The World\'s Hardest Austrian Economics Puzzle

Candidate #1, Version 0

This puzzle has to do with the benefits, if any, to society from an increase in the supply of money in a gold standard economy.

The background for this puzzle is to be found in the following pdf paper :

On The Optimum Quantity of Money by William Barnett II and Walter Block.

However, some of the contents may need to be qualified or revised and extended before being applied to this problem.

Problem Statement :

Assume a gold standard free market economy in essential equilibrium in which all of the economically feasible gold extraction from the Earth has already occurred. Assume that all of that gold has already been applied to its most valuable use and that no new profits remain for the use of available gold.

Santa Claus actually exists and is an interstellar alien with effectively unlimited and undetectable powers.

Next Christmas morning, the alien intends to deliver new gold to the Earth in an amount that is roughly 20% of the existing gold money supply on Earth.

The problem for the alien is just how to deliver the gold so as to maximize the benefit to Earth's society. He has two choices :

1. He can add to the supply of monetary gold in a neutral manner, i.e. with no effect on relative prices. This can very roughly be thought of as giving people holding monetary gold an increment of 20%.

2. He can deliver the gold to the existing empty gold vaults of the manufacturers of products that use non-monetary gold as a factor of production. The manufacturers will forfeit their gold if they use it for any other purpose than as a factor of production.

Which choice will benefit Earth's society more, and why?

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Excuse my ignorance, but I

Excuse my ignorance, but I thought the Austrian School generally rejected concepts like "social benefit" as impossible to calculate based on the subjectivity of value. Meaning, since interpersonal comparisons of value are pointless from the standpoint of long-term meaning (people change how and what they value all the time), how can one accurately calculate the aggregate benefit to a group of people, let alone compare one outcome to another?

Charles, Excuse my

Charles,

Excuse my ignorance, but I thought the Austrian School generally rejected concepts like “social benefit” as impossible to calculate based on the subjectivity of value. Meaning, since interpersonal comparisons of value are pointless from the standpoint of long-term meaning (people change how and what they value all the time), how can one accurately calculate the aggregate benefit to a group of people, let alone compare one outcome to another?

Calculation is indeed impossible, but that doesn't mean that comparison or choice or ranking isn't possible under some restricted conditions. In any case, if you look at the paper you'll see that Rothbard uses the concept of "social benefit" himself.

Regards,Don

I'm having trouble

I'm having trouble envisioning this notion of equilibrium, "in which all the economically feasible gold extraction from the earth has already occurred." Does this mean that the manufacturers of gold products no longer produce anything? Their vaults are empty. Why are they still in the gold product manufacturing business - what could they possibly produce? This doesn't seem to me to be an equilibrium, at least not for very long. Isn't the Austrian notion of equilibrium more along the lines of the evenly rotating economy, with Hayek's ideas about expectations being correct, and Kirzner's ideas about individuals reducing/eliminating uncertainty and leaving no profit opportunities unexploited? In these concepts, the market is still very dynamic. It seems some amount of gold will always be required for non-monetary (at least) purposes in this kind of equilibrium. Thanks for your help.

Chad, I’m having trouble

Chad,

I’m having trouble envisioning this notion of equilibrium, “in which all the economically feasible gold extraction from the earth has already occurred.” Does this mean that the manufacturers of gold products no longer produce anything? Their vaults are empty. Why are they still in the gold product manufacturing business - what could they possibly produce? This doesn’t seem to me to be an equilibrium, at least not for very long. Isn’t the Austrian notion of equilibrium more along the lines of the evenly rotating economy, with Hayek’s ideas about expectations being correct, and Kirzner’s ideas about individuals reducing/eliminating uncertainty and leaving no profit opportunities unexploited? In these concepts, the market is still very dynamic. It seems some amount of gold will always be required for non-monetary (at least) purposes in this kind of equilibrium. Thanks for your help.

All I was trying (unsucessfully) to accomplish was to rule out the dynamic effects that would normally take time to settle down after any action. For the purposes of this problem, time is only a factor in the sense that money wouldn't have any demand to hold without a future to be uncertain. We have individuals making purchasing decisions based on the comparisons between the subjective marginal utilities of use-valued goods and the marginal utility of money held to fund future purchases. We have manufacturers making decisions whether the manufacture of a given good will be profitable or not. For the purposes of this problem, manufacturing can be considered instantaneous and manufacturers can be waiting for orders to come in with advance payment in gold, eliminating the need for a gold stock. For simplicity, no new gold from mining, only conversion of gold back and forth between monetary and non-monetary gold, plus new gold from Santa Claus.

