Thoughts about commodity money.

Here is an argument against the goodness of a commodity money: that it will lead to deflation, which is a fall in consumer prices. The basic premise of this argument is that the supply of the commodity money will be outpaced by the supply of all other goods in the economy. So, there will be relatively less "money" being exchanged for a greater quantity of goods, and so prices of goods will generally fall.

Now, this argument against the goodness of a commodity money is not due to its causing price deflation. Rather, the argument is that price deflation will discourage borrowing in terms of the commodity money. Here's how: suppose that one day A lends B 5 pounds of gold (which at the time would by 5 widgets). Later on, when the loan is to be repaid, the principal amount of 5 pounds would have more buying power, let's say 10 widgets. That must be paid with interest. Thus price deflation means that the borrower is actually paying the loan back more dearly than if prices were inflating. If prices were inflating, then the borrower would be paying back a principle amount that actually has less buying power than when it was borrowed, and so it seems the borrower is paying back the loan less dearly.

Now, why is that bad? The argument goes that no one would want to borrow in terms of the commodity money, and so commodity money is bad. I suppose then that the desire is to have a make-believe money, one whose amount can be adjusted at will. I believe this is one of the aims of the federal reserve bank: to increase the money supply to outpace the overall supply of goods in the economy. This would cause some degree of price inflation rather than deflation, and would be impossible to accomplish with a commodity money.

The truth is that I don't understand why this argument is conclusive with respect to borrowing ceasing in terms of commodity money. It seems to me that if borrowing is desired, then a commodity money would not prevent an agreement being reached between the borrower and lender. It seems that some agreement could be reached so that the lender and borrower each benefited. Since prices are deflating, it may be that each party could still benefit if the loan were paid back without interest, or paid back at slightly less than principal.

In any case, I guess the real question is whether people are generally wealthier in an economy based on a money supply that is outpaced by the supply of other goods. This is an economy with price deflation. Now, this question is not going to be answered on a blog post by someone who has no education in economics, and the question may not even be properly stated in the first place.

In any case, this post of mine was all caused by a (one star) review on Amazon.com of Ron Paul's book End the Fed. I copy the review here and add some of my own remarks.

"But, for an easy to understand response on why Paul's tract is a load of baloney, here's a good way to think about it: gold is, in itself, a commodity. That means it's worth as much as laws of supply and demand say it's worth. It's subject to bubbles (some would say we're in one now, though I haven't spent enough time analyzing the gold market to have an opinion one way or the other) driven by what people are willing to pay for it. But it's a HORRIBLE currency because, simply, it's completely detached from output. Here's a simple model for understanding why. Imagine a closed economy with 100 people and a fixed supply of gold. Say output over 25 years doubles (a perfectly reasonable assumption if that economy grows 3% annually), but the supply of gold stays fixed. Now you've got twice as much output chasing the same amount of gold, so prices deflate (by half). Wages do the same thing. Now imagine for a second that you took out a loan in year 1 for 5 pounds of gold. Now, in year 25, the nominal value of your principal is the same, but the real value of the loan is double, PLUS interest. Given that kind of deflation, no one's going to be too willing to borrow in gold. Instead, they'll spend as little of their gold as possible and sit on it, waiting for it to appreciate. [Okay, one sentence ago, it seemed the claim was no one will want to borrow in gold, due to price deflation. Then, the next sentence seems to claim that no one will want to lend in gold, which doesn't seem to follow from price deflation.] But if everyone's doing that, then where does the demand for goods and services come from? The simple answer is: from nowhere. [Okay, so people would hang on to their appreciating gold, even if it means forgoing food, shelter, etc.?] Instead the gold standard discourages credit, depresses demand, and makes the money supply contingent on something as random and unpredictable as the amount of gold that is mined in a given year."

Money

A penny saved is a penny earned, and I find it easy to save money. At the same time I feel that money is worthless; money can't be consumed. The value of money is as money. I save money because I feel that there isn't very much to spend money on. I live in an age where labor is more valuable than ever before, and it is relatively easy to meet basic needs. But saving money is the responsible thing to do, so I do it.

