Bob wrote:
>
> David Hillary wrote:
> >
> > Claude Cormier wrote:
> > >
> > > A recipe for stagflation
> > >
> > > http://www.goldeconomy.com/thepriceofgold_08.htm
> >
> > why oh why do 'goldbugs' seemingly always seem to predict a large rise
> > in the price of gold in the medium term?
> >
> > The price of gold in terms of US dollars has been enaything but stable
> > in the last few decades, whereas, the widespread (near universal) use of
> > USD in the $10 trillion US economy, makes the price of USD stable in
> > terms of goods and services, at least in the short term.
>
> You are comparing "last few decades" to "short term". You may be
> comparing apples to oranges here. I can't say though as I don't know
> how long (or short) "short term" is.
quarter by quarter, the USD buys about 1% more or less (usually less) US
goods. At bad times the USD might by 3% less than it did before, of
domestic goods. This is because the process of inflation and deflation
(hyperinflation excepted) cannot occur at a high rate because of the
menu costs and other price rigidities in the economy.
However over 5 years inflation could be high low, zero or negative.
Currency could buy 25% less or 25% more. This magnitude of adjustment is
as much as would be required to adjust the price level of an economy, if
macro-economic shocks required it. The price level cannot jump 10%
overnight or fall 10% overnight. It takes time and dis-equilibrium in
many markets to force price changes. This is why it matters that the USD
is 'attached' to a $10 trillion a year economy -- this economy prices
USD by offering goods and services for USD with inflexible prices.
>
> > Variable inflation of this currency attached to the economic giant makes
> > the price of gold, an inflation hedge, makes for wild changes in the
> > real price of gold, as expected inflation changes.
>
> Maybe, maybe not. It depends on what country you're living/working
> in. The _*real*_ price of gold would be gold priced in coffee
> (hopefully Capulin, I've been spoiled for ever) or other things
> that have intrinsic value.
The real price of gold is the quantity of goods and services that can be
exchange for it. The prices of goods and services are in fact fixed in
various fiat currencies, and do not adjust quickly, thus the real price
of gold, in goods and services, is as volitile as fiat currencies, if
not more.
>
> The emergence of
> > inflation when nominal interest payments are heavily taxed, can easily
> > make the real return on savings less than zero, in which case savers
>
> > look for alternative stores of value. Combined with economic uncertinty
> > over the direction of stockmarkets and the real economy, and gold
> > becomes a very good investment, a stocks become risky and poor
> > investments.
> >
> > This makes gold a poor currency for a small open economy to adopt, and
> > makes gold a poor unit of account, measure of value and store of value.
> > If gold were the general means of exchange in a large open economy or in
> > a closed economy, its performance as a unit of account, measure of value
> > and store of value would be much better.
>
> I don't see how size has anything to do with it.
Small open economies cannot affect the world interest rate or the price
of gold, their economic activities are not significant enough to do
this. Large economies savings rates and other variables can affect the
world interest rate and the price of gold.
>
> > The adjustment required of a small open economy that adopted gold as
> > money would be difficult and painful. If US inflation and inflation
> > fears were ignighted, the real exchange rate of the SOE would rise very
> > sharply, and require downward adjustment of wages and prices in the SOE.
>
> Huh?
>
> The price in gold (priced in USD) wouldn't affect local business within
> the SOE (small open economy) that is using gold as money. Who cares
> what the price of gold in USD is if locally I'm getting paid in
> gold and spending gold. If there's an inflation problem in the US,
> and the SOE wants to buy some US goods or services, that's not much
> of a problem. The money of the SOE (gold) has been buying more
> USD to be able to buy the US's goods and services, as the prices of
> goods and services have been going up (in USD, not gold) in the US.
>
> On top of that, if the SOE has been using gold for .. say 2 decades,
> it's probably got a hopping, maybe screaming economy because it
> has been attracting capital (including brains) because of it's more
> stable prices, businesses are able to do better (compared to the
> US) planning because of more stable local prices.
