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What would happen to an economy if physical precious metals were legal tender currency?

Imagine money that had intrinsic value. How would this affect banking, government spending, saving, and consumer spending?

Better or worse than fiat money?

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    Mar 18 2013: the effects are many.

    first, if paired with 100% reserve banking, it immediately stops inflation, and the economy returns to a slow deflation, its natural state.

    second, since the government (or its sock puppet, the central bank) can not create new money to pay its debt, interest rates will rise to some 5-10%, which is the true rate following from the time preference of people.

    third, since there is no inflation, bank deposits fall, as some people now will consider keeping money in some vault.

    fourth, due to the rising interest rates, borrowing hugely slows down. only investments able to churn out more than 10% return will be undertaken.

    fifth, a whole bunch of businesses will go bankrupt, because they were counting on cheap loans. with the rise of interest rates, these businesses will be revealed to be not profitable, and will be liquidated. entire sectors are expected to collapse, like mortgage derivatives, and their dependent fields like the construction industry.

    sixth, since governments can not maintain their level of spending, political crisis will follow. those that live on benefits or otherwise dependent on the state will march on the streets, cars will be set on fire, stones will be cast, and the unions will cry doom. the current political system built on lies and deception will collapse like a house of cards.

    seventh, the truth will be revealed, profitable businesses will take the place of the wasteful old and corrupt ones, honest politics will take place of the dishonest old one, wars will be ended, end the economy will grow in an unprecedented rate.
    • Mar 18 2013: I think this was a great analysis right up to the Seventh effect where I begin to diverge a little:

      "..... the truth will be revealed, profitable businesses will take the place of the wasteful old and corrupt ones, honest politics will take place of the dishonest old one, wars will be ended, end the economy will grow in an unprecedented rate."

      I think we need to take a good look at he externalities. A UN study, GAEZ calculates that we can feed 10 billion people - in the current phase we can assume that we are or will be pretty well maxed out on the ecological credit card over the next couple of decades if we get that far.

      .What that means is that the New Dawn optimistically forseen by Krisztian has to take place "on the lean" - a healthy sustainable population of 10 billion without war is entirely possible within ecological limits but it would require a deeply materialist understanding and a very high discipline in the way we use material resources and accessible birth control may be a help too. I'm sure that any economy growing quickly during this time will have to be working on a zero sum basis and the role of profit itself will have to re-examined. In another post I've described the resulting state as "The new Mercantilism".
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        Mar 18 2013: i have to words for that: "UN study". enough said.
        • Mar 19 2013: I don't think anywhere near enough is said!

          There is far to little attention paid to the human condition as experienced by the human species as opposed to the individual. the literature on Population all seems to point in the same direction - although the human carrying capacity of the planet is variously estimated at between 0.25 and 500 billion many of the more realistic ones estimate agree with that 10 billion area. If you're going to treat all those other people too with the same (hope fully humorous) disdain , well, well, I'm running out of words. OK, I agree, Enough said.
    • Mar 27 2013: With 100 percent reserve banking wouldnt banks be desperate for cash and need to offer high interest rates on savings accouts, cd's, etc thus attracting peoples savings to the banks vault?

      Secondly, in your opinion would this change be good or for whom would it be good for?
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        Mar 27 2013: interest rates are set by supply and demand. interest rate plays the same role as prices for products. if the interest rate is higher, less people want to borrow and more people want to lend. if the interest rate is lower, more people want to borrow and less people want to lend. at some point, lent and borrowed amount is equal, and the equilibrium is set.

        banks has no way to change that. interest rates will rise, as they are below market level now. banks has to offer higher interest rates, but also will charge higher interest rate on their borrowers. this will lead to a shrink in total lending, which will indeed make banks desperate, until some of them go bankrupt, and we reach a new balance.

        in the long run, it will be good for everyone. it will be good for entrepreneurs, as they will be able to calculate more reliably. proper market interest rate is central to the calculation of ROI and other measures. market interest rates are also good for savers. as the investment market stabilizes, one can more easily estimate future yields, and find safe investments. and it will be good for the economy, thus benefiting everyone.
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    Mar 15 2013: The sales of billfolds would decrease signifantly.
  • Mar 15 2013: it would be like it used to under mercantilism
    • Mar 17 2013: I've voted this up though I disagree on a qualitative basis.
      We simply cant go back to 1650.