In any case, it occurred to me that it is also a risky thing to do. This is obvious to many people, I'm sure. But it is an historical fact that the buying power of the dollar has steadily diminished over time. So, it seems risky to store so much wealth for the future in the form of saved money. But now I am starting to wonder whether or not saving money is risky depends on what "money" is. The dollar has certainly depreciated. I understand that this is uncontested, although I haven't done my own empirical research on it. I do understand the argument, however. The argument goes that the dollar is not "backed" by anything and its value depends on its management. Now, this would be true of anything used as money. I believe one necessary characteristic of money is that it must be somewhat scarce. Gold is in fact somewhat scarce. Gold cannot be produced from nothing. That is not true of the dollar, and the claim goes that the quantities of dollars has not been properly controlled by its creators. A progressively greater number of dollars chase the same or fewer goods and the result is less buying power for the dollars. This is easy to understand.

But I'm sure it's only one side of the story. Perhaps the dollar isn't a perfect money, but it may be the best available. There are other advancements of science that for all of there value still are not perfect. Because the dollar is an artificial money, it can be perfectly controlled. In fact, I wonder if physical dollars will cease to be circulated in the near future. If some commodity or physical object were used as money on the other hand, then there can be no central control; what is scarce today might not be scarce tomorrow.

Now I can see what many of the critics of the fed and fiat money are libertarians. Giving the government the peculiar power to manage the money supply has allowed (and will allow) them the ability to bypass the approval of the people for their policies. Governments have no resources of their own, so it if needs money for war it must ask the people for it directly for money or create the money out of nothing. That sounds like a criminal act, but I guess that's the privileged that the creator of money is entitled to.

What's the truth? I don't know. In fact, I don't have a lot of confidence that what I have written above is the truth. I'm just trying to repeat a story I've heard about money in general on the dollar in particular. I would just like to discover some way to store wealth without having to keep up with inflation by making investments that I don't understand.

Projects

Here I will compile a list of projects that I'd like to finish someday. Today I'll write a few things down that have been on my mind recently, lest I will forget them. Projects occur to me all of the time, and, as silly as some of these I can't describe how excited I get about them. I'll come back and add to this list in the future, but the common link between all of the projects is that they are all due to some math or science that I want to either learn more about or put to the test.

Here is the list:

(1) make a sundial: timekeeping and astronomy are both interesting subjects to me, and here is one project that concerns both of them.
(2) make a simple calculator: I don't know how far out of my reach this one is, but I
I'd be happy no matter how simple it was. Perhaps with a microprocessor and devices for input and output I could at least add in binary. I have at this point at least learned how binary arithmetic can be reduced to logic circuits; it's knowledge of electronics that I am lacking.

2012 Tomatoes

I planted my tomatoes today. I bought 7 total transplants today, and this season I will be planting more tomatoes that ever. The varieties are Arkansas Traveler, Celebrity, Jet Star and Big Boy.

Actually, only 4 or the 7 transplants were planted directly into the garden. This is because I'm conducting an experiment this season, but I want to say a few preliminary remarks before I describe the experiment. I planted today, of course, but I think the truth is that the crop would have been unsuccessful if I had waited until mid to late April to plant them. The reason: tomatoes will not set fruit during very hot weather. On the other hand, the tomatoes will become mature and set fruit in suitably warm (but not too hot) weather by planting them in early spring. But planting them in early spring leads to other problems: occasional frosts and high winds. In any case, 4 tomatoes went directly into the garden, and the other 3 were planted into bigger pots with additional potting soil and alfalfa meal (fertilizer) added. These plants will keep growing as long as bigger pots are provided when needed, but they are portable enough to be hardened off gradually. They can easily avoid the cold and wind and they will be planted into the garden when conditions are right.

Update 3/24/2012: So far, anyone would agree that the tomatoes in pots "look better" than ones in the garden, although the ones in the garden look normal for their time of planting. All plants were fertilized with an even mix of bone and blood meal, then watered with a molasses solution.