Raw thoughts from Alex Dong

Book Review: In Gold We Trust

[caption id=“” align=“alignnone” width=“400”] In Gold We Trust cover[/caption]

To be bluntly honest, my knowledge in economic and financial policy is quite shallow.  I have yet understood how everything is hooked up together and how pulling one string here might trigger some consequences in other places.  I don’t have the illusion that I could one day be able to predict what’s going to happen. All I want for now is to understand the basic questions.

Questions like:

  • Why modern countries no longer uses the golden standard?

  • What is money anyway? Is it a repository or a vehicle to hold value or a pure tool that governments uses to achieve some economic results?

  • With so many appalling “crimes” Wall Street scientists committed using fiat money, what alternatives out there that offer a more solid ground for an international currency, if it’s not USD anymore?

  • Of course the core question, shall I suggest my relatives to buy gold instead of USD?

This short book offers some sound answers. I’m sure only time will know which parts are true and which need further adjustments.

The book comes with roughly 3 parts.

The first part is to lay out the reality on where we are in terms of currency and the naive claim that goes back to gold-standard will fix all problems. I personally found this part to be least interesting. I think any avid reader of the Economists magazine will find the contents here rather familiar.

It is on the credibility of governments that confidence in money has fully depended since 1971, when President Richard Nixon finally broke the link between gold and the dollar. Gold’s rise has been the consequence of this crisis of confidence in the paper promises of governments.

the advocates of this precious metal distract attention from the debate we need about how to restore the soundness of fiat money.

The second part provides the history of gold, which I enjoyed tremendously.  So it turns out that Silver is probably more widely used as a currency instead of Gold. Also, the gold-standard adopted by Britain was a side-effect from Sir Issac Newton’s calculation error.  It also lays out the process where wars forced western countries to keep deviating from gold standard and trade-inbalance ends up severing the link between dollar and gold.

From the evolutionary biology point of view, the separation of currency and gold is a natural step in the long and ongoing evolution process for money.  Money is taking up a dual role as both the container for value as well as a tool for modern governments to affect economic activities. The conflicts between these two roles is where most of the debates come from.

Money is not something absolute. It is a technology that has changed over millennia to meet our evolving need for a unit of account, medium of exchange and store of value. That technology has had to adapt to changes in the real world. The rise of democracy drove the abandonment of the gold standard as a monetary system that, though it protected the value of money, was too rigid for modern welfare states.

For cash strapped governments through the centuries the answer was obvious: find ways to create more money. The first ruler on record to do this, in or around 400 BC, was Dionysius of Syracuse, who was stuck in a long and expensive war with the powerful trading empire of Carthage in North Africa. His coffers bare, he called in all the 1 drachma coins in circulation, on pain of death, and restamped them as 2 drachma, thereby magically doubling the amount of money in the economy. Such ‘debasement’ of money — nowadays (allegedly) through quantitative easing rather than restamping coins — is not only of doubtful morality, since governments are in effect robbing from their subjects or citizens, but also tends to have bad consequences. It was a fear of the economic and social upheaval that might be caused by money losing its value that drove Britain to adopt “sound money”

The quick glimpse into the difference between John Maynard Keynes and Friedrich Hayek is fascinating as well. This is the first time that I finally understand where Keynes come from and get to appreciate his perspective. I’d certainly try to read more about these two person and their books.

Keynes, a gregarious and mercurial British intellectual, dazzled his peers with his brilliance and offered hope that even the seemingly most intractable economic problems could be solved by reasoning and, in certain circumstances, government action. Hayek, born in Vienna, was more pessimistic, warning of the excesses of big government and the inherent difficulty of top down economic policymaking. As he wrote in his last book, The Fatal Conceit, the “curious task of economics is to demonstrate to men how little they really know about what they imagine they can design.”

Keynes looked at money in a different way to his predecessors in economic thinking. Rather than judging money simply in terms of how well it measures and stores value, Keynes took a broader, utilitarian view, asking how money influenced the behaviour of the economy as a whole. Money, he believed, should be judged not on whether it was sound or not but on whether it served the needs of the economy. If sound money was causing unemployment, as it was in the 1920s and 1930s, do not blame the unemployed, blame money.

One of the implications of this reimagining of money was that, rather than celebrating its role as a store of value over time, Keynes focused on how demand for it varied with the public’s appetite for risk.

Instead of government-supplied fiat money, he (Hayek) argued, there should be privately-created money. Guided by self-interest rather than politics, this would be free from the distortions of government money. Money, he believed, should be as freely traded as any other product or service. Thanks to the wisdom of the invisible hand of the market, which always exceeds the skill of the bureaucrat, money would become smarter, more efficient and more reliable. Governments might still choose to issue currencies, but these would only remain in circulation, he predicted, if citizens found them to be reliable stores of value. Market discipline would drive out unreliable money and promote sound money. (This looks a bit like how America ran its money before the Legal Tender Act of 1862 made the dollar a government monopoly.)

The third part is, in my own words, cases for buying gold.  The book lists 3 potential scenarios where most of them would be a good case, but not an absolute one, for diversifying investments by buying in gold, which I found a quite natural and not very surprising.

This case for gold is, we believe, very different from the one offered by gold fundamentalists. The current resurgence of gold may be understood best not as a return to “true money”, nor, indeed, the beginning of the revival of a barbarous relic, but as part of the latest phase of innovation in the technology of money. It will not be the last.

As the government deficit swells, and the political costs involved in cutting it by either spending less or taxing more grow ever larger, the temptation for politicians to reach for the inflation button may prove irresistible. The details of exactly how it would be done would no doubt remain murky: a technical rule change here by the Fed or the Treasury, a dismissal of a high inflation number as a one off there. Just as it has asserted its commitment to a strong dollar while pursuing policies that seem designed to weaken it, the US government would no doubt proclaim that it is determined to win the ‘War on Higher Prices’ even as it opens the monetary spigot ever wider.

The resurgence of gold needs to be taken seriously by us all, because of what it tells us about the economic challenges now facing our world and the effectiveness (or lack of it) of our efforts to tackle them.

Money is a matter of faith. Bits of paper and computer bytes change hands billions of times a day as a measure of value because we trust the promise that they represent. In today’s era of fiat money, those promises rest ultimately on a guarantee by governments that they are valuable. If you are looking for signals to buy gold as a hedge against a government-driven policy of inflation, one would be a lack of serious debate about deficit reduction during the 2012 presidential election campaign.

The book also covers a little bit on alternative currencies and bitcoin but I found its effort rather shallow and lack of anything that’s truly new or inspirational.  It also talks about a syndicate of multiple currencies into an international currency, an idea from Hayek, but it faces so many challenges that I wouldn’t even think it’s possible.