      A Modern Mercantilism might look like a very frugal and austere economy on the surface. People would ride to physical work on bicycles, or telecommute electronically. Wasteful and inefficient transport systems like cars would have to be stripped out of the economy, and a highly integrated web of alternatives set up.

      But because of the numerous population we have now, there would need to be an underlying wireless electronic infrastructure for the rapid dissemination of knowledge and research, transactions and communication.

      The currency used in this imaginary future would be base on peer to peer agreement using a currency created from an understanding of agreed environmental limits and a basic equity between humans.

      The bloated financial services sector will collapse. The most numerate of this population can go to work in the brand new sector of Ecological Control of Currency Creation, the remainder will have to go into the rapidly evolving disciplines of Low Energy Materials Engineering, or Ecological Engineering (as Farming use to be called). Speculative research into Nano engineering, Space Travel etc will no longer have huge amounts of money being thrown at them, and investment will be severely reduced and necessarily targeted far more strategically and accurately to produce more bang for the buck.

      The Web allows the rapid viral creation of new networks, and there will be scramble to get on board, out of the infrastructure providers the smartest first adopters will take the bulk of a vastly reduced pot.

      Research, Concept Development and Standard Setting needs to be done in several areas before launch date. PM me with a 140 character outline of your interests for Job Specifications.

      • Mar 17 2013: ok you have an interesting point but the truth is fast transportation for the sake of lesure will never disappear and your idea of that economy is a good one but the real way we should do it is to have no economy at all and everyone just gets what they truly need and are suited for because hopefully in the future greed and selfishness will be eliminated and humans collectively choose where their recourses go
        • Mar 18 2013: Hi Charles,
          I posted this yesterday, but it didn't tag to you comment so got lost. I've deleted it and m reposting as a response to your comment that "everyone just gets what they truly need and are suited for because hopefully in the future greed and selfishness will be eliminated and humans collectively choose where their resources go"

          I said, 22 hours ago: Then you should sign up to the the

          That's another dream that won't work because of the anonymity at the heart of the system.
          Mutual recognition is a prerequisite to a transactional methodology.
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    Mar 19 2013: I assume you mean Gold? Countries with large untapped gold reserves will start mining them.It would cause an interesting shift in the balance of power.
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  • Mar 17 2013: To Brian:
    Yes, it is possible to have recessions and bank runs similar to our current situation with a physically backed or a commodity currency, especially following an era of easy credit. There were many recessions and bank runs before the US went off of the gold standard, as well as before the existence of the Federal Reserve System. When people do not believe that a bank can meet demand for withdrawals, there will be a bank run, which may lead to a bank panic (systemic).

    In this recession, the packaging/ sale of mortgage backed securities and under the table derivatives trading, combined with Fed policy & regulations incentivizing banks to make poor loans. The market for mortgage backed securities collapsed (people realized borrowers were not creditworthy) and the market for them dried up, leading to a liquidity spiral (banks dump securities at the same time, leading to lower prices and more dumping -> need for a lender of last resort). It would still be possible for banks to package and sell loans if there was only a commodity currency, and a commodity currency would not prevent derivatives trading.

    Any time there is a fractional reserve system (+ mix: poor national bank policy, perverse incentives & non-disclosure) this can happen.

    Also, there can be problems with the purity of the commodity (i.e. gold) as it can be diluted which can increase transaction costs relative to a fiat currency.

    To Alan:
    Yes, I agree, if there were a transition back to a physical currency standard, it would be very difficult and likely cause a collapse. In my response I was focused more on the long term consequences on funding liquidity, abstracting from the transition. You bring up a good point; I don't know if there would be a satisfactory and orderly way to go back without bank runs & panics to redeem the currency for the commodity. It would probably require a complete financial collapse beforehand or a temporary, complete government control of the financial system. Bad.
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    Mar 17 2013: "...nothing is necessary but a general panic, produced either by failures, invasion, or any other cause, and the whole visionary fabric vanishes into air, and shows that paper is poverty, that it is only the ghost of money, and not money itself." Thomas Jefferson
  • Mar 17 2013: Actually, from a longer term environmental point of view that may not be a bad thing if we could get past the first couple of years.

