked like silver coins.)

1971 - Nixon closed the international gold window (and yet people still treated them as if they were worth something.)

Now, the nature of our currency reflects the value of our currency. We had gold and silver in circulation in the past - which guaranteed value in a foreign land regardless of the exchange rate - but currently have base metal replicas that have little intrinsic value. The face value of our currency is the same; once, you could redeem your paper for gold, now it's just paper. I've put together a short chart of wage and price inflation throughout US history, with some bullets mentioning major events that affect money. Unfortunately, due to lack of records there isn't really any way to account for US Inflation prior to 1800 so I'll run inflation rates from 1800 through the currency milestones.

Inflation Percentage:

--Decade-- Wages Prices
1800-1810: 32% 8.5%
1810-1820: -24% -2.5%
1820-1830: 0% -30.5%
1830-1840: 4.2% -.1%
1840-1850: 15.3% -22%
1850-1860: 17.5% -7.5%
1860-1870: 29.5% 32.5% <---- Civil War; first currency revaluation
1870-1880: -18.3% -30%
1880-1890: 16% -3.5%
1890-1900: 1.5% -7.4%
1900-1910: 18.6% 7.4%
1910-1920: 273% 48% <----- WWI; establishment of the Federal Reserve
1920-1930: -9.5% -1% <---- Great Depression begins in 1930
1930-1940: 21.8% -19% <--- Ownership of gold made illegal; Great Depression ends in 1939; second currency revaluation
1940-1950: 218.4% 42% <---- WWII
1950-1960: 40.1% 19%
1960-1970: 34.6% 20.5% <--- Fed no longer backs dollars with gold domestically; third currency revaluation
1970-1980: 220.1% 49.5% <--- Nixon removes gold convertability internationally
1980-1990: 32.7% 41.5%
1990-2000: 27.4% 25.5%
2000-2006: 15% 14.6% (last data available in 2006)

Bear in mind that the wage rate is based on unskilled labor and the price rate is based on the official CPI. So, if you look at the years leading up to 1934, you have 700% wage inflation and 24% price deflation compounded. From 1934 to 1971, you have nearly 800% wage inflation with only 300% price inflation. But, from 1971 to 2006 you only have 480% wage inflation with a price inflation rate of over 500% - your purchasing power is being eroded away.

Taking a different track, let's look at some averages in 1934, the year we went off the gold standard domestically:

Average wages per year $1,600.00

Average Cost of new house $5,970.00 (370% of wages)
Average Cost of a gallon of Gas 10 cents (.006% of wages)
Average Monthly Rent $20.00 per month (1.25% of wages)
Studebaker Truck $625.00 (39% of wages)

Now let's look at the same averages in 1971, the year we went of the gold standard internationally and became a true fiat currency:

Average Income per year $10,600.00

Average Cost of new house $25,250.00 (238% of wages)
Average Cost of a gallon of Gas 40 cents (.0037% of wages)
Average Monthly Rent $150.00 (1.4% of wages)
Datsun 1200 Sports Coupe $1,866.00 (17.6% of wages)

Now lets look at some averages in 2006:

Average wages per year $44,472

Average Cost Of a new house $299,900 (673% of wages)
Average Cost of a gallon of Gas $2.90 (.006% of wages)
Average Monthly Rent $991.00 per month (2.2% of wages)
Average Cost of a new car $24,400 (54.8% of wages)

So, the "average American" didn't do too bad as far as their purchasing power is concerned once we went off the gold standard domestically. While inflation rose faster than before, wage inflation rose faster than price inflation. However, once we floated the currency completely, price inflation greatly exceeded wage inflation, especially for assets.

What does all this mean? When a currency has an asset backing it, only major events like a war or a national emergency causes price inflation, while wage inflation will naturally increase as goods are produced to collect more of the backing asset (which creates more "money"). It's the incidents like a war that an asset backed currency is thought of as "inflexible" because it doesn't easily allow for borrowing from the future to pay for a critical situation today. When fiat currency is managed as if it has an asset backing (from 1934-1971), then fiat can function; the currency has more flexibility and can respond more readily to catastrophe or war. Once the currency isn't managed as if it has an asset backing, fiat tends to wobble and spiral out of control (1971-2006). Once the printing presses are on full time, pretty much everything is treated as an "emergency".

I hope that helps some folks in understanding what all this talk about a gold standard means.

- Mixer