Fool’s gold

I’ve been thinking laterly about the irrational belief in gold as some sort of magical metal, the only proper foundation for a money system.  For a long time now, the most prominent gold bug has been Ron Paul, whose irrationality on the subject is underscored by the fact that he styles himself bas both a populist and a history buff as well.  But, of course, historically the populists were deeply opposed to the gold standard.  They were bimetalists, and the most famous speech related to the issue was William Jennings Bryan’s “Cross of Gold” Speech.  As Paul’s general confusion on the matter suggests, gold buggism is usually not a matter of an isolated mistaken belief.  Rather, it’s more of indicator, a tip-of-the-iceberg sort of thing.  Which is why evidence is almost always utterly useless in dealing with goldbugs. A couple more pieces of such evidence popped up this past week.

First, working backwards, from Clusterstock this Tuesday:

Gold is perceived to have two useful purposes: one, as a hedge against inflation and two, as a hedge against uncertainty.

The world has been plenty uncertain throughout the month of January. First, a revolution kicked Tunisian President Ben Ali out of power. Next, protests took Egypt by storm, with its leader, Hosni Mubarak, being challenged.

While you would assume a major political event for one of the most influential players in the Middle East would trigger a surge in gold as a hedge against uncertainty, it hasn’t.

Gold has declined this month, and only moved slightly higher in the wake of the protests (things really kicked off on January 17th, with a protester setting himself on fire in Cairo). Gold moved higher after the first big protests, but then moved lower, and has flatlined since.

Egyptian CDS, protection on the country’s sovereign debt, has spiked and stayed high since the protests began.

Then, from Paul Krugman on Sunday:

Recessions Under the Gold Standard

One of the discouraging features of economic debate today – maybe it was always thus, but it seems especially intense now – is how much of it rests on “facts” that aren’t, but which become articles of faith….

Anyway, one alleged fact I keep hearing is that recessions were short and shallow under the gold standard. I don’t know where that’s coming from, but it just ain’t so. The data aren’t as good for the pre-1933 era as they are now, but for what it’s worth they suggest that there were a number of nasty, prolonged slumps under the gold standard. In particular, the Panic of 1893 was associated with a double-dip recession that left industrial production depressed and unemployment high for more than 5 years. Here’s the estimated unemployment rate from Historical Statistics Millennial Edition:

But both these examples are of secondary importance compared to this self-explanatory chart, published in various different forms over a period of months (this colorful version from Matt Yglesias):

The fact that going off the gold standard was essential to recovering from the Great Depression is the death knell of gold bugism, from a rational standpoint.

But, of course, what’s rationality got to do with economics these days?  Which brings me to something Krugman wrote last week, “The War on Demand”, which might as well be called “The War on Macro-econmics”, which is roughly the equivalent of the “War on Evolution” or the “War on Global Warming”, although it appears to be far less intentionally organized:

Something really strange has happened to the debate over economic policy in the face of the Great Recession and its aftermath – or maybe the real point is that events have revealed the true nature of the debate, stripping away some of the illusions. It’s a bigger story than any one point of dispute – say, over the size of the multiplier, or the effects of quantitative easing – might suggest. Basically, in the face of what I would have said is obviously a massive shortfall of aggregate demand, we’re seeing on all-out attack on the very notion that the demand side matters….

More than that, it’s becoming clear that many people don’t so much disagree with the idea that demand matters as find it abhorrent, incomprehensible, or both. I fairly often get comments to the effect that I can’t possibly believe what I’m saying about monetary or fiscal policy, that no sensible person could believe that printing money or engaging in deficit spending will increase output and employment – never mind that all I’m saying is what Econ 101 textbooks have been saying for the last 62 years.

So what’s going on here?

Krugman went on to suggest three things: First, there’s a basic inability to see how shortfalls in demand are even possible.  Although Krugman doesn’t realize it, this derives in part from arrested cognitive development, explicable in terms of Kegan’s typology. Put simply, Level 3 thinking, in which the individual is the product of their social surround, cannot stand outside of itself, and comprehend the social system as a system.  And that is what you must be able to do in order to understand shortfalls in demand.  Second, there’s a fixation on Strict Father monetary morality–although, again, Krugman doesn’t explicitly discuss the Strict Father angle as such. Third, there’s a failure of traditional Friedmanite monetarists to realize that they are “part of the problem” in they eyes of the newly-emergent demand-deniers.

On the first point, Krugman writes:

First, Keynes was right: Say’s Law – the notion that income must be spent, and hence that supply creates its own demand – really is at the heart of the issue. Many, many people just can’t see how it’s possible for there to be an overall shortfall of demand. The reason I’ve always loved the baby-sitting coop story is that it’s a human-scale example of how demand shortfalls are possible. But my experience is that if you try telling that story to someone convinced that demand can’t ever be a problem, it just bounces off: the minute you finish, they’re back to saying that income must be spent on something, so a shortage of demand can never happen, and any rise in one person’s spending must lead to an equal fall in someone else’s spending.

