What Is A Promise Worth?

Mike Northover and myself have been going back and forth over the gold standard issue. Pretty much we've come to the point where I favor some sort of a return to the standard, whereas he wants to continue on with the current fiat system. Today, however, he linked to an article from The Economist which looks at how our current economy is based on promises and how that may become a problem down the road.

In my last post on reverting to a gold standard (which by the way, would not need to be strictly a gold standard, a bimetallic or even tri-metallic system could work just as well), Thomas left a comment, which I think is rather important for a number of different reasons:

With GNP growing 2-4% a year can we really dig up enough new metal out of the ground to keep up? Since we clearly can not, than a gold/silver standard commits us to deflation. Good for people with money in the bank, very bad for most of the rest of us with debts.

Thomas is absolutely correct in his assertation that reverting to a gold standard would lead to deflation, which is bad for those with debt (like me also, Thomas). But the real problem isn't in the deflation itself, it's in the way our economy has been being primed for the last few decades.

Prior to moving off the gold standard, economically we went through cycles of inflationary pressures and deflationary pressures. Inflation was caused more often than not by the consequences of excess savings flooding the market chasing after too few goods. It encouraged businesses to expand, taking on more debt in the process. Deflation was more often than not the consequence of too much debt and the resultant overexpansion it created. Deflation weeded out the inefficient companies and forced the others to streamline in order to maximize efficiency and therefore profits. Neither extreme was pleasant, but both played an integral role in maintaining our economic efficiency.

Once we left the gold standard, it became politically unacceptable to suffer through the rigors of deflation. Companies went bankrupt; people lost their jobs and life was generally hard during those times. Through a constant expansion of the money supply, deflation could be warded off, with the added side benefit of companies being able to repay debt in inflated dollars, rather than in virtually nominal ones like they had in the standards' days.

And what has been happening for a while is a constant expansion of debt coinciding with a steady deterioration of savings. Companies are willing to expand through debt because they expect the payments to be inflated into reasonable amounts. Consumers take on excessive debt on the expectation, justified or not, of constantly rising incomes to make their debt loads manageable. This is not healthy behavior.

One of the great virtues of the gold standard was that it introduced real consequences to the assumption of debt while simultaneously providing real incentive for saving when the balance started to get out of whack. No company or individual was be willing to take on additional debt loads if they felt that their revenue or income was going to be decreasing, as servicing the debt load becomes more difficult. On the contrary, the would be more apt to save that money for a time when it would be better spent. When the time came, the cash was on hand to take advantage of new opportunities, without having to immediately resort to debt for funding.

The lack of deflation since we left the gold standard has given many people a false sense that deflation is an absolute evil with no redeeming attributes and that we are no longer subject to the inflationary/deflationary cycles of economic history.

Deflation is uncomfortable. Deflation is unpleasant. But it does have a balancing effect on the debt/savings continuum.

And there is nothing that has made us exempt from the economic cycle. Just as companies go through cycles, so to does the economy. Inflation and deflation are the growth and contraction phases of the economic cycle. Both are necessary to the maintenance of a healthy economy.

Which is something our debt-loaded society desperately needs.