"Now, the gold bugs will no doubt reply that under a gold standard big bubbles couldn't happen, and therefore, there wouldn't be major financial crisis. And it's true under the gold standard America had no major financial panics other than in 1873, 1884, 1890, 1893, 1907, 1930, 1931 and 1933. Oh wait. The Truth is that returning to gold is an almost comically (and cosmically) bad idea." Paul Krugman
This quote is the typical opinion of economists with a Keynesian bent. The only problem is it has no bearing in real economic history.
It is true that the United States used gold as money during the 19th century, but it was not the only form of money. Private fractional reserve banking was extensively used, and when fractional reserve banking is utilized it produces debt based money similar to the money we use today. The instability the Keynesians often refer to were the many panics that occurred during the first half of American history as Krugman points out above. The term panic is actually very apt and descriptive for these economic downturns.
The private banks would print money when they made a loan. Instead of the money stating that it was backed by the loan, it would be printed with an implication that the currency could be redeemed for gold and silver from the originating institution. As the banks expanded money and debt, a credit created boom would occur as entrepreneurs and businesses would use this borrowed money to produce real goods and services. Unfortunately, as banks always do, they would create too many loans and too much of this debt based money. The first cracks in this scheme could start if some of these loans defaulted or if depositors started withdrawing too much from accounts. For those paying attention, it would become clear that the bank would not be able to make good on the promises printed on their currency. This would result in a 'panic' as people came to the realization that they would not be able to withdraw their money from their accounts, also known as a bank run.
If gold and silver were used alone with no expansion of the money supply through fractional reserve banking, these panics would not have occurred. The economic turmoil of the 19th century was actually the result of debt based money, which the likes of Paul Krugman advocate, not gold. The revisionist history Krugman's ilk practice, blaming gold, would be comical if not for the fact that they are the ones driving world economic policy.
Economic participants suffered significant psychological damage as a result of the panics associated with fractional reserve banking in the 19th century. The question is, was the damage done to the economy in the aftermath of the panic/crash enough to wipe out any or all of the real growth that occurred during the boom (compared to if only gold and silver were used as money). Frankly we don't know for sure. I would like to think that the certainty of sound money, as well as not having huge gyrations in money supply, would have allowed for the industrial revolution, and the growth of this period just the same, but this can't be proven.
The growth of the 20th and 21st centuries on the other hand has nearly all been the result of debt based money. Any time the loose ties to gold attempted to restrict the exponential growth of debt, and debt based money, those ties were severed. All of the kudos for the growth of this time should admittedly be placed at the foot of this debt-based monetary system. You will not get an argument from me that the real economic growth as a result of a debt based monetary system is anything but impressive; only that it is unsustainable and unhealthy. By unsustainable I mean that all debt based monetary systems will result in unsustainable debt, bubbles, and ultimately an overhaul of the system. By unhealthy, I mean it misuses resources, and I think we can all agree unsustainable systems are inherently unhealthy.
As Ludwig von Mises said in my favorite quote:
"There is no means to avoiding the final collapse of a boom brought on by credit expansion. The alternative is only whether the crisis should come sooner as a result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved."
The world has experienced two major credit created booms since 1900. The first lasted for about three decades, the first of the 19th century. Pinpointing the beginning of credit booms can be difficult depending on the criteria used, but this credit expansion ended with the Great Depression. During the 1930's debts were wiped out, and there was an obvious crash. The system was overhauled by removing gold from circulation and major banking reform, including deposit insurance, and the Glass-Steagall act. There was a second overhaul that took place at the end of World War Two with the adoption of the Bretton Woods world monetary system.
Again pinpointing the beginning of this second credit created boom is difficult, but it was some point during the 1930's. What is less difficult is to know when it ended, and that is...it hasn't. Yes, we have been experiencing an unsustainable credit created boom for over 80 years.
Some readers, and of course Keynesian economists, would call foul. If a system has lasted longer than a lifetime with nearly everyone alive never having experienced the Von Mises predicted crash, then it must be sustainable. Not to mention the undeniable growth that the world has experienced since WW2.
I understand this line of thinking, but it is no different than saying the equator is a straight line because it appears to be to anyone looking at it from earth. Yes, for someone born in 1940, and passing last year, I could understand how our monetary system would appear sustainable, but there is one simple set of data points that prove to me that this is a fallacy. Since the beginning of this boom, the expansion of debt has outpaced the income that is necessary to service it. They are both growing on a near exponential curve but debt at a faster rate. The only time the total credit market debt dropped was in late 2008-'09, income was also falling, and I think we can all believe that if the Fed didn't step in with unprecedented policies it would have resulted in the aforementioned crash. As a result of these policies the unsustainable divergence of debt and income has remained at elevated/crisis levels. We don't know when the crash and monetary overhaul will occur. Nor can we know how much of the economic growth of the past eight decades will be wiped out, but it could be significant. Below is a graphical representation of my point, it is a ratio of total debt in the US economy to GDP, a measure of national income to service that debt.