Regards, Don

It seems like giving the

It seems like giving the gold to the manufacturers would reduce a lot of the transaction costs that would occur if gold was distributed in the other manner. Of course this way, the only effect is perhaps a lower cost of gold-containing objects and higher profits for the manufacturers. In the helicopter-like example, while gold containing objects will eventually be cheaper, it would take more time and the big winners will be the earliest spenders of the money.

2. He can deliver the gold

2. He can deliver the gold to the existing empty gold vaults of the manufacturers of products that use non-monetary gold as a factor of production. The manufacturers will forfeit their gold if they use it for any other purpose than as a factor of production.

It's not clear to me exactly what you're trying to accomplish with that restriction. Regardless of what the manufacturers are allowed to do with the gold, an increase in the supply of non-monetary gold will drive down its price, prompting existing owners of non-monetary gold to melt it down and coin it. Is this disallowed, as well?

Even if you add this restriction, increases in productivity will presumably make the mining of gold economically feasible again at some point in the future. With a price differential between monetary and non-monetary gold, this gold will presumably be used to mint coins. Is this also forbidden?

It doesn't seem possible to stipulate that option 2 not ever in any way increase the money supply, unless we state simply that the money supply will never again increase if option 2 is selected. Is this what you intended? If so, does this apply to option 1 as well? Should we assume that there will never again be an increase in the money supply except for the one-time infusion in the event that option 1 is chosen?

Jeff, ... In the

Jeff,

... In the helicopter-like example, while gold containing objects will eventually be cheaper, it would take more time and the big winners will be the earliest spenders of the money.

The reason that I attempted to specify a neutral distribution is to avoid any consideration of early/later recipients. This has no significance for this problem and would simply add an unnecessary additional confusion.

Regards, Don

Brandon, It’s not clear to

Brandon,

It’s not clear to me exactly what you’re trying to accomplish with that restriction. Regardless of what the manufacturers are allowed to do with the gold, an increase in the supply of non-monetary gold will drive down its price, prompting existing owners of non-monetary gold to melt it down and coin it. Is this disallowed, as well?

Even if you add this restriction, increases in productivity will presumably make the mining of gold economically feasible again at some point in the future. With a price differential between monetary and non-monetary gold, this gold will presumably be used to mint coins. Is this also forbidden?

It doesn’t seem possible to stipulate that option 2 not ever in any way increase the money supply, unless we state simply that the money supply will never again increase if option 2 is selected. Is this what you intended? If so, does this apply to option 1 as well? Should we assume that there will never again be an increase in the money supply except for the one-time infusion in the event that option 1 is chosen?

Let me summarize the restrictions that are intended to reduce the unnecessary complexity of the problem.

Only the Santa Claus gold is restricted. It must be stored in the vault or used in production of consumer products. The problem answers will appear in the short term, so the Santa Claus gold restriction need not be permanent.

For definitiveness, assume that no more gold is left in the ground to be mined.

Otherwise all monetary gold and the non-monetary gold that exists in already manufactured products can be converted back and forth, although I don't believe that this is vital to the answers that I have in mind.

With these points in mind, you should revisit your conclusions. I don't want to be more specific here and now so as to avoid too much bias.

Regards, Don

I'm still thinking about the

I'm still thinking about the problem, but in the meantime I'd like to comment on the paper. There's something about the reasoning that seems a bit off to me.

We all agree, I think, that under a fiat system, creating a bunch of new money and giving it to a subset of the population has a detrimental effect. This detrimental effect still exists with commodity money. The positive effects of a greater supply of the commodity may outweigh this effect, but we can't know a priori whether or not this is the case. Barnett and Block introduce a third factor: the ability of an increase in the money supply to enable previously infeasible transactions. The fourth factor, of course, is the cost of producing or extracting the commodity.

Determining whether or not mining of gold in the context of a gold-standard economy is socially beneficial requires comparing four different quantities which cannot be known a priori, so it's not at all clear to me that their conclusion--that the free market always produces the optimal supply of money--is correct.

It seems like 2 has to be

It seems like 2 has to be better. Isn't 1 equivalent to Milton Friedman's "helicopter" argument? Prices would immediately increase by 20%, nothing else would change. No benefit. Whereas using the gold to make real stuff provides real benefit.

But I could be missing something more complicated.