Krugman’s baby-sitting coop example comes from a 1978 paper, which he described in a 1998 article in Slate. It comes from a real-life experience with a decent-sized baby-sitting coop that used script to keep track of what was basically a simple swap of services. Yet, despite the underlying simplicity and the fact that every act of baby-sitting created a matching credit and debit, hoarding–and thus demand shortfalls (i.e. recessions) still occurred and had to be dealt with. In the original Slate article, Krugman describes it like this:

[T]here must be a system for making sure each couple does its fair share.

The Capitol Hill co-op adopted one fairly natural solution. It issued scrip–pieces of paper equivalent to one hour of baby-sitting time. Baby sitters would receive the appropriate number of coupons directly from the baby sittees. This made the system self-enforcing: Over time, each couple would automatically do as much baby-sitting as it received in return. As long as the people were reliable–and these young professionals certainly were–what could go wrong?

Well, it turned out that there was a small technical problem. Think about the coupon holdings of a typical couple. During periods when it had few occasions to go out, a couple would probably try to build up a reserve–then run that reserve down when the occasions arose. There would be an averaging out of these demands. One couple would be going out when another was staying at home. But since many couples would be holding reserves of coupons at any given time, the co-op needed to have a fairly large amount of scrip in circulation.

Now what happened in the Sweeneys’ co-op was that, for complicated reasons involving the collection and use of dues (paid in scrip), the number of coupons in circulation became quite low. As a result, most couples were anxious to add to their reserves by baby-sitting, reluctant to run them down by going out. But one couple’s decision to go out was another’s chance to baby-sit; so it became difficult to earn coupons. Knowing this, couples became even more reluctant to use their reserves except on special occasions, reducing baby-sitting opportunities still further.

In short, the co-op had fallen into a recession.

The solution was fairly straight-forward: Issue more script. (Expand the money supply).  This is a traditional monetarist solution, but it depends on recognizing the systemic nature of the problem (it’s not bad couples who refuse to baby-sit for others, or who go out too much), and the importance of finding a way to create effective demand (the ability to purchase what’s wanted) where only latent demand (the want itself) currently exists.

This gloss on Krugman’s story actually shows how all three of his points fit together.  But I’m getting a bit ahead of myself.  Another key point is how this story fails to penetrate.  As Krugman put it:

[I]f you try telling that story to someone convinced that demand can’t ever be a problem, it just bounces off: the minute you finish, they’re back to saying that income must be spent on something, so a shortage of demand can never happen.

This ability to hear something, but not actually grasp it, is explicitly discussed by Robert Kegan in his discussion of different levels of cognitive development in In Over Our Heads.  The clearest example is his discussion of a teenager staying out after curfew, confronted by their parents on finally returning home. The problem, Kegan explains, is not a moral failing on the teenager’s part.  It’s actually a cognitive, well “failing” isn’t really the right word.  But it is something missing–and it’s missing at the beginning of the scenario, when the teenager promised to be home by midnight, or whenever.  The problem is, by the very structure of the teenager’s consciousness, they can’t make that promise in the same sense that his parents hear it.  

The problem here is at Level 2, but the principle is the same.  At Level 2, the teenager is their point of view (it is subject for them). They can’t actually have their parents’ point of view (take it as object), because that’s a function of Level 3 consciousness.  They can only appear to take on their parent’s point of view when it doesn’t actually conflict with theirs.  Which is fine at 7:30, when they ask for the car keys.  At 7:30, there’s no conflict.  The conflict only occurs later, when their friends say, “Don’t be a party-pooper.”  But Level 2 consciousness simply can’t take that future state into account: It’s simply not real for that level of consciousness.

In the same way that the Level 2 teenager at 7:30 cannot cognitively grasp the midnight conflict of points-of-view–and cannot grasp what it fails to grasp–the Level 3 demand-denier cannot grasp the point of the baby-sitter coop story, and cannot grasp what it fails to grasp.  In Kegan’s story, the parents are just as mystified as the teenager–because they have no idea what it’s like not to think at Level 3.  Even if they did, of course, that wouldn’t help them fix things. Level 2 can’t be “fixed” in that way.  It can only be grown out of.  And that’s the same problem we face today with demand deniers.

Except for one thing: It is possible to find work-arounds.  Perhaps most simply, those incapable of actually grasping the baby-sitting coop story can simply trust people who do grasp it.    Mostly, in the past, that’s precisely what did happen.  And it was a perfectly rational arrangement: the right people were trusted to say and do the right thing, because it worked.   That was how things worked during the era of macro-economic competence, before the era of chicanery began with the election of Ronald Reagan in 1980.