The next issue with the amazing growth experienced over the past several decades, and there is no question it has been impressive, is the cost of this growth. To facilitate that growth, the economy has had to burn through resources such as oil, lumber, copper, iron, uranium, and water to fuel not only products essential for our population and its increased prosperity but also bubbles. These bubbles/misallocations caused the building of homes, cars, bridges, oil wells, roads and entire cities that really were not necessary. China is a perfect example of this. In addition to the wasted raw materials there is also the untold millions of man hours wasted on products that are simply not necessary; financial sector I'm looking at you.
I'm certainly want advancement, and at times overall growth, but an economy with a debt based monetary system must grow and is not flexible on this point. It will burn through resources, both natural and human, with no regard as to whether that growth is necessary for our development as a society. Any study of history makes it clear that capitalism is the only system to allow for a peaceful human society, but there must be a better monetary system to allow capitalism to function more efficiently. Certainly better than a system that must grow based on its fundamental nature. Here are some recent examples of how wasteful debt based monetary systems can be.
This is a picture of a building in China being destroyed because it had never been used. I feel for the guy who did the drywall, looks like digging holes and filling them in again to me. Krugman would be proud. Source:People's Daily Online
Here is one of the famous ghost cities of China, Erenhot, in Inner Mongolia. It was built in the middle of a desert. One part is unfinished, and the other has no one living in it.
Of course the US is no stranger to waste brought on by bubbles. How many houses still sit unused from the housing boom. I for one live next to one.
The latest casualty is in the oil industry. I discuss how the root cause of the oil price crash is the debt based monetary system here, and how a different debt dynamic is exacerbating it here.
There are 800 million dollar drill ships, that are only a fraction of of their design life, that may never work again. By the time prices recover and companies are ready to put them back to work, due to neglect and technological development, it may make more sense to cut them up and build a new one rather than the nightmare of trying to re-mobilize what has become obsolete.
There is also the emotional toll and waste of human resources. Consider someone who started working in the shale oil boom in 2010. He built up some skills and is now laid off. If they don't sell all of the shale oil at ridiculously low prices, and that industry comes back when prices rise, will that worker ever come back? He will have moved on to another career by then, and wouldn't like the thought of getting burned again. Those skills, likely only applicable to the oil field, will go to waste. What if that same person had been employed in home-building before that?
Using a sound monetary system such as gold on the other hand would not cause nearly as much waste that seems inevitable with debt based money. Krugman actually admitted that wasteful bubbles are the only thing that can keep our system afloat at this point here. The "growth" may be slower using gold as money, but now may be the perfect time to shift to such a system, as we are confronted with the limitations of a finite world, as is often discussed eloquently on Chris Martenson's peakprosperity.com.
The financial powers that be would have you believe that using sound money would result in no credit being available for anyone. For people who have become so addicted to debt for their homes, education, cars, and businesses this is unthinkable. This is not the case, loans would be available under a sound money regime, though they would certainly be curtailed. Credit would most likely be offered by those producing goods and services, and who better to determine the terms.
A homebuilder wouldn't build a house for no money down, and a 30 year repayment schedule at 3.5%, but with 30% down and the remainder paid back over 10 years at 8%, the home would get built. With these more stringent terms the home buyer may build a smaller home or opt to stay in an apartment instead of diving into a 4500 square foot Mcmansion, but think of the lumber, fuel, and electricity that will be saved and used for a more productive purpose. Did the 3 person family really need that much house anyway? No of course not. This is a small example of how resources will be saved, and hopefully better allocated or saved for future generations. I doubt we would see 27 floor buildings built, never used, and destroyed in a short time under a sound money system.
We don't know what the industrial revolution would have looked like without debt based money, and while the growth of the past century is undeniable, it was also unquestionably wasteful. It has also been a clear credit created boom with no evidence of having avoided Mises's crash. If that crash comes to pass, an overhaul of our monetary system will be required. When deciding what that system should be, those who are concerned about the sustainability of our environment should consider that sound money would promote not only a healthier and sustainable economy, but would also create far less waste.
Here is a possible first step toward sound money without tipping the fiat apple cart, but this is a more likely path the powers that be will follow.