    In the chaos we'd have to triage/restore the most essential systems first and it would be an absolutely fantastic opportunity to rebuild the rest on a fully sustainable basis (as measured by the Ecological Footprint system).

    I've just posted an outline of this "New Mercantilism" on another thread - I'll see if i can recover it and post it up here if you're interested. EDIT - Found it by looking up "Full conversation" and looking down the list - right there under my name. I'm new this TED game, as you will understand....
    • Mar 18 2013: I would be interested in this 'New Mercantilism.' Can you give me a link?
      • Mar 18 2013: Hi Brian, I made the term up in response to Charles Cort's comment- "It would be like Mercantilism".

        I took that to mean the phase before capitalism when trade was just starting to lubricate the move onward from feudalism. Yes, but there are aspects of modern life it would be unthinkable to lose.

        If we triage those and develop essential network functions intelligently we could the reduce our ecological impact in Europe buy a factor of 4 to bring it in line with the best guess of a sustainable Ecological Footprint. Such a deeply political process could be sustained (but only under conditions of financial implosion/duress because of the deep rooted problem of vested financial interests) through intensive advertising and propaganda - impolite but brutally honest terms we should use for for the highly necessary and highly ethical process of Rapid Education/Knowledge Delivery.

        I'd be delighted to cooperate with anyone interested in this thesis to promote the concept under the banner of "New Mercantilism" or any other banner you like - It been thoroughly thought through to the ultimate conclusion and I'm ethically comfortable with those conclusions. The idea is now complete and needs properly laying out, elaborating scrutiny, editing and development. Further research is needed on many facets of it (How to create more scientifically robust EF standards, Game theory, Marketing, Licencing issues and Maintenance and many others).

        The Internet is a fantastic medium but NM is simply set of principles which could be established with a small manual and a pencil and paper. NM is not an ideology it is an idea. As it is science based it is inevitable that it ill change as the knowledge base increases (Initial rapid growth) , and admin overheads will also increase (linear growth). Uptake, if the principles as explained become acceptable would be exponential and hopefully keep pace with the decay of the old regime, mopping up the mess.
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    Mar 17 2013: Well, the U.S.and U.K economy, among others would collapse and those who have a shot at a gold standard and are actually seeking one ( both Libya and Ira were moving towards that). We are locked into our shaky fiat system of "funny money" and we could easily be brought down if enough "players" change the game or insist that oil and other commodities be settled in their own gold backed currency..

    I actually think currency should have a measureable common global value.but the U.S,and the U.K. could not conceivably willingly choose that without risking a long time of economic collapse and uncertainty

    What we really need to do to stabilize our economy and make our currency "real" is figure out how to achieve sustainable get off needing to grow at 3% plus per year. Then we would be getting somewhere worth getting..
    • Mar 17 2013: I've set a common global value and designed a peer to peer money creation process - will PM a summary to any interested party.
  • Mar 16 2013: If only physical currency was accepted for business, then you start getting into logistical problems, transporting the currency would be costly & inefficient (so much for the ability to pay with credit or debit). Also, inflation & the price level would be determined by the mining of raw materials relative to the creation of new goods. Also, the fractional reserve system would likely run into some problems, slowing growth.
    • Mar 17 2013: Under physical currency, would it be possible to have the current recession that was caused by the housing boom among other factors?
      • Mar 18 2013: I don't think it would be possible to have such a large boom in the first place. But Boom/Bust cycles would still happen on a ripple scale because they are generated by human optimism / pessimism moods.

