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Rustam Eynaliyev

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Gold standard

The biggest drawback of a gold standard as well as it's biggest advantage is that gold is scarce. The advantage is that central banks can not create more money, thus causing inflation (essentially another form of taxation). The drawback is inevitable deflation from increasing productivity of the economy which could cause decrease in lending as well as make production less competitive on international markets. Here are my propositions to solve these drawbacks: Tax cuts on revenues coming from lending. Allowing fluctuating exchange rates do their job and allow internal market to adjust to new market realities.

I'm wondering if there any other drawbacks that I'm missing out on, as well as flaws some of you might notice in my ideas.

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  • W T 100+

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    Feb 22 2013: Who sets the price for gold?

    Any links to read up on it?
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      Feb 22 2013: market. If nobody's willing to pay for your gold price goes down, if everybody wants it you raise the price. Forces of supply and demand.
      • W T 100+

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        Feb 22 2013: No, I want to know WHO?

        There must be a person....a bank....a family....a house of something, somewhere in the world....who puts the price out there...WHO?
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          Feb 22 2013: who puts a price on the shoes you have? Is it the business owner? Sure, retail store owner says to sell it for e.g. $100. But why...why not $10000000? Because nobody'd buy it. Why not for $1 so that everybody can buy it? Because the manufacturer sold it to him for e.g. $40 and he'd be losing money if he sold for anything less than that. Why did manufacturer charge $40? because he figured out he'd make the highest price at the given price. Now moving to gold. Let's say dollars are replaced by gold. And all goods in an economy are shoes. Everybody produces shoes, buys shoes and loves shoes. If there are 100 grams of gold in an economy, and that gold is commonly accepted as means of exchange, and there are 100 shoes produced in the economy each shoe would cost a gram of gold. Forces of the market decide the prices of goods.

          Currencies don't have intrinsic value. They are only worth the goods people are willing to give up for them. E.g. 10 eggs are 1 gram of gold and a watermelon is 1 g of gold. That means people value 1 watermelon and 10 eggs the same. You can do barter, but currency makes exchange more efficient.
      • W T 100+

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        Feb 22 2013: Found the answer on google........sorry to have bothered you.
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    Feb 20 2013: You cannot dodge the challenge to define "money" and expect a helpful exchange of opinion here. What do you mean by the word "money"? Do you mean Commodity Money, Receipt Money, Fiat Money, Fractional money, or some other type of money? Please explain sir.
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      Feb 20 2013: I am talking about money - means of exchange. Current system is fiat money. I propose replacing it with gold standard money. I acknowledge challenges associated with it and propose solutions. I am asking for additional opinions on my proposed solutions, alternative views, opinions on the issue.
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        Feb 20 2013: OK. You propose replacing Fiat Money with Commodity Money, specifically gold based currency. You propose to offset the ensuing deflation such action, you say, will cause by reducing taxes on revenues coming from lending.
        What convinces you that deflation is a given in such a transition?
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          Feb 20 2013: i do not propose to offset deflation by cutting taxes on lending income, merely one of the effects of deflation on the economy, namely decreased lending. I propose this tax cut to increase incentives for lending that'd be greatly reduced in case of deflation which would negatively affect future GDP. The reason why I believe in case of a gold standard (or any non-renewable, scarce resource based currency) the amount of goods will increase over time (due to increasing productive of economies due to higher population, investment as well as technological advancements) while the amount of money will stay the same (because you can't print scarce resource). When amount of goods in relation to amount of money rises, prices on the goods fall.
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    Feb 20 2013: I agree that gold standard exists to prevent inflation - yes fractional reserve banking creates new money but there is limit they'd need to maintain a certain ratio to be able to survive runs on the banks (they still maintain a ratio of lending to assets but in case of big demand for money, central bank could just send it to them which would be harder under gold standard imo). They don't need to do that now. I wasn't talking about cutting taxes on income from lending under a fiat currency based system - only if we were to move to gold standard. Depreciation has a negative impact on lending which reduces future GDP which in my opinion is one of the largest reasons many economists would rather maintain small rate of inflation.
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      Feb 20 2013: "Depreciation has a negative impact on lending"