I'm left with #2, since #1

I'm left with #2, since #1 would just increase the price level. Didn't Spain experience a similar, but significant inflation when all of the "New World" gold (and silver) was hauled back across the ocean? In this case, the Incas, etc were the (unwilling) aliens?

1 has a definite benefit

1 has a definite benefit apart from that proposed by Barnett and Block (i.e., enabling low-value transactions). All prices would not rise by 20%. If that were the case, five ounces of non-monetary gold would cost six one-ounce coins, which is obviously unsustainable. Some of the coins would be melted down and used for non-monetary purposes, until we reached some short-term equilibrium with all prices having increased by something less than 20% and the total wealth of society having increased by the sum of the value of the new gold used for non-monetary purposes and the value of the new transactions enabled.

Actually, there may be a third benefit. With a fixed supply of commodity money and a growing economy, there's a tendency, as time goes on, for that commodity to become more and more scarce, not only in relative terms (as is the case for any good with a fixed supply), but also in absolute terms. As prices fall due to economic growth, the opportunity cost of non-monetary uses of the commodity increases, and marginal non-monetary uses of the commodity will become economically infeasible. When an ounce of gold buys a suit, maybe it's worth making some rings out of it. But when it buys a car, maybe it's not such a great idea. A general increase in the supply of gold delays this situation.

So...I choose option 1. Under option 2, there would be a sudden decrease in the value of non-monetary gold relative to monetary gold. People would be tempted to monetize their non-monetary gold, which would result in destruction of the goods into which they were incorporated (e.g., melting down jewelry).

Question for discussion: Under a fiat system, a general doubling of cash holdings, if made known universally, is neutral. Under a gold standard, for reasons stated above, this is not neutral in the sense of having no effect whatsoever. Is there some other sense of the word "neutral" under which some method of increasing the supply of gold could be said to be neutral? If so, define "neutral" and describe the method.

Brandon, ... Under option 2,

Brandon,

... Under option 2, there would be a sudden decrease in the value of non-monetary gold relative to monetary gold...

Setting aside conversion costs (or alternately taking them into account on a case by case basis), the basic exchange values of monetary gold and the non-monetary gold embedded in exchange-valued goods are effectively the same. The only gold in any question is the specific Santa Claus gold. IT has a sunk cost of zero, but its economic exchange value is probably best described here as its replacement cost. In sum, there is effectively only one gold price.

Regards, Don

In sum, there is effectively

In sum, there is effectively only one gold price.

Right. If there's a significant increase in the supply of gold, then some of it is going to be used as money, and some of it is going to be used for non-monetary purposes. This has to happen in order to maintain a single gold price.

Since this is a candidate for the world's hardest Austrian economics puzzle, not the world's hardest neoclassical economics puzzle, we can't ignore transaction costs. If Santa Claus gives us the gold as money, the costs of converting some of it to non-monetary uses are very low--we just melt it. But if he requires that it be used for non-monetary purposes, then we need to monetize some non-monetary gold to maintain a single gold price.

Basically, the only gold available for this purpose is jewelry (destroying electronic equipment for minute amounts of gold is generally not economically feasible), and if we monetize jewelry, we sacrifice the difference between the value of the jewelry and the melt value of the gold it contains.

Note that this assumes that it will be economically feasible to monetize some non-monetary gold. Maybe there just isn't enough jewelry. I suspect that in a gold standard economy, only a small fraction of the available gold would be used for non-monetary purposes. Or maybe all of the non-monetary gold is integrated into goods too valuable to destroy to recover the gold. In this case, it's possible that all of the gold in option 2 would be used for non-monetary purposes, and the gold market would remain segregated until the demand for cash holdings rose enough to justify destroying some of these goods. In that case, option 2 might be better.

On the other hand, I suspect that dumping so much gold into the hands of such a small subset of the population would cause economic disruption, so maybe option 1 would be better even under the circumstances described in the previous paragraph.

Brandon, ... If there’s a

Brandon,

... If there’s a significant increase in the supply of gold, then some of it is going to be used as money, and some of it is going to be used for non-monetary purposes. This has to happen in order to maintain a single gold price.

I don't think so. Monetary gold is distinguished from non-monetary gold not by its physical form, but whether its owner values it more for its subjective use-value or for its exchange-value. A solid gold statue of a panther could have three different possible values to its owner.

1. Its subjective use-value as a work of art.
2. Its exchange value in a potential sale as a work of art to the buyer.
3. Its exchange value for its gold content only, net of any conversion costs.

