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DIGRESSION ON ETHICS
One of the themes of this book emerges here with crystal clarity. It is very easy to assume that certain ethical views, or “value judgments” should be adopted, even though examination shows them to be controversial and in need of justification.
Our reformer has made two such controversial assumptions. First, he correctly notes that changes in supply and demand take time before they affect prices. Even though the 16 to 1 ratio no longer corresponds to the actors’ present utilities, it remains in place until changed.
But why should we think that something is wrong with this? Why should adjustment of prices to changes in demand and supply be instantaneous, or at any rate, faster than the market accomplishes by itself? Be careful not to make an unjustified assumption about what I am saying here. We do not contend that the ideal of instantaneous price adjustments is misplaced.
Rather, I wish all readers to note that an ethical assumption has been made by the reformer. If he moves from (1) price adjustment takes time; to (2) price adjustment takes too much time, he has taken a step that requires argument in its support.
And our reformer has smuggled in another unexamined assumption: adjustments that take place through arbitrage are “bad.” What is wrong with arbitrage? Our reformer must tell us. Once more, we have not assumed that arbitrage is morally all right; we have wished merely to call attention to a burden of proof too often overlooked.
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reform contain smuggled-in value judgments.
172 An Introduction to Economic Reasoning
GRESHAM’S LAW
We shall not, for the moment, take our discussion of ethics further. Here we shall restrict ourselves to “positive” economics. (Recall the distinction between positive and normative statements, discussed earlier.)
Suppose, once again, that the market has established the 16 to 1 ratio. New gold mines in Patagonia are discovered, and an increased quantity of gold has come onto the market. Assuming that utilities otherwise remain unchanged, the price of gold will fall. One ounce of gold will be able to command only 15 ounces of silver in exchange, for example.
But the state has imposed a 16 to 1 ratio. If you have one ounce of gold, you will be able to get 16 ounces of silver for it in the market. You would have been willing, by hypothesis, to take 15 ounces of silver for your gold; but you certainly have no objections to getting an extra ounce.
Silver dealers will prove more recalcitrant. The 16 to 1 ratio no longer reflects the market price. If it is enforced, silver dealers will be less willing than before to offer silver on the market. Gold will tend to become the exclusive medium of exchange.
Why will these results ensue? We must, as always, revert to a basic principle. Money is a commodity.
?1. How does this principle enable us to analyze the effects of a fixed exchange ratio?
SURPLUSES AND SHORTAGES
We hope that you answered the question by reference to surpluses and shortages. Remember the effect of a maximum price
Chapter 10: The Gold Standard 173
below the market price? There will be a greater quantity of the good demanded at the artificially lower price than will be offered for sale. In brief, there will be a shortage. This is exactly what has happened in our example. The price of silver is artificially low. Its market value is 1/15 ounce of gold, but its state-mandated price is only 1/16 ounce of gold. Hence a shortage.
Looked at from the opposite angle, the price of gold is artificially high. There is a surplus of gold at the artificially enforced ratio. Purchasers of gold demand a lesser quantity of gold at the 16 to 1 ratio than suppliers offer at that price.
In sum, money overvalued by the state will tend to drive money under valued by the state off the market. This is Gresham’s Law, usually stated as “bad money drives out good.” Our formulation, which comes from Murray Rothbard, is preferable to the traditional one. It tells us what “bad” and “good” money are.
A SINGLE METAL STANDARD
As we have learned in this chapter, the free market can readily handle a system with both gold and silver as money. So long as the state does not impose price controls, both metals will circulate as money.
But people’s preferences may change. They may find two sorts of money, with frequently fluctuating exchange ratios, to be inconvenient. In that case the market stands ready with a solution. If enough people stop using one of the metals as money, it will cease to be money. Remember the money regression theorem? The demonetization process goes exactly in reverse from the path it delineates.
A commodity that grows more and more in demand as a medium of exchange gains extra value by this fact. Silver, e.g., becomes valuable not only for its use in rings or teeth, but for its services in making exchange easier.
174 An Introduction to Economic Reasoning
If some people stop accepting silver in exchange, then it will lose its value as a medium of exchange. As it loses value, it becomes even less demanded by market exchangers. A spiral-like effect occurs, just the opposite of the process by which money is created.
If a commodity loses all (or nearly all) of its value as a medium of exchange, it has been demonetized. Its value is now determined just like that of any other non-monetary good. Though this is not a praxeological law, it is safe to predict that a free market will tend to supplant a two-metals currency with a single-metal standard, for convenience. The metal chosen will normally be gold.
?1. Why will a free market tend to establish a gold rather than a silver standard?