>
gold for money fixes the nominal exchange rate with other economies to
the price of gold, in terms of their currencies. If inflation fears are
ignighted in a large open economy, the price of gold will rise, as will
the nominal exchange rate of the SOE. This exchange rate movement has
almost nothing to do with the factors that equilibriate international
trade and finance for the SOE. Thus the appreciation of the nominal
exchange rate leads to downward pressure on domestic prices (deflation).
Thus the real effective exchange rate is arbitrarily jacked up,
exporters and import competitors go broke, deflation drives the real
interest rate in the SOE sharply upward, asset prices crash and a
recession is likely to occur.
The nominal exchange rate has large effects on SOEs, and the allocation
of resources between tradables and non-tradables sectors. Open economies
are not immune to foreign events.
> > This deflation would cause land and building prices to collapse.
>
> No.
Yes, deflation and inflation, when the nominal interest rate is fixed at
the world interest rate or a large economy currency interest rate, has
very large effects on asset prices. If the demand for fixed assets is
expected to grow in nominal terms by 5% p.a. along with inflation and
replacement costs, and the nominal interest rate is 5%, the that is the
same as a zero discount rate with price stability. An asset expected to
last 20 years will be worth 20 times the current annual hire. If the
interest rate stays at 5% but price stability is expected, the asset
falls to 13.09 years hire. If the price level is expected to fall 5%
p.a., the asset falls to 9.08 years hire. I guarantee that the property
market will crash in Ireland when the inflation ends and the deflation
starts and the nominal interest rate is about the same. Inflation and
deflation have consequences.
>
> The
> > inflation and deflation in a SOE that used gold would be significant and
> > arbitrary, and cause asset prices in the SOE to be highly volitile.
>
> No.
If the price of gold in terms of other currencies rises and falls
substantially, as it does now, a gold economy will suffer appreciations
and depreciations of its exchange rate which will force price level
adjustments to occur. Price level adjustments will inflate or deflate
asset prices.
>
> The
> > situation would be similar to SOE such as Hong Kong, where the currency
> > is fixed to the USD.
>
> No.
Hong Kong's nominal interest rate and nominal exchange rate are imported
from the USA. Thus if Hong Kong's Trading partners currencies depreciate
against the USD, the HK dollar appreciates against its trading partners
and its real effective exchange rate rises. If this appreciation was not
warranted from HK fundamentals, HK price level must fall. This is what
happened in 1998-2001, and HK has suffered deflation of 3-5% p.a. during
this time, ending inflation of 4-6% p.a. (and crashing the property
market and causing a deep recession in the process).
>
> Property prices fell by around 40% in 1998 in Hong
> > Kong as inflation turned to deflation. Unemployment rose from about 2%
> > to over 6%, real GDP fell by over 5%. By contrast Taiwan and Australia,
> > both highly exposed to the Asian Crisis, continued to register
> > significant growth and asset prices did not crash and unemployment did
> > not rise. This is largely because their nominal exchange rates fell,
> > reducing the need for adjustment and the extent to which sticky prices
> > cost output.
>
> I can't say one way or another about the above.
The real effective exchange rate (REER) is a combination of the nominal
exchange rate and the differential inflation. Where the nominal rate of
a SOE is fixed, wheather to another currency or to a commodity,
adjustment cannot occur in the REER except by differential inflation. So
kiss goodbye to price stability if your SOE fixes its exchange rate
either to another currency or to a commodity. And BTW, hold your wealth
in financial assets diversified accross economies if you live in Ireland
or HK or such a SOE, because the house you live in (don't own it) and
the shares in your local service companies will be anything but safe
investments when inflation turns to deflation!
David Hillary
>
> Bob
>
> "We assume that the currency which is in all our hands is fixed,
> and that the price of bullion moves; whereas in truth, it is the
> currency of each nation that moves [i.e., loses purchasing power],
> and it is bullion which is the more fixed [i.e., maintains
> purchasing power]." - Henry Thornton, An Enquiry Into the Nature
> and Effects of the Paper Credit of Great Britain, 1802.
>
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>
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>
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