Only number three can be considered as a part of the effective money/gold supply, and then only if its owner takes it into account when making purchasing decisions by using it to further diminish his subjective marginal utility of gold/money.

Ths Santa Claus gold in choice 2. does not become part of the gold/money supply, nor does it affect the market exchange value of gold because it is prohibited from being brought to market.

Regards, Don

I was thinking along the

I was thinking along the terms of Brandon. However, I think this needs some more simplification. You don't for instance state the percent of monetary gold vs. non-monetary. This is important. Is the society on which this gold being dropped one that highly values the non-monetary uses and therefore has much less gold in monetary form. If only 5% of the gold is monetary then your 20% increase in this amount is a drop in the bucket. If 99% of the gold is monetary then the 20% if dumped on the non-monetary market would suddenly increase supply by 20 times. With either method of adding the gold it will seek it's new equilibrium.

Don't forget that this is going to have the most serious effects on contracts. Debtors get a 20% bonus and creditors get screwed by 20%. Not only that but industries that buy or sell forward or backward will also see windfall profits and unexpected losses. This will disrupt production.

I built some Excel charts to illistrate this, but I just made the increase 20% of total gold.

Chart before gold drop:
http://images9.fotki.com/v165/photos/4/42604/529214/HardAustrianProbAfter-vi.gif

Chart after Santa gold drop stretches chart by 20%:
http://images9.fotki.com/v165/photos/4/42604/529214/HardAustrianProbAfter-vi.gif

The pink line in the above charts is of the form y = -k/(x-n) where n is the total amount of gold, x is the amount of non-monetary gold, y is the value of gold, and k is a constant determined by the how long people hold gold on average between transactions. This does not take into account problems that occur when gold is so cheap you have to pay by truckloads, or so scarce that you need to pay in flakes, a.k.a. transaction costs. A 20% increase in monetary gold will not alleviate either problem much anyway. So it may be ignored as an effect.

The yellow line is the marginal value of gold. It has no specific formula but will tend to drop from the upper left to the lower right.
In these graphs the lines cross in the middle with shallow slopes. There is no reason why they could not cross towards either end and with a steeper slope.

The area under the yellow line up to the equilbrium point is the total value of the non-monetary gold. In the second chart the area under the yellow curve between the red and blue equilibrium dots is the final value that the new gold adds to the economy.

If the increase was 20% of total gold and the equilibrium was already sitting to the extreme right, say at 99% non-monetary gold, then adding the new gold as monetary gold would cause quite a bit of havoc. That would be a twenty times increase.

Ths Santa Claus gold in

Ths Santa Claus gold in choice 2. does not become part of the gold/money supply, nor does it affect the market exchange value of gold because it is prohibited from being brought to market.

But it does affect the money supply. Suppose that gold has only two uses: money and rings. If Santa Claus drops a bunch of gold off at the ring factory, then the supply of rings goes up, and the price falls, right? To get rid of all those rings, they may even have to sell them below melt value (i.e., for an ounce of gold, you can get eleven tenth-ounce rings).

Naturally, the jeweler down the street, who's been selling them at a ninth of an ounce each, is rather upset at this turn of events. If he wants to keep selling rings, he'll have to do it at the market price, or 1/11 of an ounce. But why should he do that? If he melts them down and monetizes them--which he can do because there's nothing magic about his rings--he can get a tenth of an ounce for each of them. And thus we have new money.

It's like food stamps. You can give someone certificates redeemable only for food, but if he has another source of income, you can't stop him from spending less of that on food and more on booze.

Brian, ... You don’t for

Brian,

... You don’t for instance state the percent of monetary gold vs. non-monetary. This is important. ...

I don't think so.

The amount of gold was specified as 20% of the existing monetary gold. The vast majority of non-monetary gold is embedded in goods that are valued by their subjective use-value to their owners. Since we are adding gold, the exchange value of gold will either decline or remain the same. There is no special reason to expect that a fall in the exchange value of the gold contained in a non-monetary good would cause the good to be moved from the subjective use-valued column to the exchange-valued column and become monetary gold. In fact, any movement would be expected to be in the opposite direction, although likely relatively insignificant. ( edit: I thought of a reason : poverty might make subjective use-valued goods unaffordable.)

The area under the yellow line up to the equilbrium point is the total value of the non-monetary gold. In the second chart the area under the yellow curve between the red and blue equilibrium dots is the final value that the new gold adds to the economy.

