barbarous relic

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Fiat Money Kills Productivity?

I have long suspected that a money supply based on nothing other than faith in government could be a productivity killer.

Last November I wrote:

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 exchange standard was a free lunch: GDP growth could be achieved without any real gains in productivity, or efficiency, or in infrastructure, but instead by just pumping money into the system.

And now I have empirical evidence that my hypothesis may possibly have been true — total factor productivity.

In 2009 the Economist explained TFP as follows:

Productivity growth is perhaps the single most important gauge of an economy’s health. Nothing matters more for long-term living standards than improvements in the efficiency with which an economy combines capital and labour. Unfortunately, productivity growth is itself often inefficiently measured. Most analysts focus on labour productivity, which is usually calculated by dividing total output by the number of workers, or the number of hours worked.

A better gauge of an economy’s use of resources is “total factor productivity” (TFP), which tries to assess the efficiency with which both capital and labour are used.

Total factor productivity is calculated as the percentage increase in output that is not accounted for by changes in the volume of inputs of capital and labour. So if the capital stock and the workforce both rise by 2% and output rises by 3%, TFP goes up by 1%.

Here’s US total factor productivity:

As soon as the USA left the gold exchange standard,  total factor productivity began to dramatically stagnate. 

Random coincidence? I don’t think so — a fundamental change in the nature of the money supply coincided almost exactly with a fundamental change to the shape of the nation’s economy. Is the simultaneous outgrowth in income inequality a coincidence too?

Doubters may respond that correlation does not necessarily imply causation, and though we do not know the exact causation, there are a couple of strong possibilities that may have strangled productivity:

  1. Leaving the gold exchange standard was a free lunch for policymakers: GDP growth could be achieved without any real gains in productivity, or efficiency, or in infrastructure, but instead by just pumping money into the system.
  2. Leaving the gold exchange standard was a free lunch for businesses: revenue growth could be achieved without any real gains in productivity, or efficiency.
And it’s not just total factor productivity that has been lower than in the years when America was on the gold exchange standard — as a Bank of England report recently found, GDP growth has averaged lower in the pure fiat money era (2.8% vs 1.8%), and financial crises have been more frequent in the non-gold-standard years.

The authors of the report noted:

Overall the gold standard appeared to perform reasonably well against its financial stability and allocative efficiency objectives.

Still think it’s a barbarous relic?

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Italian Gold Heading to China?

James Rickards and Max Keiser suggest one of the logical conclusions of the Italian-debt blowup is that Italian gold will be auctioned off, perhaps to China:

With Italian external debt standing at $2.2 trillion, and Italy’s 2,400 tonne gold holdings worth only $137 billion, gold would have to rise pretty significantly for that option to come into play.

Of course, these figures ram home the idea that gold is significantly undervalued relative to current credit/debt levels. America’s external debt stands at $14.3 trillion, yet its gold reserves are worth just less than $500 billion.

Officially, gold is not money. Officially, levels of debt should have no tie to gold reserves (i.e., the ability to pay in the 6,000-year old store of value).

But with the current malfunction in the global economic system, which soon may have to deal with the consequences of Euro breakdown, or an oil shock, or a new middle eastern war, it is perfectly plausible (or even likely) that the newer fiat monetary systems — all of which are subject to counter-party risk — will crumple, and bring the old currency — gold — back into play.

While a chance of systemic collapse remains, nobody will be keen to see their gold reserves sold off. Nations with less gold than their rivals — particularly China who have recently shown particular interest in converting their FX hoard into gold — will be keen to see the system live on for as long as possible (to cash out into physical assets and gold).

And that is the fundamental contention — the Eurozone wants to keep its gold, but fear the catastrophic impact of Euro-breakdown — and the Chinese want to keep the system going while slowly accumulating gold.

I can see that there is quite a lot of scope for a middle ground. The real question is how much would a Sino-European bailout-for-gold deal cause gold to spike…

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Chavez: “We Want Our Gold”

According to Federal Reserve Chairman Ben Bernanke:

Gold is not money. It’s a precious metal. We keep it in our vaults because of tradition.

So, if a nation — say, Venezuela — were to demand the full and final return of its (multi-leveraged) gold reserves from vaults across the West, would it be safe to assume that the “ barbarous relic“, and”anachronism” would be delivered quickly and in full? Further, would it be safe to assume that the price of gold would not shoot through the roof? Well, it seems like we are going to get to find out just how “barbarous” this “relic” really is. From Zero Hedge:

In addition to the nationalization of his gold industry, Chavez earlier also announced that he would recover virtually all gold that Venezuela holds abroad, starting with 99 tons of gold at the Bank of England. As the WSJ reported earlier, “The Bank of England recently received a request from the Venezuelan government about transferring the 99 tons of gold Venezuela holds in the bank back to Venezuela, said a person familiar with the matter. A spokesman from the Bank of England declined to comment whether Venezuela had any gold on deposit at the bank.” That’s great, but not really a gamechanger. After all the BOE should have said gold. What could well be a gamechanger is that according to an update from Bloomberg, Venezuela has gold with, you guessed it, JP Morgan, Barclays, and Bank Of Nova Scotia. As most know, JPM is one of the 5 vault banks. The fun begins if Chavez demands physical delivery of more than 10.6 tons of physical because as today’s CME update of metal depository statistics, JPM only has 338,303 ounces of registered gold in storage. Or roughly 10.6 tons. A modest deposit of this size would cause some serious white hair at JPM as the bank scrambles to find the replacement gold, which has already been pledged about 100 times across the various paper markets. Keep an eye on gold in the illiquid after hour market. The overdue scramble for delivery may be about to begin.