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April 19, 2009


Alexander Kolpakov

I would honestly admit, that basically the mechanics of gold standard is much more complicated than You have explained as simple as "World With ~1% p.a. Money Supply Growth". There is a throughout analysis of this issue provided by Antal E. Fekete ( I would be happy if You take a look on his articles and probably even give Your feedback, as Your qualified opinion is very valuable for me.
Kind Regards


I believe the PC revolution clearly demonstrates that prices do not have to consistently rise to keep the economy humming. Also small annual deflation rewards savers. The economy did fine for stretches in the 19th century with a true gold standard. Your call for Friedmanesque monetarism clearly has not worked in the past, why do you expect it to work this time. Congress and the Fed have learned their lesson?? Puhleeze.

C. Santiago

Andy -- there's something else to consider: all that money "created out of thin air" (your words) by the shadow banking system is quickly evaporating. Pffft.

Indeed, the credit losses that brought about the collapse of the shadow banking system are reducing the money supply (sunny _and_ shadow) by trillions of dollars. (Some estimates of the total eventual write-offs are higher than $3 trillion.) Could it be that the chart above may not be capturing these 'shadow money supply' dynamics?

I'm not sure, but it strikes as likely that the Fed so far has only partially offset the ongoing destruction of money, in which case the risk of inflation down the road is much lower than you suggest here.

Don't you think?

David Anderson, CFA

The Fed may be able to estimate the supply of money (and even that is highly questionable) but they cannot estimate the demand for money as the last twelve years show. Andy correctly addresses the velocity issue as the key issue. We risked deflation in the late 1990’s. The deflationary trend exposed the excesses of that economy and caused the recession of the early part of this decade. Then the Fed went overboard in 2003-2006 and created an inflationary boom concentrated in the housing industry. Inflation was just beginning to show up in the CPI when the economy hit a brick wall due to the liquidity issues caused by the failure of the banking industry.

As the most monetary of all commodities (all that ever existed is still in existence somewhere), the real economic function of the gold standard is to use the price of gold as a clearing price between the supply of money and the demand for money (the number of gold bars in the vault is irrelevant). What the Fed needs to do is manage the price of gold. If the price begins to increase above a certain targeted level the Fed should drain reserves from the system until the price settles back to the target. If the price decreases as it did in the late 1990’s, they should add reserves to the system until the price increases back to the target. Thus, the “supply” of money is allowed to expand and contract as dictated by demand for money and the need to maintain its purchasing power. The price of gold is the canary in the coal mine.

I believe the stable value of the dollar was one of the three keys to the success of the economy under the Clinton administration (free trade and the capital gains tax rate cut were the other two). The price of gold was reasonably stable in the $300-400 range from 1989 to 1997. Beginning with the economic recovery of the early 1990’s, inflation was significantly reduced as a factor in corporate and personal planning. Thus, PE’s were justified in reaching the highs attained the last time we were on a gold standard

While some may scoff at using a commodity price rule, it certainly can’t do any worse than the Greenspan/Bernanke standard has done over the last 12 years. What it would do is add a degree of predictability and certainty to monetary policy. For more information see Jude Wanniksi’s paper “A Gold Polaris”.

Robert Dobb

"one of the three keys to the success of the economy under the Clinton administration" ...

he signed into law the largest tax cut in history. The Tax Payer Relief Act of 1997.

The top capital gains rate fell from 28% to 20%. The 15% bracket was lowered to 10%, exempting from taxation profits on the sale of a personal residence of up to $500,000 for married couples filing jointly and $250,000 for singles.

The $600,000 estate tax exemption was to increase gradually to $1 million by the year 2006.

Family farms and small businesses could qualify for an exemption of $1.3 million, effective 1998. Starting in 1999, the $10,000 annual gift tax exclusion was to be corrected for inflation.

The economic bucket Andy speaks of, was enlarged. Money was freed up to slosh around the bucket.

Economic growth ensued. Inflation was put off into future years, as people wanted things that produced growth prospects. Not boring old gold.

That came later in the cycle.

Jon Niebling

Andy, I've been following your writing ever since you were a tech analyst at Paine Webber. Always insightful, keep up the good work. Your June 21, '07 Blackstone article was more right on than you get credit for. Onward...

Vik Rubenfeld

Andy, if the Fed can put the toothpaste back in the tube, does that mean they could use the money so collected, to pay off the massive Federal debt?

Thanks very much in advance for any info or thoughts.

Bob Allard

Great analysis for the laypeople out here trying to keep score. Your prescription at the end for the Fed(s) to get out in front of the issue and "telegraph the pass" is exactly the right idea, in my opinion. It is quite similar to what they are doing today with the Swine Flu issue: being forthcoming, explaining what we know, what we don't, what we plan to do, etc. Note that the market barely moved of of its trajectory on this worrisome issue. Thanks for your insights!

C. Santiago

Andy -- apropos, this blog entry posted yesterday at Zero Hedge made me think of your column. Zero Hedge articulates in much more detail (with facts and figures) what I suggested may be happening -- i.e., that our traditional money-supply statistics fail to capture the sharp contraction in the "shadow money supply," and therefore that the risk of inflation might be a lot lower than you suggest: .

חדרי תינוקות

Andy it's awesome!! keep up your good work.I like to think of the economy as a giant bucket filled with money (money supply) sloshing around the bucket. We all hope the bucket is filled to the rim. Thanks once again Andy:)

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