The True Gold Standard (Second Edition)
Previous article: Rueff Restates the Quantity Theory of Money
We said that to demand money, people must supply goods or claims; this tends to lower the price of goods and claims. Under a gold standard, however, the money price of gold is constant because some monetary institution keeps the money it issues convertible into gold at a fixed parity. The fall in price of other goods lowers the cost, and increases the profitability, of mining gold. Shifting some labor and capital from producing other goods to the gold industry (or, in a country without gold mines, to producing goods for export to acquire gold) provides employment for labor and, through coinage or monetization, results in the quantity of money demanded.
Moreover, Rueff points out, the same thing can occur under any monetary standard, as long as people can discount commercial paper at the central bank (in effect, borrow money from the bank by exchanging it for an IOU issued against their assets). Again, when people sell claims or goods to acquire cast, it lowers the price of both goods and claims. (Rueff showed that if one happens, it will lead to the other.) But a fall in the price of claims means at least a temporary increase in the interest rate.
As long as the central bank’s discount rate (or today, the Federal Funds rate) remains above the market interest rate, then the excess demand for money will be satisfied by a fall in the price of goods and a rise in the rate of interest. But when the market interest rate rises to the central bank’s discount rate – or the central bank lowers its interest rate to the market rate – people can receive the whole quantity of money they demand, without any further fall in the price of goods or any further rise in the interest rate, by discounting their claims at the bank.
Because in the real world there are delays in adjustment, stability of the general price level is not literally possible; because in many markets the price differences must become fairly large before the process of arbitrage is profitable. For example, you and I don’t pack up and move because, say, salaries in our line of work have risen a few pfennigs this week in Germany. The differential would have to become rather large for us to even consider it. This is one reason why the general price level tends to rise and fall over time even in the best-regulated monetary system. But the adjustments do occur. The advantage of the gold standard, according to Rueff, is that its mechanism guaranteed that the general price index would always return to approximately the same level.
Next Installment: Rupturing the Link
The Rueffian Synthesis