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If you subscribe to the New (and old) Keynesian orthodoxy, you would tend to consider people that increase their demand for money balances (i.e. “hoarders”) to be somewhat akin to economic villains. The simplest version of the story is this: if people irrationally stop spending money on consumption goods and services (things that are produced) and turn their focus on consuming a good (money is just another good) that is itself not produced, then the sectors of the economy doing the producing will find that they cannot sell their output.

Of course, in a normal world, producers facing increased inventories would figure out a way to lower prices to get rid of the excesses, but in the Keynesian world, both prices and wages are sticky, so they cannot adjust downward fast enough to equilibrate supply and demand. Thus, we have a shortfall in “Aggregate Demand.” You know what comes next – governments should run massive deficits to make up for this demand shortfall. I do not intend to analyze this point, but rather I’d like you to think about the implications for this in terms of the monetary system we use.

The underlying problem according to the Keynesians is not that people hoard “money” per se, but rather that they are hoarding something that is not “produced.” Well, is that not a wee bit a function of the printing of money and even moving to a fiat system? Granted, even under commodity standards the amount of gold in circulation was small (because banks and their customers found it far more convenient to use bank notes and warehouse certificates that represented stocks of gold), but this does provide us with a framework for dealing with money demand increases without having to rely on the awesome omniscience of the fiscal authorities to stimulate the economy every time there is a downturn. So, perhaps one way to reform the system is to move to a currency that is backed by large percentage reserves of physical goods and services. I mean more than just gold. I mean beer, oak trees, maple syrup, bricks, and precious metals.

HT on Image to Jeffrey Ellis

This reform would have two benefits:

  1. For those who find fractional reserve banking unstable and undesirable, the large reserve requirements would provide a strong measure of insurance for the safety and soundness of the payments system.
  2. When demand for “money” increases in this world what we would see is not a decrease in “Aggregate Demand” as the Keynesians argue, but instead a shift in consumption from some goods (like cars and TVs) and toward other goods (like beer and maple syrup). The shift toward the beer and syrup would happen naturally since the increase in money demand would require an increase in the amount of base commodities supporting these new holdings of paper. And, if you like in the Keynesian world, such a reform should be seamless – after all, for the Keynesians, it does not matter where the demand is directed, just so long as it is there. If you wish to dispute that last point and you claim to be a Keynesian, then you are going to have an awfully tough time defending fiscal stimulus that is not perfectly targeted to the industries where demand has been declining for irrational reasons.

In summary, a high reserve commodity backed currency would contain an implicit “aggregate demand” stimulator in it without having to rely on the fiscal side to do our bidding. This sort of thing should be attractive to Keynesians, who, after all, support the idea of government welfare programs as counter-cyclical fiscal policy measures that obviate the need for additional stimulus during “normal” business cycle down-turns.

And that leaves us with an open question: in the Keynesian mind, is there ever just a “normal” downturn that does not require stimulus beyond the automatic stabilizers?

One Response to “Mining, Money and Macro Policy”

  1. Harry says:

    G. F. Warren, Professor of Agricutural Economics at Cornell and others proposed a commodity dollar in the 30’s. I believe the organization was called The Committee for the Nation. Wintercow may have better access to information on this through his Cornell connections.

    The idea was to tie the dollar to a broad index of commodity prices, thus avoiding the pitfall of any fluctuations in the supply or demand for a single commodity.

    I do not know the rest of the history, especially why it never caught on. Perhaps the inflationsts and fiat currency crowd thought it would restrict their social mission.

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