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Chancellor: Not Enough Gold

July 17, 2011

Edward Chancellor in The Financial Times (requires free registration) after a few paragraphs on the perversities of the current international monetary system, asks “What’s to be done?”. Replying:

Some yearn for a return to the strict discipline of the gold standard. But there is not enough of the precious metal and it would be absurd to restrict global growth to the rate of future gold extraction. There are no clear alternatives to the dollar.The euro is not a candidate since it is a “currency without a state”, in Mr Eichengreen’s words. China hopes to challenge US financial supremacy, but its capital account remains closed and the banking system is state-controlled.

That an economy needs an increasing quantity of money in order grow is widely believed, yet false. In this article, Chancellor makes an even strong claim: that the rate of growth of the economy must be equal to the rate of money growth (which is the rate of gold extraction under a gold standard). In the financial media, where this belief is regarded as fact, I have never seen a reason given by anyone for thinking so. And, even if there were money growth and restricted economic growth, what reason is there to think that the rates should be identical?

Austrian economics gives us reasons for thinking the opposite. Economic growth, defined as an increase in the quantity of goods produced per capita, requires the capital to labor ratio increases in favor of more capital per unit of labor. Capital accumulation must be funded by real investment. However, while nominal investment depends on the quantity of money, real investment does not. Any amount of real investment can take place with any amount of money because prices adjust not only to the quantity of goods but the quantity of money.

Economic history also suggests the contrary: during the 19th century, the economy grew faster than the rate of gold mining. Prices remained constant or slowly fell over time.

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