      no it does not. lenders are aware of deflation, and adjust their interest rates accordingly. they care about the real value of returns, not the nominal value. in deflationary environment, lending might happen on zero or even negative nominal interest rates, which still would mean positive real interest rates. it is advisable not to treat every single investor a moron.
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        Feb 20 2013: sure, they'll adjust interest rates, (meaning raise them because incentive to hold money is bigger with deflation), which'll cause the demand for investment go down as well as total lending going on in the economy. Lending at negative nominal interest makes no sense at all, since not only they'd be risking losing money, but also see no profit from it. No lending makes sense at negative nominal interest rates.
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          Feb 20 2013: your ignorance and refusal of thought is painful. how on earth would someone raise interest rate in a deflationary environment, and still have any clients? if lending goes down, interest rate falls. econ 101: downward sloped demand curve. okay, negative interest rate won't happen, but interest rate can go way down from the current market rates (not the FED rate, the market rate). simply put, deflation does not change the overall picture. investment uses excess resources to increase future production. deflation does not affect the existence of excess resources, and the ability to use them to increase production. and this is not all. even if lending completely stops, which won't happen, capital accumulation and investment still can happen. if people decide to keep their savings entirely in a chest in their basement, it is just as good for the economy as putting it in a bank. the important thing is that production is higher than consumption (that is saving), which means that we can turn some production capacity to capital production. how it happens: through the price system. if the guy puts gold in his basement instead of consuming, the demand for consumption goods go down a little. it will lower prices through all layers of production. reduced prices will allow investors to build new capital at a lower price, as the old demand meets the lowered supply curve at a different point. but this elaboration is really not needed. it is as simple as working the same amount, but consuming less results in more capital goods. regardless of any deflation.
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        Feb 20 2013: you ask why would they increase interest rates in deflationary environment? simple: risk. Inflation causes higher propensity to lend - why? because if your money is sitting in the basement you're losing out. Accumulating for risks, inflation and expected profit market interest rates are the way they are. Now imagine if your income is gonna grow if you simply kept it in a chest. You don't have to worry about anybody defaulting. Your incentive to lend is smaller - supply goes down, price goes up genius...but still thanks you reminded me of another problem associated with deflation - reduced consumption. As far as GDP goes - indeed you are wrong..remember production function? Y(output) = Z(productivity) [K(capital/investment)/L(Labor)]...what happens if investment goes down? that's right, Y goes down as well. Consumption is part of GDP...if people keep money locked up that just reduces the amount of money in circulation in relation to goods - additional deflation. Consider great Depression - why was it? I would argue (and a few Nobel Prize winning economists alongside me) that it was to a dramatic decrease of money in relation to goods. Following videos address some of the issues of printing money as well as Great Depression:
        http://www.youtube.com/watch?v=THAaIZmxfNA
        http://www.youtube.com/watch?v=SWVoPrntBso
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          Feb 21 2013: if you lend more, the risk is higher. obviously, you first invest in low-risk-high-return businesses, and if they are all taken, you go for higher risk and lower return options. as the supply goes down, obviously interest rates rise ... in real terms. but in nominal terms, since there is deflation, interest rates go down. i also explained why it is not a problem if total invested saving goes down, and gives places to mattress saving. so this is all just fine, no dangers around here.

          such aggregate measures don't mean anything to me. it is the typical keynesian/neoclassical nonsense that never made sense, and continues to not making sense.

          the great depression was caused by government created money. in order to increase consumption, as your theory suggests, they pumped new money in the economy. what they didn't know, is that money refuses to nicely distribute in the economy, or even to end up in meaningful businesses. injected money tends to lump up at places we expected the least, like housing, stock market, any sort of usually highly speculative derivatives and such. the actual crash is not the problem. the problem is the high before it. a lot of resources are sucked into crazy areas nobody asked for, like houses and dotcom startups. the crash is when people realize that they have built useless stuff, and they start to value things as they really worth. they start to dismantle all the crap, and start to build real stuff. the expanded credit is contracted back, and we have a fresh start. but it hurts. for a 6-18 month period, it really hurts. so after '29 and after '08 and after dotcom, politicians decided to not allow recovery, and continue to prop up unneeded areas with money. this prolongs the crisis do decades. the very medicine, money creation, is the actual cause.
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    Feb 20 2013: I have studied the history of bankiing in-depth.

    Banks began as a safe storage facility for wealth. The original currency was a receipt for assets in storage, for which a small storage fee was charged. Then, bankers figured out that not everyone wanted all of their assets at the same time, so they started "lending" assets that they didn't really have without telling everyone what they were doing. People thought that their assets were safe and had no idea that a "run" would expose the fraud. In this way, bankers created faith.

