The resource costs of a gold standard

This is one of those topics which bugs me.

I’m not happy with counting the stock of “monetary gold” as the “resource costs of a gold standard,” as did Milton Friedman.  We also hold stocks of oil, copper, and other commodities — how about books in libraries? — and no one considers inventories of those commodities as costs per se.  For one thing, holding monetary gold in vaults still involves an option to convert into commodity uses and it may in essence serve as a useful commodity inventory for gold.  Another way to put the point is that a properly capitalized bank can simply hold its gold in dental offices — or in wedding rings — if need be.  How about if they hold their assets in the form of securities (T-Bills?) which can be, if needed, traded for gold mining stocks?

Is there a systematic market failure when it comes to locating inventories too close to major shipping centers?  I don’t see why.  But that’s arguably the same question as the one about the resource costs of a gold standard.

Or consider the Hotelling resource pricing rule, namely that a resource price should rise at the nominal rate of interest, with various adjustments for costs and changing costs and risk tossed in.  Let’s say there is a gold standard and gold is also the medium of account.  The price of gold rising at the nominal rate of interest thus means the general price level is falling at the nominal rate of interest.  During the times of the classical gold standard, expected price inflation was roughly zero, but nominal interest rates were higher than zero.  Either prices weren’t falling fast enough or nominal interest rates were too high or some mix of both.  Say prices weren’t falling enough.  Well, that is violating the Hotelling rule but in fact gold production is then falling short of an optimum, not exceeding it.  Alternatively, you could toss in a liquidity rate of return on holding gold inventories and maybe then things would be just right.

A way to put this point more generally is that pricing some contracts in terms of a commodity does not itself create violations of the Hotelling rule.  You might think that the liquidity premium on gold has to create an inefficiency, perhaps because social and private returns to liquidity differ.  But do they, in the case of base money?  Or isn’t the social return to liquidity arguably higher, if you see bankruptcy costs and benefits from thick capitalization using the liquid asset?  In any case, the marginal liquidity return on money gold has to equal the marginal liquidity return on “commodity gold inventories” and then I am back to not being so sure there is a significant externality wedge.

It is unlikely that a final “all things considered” view will have the quantity of gold mined and held be just right.  Yet as a first cut answer, postulating zero real resource costs for a gold standard is more reasonable than it might at first appear.

By the way, for macroeconomic reasons I’ve never favored a gold standard, but the resource cost argument has long seemed to me weak.  All things considered, we might not end up digging up enough gold (liquidity) and that is the real worry we should hold.


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