An Isolated Question on the Cost of a Gold Standard

It is commonly held that a part of the cost of a gold standard, or of the holding of gold for its exchange-value in the absence of a gold standard, is the reduction in the supply of gold for non-monetary purposes that results in lower production of, and higher prices for, consumer and industrial products that utilise gold.

This seems to be a valid observation, but it raises a follow-up question.

If gold had never been used as money, and had never been held for its exchange- value, would the current supply and prices of consumer and industrial products that utilise gold be higher or lower? I suspect, without proof or evidence, that the past demand for monetary gold has resulted in an increased supply of, and lower prices for, consumer and industrial products that contain gold.

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Prices would

Prices would fall.
Converting to a gold standard (or any other hard commodity standard) would fix the amount of currency issued by the government to the amount of gold surrendered to the government. If the US converted today, it would merely set the number of dollars at the amount of gold in vaults (Reserve banks hold half of all extracted gold as it is, so I understand). No more or fewer dollars would be issued. No more or less gold would be needed. An increase in gold reserves would come about only if the monetary value of the commodity were greater than the commodity value, that is if individuals voluntarily surrendered their gold to the banks for notes. The gold standard alone would not change the demand dynamics of the use of gold.

A gold standard would produce a gradually deflationary environment, as efficiencies increase over time. Hence prices would fall and products that use gold would cost less in dollar terms.

Mike: you're right, under

Mike: you're right, under the gold standard nominal prices would tend to fall over time. But that's not what Don was talking about (I presume). Don was talking about the supply and price of gold itself, or rather, goods that used gold as an input, and the only useful meaning of "price" in that context is *real* price, i.e. price as measured in goods and services.

The nominal price of gold under the gold standard is of course fixed, since nominal prices would be measured in gold. But the real price of gold and thus of goods using gold as an input might be higher or lower. Don contends it would be lower, I suggest it would be higher.

eddie, Your conclusion is

eddie,

Your conclusion is also correct, but only because the demand for gold-as-money has fallen (probably to near zero). Since demand for gold-as-commodity represents consumption but demand for gold-as-money represents holdings of wealth, as demand for gold held for wealth falls it makes more gold available for consumption by industry, thus reducing prices.

It is highly likely that the current demand for monetary gold, whether or not it is actually money, including all gold held for its exchange-value, exceeds the demand for non-monetary gold.

Regards, Don

Don, It is highly likely

Don,

It is highly likely that the current demand for monetary gold, whether or not it is actually money, including all gold held for its exchange-value, exceeds the demand for non-monetary gold.

I'm sure you're right; I don't follow gold, so I defer to you. I shouldn't have said that demand for monetary gold *has* fallen; whether it has or not is immaterial to your hypothetical question. My point is that past use of gold as money could only have made non-monetary gold cheaper and more plentiful in the present if the monetary demand for gold had fallen over time. The reduced monetary demand would have freed up gold stock to meet industrial consumption demand.

Another possibility is that the earlier demand for monetary gold increased capital investment in mining, which lowered the cost of both monetary and non-monetary gold. But this can't be used to argue that the gold standard was good because it made industrial gold cheaper; without the gold standard, there would have been less capital investment in mining and therefore gold would be more expensive, yes, but there would have been more capital investment available for other purposes and other things would have been cheaper.

It's obvious that mining of

It's obvious that mining of gold is a huge waste of resources.

The commonly held view is

The commonly held view is correct: if the demand for gold-as-money increases, the overall demand for gold will increase and thus both price and production will increase. However, only part of the increase in demand for gold-as-money will be met by increased production; some of it will be met by reduced consumption of gold-as-commodity. Thus higher prices and lower production of gold-containing products.

Your conclusion is also correct, but only because the demand for gold-as-money has fallen (probably to near zero). Since demand for gold-as-commodity represents consumption but demand for gold-as-money represents holdings of wealth, as demand for gold held for wealth falls it makes more gold available for consumption by industry, thus reducing prices.

However, once the demand for gold-as-money stops falling (either by a return to the gold standard or a complete abandonment of the hope of ever returning to the gold standard) then there will no longer be any gold held as money available to supply the demand for industrial consumption. The price of gold will once again be determined by the marginal cost of production and the shape of the demand curve, the demand curve consisting of the demand for consumption by industry plus the demand for monetary holdings (which may be zero).

If there had never been a gold standard, but then one were imposed by fiat and later abolished by fiat, there would have been a boom in gold prices followed by a bust in gold prices. The boom and bust would have been an inefficient allocation of resources since it would have been imposed by fiat rather than market choices. Of course, the gold standard did arise freely; I'm only addressing your hypothetical.

I think this is a classic

I think this is a classic example of the old debate: does demand create its own supply, or does supply create its own demand (or, in a vibrant, dynamic economy, are both perpetually true)?