    When, through fractional banking, it took fewer and fewer people to create a "run on the bank", those receipts were replaced with "promissory notes". The notes were based (in the US) on the full faith and credit of the government that gave the banks the power to invent money at will so that there would always be enough.

    But this doesn't work if the banks don't keep printing inflationary money (as the Great Depression shows), or if automation and unfair trade irreparably harms the ability of consumers to consume. When this happens, faith in the currency falls. So the banks keep inventing money into existence to keep up the appearance of legitimacy in the eyes of the majority who are wholly uneducated and uninformed about such matters.

    Banks DO create faith - through lies and deception. Even now they make promises that it is mathematically impossible for them to keep.
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    Feb 20 2013: Your assumption that a return to the gold standard will prevent banks from creating inflation. This is an incorrect assumption. The gold standard was the basis of the creation of banks, who lend bigger and bigger percentages of their holdings based on the reasoning that all will not want their gold back at the same time. Non-withdrawal of holdings by the depositor was encouraged through the issuance of "gold certificates". These certificates (money) were easier to carry around. Unfortunately, if there was a run on the bank, there was not enough gold to buy back the gold certificates, so bankers, knowing this, replaced the gold certificates with promissory notes (called currency) that are based on faith that they have value, and the bankers can invent all the money they want into existence to cover the possibility of a run on the bank - thus keeping the dirty little secret (the gold is gone - having been transferred to the private holdings of the bankers themselves) buried.

    Tax cuts on interest revenue will make the problem worse. Fiat currency by governments - print money rather than borrow money which must then be printed - as long as the dollars to pay back the interest is never printed - will help solve the problem.
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      Feb 20 2013: you really need to learn more about the history of banking. especially you need to clarify this part "there was not enough gold to buy back the gold certificates, so bankers, knowing this, replaced the gold certificates with promissory notes (called currency) that are based on faith that they have value". because such a thing did not happen, and could not happen, since banks can not change the minds of their clients. banks can not simply create faith.
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        Feb 20 2013: I have studied the history of bankiing in-depth.

        Banks began as a safe storage facility for wealth. The original currency was a receipt for assets in storage, for which a small storage fee was charged. Then, bankers figured out that not everyone wanted all of their assets at the same time, so they started "lending" assets that they didn't really have without telling everyone what they were doing. People thought that their assets were safe and had no idea that a "run" would expose the fraud. In this way, bankers created faith.

        When, through fractional banking, it took fewer and fewer people to create a "run on the bank", those receipts were replaced with "promissory notes". The notes were based (in the US) on the full faith and credit of the government that gave the banks the power to invent money at will so that there would always be enough.

        But this doesn't work if the banks don't keep printing inflationary money (as the Great Depression shows), or if automation and unfair trade irreparably harms the ability of consumers to consume. When this happens, faith in the currency falls. So the banks keep inventing money into existence to keep up the appearance of legitimacy in the eyes of the majority who are wholly uneducated and uninformed about such matters.

        Banks DO create faith - through lies and deception. Even now they make promises that it is mathematically impossible for them to keep.
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          Feb 20 2013: "and credit of the government"

          am i wrong, or this is an addition you did not mention in the first post?

          let me fix that for you: in a free banking system, fractional reserve can be maintained for a very limited amount of time, then it busts. with the continued interference of kings and states, this practice was maintained. but even with all these measures, governments were forced to come off the gold standard, because it stood in the way of inflation.

          in short: inflation is NOT possible under gold standard.
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      Feb 20 2013: Germany is having trouble as we speak getting a look at her gold reserves being "kept safe" by the Federal Reserve Bank (which is not Federal, has no significant Reserves, and is not a Bank) in New York.
      http://www.spiegel.de/international/germany/german-politicians-demand-to-see-gold-in-us-federal-reserve-a-864068.html
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    Feb 20 2013: how could you screw up in the first sentence? it is essential for any proposed money to be scarce. if something is not scarce, it can not be used as money. fiat money is also scarce, and when it is not, it is called hyperinflation, and the said money collapses within months.

    deflation is the normal state of the economy. more precisely it was, before the fiat money systems were invented. as we produce more stuff, one unit of stuff gets cheaper. it is something everyone knows and understands. it is something everybody likes! it does not stop or hinder anything. it is a complete myth, and a kind of dumb one, that deflation would cause any problems whatsoever.
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      Feb 20 2013: True that. Salt was once scarce and was used for money. Then it became super-abundant and could no longer serve as currency because its availability was virtually without limit.
  • Feb 20 2013: That's sort of old-fashioned. Also, one could be bimatellic