We didn’t know it at the time, but that’s when the inevitable slide into gold buggery began.  The trust in gold is a very Level 2 sort of thing, since the organizing principle of cognition at that level is the “durable category”, a perfect description of how gold bugs see gold as an unambiguous emdodiment of value.

12 thoughts on “Fool’s gold”

  1. Paul, I think you’re being unfair here.  While I’ll be 1st in line to point out that many if not most Liberatarians are not just inconsistent, but just plain nuts, the blind pig has found an acorn here.

    Contrary to opinion, inflation is not caused by rising prices or wages.  It is caused by an increase in the money supply.  As more money is printed (or created via pixels), it is worth less.  This is the fundamental point of goldbugs, me included.  Every single fiat currency has failed.  All of them.  There is no question that Bernanke has flooded the market with dollars.  Can you say Quantitative Easing?  Gold (and silver) cannot be created out of thin air.  When people are fearful, they reign in their investment horns.  Gold and silver have ZERO counterparty risk.

    If nothing else, google ‘jp morgan and the great silver caper’.  Citizens are buying physical silver to punish the banks.  I think this is populism writ large.  

    Please reconsider being anti gold.  It is pro people and anti big bank.  Thanks.

  2. IE, supporters of so-called fiat currency. Approximately the system we have today, except with a national bank instead of a semi-private Federal Reserve.

    The bimetallists took over the 1896 convention, in part by underhanded means. It was part of the fusion plan to support Bryan and the Democrats, and was supported by silver interests. Because of new mines, the price of silver was dropping, so its use as specie currency became newly profitable for the silver producers. The silver producers had money to give and helped finance the Bryan campaign, but even so the Republicans vastly outspent the Democrats and Populists backing Bryan. It was the first big money, professional campaign, and Mark Hanna was the first Karly Rove / Lee Atwater.

    Both the bimetallists and the gold bogs were fetishists, but the bimetallists at least wanted to increase the currency supply and reduce the pressure of debt. “Sound money” (a deflated currency) was what was at stake, and sound money favors creditors and people who already have money over debtors and those without, and it also favors the past over the future. Some of the people who wanted an increase in the currency supply were people in manufacturing who wanted to beef up the domestic marker and expand their businesses.

    The Populists have this funny-money reputation, but as far as I can see the greenbackers among them were the only rational people in the argument, perhaps the first monetarists.  

  3. Greider, William, Secrets of the Temple, Simon and Schuster, 1987.

    Nugent, Walter, Money and American Society, 1865-1880, Free Press, 1968.

    Friedman, Milton, A Monetary History of the United States, 1867-1960, Princeton, 1963.

    Lasch, Christopher, The True and Only Heaven, Norton, 1991.

  4. it’s a honor for UK universities that they have become the top six universities of the world in language courses.These universities helps students to learn all national languages and make their career in different regions of the world and dissertation help is there for help.

  5. Don’t argue with me.  Argue with history.

    Every single fiat currency has failed. All of them.

    This is an utterly absurd claim.  “Failed” by what criteria?  Look at what happened in Great Depression if you want to see currencies fail–GOLD-based currencies, that is.

    Not to mention math:

    Please reconsider being anti gold.  It is pro people and anti big bank.

    Who gets hurt most by inflation?  Those who have the most assets.  The top 1%.

    Who gets helped the most by inflation?  Those who have nothing or who are being crushed by debt.  The bottom 50%.

  6. Since the Fed has been creating money hand-over-fist for the last year, obviously we are currently suffering this amazing inflation according to you. Yeah, right.

    First point: there is NO monetary system that cannot be mismanaged. That includes the gold standard. The question is always political. Who wins and who loses by the management techniques applied. The use of gold only shifts who the winners and losers are.

    Second point: You provide such perfect example of the kinds of gold bugs who refuse to look at the subject rationally it is quite amazing. We should all thank you for demonstrating the kinds of people who simply don’t understand the absence  of demand as the key cause of recession. You are the person Krugman was talking about.  

  7. You meant to state “Those who have the most financial assets.” Real assets increase in value with inflation.

    Most of us who bought a house did so at least in part because in case of inflation it protected us from rent increases. Banks (who get richest managing the money of the most wealthy) lose because the value of their mortgages decline, hurting investors whose investment is locked into financial investments.  

  8. Bimetalism had a long history in the US.  I agree it was far from an ideal solution. But it was damn sure opposed to the gold standard, and made famous by Bryan’s speech.

    My point in bringing it up was simply to illustrate how deeply incoherent & confused Ron Paul is.  Not to advocate for it.

    Also, there actually was a Greenback Party.

    The Populist’s “funny money” reputation, came, of course, from the gold bugs.

  9. In today’s heavily mediated world, that sort of goes without saying.

    But you’re right. It ought not be forgotten.

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