Citizens of the U.S.A. (and foreigners alike, especially those who hold U.S.-Dollar denominated securities that are not inflation hedged) are becoming increasingly concerned about the United States of America's exponentially increasing supply of money, which grew 12% in 2009, and the nation state's ballooning budget deficit.
A crescendo of voices from academia are proposing a diverse range of fixes to curtail this growth of money supply and the budget deficit. Generally, the remedies that have been put forward to assuage the U.S. society's pains from the said 'money supply ailment' include; limiting the government's financial intervention in private sector affairs, and a return to the "gold standard" of fiat currency supply management.
In fact, it appears that a growing number of academics and policymakers assert that the specie gold standard is the panacea for the tendency of central banks to debase currencies (through ill-conceived policies and the inept regulation of money supply).
In my opinion, that assertion only holds for countries that have a limited accessible endowment of gold, and or, 'thin' reserves of gold. And, it becomes a fallacy when it is applied to countries that have a readily accessible large endowment of gold, and or, abundant reserves.
In this post I want to illustrate, using examples that I have cherry-picked from history, that hyperinflation cannot be prevented by just pegging a currency to something "real", as some economists assert. If governments fail to keep the money supply's growth at rate that is at par with GDP growth, hyper inflation will materialize. I'll borrow one example from Malian history and the other from Spanish history:
Story 1: Mansa Moussa / The Emir of Melle / Lord of the Mines of Wangara / Conqueror of Ghanata / Futa-Jallon / Kankou Musa / Kankan Musa / Kanku Musa / Mali-koy Kankan Musa / Gonga Musa / the Lion of Mali goes to Mecca
According to the writings of a fourteenth century Arab scholar called Messr. Abu-sa'id Uthman, Mansa Moussa was the King of imperial Mali, and its colonies that stretched from Ghana to Songhai, when Mali was at its Zenith. It is estimated that Mansa Moussa's reign lasted for a total of 25 years. Historians assert that his reign did not begin before AD 1307 and that it had ended by AD 1337.
Mansa Moussa was a Muslim, and is credited with building centers of learning throughout the Malian empire, and it was during his rule that the first university in the world was built at a location in Timbuktu.
In 1324, i.e. around the time when the Aztecs commenced the construction of Tenochtitlan and approximately when the Ottoman Turks began the creation of their empire, he took the hajj, an obligatory pilgrimage (for Muslims) to Mecca that earned him a spot in history as one of the world's most extravagant rulers.
On his hajj, he took with him:
- An entourage of sixty-thousand people adorned in the finest silk,
- Eighty camels carrying over two tonnes of gold,
- Twelve-thousand servants, of which five hundred carried staffs of gold that each weighed four pounds.
And he dolled-out most of the gold he had with him to poor people he encountered as he was traveling. In fact, he was so generous that he didn't have the wherewithal for his return journey and had to borrow money to finance the 'homeward trip'.
A concomitant of these unprecedented acts of generosity was inflation. His massive generosity undermined the value of gold and caused inflationary pressures that plagued Egypt for twelve years. Inflation is too much money chasing on too few goods, and Mansa Moussa's generosity flooded Egypt with gold, whilst production was left unchanged.
Story 2: The Spanish search for El-Dorado (The realm of the gold-covered King)
Note to Reader: This story isn't about gold, it's about silver. Just pay attention the dynamics: they would exist, in their exactitude, if gold was used as the unit of exchange in those times.
During the middle-ages, there were many tales of fantastical realms that had extreme wealth, could enable men to regain lost health and lands in which men could forever live a Utopian existence. One of these fantastical lands was El Dorado, the realm of the gold-covered King, and the Spaniards believed that it was somewhere in Latin America.
In 1524, i.e. 208 years after Mansa Moussa made his inflationary pilgrimage to Mecca, Francisco Pizarro González, a Spanish conqueror, went to what they termed upper Peru, which is now part of modern-day Bolivia, in search of El Dorado, the realm of the gold-plated King.
With him were forty horses, and eighty men who were armed to the teeth and ready for combat. After defeating the Incas, who were the indigenous owners of that territory, in the battle of Catarmarca, González discovered the Cerro Rico (which literary translates to the 'rich hill') silver deposits in a mountain located in Potosi. There they extracted silver, using forced labor, and shipped it to the Spanish crown. This mine was one of the many mines that shipped over two billion ounces of silver over period of 250 years of Spanish colonial rule.
To quote the celebrated Economic Historian and author, Professor Niall Ferguson, "they thought that they had become rich beyond the dreams of avarice". But they were wrong.
With their increased supply of money they couldn't buy more things, as they thought, because the flood of silver that they had created was chasing on a fixed amount of goods. Simply put, they had caused inflation.
Conclusion
Thus, this implies that if a country, that employs the gold standard, has an abundance of gold reserves, and a declining base of production, there will be inflation. And, conversely, if the country has a rapidly growing production base, and declining gold reserves, it will experience either a recession or a gut-wrenching depression.
It doesn't matter whether a country uses the gold standard, silver standard or nothing at all. If the growth in money supply outpaces the growth in productivity by a wide margin, inflation will always materialize.
So instead of talking about returning to the gold standard to preserve the value of a currency and to ensure price stability, people should be saying that "the increase in money supply should move in tandem with the GDP most of the time."
