Income Inequality, Aggregate Demand & the Gold Standard

Paul Krugman presents a graph that I think is pretty relevant to the state of America:

During 1947-73 (for all but two of those years America had a gold standard where the unit of exchange was tied to gold at a fixed rate) average family income increased at a greater rate than that of the top 1%. From 1979-2007 (years without a gold standard) the top 1% did much, much better than the average family.

As we have seen with the quantitative easing program, the newly-printed money is directed to the rich. The Keynesian response to that might be that income growth inequality can be solved (or at least remedied) by making sure that helicopter drops of new money are done over the entire economy rather than directed solely to Wall Street megabanks.

But I think there is a deeper problem here. My hypothesis is that leaving the gold standard was a free lunch: GDP growth could be achieved without any real gains in productivity, or efficiency, or in infrastructure, but instead by pumping money into the system and assuming that this would have a positive effect on the economy as a whole. After all — say the Keynesians — “aggregate demand” (i.e. money circulation) “is the state of the economy”.

But in reality “higher GDP” and “higher aggregate demand” just mean more money circulating. It’s perfectly possible for more money to circulate while the real economy (productivity, labour, technology, infrastructure, etc) deteriorates. In fact, in many respects this is exactly what happened during the Bush administration, where trillions of dollars of productive capital was burnt up on military adventurism.

So — in effect — I hypothesise that fixed money acted as a check on irrational exuberance. GDP growth could not be conjured up via money printing (and resulting credit expansion) but instead had to be earned slowly and laboriously through real development. It also made investors and financial institutions significantly more cautious — they could not lose it all playing at the derivatives casino, and then enjoy a recapitalisation from newly printed money.

Most importantly, governments could not run up and monetise absurd deficits on spending in the name of military adventurism and maintaining the petrodollar standard. Government spending had to be of real, palpable benefit to the nation — infrastructure, medicine, education, technology, defence (clue for George W. Bush & Barack Obama: “defence” does not mean “attack”) etc. The bare necessities.

The trick here is that the only difference between gold and paper is that gold is naturally limited, and governments can’t just conjure large quantities of it out of thin air at will in the name of largesse, or saving the world from non-existent weapons of mass destruction, or whatever takes the central planners’ fancy.

In theory a fiat system could work so long as in the long run (when we are all dead) governments are willing to practise the discipline to save in the fat years, and spend in the lean ones.

The problem is that such self-discipline has never been maintained in the long run. In fact, governments (in Britain, the Eurozone, and America) seem to misunderstand that concept altogether, running huge deficits in the fat years, and then trying to undertake austerity programs in the lean years — exactly the opposite of what Keynes intended.

Which suggests to me that as a society we are not yet mature enough to leave the haven of fixed money, for when we do, we wreck everything.

A Keynesian or Krugmanite perspective would be welcome, of course.

About these ads

7 thoughts on “Income Inequality, Aggregate Demand & the Gold Standard

  1. “My hypothesis is that leaving the gold standard was a free lunch: GDP growth could be achieved without any real gains in productivity, or efficiency, or in infrastructure, but instead by pumping money into the system and assuming that this would have a positive effect on the economy as a whole.”

    While the overall article and conclusion you draw about our societal maturity seem correct, this hypothesis doesn’t seem totally valid. When considering 1979 to 2007 it’s impossible to say that there haven’t been improvements in productivity, efficiency and infrastructure. 1979 coincides pretty closely with the introduction of the personal computer. It’s possible that there has been no greater boon to productivity than a computer on every desk.
    But if you want to talk about efficiency outside of the office space and in manufacturing, well the early 80’s is when we started to see Lean and automation hit the factory floor. So efficiency and productivity improved there as well.
    For infrastructure, we’ve had a huge build out of data infrastructure (the internet and the data centers that house millions of servers across the country). Granted, it’s not necessarily roads and bridges but our economy has changed from one that moves physical things to one that moves virtual things (to a large extent anyway).

    So that lack of growth in income likely has a correlation to the fact that fewer people are needed to do the things that make up our economy precisely because of the growth in productivity, efficiency and infrastructure. Pumping money into the system has been trying to cover up that fact in hopes that loose money would create new jobs for those people displaced by our improvements. I think there is a chance this would have worked if there hadn’t been wholesale outsourcing due to globalization. It’s worth examining how globalization would have been slowed by a fixed currency and where we would be today as far as income inequality.

    • No doubt this is a factor in current employment figures, but I wonder whether it really made that much difference to income growth? Even in the mid ’00s when unemployment was at lows (much, much lower than ’79 in terms of U3 and U6) the same income growth disparity existed. I believe the Keynesians are right to draw attention to these figures, I am just very suspicious that gold is the missing link here…

  2. Pingback: Ron Paul & Austerity « azizonomics

  3. Pingback: Fiat Money Kills Productivity « azizonomics

  4. Pingback: Fiat Money Kills Productivity « Silver For The People – The Blog

  5. Pingback: Fiat Money Kills Productivity [azizonomics] « Mktgeist blog

  6. Pingback: Atlas Sound Money Project » Blog Archive » Fiat Money Kills Productivity

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s