        Precious metal has many disadvantages, the main one being that it ignores the real needs of man in favour of an idea. I propose a physical currency based on the concept of Land-Time, which relates directly to the human material condition. Because of the lack of a speculative upside, and omitting the (considerable!) value of "footfall" the cost of a house should tend toward;

        Cost of land (in term of the lost potatoes its not growing)
        Cost of Materials (in terms of land required to sequester carbon emissions + mining materials + labour).
        Cost of labour (in terms of land required to support the workmen for that much time)

        These "Real" costs do not change much year on year - but changes to higher technology have actually INCREASED Land-Time costs considerably. This can be reversed by designing more intelligently, using materials neared their natural state (Masonry, Timber in the round, Thatch or Slate) or very carefully chosen higher tech materials in very carefully audited contexts ( Glass is extremely expensive but lasts for very long times). In real terms the cost of a thatched cottage is the same today as it was in 1600.

        This analysis is based on the Ecological Footprint equivalent of the "Perfect Marketplace" in Classical Economics. In real life a house closer to the shop or with or footfall is always going be preferable, so worth more (even in the stable Land-Time currency proposed) , just as in the real Cash Market, the inflated price of a ridiculously over-large house miles from the shops is set by the willingness of Banks to dish out mortgages and not by the theoretical "perfect marketplace" economy it exists within. .
    • Mar 17 2013: "... the fractional reserve system would likely run into some problems, slowing growth..."

      That's a bit of an under-statement isn't it? It sees to based on the idea that we are still growing, but slowly. In the UK and other overdeveloped economies we are contracting in real terms.

      Wouldn't Fractional reserve banking completely implode at the first whiff of any alternative? Its all the world's financial authorities can do at the moment to manage a sustained and relatively gentle deflation....what do you really think would happen if people saw a realistic alternative?
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    • Mar 15 2013: True Africa was colonized to exploit its resources.

      I don't know for sure but I don't think it is a mineral bonanza as you describe it. There are other regions in the world that can definately compete.
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    Mar 15 2013: Everything of value is currency. Capitalism is not restricted to arbitrary pieces of paper. A goat is money. A pencil is money.
    • Mar 15 2013: Unless you are speaking of a bartering economy It's just a lot easier to use precious metals.
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        Mar 17 2013: that may well be so but shifting for the U.S., the UK and all other nations on fractional reserve would create a major shift in the balance of power globally towards those countries that both posses critical global resources ( like gold & oil) and who have sufficient gold reserves to have a strong and viable gold backed currency. ( see my earlier Ted discussion on this)
        • Mar 18 2013: Power will accrue to those who have the most intellectual / creative muscle, diplomatic skills or physical military resources, I'm not sure where balance comes into it - its one of those phrases like the balance of nature which on closer inspection turns out to be a virtually chaotic system .

          Money is not Gold or oil Butterflies or butter. It is a fungible concept of value and as a concept it can be very simply changed by thinking differently. The irrational fluctuating value of Gold will not go away if it is adopted as a standard unit of currency. It will still rise and fall as the need for the metal changes with fashion and technology.

          If countries have no food producing capacity but they do have Oil then we have to sell them food NOT because we need the Oil (We don't, because we did the sums and worked out how to organise ourselves around the problem) but because we have an obligation toward our fellow man. If they have both food and oil , what's the problem?

          Power is not found down a back alley squabbling to the death over the last barrel of Oil - it is found in the minds of the intelligent and civilised - those with the capacity to organise communities to feed, house, clothe, police and educate themselves within sustainable system boundaries.

          Addiction to Oil or Gold is not power. It is weakness, and when you talk about the strength of a currency, you must also ask what value it has, what can it buy.
  • Mar 15 2013: it happened before in rome. a lot of people think that having money linked to metals is good because it means money has intrinsic value, but that also mean that money is in limited supply. people with enough wealth could hoard their money, and we'd have a shortage of money because no-one would be able to get anyone to sell their metals and so no-one would get paid. can you imagine at the end of the month your boss saying they couldn't pay you because they couldn't get any gold, silver or anything at all to pay you with because the only people who had any weren't selling? gentle inflation is good because it means there's no benefit to hoarding, which means there's enough money moving around the economy.

    to combat the huge banking scam, how about setting an upper limit on income (we have minimum wage, so make a maximum too, say $10m a year)? that way there'd be no benefit to gouging customers because the bankers couldn't possibly make any more money anyway.
    • Mar 15 2013: That's weird.. I honestly had that same idea about setting an upper limit to income. And $10m/year was my number too.