As an aside, Austrian Economic theory doesn't permit total values unless the total good is also the marginal unit under consideration.

Regards, Don

Brandon, But it does affect

Brandon,

But it does affect the money supply. Suppose that gold has only two uses: money and rings.

No, it doesn't affect the money supply. If a gold treasure shipwreck sits on the bottom of the South Atlantic, its gold certainly isn't part of the money supply, at least in any valid economic sense. It could be salvaged and become part, but it isn't before that point.

...If Santa Claus drops a bunch of gold off at the ring factory, then the supply of rings goes up, and the price falls, right?...

No, you are assuming that 'gold at the ring factory' equals 'production of rings.'

Also, produced rings will be held by the consumer as subjective use-valued goods, at least initially. An increase in rings won't affect their subjective value to their owner, at least for economic reasons. Their increasing commonness may well reduce their value for psychological reasons.

Regards,Don

No, it doesn’t affect the

No, it doesn’t affect the money supply. If a gold treasure shipwreck sits on the bottom of the South Atlantic, its gold certainly isn’t part of the money supply, at least in any valid economic sense. It could be salvaged and become part, but it isn’t before that point.

You're right--it's not. But so what? If it's only six feet deep, which I think is a fairly valid analogy for gold trapped in rings, someone's going to salvage it.

No, you are assuming that ‘gold at the ring factory’ equals ‘production of rings.’

Sort of. More accurately, I'm assuming that if ring makers have a bunch of gold which they can't sell or use as money, they're going to use it to make rings, which they can sell. Why is that an invalid assumption? I suppose they could hold some or all of it in hopes of getting a better price in the future, but that depends on time preferences, interest rates, and projections of future demand patterns.

Also, produced rings will be held by the consumer as subjective use-valued goods, at least initially. An increase in rings won’t affect their subjective value to their owner, at least for economic reasons.

I just gave an example of someone for whom their value would decrease--a jeweler who bought them for resale, and finds that the increased supply of rings makes him unable to sell his stock above melt value. At enough of a margin, even someone who wore a ring, and wanted to continue wearing a ring, would find it worthwhile to melt down his ring, use it to buy one of the restricted rings, and keep the change.

Don, You are correct and I

Don, You are correct and I am wrong with regard to this:


… You don’t for instance state the percent of monetary gold vs. non-monetary. This is important. …

I don’t think so.

The amount of gold was specified as 20% of the existing monetary gold.

It was only important with my assumption of an increase of 20% of total gold. When I first read the problem I though that it was going to be 20% of monetary stocks to owners of money, or 20% of non-monetary gold to producers. I see that I misread. I do agree with the other fellow that in your scenario there would be no producers as they would have long gone out of business.

Brandon, You’re

Brandon,

You’re right–it’s not. But so what? If it’s only six feet deep, which I think is a fairly valid analogy for gold trapped in rings, someone’s going to salvage it.

To be part of the economic money supply, it must be possessed by some specific person or association of persons. It must diminish his indirect subjective marginal utility of money due to its existence among his property.

Sort of. More accurately, I’m assuming that if ring makers have a bunch of gold which they can’t sell or use as money, they’re going to use it to make rings, which they can sell. Why is that an invalid assumption?...

They will only make rings if they can do so for a real profit. Their historical accounting cost for the gold is zero, but if they mean to stay in business they will eventually need to replace the gold, which means that the replacement cost for the gold should be used to determine profitability. The artificial limitation on their use of the gold is only temporary, and an artifact of the problem itself.

I just gave an example of someone for whom their value would decrease–a jeweler who bought them for resale, and finds that the increased supply of rings makes him unable to sell his stock above melt value....

The resale holding guarantees that the jewelers hold the rings for the exchange value, not their subjective use-value. You can expand the scope of the manufacturers so that they own the jewelers as part of their distribution strategy. That may make it clearer that it is profitability that rules.

Regards, Don

Brian, ... I do agree with

Brian,

... I do agree with the other fellow that in your scenario there would be no producers as they would have long gone out of business.

Might it not be a benefit to society to bring them out of quiesence?

Regards, Don

They will only make rings if

They will only make rings if they can do so for a real profit. Their historical accounting cost for the gold is zero, but if they mean to stay in business they will eventually need to replace the gold, which means that the replacement cost for the gold should be used to determine profitability.

