Tuesday, May 11, 2010

Gold and the supply – and demand – side (Domitrovic post).

(Thanks to Econoclasts author and historian Brian Domitrovic for being the first to submit original content to this blog.)

A comment on last week’s piece in the Wall Street Journal, where supply-side pioneer Jeffrey Bell and colleague Sean Fieler’s op-ed suggests that the planets are aligning for a return to the gold standard. They see a major sign in the Tea Party movement, with its strong favor for gold, and which is getting too big and resonant not to have practical impact. As for the economics, the authors point out that if the US (let alone the world) went back to gold, it would become passing difficult to run budget deficits. Given gold, the Fed would be incapable of creating money to buy up Treasuries not demanded by the market, in that the new currency would have to be backed with gold already on hand. It would be impossible to supply government debt.

It would also be the case that demand for government debt would dry up. The major reason that the market for debt exploded in the 1980s was that inflation got low but still existed. Low inflation can be covered by a bond coupon dunned by low taxation. In the low inflation/tax years from then till now, demand for debt soared. But with gold, inflation scenarios are nil, and investors are pleased to hold cash in that portion of their portfolios they wish not to risk to depreciation and default. Gold cuts out the reason for government debt coming and going. It renders its supply impossible, and dries up the reason for its demand. In the offing, virtually all money out there is devoted to the real economy, with remarkable consequences for growth and opportunity.

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