      Here was my thought, have a flat tax rate for everyone and any income over $10 mill gets taxed 100%. This would help control concentration of wealth.

      Obviously some greedy bastards would leave this country so that they could be even richer.
      • Mar 16 2013: why flat tax? flat tax sounds good at first inspection but it's not that simple. say i make $100,000 a year at my company and i employ 5 people at my company at $20,000 a year. we each pay 10% tax so i make $90k and they make $18k, sounds fair right? nope. all i do is re-employ people at $18k a year instead of 20, so i'm left with $110k a year, we all pay 10% tax on that meaning i make (close enough to) the $100k - i effectively get my employees to pay all of my tax for me. this is why the rich try to push for flat taxes, because they know that taxes on a curve means they can't pull this trick to get away with not paying tax.
        • Mar 17 2013: I'm not sure I understand your reasoning on why flat tax is bad. If you hired people at 18k then they would make 16200 and may decide it be in their interest to work for a competitor.

          The flat tax wasnt really the main point of my idea anyways. I just thought it would put everybody on an equal level. Also no more deductions or subsidies.
      • Mar 18 2013: that would seem logical, but remember if one person can do that then anyone can - the competitor would be at a disadvantage if he didn't also reduce salaries to get his employees to effectively pay all his tax for him.

        a tax curve does put everybody on an equal level! you pay for what you use, and usually people with more money are employers, and have a much larger dependency on public services such as roads to ensure their goods keep moving and their customers can keep coming. completely agree that all deductions and subsidies should be ended, though there should be kickstarter funds given to advance business, to keep our quality of life improving.
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    • Mar 15 2013: Why Africa? Because they produce the most gold?
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      Mar 17 2013: 100% correct Carolyn..and not just african nations ( which includes Libya by the way) but also Iraq wanted to do that. That in combination with demanding that their petroleum be settled in their gold back currency would instantly devalue the UK and US currencies to a level that would shift the balance of power.
  • Mar 15 2013: Our country use to have silver certificates and be on a gold standard.
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      Mar 17 2013: until our war debt got bigger than our gold reserves..that's when we shifted to silver certificates and then we needed to have a bigger money supply than we had silver to back it so we went fiat. The whole problem is that our economy is premised on a non viable growth rate that requires a non sustaianable expansion of our mney supply that can never attain balance or stability.
      • Mar 18 2013: The real resource movements the currency enables are more real than the currency (but less volatile - eg wheat price goes from $7.50 per ton to $10 while physical supply/demand ratio stays pretty constant) .

        But there's a problem because we don't have any very sound ideas of what we can get away with (In terms of Climate change, Fertiliser and other input costs, Oil stocks and costs of conversion to useful fuel, Food production capacity, long term capacity to monitor used fuel dumps) in crude physical terms.

        The markets are supposed to value the risks on these things and generally do a good job, but one could say they are not working so well because of the speculative element. How would non - market intervention based on production planning and consumer portion control affect the international value of a Country's currency (Assuming the currency was based on the value of its own wheat stock) ?
  • Mar 14 2013: I am not talking about promisary notes. I am referring to money that has intrinsic value. The banking system could not run it's scam if the money it was handling had intrinsic value.
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    Mar 14 2013: It would make no difference at all for as long as banking systems exists as they do now. In fact, bankers destroyed the precious metals standards.

    Once upon a time, you could hire a bank to hold your assets securely. But one day, bankers realized that not everyone wanted their assets back at the same time, so they could lend assets that they didn't own and charge interest - and no one would know about it (unless there was a run on the bank - which was prevented through the establishment of a federal reserve - a cartel of bankers - who convinced the people that the dollar in your pocket has value, and who never get around to telling you that it is nothing more than a promissory note. They could do this for as long as they had the government-granted authority to print - invent into existence - more money to cover their theft)

    But one day, when they saw what had happened to them and how they had been deceived, they created a corruption free social glue to replace money as a social glue, and they lived more-or-less happily ever after.