If a ring company has gold, and it cannot sell this gold as is or use it as money, then what options does it have that are more profitable than making rings out of it? What specific actions would you expect makers of rings to undertake in this scenario?

The artificial limitation on their use of the gold is only temporary, and an artifact of the problem itself.

How is it temporary? My understanding is that are magical gold atoms which are incapable of ever being used as money.

Brandon, How is it

Brandon,

How is it temporary? My understanding is that are magical gold atoms which are incapable of ever being used as money.

Try to think of it this way. For the purposes of this problem, the economy is only being allowed to run in a 'Trace and Debug' mode. It is not that the gold product manufacturers cannot sell the gold or use it as money, but that a 'breakpoint' is triggered if they attempt to do so. The problem is set up to be a choice between 100%monetary gold and 100% non-monetary gold. The actors cannot be allowed to depart from the script or sell the props out the rear door of the theatre. That doesn't rule out consideration of the economic incentives that may make them want to do those things.

Regards, Don

"What specific actions would

"What specific actions would you expect makers of rings to undertake in this scenario?"

Manhole covers! ;)

"The problem is set up to be

"The problem is set up to be a choice between 100%monetary gold and 100% non-monetary gold. The actors cannot be allowed to depart from the script or sell the props out the rear door of the theatre. That doesn’t rule out consideration of the economic incentives that may make them want to do those things."

Well in that case the answer is easy. It's the non-monetary option which is best. According to Austrians the amount of currency doesn't matter. So there is zero value in increasing the money supply. The non-monetary gold serves at least some purpose, if only for decoration.

The equilibrium point will be at a lower value for gold so no matter where you insert the gold some will be leaking to the other side.

Brian, Well in that case the

Brian,

Well in that case the answer is easy. It’s the non-monetary option which is best. According to Austrians the amount of currency doesn’t matter. So there is zero value in increasing the money supply...

With the advent of the Barnett/Block paper it would appear that the Austrian view is no longer unanimous.

Regards, Don

Myself, I would prefer to

Myself, I would prefer to get more gold.

As to this statement, "He can add to the supply of monetary gold in a neutral manner, i.e. with no effect on relative prices."

Only if Santa Claus also has the power to suspend the laws of economics would this be possible.

I can't imagine any "Austrian" choosing the big hand out to the small group.

This is simply because when money becomes cheaper, people will themselves allocate it to non-monetary uses. This is the view of the Selgin / White free bankers, as well as the Block / Hulsmann types. So the person to whom the money is allocated isn't really at issue. The Rothbard view of "social benefit" basically states that whatever gives Santa Claus the most benefit is most beneficial. The basic choice is to give the gold to a small are large group, your caveat is essentially a price control. The long run out come for the money supply and money prices is likely quite similar.

The contention that gold product producers have empty vaults is absurd. This sort of "equilibrium" is not one used by any school of economics as far as I can tell.

Basically, I don't see this is as being a very Austiran problem at all.

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I think the answer is quite

I think the answer is quite obvious.

The end products are essentially the same in each scenerio. People who value the additional gold as a good unto itself will transform the gold into that good. Others will simply spend it. All will benefit from having an additional capital commodity. The only difference is, under the second scenerio, all of the gold would be FORCED to change into a good at least once, even if the end users inted to liquidate that asset and revert it into currency form. Here's why...

No manufacturer would ever "forfeit" any capital good. All of he gold put in the vault would be exploited as capital in some way or another, even if this meant that everyone in the world would be driving cars on gold rims and wearing gold watches. This would put all of the gold into direct use as an end product. These products would still retain intrinsic monetary value though, because they could be melted down and used as currency. Anyone who valued the gold in its currency form would liquidate that asset and spend it as currency. Anyone who doesn't would retain the asset.

The very same end is acheived under the first scenerio. Very little of the new gold supply would be put into use. If everyone had an additional gold supply of 20%, prices would simultaneously rise 20%, and the only increased productive capacity would come from the cheaper factors of production to the manufacturers. This would undoubtedly shift the supply curve of each of these products, thus increasing the amount of products used. However, at some point people would value the gold as a form of money more highly than as a form of product. The rest would simply be used as currency. i.e. people would simply carry around 20% more coinage. But, they would have the same alternative to change the form of the gold into a useful asset, such as a watch, which would still retain value.

The end products are essentially the same. But under the second scenerio, large amounts of productive capacity would be lost in simply transforming the gold asset unnecessarily. It is obvious that chioce #1 is the best solution, because it avoids this problem.